Privatization Pep Rally

Doug Henwood dhenwood at
Wed Jul 29 12:37:37 PDT 1998

Max Sawicky wrote:

>The political fact with which we have to work
>is that the 'middle' scenario assumes anemic
>growth, relative to the present, so the shortfall
>becomes a political fact.
>We could yell and scream that there will be no
>shortfall and be ignored entirely.
>Alternatively, we could dispute the probability
>of slow growth and provide palatable solutions
>to the shortfall that the rest of the world is
>referring to when they deal with the issue.
>We chose option b.

Boy, if that doesn't show what life in Washington does to your political imagination. The elite agenda-setters cast an untruth as truth, and all you can do is kvetch about the details. Since politics is all about compromise, if you start out compromised, you'll end up with something between mush and disaster (e.g., the Clinton health plan).

The August issue of the Chicago Fed Letter <> features an article, "Whither The Stock Market." Based on dividend yields - now at an all-time low since numbers began in 1871 - the Chicago Fed economists predict a 4.5% real annual return as long as yields remain this low. That's well below the historical average of 7.0%.

Here's their conclusion (thanks to my brand-new scanner):

<quote> Our results have important implications for those saving for retirement. Many retirement planners base their investment allocation strategies on the continued strong performance of the stock market. If stock returns decline to a new, permanently lower level of 4.5%, many retirees will have undersaved for retirement. Similarly, those who advocate privatizing Social Security argue that individuals could more effectively save for their retirement by investing their Social Security contributions in the stock market. This argument assumes that stocks will continue to provide investors with the same outstanding returns that they have historically provided. Our analysis casts doubt on this assumption. Therefore, estimates of the benefits of Social Security privatization, like retirement savings strategies, should consider both pessimistic and optimistic forecasts of future stock returns.


What might account for the current low dividend yields and the implied low expected future returns? At this point, we can only form tentative conjectures. One theory is that members of the Baby Boom generation had not adequately saved for retirement in their early working years. Now that they are in their prime earning years, they are making up for lost time. The resulting flood of retirement savings both drives asset prices up and indicates that savers are willing to accept a lower return in order to secure some reasonable parking place for their money.

The problem with this theory is that it implies that allexpected returns (not just stock returns) should drop. However, we find, along with Cochrane, that the equity premium (the expected equity return above the Treasury bill rate) has dropped in recent years. In other words, expected future stock returns are lower relativeto alternative assets. The equity premium is properIy understood as a compensation for risk. Why would today's investors require a lower compensation for bearing the considerable risk of the stock market? Three possibilities emerge. Perhaps the current generation is simply less risk averse. The per capita wealth of investors is higher than in the past. It is reasonable to believe that wealthier investors are more willing to bear investment risk. Perhaps the stock market is less risky now than in the past. This is a possibility, but arguments of this type have been made before only to be refuted by the next crash. Consider, for example, the following: "For the last five years we have been in a new industrial era in this country. We are making progress industrially and economically not even by leaps and bounds, but on a perfectly heroic scale." This quotation appeared in For/oes magazine in a June 1929, and the sentiment reflects a popular opinion of the current American economy as well. Finally, some investors today may truly misperceive the amount of risk in the market. They do not share their parents' memories of the stagflation of the 1970s or their grandparents' memories of the Great Depression of the 1930s. Only time will tell which of these explanations proves most satisfactory.

-David MarshallEconomic advisor and senior financial economist

-Denise Duffy Associate economist <endquote>

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