Philadelphia Reflections

The Coming Baby Boomer Retirement Problem

In a few years, the baby boomers will retire and two things will happen. They will have to retire later in life, and the country will have to borrow money to pay for the rest.

In 2004, the Nobel Prize in economics was shared by Edward C. Prescott and Finn E. Kydland, for advancing the concept that business cycles are caused as much by what people expect to happen as by what actually does happen. By this reasoning, myriads of individual decisions are constantly made in the direction suggested by simple undeniable truths. What truths face us? Demographic facts related to how many people have already been born, and how fast they are dying, force everyone to acknowledge that both Social Security and Medicare are seriously underfunded. Consequently, it seems inescapable that the boomers must work longer and retire later. To whatever degree they don't, the country must go deeper into debt.

Prescott, writing in the December, 2006 Wall Street Journal, stated this truism slightly differently to reach the next step: the national debt must increase. Increasing the national debt raises interest rates, which is good for savers. At the moment, the main savers are American retirees and foreign governments. However, the bond market is and always has been a zero-sum game. What's good for American retirees is bad for American business. And mortgage-holders. And everyone else who is in debt. Higher interest rates, which are seemingly inevitable, encourage saving and discourage borrowing. Prescott seemingly welcomes those features, because he is remarkably cheerful about the inevitable coming demographic crunch.

There are at least two things about it which should be bothersome. The first is that the boomers will not be borrowing money from their own generation but from their children. Getting the chance to live longer than their parents, they seemingly want to retire at the same age or earlier, asking their children to pay for the unearned twenty-year vacation. Boomers simply must be shamed into later retirements. The American Gross Domestic Product has a long term growth rate of about 3% per year; 2% of that total comes from increased productivity, about 1% from population growth. Extending domestic working years has the same economic effect as, say, illegal immigration; it's good for the whole country to make this nativist substitution.

The other disturbing consequence of borrowing our way out of debt is the effect on banks. That's harder to explain, but the interest rates we have been describing are long-term rates, established by the world marketplace. Short-term rates are independently set by the Federal Reserve to control (or "target") inflation, and currently they are higher than market-set long term rates. Any sensible saver will therefore use moneymarket funds rather than buy bonds. That's mostly bad for banks because their profit largely derives from "borrowing short and lending long". The so-called inverted yield curve, then, is good for old folks and bad for banks. If the Treasury fails to issue enough long term bond debt, or the Federal Reserve fails to issue enough short-term debt, banks are in danger of going broke. To summarize the whole puzzle, the government clearly will become more deeply indebted, but it must preserve a proper balance between short-term and long-term borrowing. Otherwise, either a bank crisis or inflation will sink us.

As a guess, I would say that banks are the likeliest to fail. They are in precarious condition anyway because of wrenching changes in technology. And they are in the process of discrediting themselves by failing to pass along the currently soaring short-term rate bonanza to the public. Just compare your own money-market interest rate with the 5.25% which the Federal Reserve has dumped on the banking system, and see if your blood doesn't boil a little. If this pick-pocketing continues much longer, banks will be in a bad public relations position when they must come to the public with hat in hand.

So, there's only one defensible response to this demographic retirement problem. The baby boomers, having been handed several years of unexpected longevity, must spend a portion of it working longer.

Originally published: Tuesday, December 19, 2006; most-recently modified: Sunday, July 21, 2019