Economist Herb Stein famously said: “If something cannot continue forever, it will stop.” We now see many socio-economic systems in USA that cannot continue as they are forever, and which seem to be close to the point at which they could easily move into damaging and chaotic states. Let’s take a look at some of our favorites: But first, we need to roughly define a “Tipping Point”.

What’s a Tipping Point?

Every system has limits, including social systems. For every system there is some generalized boundary of system behavior and its use of resources that constrains system operation. When a system reaches its boundaries, some form of dramatic behavior can ensue. As systems approach these boundaries, they may cross their “tipping point.”

The “tipping point” is the state of the system at which catastrophic and usually unpredictable results emerge. For a simple, physical example, consider a sand pile. If you add sand by dripping handfuls on a flat plate, eventually you will have a cone and then it eventually takes only one more grain of sand to cause the whole pile to collapse. For socio-economic systems, people’s behaviors will change as the tipping point is neared. What will happen when these systems get close to their limits? We will make this general question more specific in several current socio-economic systems.

The Banking System Tipped

We have already seen a painful example of a system that tipped over its boundary: Banking. When people and corporations are unable to pay their debts (induced in large scale by government easy-borrowing policies), they default. Defaults vaporize money (the amount owed and not paid back), promoting deflation and breed wide distrust by lenders and leading to a freeze in economic transactions. Then government succumbs to the urge to stop the crisis by “bailing out” the biggest debtors. These government payments (effectively making money materialize) thus relieve the borrowers of the consequences of the risks they freely chose to take. Bailouts are examples of “moral hazard”, which is a condition in which risk-takers expect no unpleasant consequences since they expect to be indemnified by other People’s Money (OPM).

Systems Near Their Tipping Point

We have compiled a series of some of the more obvious social systems near their tipping points. We present them in tabular form, describing the system, a natural tipping point, and give some examples of what could happen once the tipping point is reached. This is the heart of the matter, and will affect almost everyone. We give a number for each system described, starting with Banking.

Financial

Demographic

Health Care System

State and Local Government

Foreign Affairs

The Biggest System: For How Long Can Government Itself Continue to Function so Incompetently?

People choose their governments for pretty basic reasons, such as maintenance of a legal system, operation of courts and enforcement of contracts, construction of shared infrastructures, protection from foreign invasions. Governments have naturally massively expanded beyond these basic roles, but one expects that whatever they do should at least be done reasonably well, even if not really in their charter. We are starting to see that governments have become so big they cannot successfully solve the problems they were elected to solve, let alone efficiently operate in their vast regulatory systems.

Government failures to competently manage recovery from natural disasters set off alarms, because one expects government to at least get that function right. Such management is one of the few things governments are actually required and expected to provide the tax payers.

Since the attacks of Sept. 11, 2001 (a failure of our expensive intelligence bureaucracy) the world has seen these catastrophic events and others:

• Tsunami in the Indian Ocean,
• Hurricane Katrina,
• Global flu pandemic,
• Global financial crisis
• Earthquake in Haiti,
• Oil spill in the Gulf of Mexico,
• Devastating floods in Australia and New Zealand.
• Earthquake in New Zealand
• Japanese earthquake, tsunami and nuclear crisis.

It seems that despite national governments having an uncontroversial mission to help its citizens recover from disasters, every government has been incompetent in trying to do so. This government incompetence seems evident even with the Japanese in their current crisis-the same Japanese who have the most disciplined society in the world, and who were famously meticulous in their preparations for earthquakes and tsunamis. Has government size reached a tipping point where it collapses under its own bureaucratic weight and becomes generally incompetent?

In many socio-economic systems in USA, this fear seems born out.

A recent article by Steve Greenhut in the Orange County Register elegantly describes the situation and the political framework. Quoting Greenhut (who refers to the Little Hoover Commission report):

This is a battle over the future of California, as communities spend more than a third of their budgets on pensions (plus even more for other retirement costs for public employees, such as health care), which means “an intensifying fight for diminishing resources from which government can pay for schools, police officers, libraries and health services.” And because public employees “appear to have little incentive to push for reforms,” they, too, will suffer, as they look at cutbacks in public services. Per the report, “A pension cannot grow without a job attached to it.” Maybe that reality eventually will get the unions’ attention.

Yet I’m convinced that the state’s public employee unions will take the state over the cliff rather than pare back their generous benefits. What happens when these pension costs push the state toward insolvency and the dominant political players refuse to give in? We might get to watch this unfold, and the result is unlikely to be pretty.

Little Hoover hit on the real problems: Governments are in the position of paying employees for more years in retirement than they worked thanks to the very low retirement ages creating, in essence, a shadow workforce that costs as much as the real workforce but doesn’t do any work! Police, fire and other public safety pensions must be addressed – California politicians cannot make a devil’s bargain and put the biggest part of the problem off the table, as did Wisconsin Gov. Scott Walker, who made a craven political calculation.

What will happen as the unions and the Democrat politicians (elected with massive help from union dues) defend their pension goodies? This is a system at it’s Boundary. Meaningful changes to make the system financially sustainable will hurt those who got the sweetheart deals, or the entire state can suffer by working to provide the pensioners with a risk-free future.

Budgeting skills are as important as what your portfolio is doing—probably, more important really, because budgeting is an everyday issue. If a person can scale back appropriately so that they can actually survive on a 4 percent withdrawal rate, they’re good. Any reasonably designed retirement portfolio will last with a 4 percent withdrawal rate. Eight percent? You’re going to have to get really lucky in your investments.

We love reading his work and he’s a very sharp, knowledgeable finance maven. But his claim about the 4 percent withdrawal rate seems a tad glib–there are many assumptions built-in to this claim that need explanation. Would you really like to bet on such a simple number for your retirement? We think not.

Intuitively, at 4% withdrawal rate,  if your return is 4%/YR and inflation is nil, then in fact you can simply withdraw the gain each year and never deplete the principal. But if, for example, inflation is 2%/YR and your return is 4%/YR, then we can show 4% withdrawal rate would last you 34 years. Not bad. But if your return is 3%/YR and inflation is 4%/YR, then this account will deplete after 22 years if withdrawals are at 4%/YR.  That’s probably a big difference. We show you how to handle all these “What Ifs”.

This post introduces the idea of the Safe Withdrawal Rate (SWR), a concept that has recently captured the attention of many investment advisors and publications. We introduce our own focus on this topic now. We announce two initiatives. First, we published a descriptive piece in Advisor Perspectives, a highly respected and popular website for investment professionals. This piece explains SWR ideas without math for the average investor. Second, we published our full research results in detail here, in our permanent pages (see Investing Tools drop-menu above, or click this link):

Investing Tools> Safe Withdrawal Rate

This page introduces our technical analysis and methodology to determinine your own, personal SWR. Our innovation: we capture each individual’s beliefs about his own future returns and inflation to find the expected value of his SWR, irrespective of market history. Ultimately, your personal beliefs about how future returns and inflation evolve is all that matters for your planning purposes.