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.
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.
The full series: