Do you know what the most important financial number in the world is? 56

56…that is num­ber…56.

56 is the ratio of Gov­ern­ment Promises to its income.  To give you some per­spec­tive on that num­ber, think of how big of a promise the bank let you make when you bought your first home. Lots of peo­ple I know bought their first home with a mort­gage (their promise) that was 3 or 4 times their income. What would have hap­pened if you bought your first home with a mort­gage that was 56 times your income? You don’t have to think about that to long…cause you would have lost the house.

Gov­ern­ment Promises today are approx­i­mately 130 Tril­lion Dol­lars (US Trea­sury Debt 15 Tril­lion, Social Secu­rity 15 Tril­lion, Pre­scrip­tion Drug 20 Tril­lion, and Medicare 80 Tril­lion). Gov­ern­ment Income today is approx­i­mately 2.3 Tril­lion (from  per­sonal income tax, pay­roll tax, and cor­po­rate tax). SO…the Promise to Income ratio is cal­cu­lated by tak­ing the 130 Tril­lion of Promises and divid­ing them by 2.3 Tril­lion of tax income which equals 56. If our Gov­ern­ment reduced their promise by 90%…we are still not guar­an­teed that our Gov­ern­ment will be on sound finan­cial foot­ing. “Har­ris­burg Penn­syl­va­nia, Files for Bank­ruptcy”…the State Cap­i­tal of Penn­syl­va­nia, files for bank­ruptcy with promises about 5 times its income. A cou­ple of years ago I worked through the books of the State of California…and at that time their promises were about 6 times their income.  COMMON SENSE WOULD SAY THAT THE US GOVERNMENTS PROMISES TO INCOME MUST BE REDUCED TO UNDER 5…TO BE SUSTAINABLE. THAT MEANS REDUCING PROMISES OVER 118 TRILLION DOLLARS.

What does this mean to you and me?

At some point these promises collapse…and the US Dol­lar with them. I hear many say that the US will not default on our promises. But I also can remem­ber how many times peo­ple told me that Home val­ues do not go down. To me, this Promise Bub­ble today, is much larger than the Real Estate Bub­ble that started to burst in 2006, and nation­wide home val­ues have declined in 32%.

There is no con­ceiv­able way that we can duck the dif­fi­cult and painful path of hav­ing over 118 Tril­lion Dol­lars of Promises reneged on. Our Gov­ern­ment will likely renege in both of the ways it has avail­able to it. By Implicit Default…which is print­ing a lot more money, and debas­ing the currency…”paying with dol­lars that are worth pen­nies”. And by Explicit Default…”paying pen­nies on the dol­lar”. An exam­ple would be chang­ing full Social Secu­rity retire­ment age to 73, and cap­ping the ben­e­fits. It is eas­ier for politi­cians to get elected with Implicit Default…the print­ing of more money, so expect that in increas­ing quantities.

The next 5 to 10 years will likely be much more chal­leng­ing and dif­fi­cult than the last few years.

What can we do?

Cre­ate diver­si­fied sources of income from your deposits and invest­ments that are not depen­dent on the health of the US dol­lar.  You can call or email me to talk about this.

Bank of New York Mellon ranks as the safest U.S. bank, for the third consecutive year…August 25th, 2011

Smith Invest­ment Man­age­ment uses BNY Mellon’s Bank Trust Plat­form to hold client assets.

It is an insti­tu­tion that is liv­ing up to its rich heritage.

• In 1784, Alexan­der Hamil­ton founded the Bank of New York, now the old­est ongo­ing bank­ing orga­ni­za­tion in the United States.
• In 1792, The Bank becomes the first stock traded on the New York Stock Exchange.
• 2009 FORTUNE magazine’s rank­ings of The World’s Most Admired Com­pa­nies, Bank Of New York Mel­lon ranked num­ber one for the 2nd straight year in a row among Super­re­gional banks. It has been ranked num­ber one, five of the last six years. It is a global leader in asset ser­vic­ing and asset management.
• It is the world’s num­ber one asset ser­vicer, with over $20 tril­lion in assets under cus­tody.
• August 25th, 2011; Bank of New York Mellon ranks as the safest U.S. bank for the third con­sec­u­tive year, by Global Finance Magazine.

Are your Mutual Funds and ETFs disguised Hedge Funds?

A client asked me to look at some Van­guard Mutual Funds that he owns.

I was sur­prised at what I found in their “prospec­tuses” and “state­ment of addi­tional infor­ma­tion“.

• There is no assur­ance that any deriv­a­tives strat­egy used by a fund’s advi­sor will succeed.
• Cer­tain deriv­a­tives have the poten­tial for unlim­ited loss, regard­less of the size of the ini­tial investment.

Bot­tom line...

1. They are using deriv­a­tives. They may be doing it intel­li­gently or fool­ishly, I don’t know, but they have given them­selves the rights to be involved with FUTURES, OPTIONS ON FUTURES, COMMODITIES, CURRENCIES, CDS (Credit default swaps).
2. They give them­selves the right to use LEVERAGE (BORROWED MONEY)
3. They lend cus­tomer secu­ri­ties to other institutions.

TO ME…MANY MUTUAL FUNDS and ETFs ARE DISGUISED HEDGE FUNDS.

It was a wake up call to me to review all invest­ments and look for hid­den risks.

If you look into your own mutual funds and find some­thing inter­est­ing please let me know.

Is Social Security a Ponzi scheme?

A def­i­n­i­tion of Ponzi scheme is…a fraud­u­lent invest­ment oper­a­tion that pays returns to sep­a­rate investors, not from any actual profit earned by the orga­ni­za­tion, but from their own money or money paid by sub­se­quent investors.

Social Secu­rity fits that def­i­n­i­tion per­fectly other that it a gov­ern­ment pro­gram where leg­is­la­tion passed the House and Sen­ate and was signed into Law by FDR…so it is not a fraud­u­lent invest­ment oper­a­tion.  But…it cer­tainly matches the rest of the def­i­n­i­tion…pays returns to sep­a­rate investors, not from any actual profit earned by the orga­ni­za­tion, but from their own money or money paid by sub­se­quent investors.

Social Secu­rity has Unfunded Promises of 15.2 Tril­lion Dol­lars. That num­ber reflects the cost in today’s dol­lars of pro­vid­ing ben­e­fits, above and beyond what cur­rent taxes will cover.  In other words…the Gov­ern­ment needs to set aside 15.2 Tril­lion Dol­lars in an inter­est bear­ing account to pay promised Social Secu­rity ben­e­fits, in addi­tion to col­lect­ing the exist­ing Social Secu­rity Tax at its cur­rent rate.

The US Trea­sury (IRS)  took in just over 2 Tril­lion Dol­lars last year. So…if the Trea­sury had just one bill to pay for the next 7 years it might be able to make up this short­fall.  With the US Trea­sury bor­row­ing 40 cents out of every dol­lar it spends it will not be mak­ing any spe­cial con­tri­bu­tions very soon. I read one report that said if full retire­ment age is increased to 72 or 73 from the cur­rent full retire­ment age of 67 (for baby boomers). And if a cap is put on infla­tion adjusted ben­e­fits and some are means tested out of benefits…Social Secu­rity is sus­tain­able at cur­rent tax lev­els. That would be an explicit default on promises made to mil­lions of people.

Social Secu­rity will be paid “pen­nies on the dol­lar”, through explicit default…or with “dol­lars worth pen­nies” through implicit default – which is print­ing a bunch more money.  Gotta cover that 15.2 Tril­lion some­how. Unfor­tu­nately that is the good news…the bad news is that Medicare and Pre­scrip­tion Drug are in the hole 100.1 Tril­lion.

So…is Social Secu­rity a Ponzi Scheme? No. But we do need to make up a new term…the “GONZI SCHEME”. A GONZI SCHEME is a Gov­ern­ment Invest­ment Oper­a­tion that pays returns to sep­a­rate tax­pay­ers, not from any actual profit earned by the Gov­ern­ment Invest­ment, but from Gov­ern­ments freshly printed money or money paid by sub­se­quent tax pay­ers.  Ponzi schemes do not end well, nei­ther will our GONZI SCHEME. In due course the like­li­hood of a finan­cial con­vul­sion is high.

Bot­tom Line: So what does this mean to investors? We need to order our invest­ments to sur­vive and hope­fully thrive despite the dif­fi­cul­ties com­ing in due course. I think we have some real abil­ity to help many investors in this area. Call or email us to see if we can help you.