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Social Security: We Aren’t Investing

This is part of a week-long series about Social Security. If you want to read the whole series, links are provided at the bottom of this post.

House built from $100 bills.

“Money House” by 401(K) 2012. Some rights reserved.

When we set aside money now to fund our retirements later, we call that investing. Frankly, though, most of what we’re doing is gambling with pretty good odds, not investing. To understand what I mean, you have to know a bit about stock markets.

The original stock markets were mostly set up to fund colonization. (What follows here is some gross generalization.) A trip across the world in a fleet of ships, the locating and setting up of mining operations, the consolidation of local fruit markets to siphon off some of the product for export, the fending off of competing countries’ interests–all those things take time. They all take money. That means they all required funding that could be tied up for a length of time with an uncertain outcome.

There aren’t a lot of individuals who are willing to fund that kind of project in toto or with just a few investors. This kind of colonization was done in a world shifting from a feudal system to a mercantile system, which meant that royalty was often broke, even more so than previously. There hadn’t been much consolidation of mercantile interests at that point; monopoly was rightly seen as a source of power that monarchies were wary of. Companies that wanted to exploit colonies had a limited number of choices for funding that exploitation.

Rather than giving the whole thing up as the bad business it was, companies found a new way to find funding. They crowdsourced it. They received a small amount of funding from each of many sources, granting each a small interest in the company. Markets were set up to handle the trade between investor and company.

Almost concurrently with the transactions between investor and company came transactions between investors. Because this funding was long-term in nature, some investors found that they couldn’t spare their investment funds for as long as they had expected to. They had to recoop at least some of their funds by selling their interest to someone else.

This type of trade then led, also very quickly, to a third type of trading. This type involved creating various types of financial agreements that people could use to hedge their bets or make new bets on how much return the original stock would produce. These days, we refer to this kind of trade as “derivatives”.

Again, this is all very simplified, but that gives you an overview of the structure of the financial markets in which our retirement funds are put to grow.

All of this activity is referred to as “investing”. However, when we talk about the virtues of investing, it is generally only that first kind of trade we’re talking about. We think of investing as providing companies with funding they can use to grow, to create more jobs, to buy property for production, to eventually create more profit that will be shared with investors.

That isn’t how most investing works these days. Very, very little in the way of stock purchases go directly to fund companies’ operations. Much of the stock offered in retirement funds has been issued for ages. Little of it produces direct returns in the form of dividends. Additional shares are issued from time to time, and some shares are repurchased, but much of it just gets traded around and around without any more funding going to or coming from the company.

Moreover, this back-and-forth trade in pieces of company paper can only absorb so much retirement money. The money isn’t buying equipment. It isn’t paying wages. It’s only inflating the investment segment of our economy. And that has consequences as well.

We saw those consequences with the housing collapse. The excess of funding came from monetary policy instead of retirement savings, but the result was the same.

The housing bubble itself and the problems stemming from it may be Greenspan’s fault. The dot com bubble burst in early 2001. In September, America’s confidence was shattered. Markets fell further. The Fed responded by drastically dropping interest rates and flooding banks with cheap cash. Those rates stayed ridiculously low until rising gas prices triggered general inflation a couple of years ago.

The banks, with their “responsibility to shareholders” (see also this), had to do something with that money. Because the average consumer was already overextended with debt, because much of the production for our economy has shifted overseas, because there was no political will to invest in infrastructure, because confidence at the top doesn’t mean everyone is confident, the banks had to create a place to invest that money. There was nowhere real to put it, so we got a bubble instead.

Then we got a collapse.

We need a certain amount of funds available for investing in order to produce growth. More investment funds than we can or are willing to put into production, however, leads to unhealthy behavior in derivatives markets.

In contrast to stock markets, there is one area where we invest our retirement funds that typically counts as investing. That would be government bonds. The return is indirect, but government spending largely ends up recirculated into the economy through government employees, aid programs to poorer citizens, and direct purchase of goods. All of those things result in tax revenue, which in turn pays the return on the bonds.

This, by the way, is how Social Security works as well. Funds are put into the economy through the spending of benefit payments and through the purchase of Treasury bonds supporting other government. Return on that investment is complex, but recent analyses tell us we’re getting a pretty good deal.

So if you think your money should be invested in both senses of the word, Social Security is not a bad way to go.

