The Crushing Reality of Mathematics

A fun book to read, if you have a thick skin, is called The Big Questions by a libertarian crackpot named Steve Landsburg. Somewhere in the book he makes the excellent point that mathematics is universal and immutable. At the dawn of time, two plus two equaled four for all values of two. It’s never changed and will never change, even if the universe collapses into an infinitely dense mass.

If you are looking for a nice shorthand definition of reality, mathematics is a good choice. Consequently, a good definition of “crisis” is when beliefs violently realign with mathematics. The Greek crisis is about the number of Euros they owe to creditors is bigger than the number of Euros they have in their accounts.

To paraphrase Philip K. Dick, math is that which, when you stop believing in it, doesn’t go away. Like reality, people can only take so much math so we spend a lot of time pretending it is negotiable. The most obvious example is the American pension system. Every week we see stories like this one about how cities and towns are being crushed by pension debts.

There are three bits of math to consider here. One is the fact that you can only tax people so much before they revolt. They may revolt by tax avoidance or they may hang their politicians, but there’s a point where they will not pay any more in taxes. That means every government has a cap on what it can collect from its subjects.

The second bit of math is that people expect certain minimum things from their rulers. Towns have to keep the streets clean, catch criminals, runs schools, etc. National governments have to defend the borders, run the courts, police the economy, attack the muzzies and so on. These things cost money and that amount is always more than the people think they should pay, but it is just below the maximum they will pay.

The final bit of math is the hardest and that has to do with debt. Pension systems are a type of debt. If I hire you and as a part of your compensation I promise to pay you a monthly stipend after you turn 65, that’s a debt. That debt must be backed by collateral. In a pension system that collateral is the cash contributed by members and the employer, plus whatever interest that cash earns.

Pols have been jacking up the benefits for decades as a way to buy support from unions. This is just another way of saying they have been borrowing massive amounts to buy votes. To hide this reality, these pension systems claim their investments will return 7.5% or more, which they promise will cover their liabilities.

The trouble is the math says otherwise. If your pension system has $100 million in liabilities and those liabilities are growing by 7.5% per year, your returns have to be 7.5% to keep pace, as long as your assets are $100 million.  In many cases, these pensions have assets between 60-70 percent of liabilities. That means 10-12% returns are required and most of these funds are seeing returns of 2-3%.

The only way to make up for this gap, which is getting worse every year, is to divert money for operating expense like street cleaning, to pay pension debts. That and raise taxes, but in most of America we are at the maximum people will pay. The result is the people pay more and more for less and less government. At some point, mathematical reality crushes these municipalities and the states.

Most estimates put the math problem at about $4 trillion, but we have to assume that is the best case scenario. Greece is an excellent example of how math avoidance leads to compounding mistakes, thus making the math worse. Ten years ago Greece could have unwound their debt with an orderly exit from the Euro. Now they just wait for the revolution.

There’s no reason to think the same thing will not happen in the state pension systems. Some states can cut benefits and others have quietly transferred the liabilities to cities and towns, which can use bankruptcy to cut their debts. California, on the other hand, is looking at a Greek-style economic meltdown in the next decade.

None of these things happen in a vacuum. California owes its former workers money it will not pay. Those employees owe money they cannot play. Of course, California bonds sit on the balance sheet of banks who pledge them as collateral. The math of the pension crisis says it is going to wipe out more than the savings of a few retired bus drivers. The math says we’re all doomed.

 

 

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Kathleen
Kathleen
4 years ago

The Maths are hard! So many people are math-challenged, not really sure why. My husband is forbidden from touching the checkbook. Every other time he has dared, bad math things happen and I have to hide it again. People don’t want to spend any time thinking about the things they’re not good at, it’s not fun and rarely productive. Once upon a time I found math hard until I realized that most of it is not rocket science, although the “hard math” is essential to it. Pensions are more than just math, though. To a degree they’re a sign of… Read more »

Tim
Tim
Member
4 years ago

Here in NY the math is already leaving some burn marks, with the county cutting lots of support services, cutting back on road patrol, etc., in order to make payments to the state mandated pension plan (plus build the new prison for meth and heroin addicts!) They are making heroic efforts however not to eliminate any county jobs…. I’m 67, so I think…um hope…that I’ll be alive to witness the math leaving more than a burn mark. They’ll have to cut hard or inflate the currency, so it’s going to be fun. Maybe you’ve got the right attitude. It’s already… Read more »

jdallen
jdallen
4 years ago

The feds will bail out their friends all over CA and in the urban paradises (Detroit, Chicago, NY, et. Al.) as long as they can. When that becomes impossible, the fun will start. We’re almost there. I too am 67, and I don’t know if I hope I make it to see how it turns out or would rather go ahead and croak before it all falls completely apart.

bob sykes
bob sykes
4 years ago

The legal status of city and state pensions greatly complicates the situation. In Illinois, for example, pensions are protected by the state constitution, and payments cannot be cut without a constitutional amendment. In others, they have a privileged contract right to state revenues. It should also be noted that our economy does not provide jobs for everyone who would like to work, and open borders immigration is increasing the demand for those jobs that do exist. Middle income people are seeing moderately declining incomes, and working class people are seeing rapidly declining incomes. The consequence is that significantly cutting payments… Read more »

trackback
4 years ago

[…] You can run (for a while), but you cannot hide. […]

Andrew
Andrew
4 years ago

Found via WRSA.
It’s funny, I can’t claim an “IOU” I lend to, say, my brother as an “asset” but yet a bank can…to them it’s “collateral”.

pdxr13
pdxr13
Reply to  Andrew
4 years ago

Yes, an IOU contract that has the essential bits (identified lender, identified debtor, date of the obligation inception, any property held in trust to guarantee the debt and details, payment schedule, interest rate, penalties, and the other details) is “Commercial Paper” and is most-certainly an Asset of yours. The disadvantage you have by not being a Bank is that you cannot conjure the cash to lend from thin air. You have to lend assets that you own/control that ARE REAL. Banks can just do bookkeeping entry (manufacturing digits = “currency”) and MAGIC- It’s a Loan! If the bank is “honest”,… Read more »

Math Chopper
Math Chopper
4 years ago

“It’s gonna be fun to watch”. Being a “prepper” and being prepared, I didn’t realize so many others were saying the same thing. Sort of like a universal “I told you so”.