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The full series:

Comments

  1. msm16 says

    Just an added fact for the peanut gallery, the Dutch were the first to set up a modern stock market back in the early 1600′s; and it is still trading to this day. They were also the first people to experience a bubble bust, for them it was tulip bulbs they just couldn’t get enough of them, well until they did.

    Wonderful article

  2. says

    Corporate ownership, in the modern sense, has been around since the Renaissance. The pooling of capital for business pursuits existed in Imperial Rome and in ancient China. When Christopher Columbus went to King Fred and Queen Izzy, he wasn’t asking for a royal hand-out: he was buttering up venture capitalists with wild promises of profit.

    Stock markets are a different creature. They are exchanges where people can buy and sell shares of existing entities. Modern exchanges got their starts as commodity markets in the late Middle Ages in France, where guilds of financiers managed farm debt trading the expected produce of those farms. A hundred years later, the first banking families in Venice were trading promisory notes backed by the Doge and other noble families. The Dutch East India Company was the first corporation to sell fixed-capital shares, which were traded among investors at the DEIC office in Amsterdam; eventually, that office began trading derivatives and other instruments, becoming the first stock exchange in the modern sense.

    Anyway, the real problem is that the nature of investing has changed radically over the last 40 years. It used to be that you buy stock, hold it for several years collecting dividends (a share of the profit), then if you needed to, sell the stock. There was little volatility in “blue chips” so, over 10 years or so, your return on the investment was whatever got paid out in dividends.

    Nowadays, the market has turned very firmly towards speculation. Few corporations pay dividends anymore: instead of investing for a share of the profits, you are gambling that the perceived value of the company will continue to increase, driving up the market price of the stock. Your return comes when you sell the stock at a profit later on, usually within a few months and sometimes within a few minutes.

    The housing crunch came about because of the (expetive deleted) who speculated on home prices, buying them cheap and trying to sell them at a profit. People were forced to pay tens of thousands more for a home than they would have for the same home a month earlier. Banks offered predatory rates because prices kept going up and up; buyers were willing to pay those rates because prices kept going up and up. The problem is that while volatility has a huge profit potential, it can crash just as quickly. That’s what happened, and everyone who bought short got screwed.

  3. magistramarla says

    I worked in a huge Texas school district that “opted out” of paying into SS and instead mandated that we pay into the Texas Teachers’ Retirement Program. First, I think that this should be illegal. Just think how much healthier our SS system would be with all of those Texas teachers paying into it!
    I was told that if I worked there long enough to draw my retirement pay, it would make me ineligible for spouses’ benefits from my husband’s SS, which truly made me upset.
    My husband got orders, so I left that job in 2009 and was able to “roll over” my retirement funds into a private account. This was after the district had lost a third of it in the 2008 downturn.
    I am physically disabled, so I looked into SSD. I had paid into SS when I taught in other states, but thanks to Texas, I’m a few “quarters” short for being eligible for SSD.
    Teachers are screwed in every way by the state of Texas!
    I think that this little scam of theirs ought to be investigated and that the school districts should be forced to pay into SS, or at least give those teachers who would prefer it to their retirement system the option.

  4. Corvus illustris says

    This post is a beautiful explanation of how things work, and somebody should read it into the Congressional Record every time the privatizers show up trying to sell their snake oil. One more thing that is true in connection with

    In contrast to stock markets, there is one area where we invest our retirement funds that typically counts as investing. That would be government bonds. The return is indirect, but government spending largely ends up recirculated into the economy which in turn … pays the return on the bonds. This, by the way, is how Social Security works as well.

    is that private investment in “municipal” bonds–bonds of governments at a lower level than federal–has some of the same advantages, both as to safety* and social value. Local government where I live sells these, in small denominations, directly to citizens–no rakeoff by brokers. Obviously this is not an argument against SS! but it is a responsible place to put your savings. Disadvantage: hard to liquidate (with a possible loss, particularly when inflation is running), so you may have to wait to get your principal back.

    *Defaults occur but eventually you get your money–else the issuers will never sell another bond.

  5. Corvus illustris says

    It’s worth following the link at “(see also this}” if only for the comment

    September 25, 2008, 1:33 pm

    I wrote about this, oh, 4 years ago. We have a system where people who contribute nothing dictate terms in such a way that rapid destruction of a company and thousands of jobs is an excellent idea – if you can suck millions out for yourself first!

    giving us advance notice (2004?) about the real Willard Romney.

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