Saturday, October 06, 2007

A new head: Imagine there's no social security fund

The language of the Social Security Trust Fund gives the illusion that it is an investment fund with tradable economic assets that can be held until needed to pay the benefits of future employees. But it is a fund in name only. It holds no real assets. Consequently it does not generate funds to pay future benefits. These so-called trust fund “assets” (essentially US Treasury IOUs) simply reflect the accumulated sum of funds transferred from Social Security over the years to finance other government operations. Former Congressional Budget Office Director June O’Neill

Imagine there's no SS Fund
It's easy if you try
No savings below us
Above us only sky
Imagine all the people
Living for today
John Lennon (adapted by Dude)

Apologies for my almost week long absence from the screen...the final stages of my new house are taking more time than I expected.

My previous post was written under the assumption (back when Adam Smith wrote the Wealth of Nations the preferred phrase was "under that head", meaning belief structure, but these days "belief" itself has a negative we "know" things...which is to write, are immersed in the metaphysics, or in the patois of the Grateful Dead, have drunk the Kool Aid...but I digress) that Social Security was actually a Fund whose investments included nearly $2T worth of Treasury Securities, albeit of the non-marketable variety, kind of like Savings Bonds.

Yet, as the June O'Neill quote, above, states, this just ain't true.

The Social Security Trust Fund is about as real as Santa Claus. To put it in bond market terms, there ain't no CUSIP numbers on 'dem non-marketable Treasury Securities in the SS Trust Fund.

Of course, just because something isn't real, by which is meant, fills no space in the material plane or as Descartes would have put it, has no "extension," doesn't mean it won't have an effect on our lives. The idea of Santa Claus in the minds of children significantly effects not only their behavior but also that of their parents as they seek to maintain the illusion- an idea to keep in mind as we explore this issue.

In a sense, the 2005 effort by President Bush to use the political capital he earned in the 2004 election to "privatize," "reform," or "fix" Social Security, was really a debate over whether to tell the kids that there really isn't any Santa Claus (perhaps reverse Tooth Fairy would be more apt, i.e. a Tooth Fairy you pay, instead of one from whom you receive). In the event, his effort failed in Congress. The parents decided not to tell the kids there isn't any Santa Claus. If you have children you know what that means....hiding presents, sneaking them under the tree after they go to sleep, and acting surprised in the morning (and paying the credit card bills in January...or whenever, as seems more likely these days).

What's the problem?

According to the White House site from 2005 when the issue was in play:

1. What is the problem?

The Social Security system operates on a "pay-as-you-go" basis, where the payroll taxes of current workers are used to pay for the benefits of current retirees. The system is 70 years old. It was designed at a time when most people didn't live long enough to receive benefits.

We had far more workers per retiree paying into the system than we do now. In 1950, this worker-to-beneficiary ratio was 16 to 1. Today, it is about 3 to 1. By the time today's young workers retire, it will be 2 to 1.

Until about three decades ago, the Social Security system was no different than most private employer pension systems. These "defined benefit" plans promised retirees and other beneficiaries a certain income level, no matter what. For a variety of reasons, including the growing financial literacy of America's workers, most companies have shifted to "defined contribution" plans like 401(k)s. Meanwhile, Social Security has stood still.

As conceived, Social Security was something of a scam- since most people 70 years ago wouldn't live long enough to receive benefits, promising them created a lot of good will towards the government, cheaply. Or so they then thought. And back in 1935- as the Great Depression raged- generating good will amongst the people towards the government, or more broadly, towards the economic system in general, was crucial. When people lose faith in the system, economic growth is tough to come by.

Depressions, as was amply demonstrated 7 decades ago, are not the times to ask people to tighten their belts. At least they aren't if the ruling corporations, be they commercial or governmental, have been channeling a larger and larger share of the national flow of funds into their owners' and leaders' pockets in compensation for the previous good times.

To digress for a moment; in primitive cultures, people often "pay" for rain or sun or even to stop a volcano from erupting (I might even add to stop the globe from warming up...but that's another discussion). In my view, one of the genius aspects of laissez-faire was the separation of the responsibility for economic growth from the government. This allowed governments to transcend economic slowdowns, and allowed people to think of "the economy" as a natural, social, phenomenon- a "head" which led to the production of most of the classic works in the field.

These days, having drunk the Kool Aid, many, especially the Maestro himself, Alan Greenspan, speak of the economy as something which can "collapse" if not maintained. This is, to my mind at least, an odd idea if economics is defined as the study of the manner in which humans cooperate to produce the goods of society. Even in the dark ages after the fall of Rome there was still an economy, albeit one in which trade was in steady decline.

Let's get back to the issue at hand- the unfunded liability that is Social Security, and the effects of maintaining the illusion that it isn't.

Congress just recently raised the debt ceiling to $9.815T. If the SS Trust Fund doesn't really exist, the national debt is at least $2T less than the current $9.05T. Under that head, the debt ceiling hasn't been a "real" issue for many years. In the language of my last post, it isn't that a large portion of the Treasury Market is captive, the US National Debt is actually far smaller, by at least $2T, than assumed. If all intragovernmental holdings are essentially fictitious accounting entries, the US Federal Public Sector debt to GDP ratio is actually 37%. Either "head"- captive bidding or fictitious intergovernmental holdings- explains the recent, anomalously low yields in the US Bond market.

Of course, under that head, foreign control of the Treasury Market rises dramatically. According to the most recent Flow of Funds report, the rest of the world owns $2.184T of the $5.043T debt issued to the public or 43%, which seems to me a serious national security issue.

Bu the tangled webs get even more tangled, and the problem, the real, deep seated problem, is one of tangled webs of deception- the necessity of maintaining the illusion at full force for as long as possible (the bubble phase) and letting the air out as slowly as possible when the illusion runs into reality (the inflationary resolution phase).

As noted above, just because Santa Claus isn't real, doesn't mean the kids won't want presents. They do...and they haven't been paying for them for years, either, as we US citizens have with SS.

The last reform for Social Security, the Greenspan reform, raised taxes significantly to make the system solvent, or so the promise went. But, as June O'Neill told us, those funds actually went to general government expenses. This had the salutatory effect of keeping bond yields, both in the US, and by virtue of the US $'s role as reserve currency, the world at large, quite low, at the potentially tremendous cost of a very pissed off population upon discovery that their SS taxes were actually disguised general payroll taxes.

I suspect the desire to avoid the wrath of a taxed population scorned played a large part in Congress' decision to maintain the illusion of Santa Claus. Another factor which, I suspect, weighed in the decision, is the fear that such a deception exposed would inspire a more general desire to "peer under the financial hood" so to write, and that wouldn't be a good idea at all- the SS Fund is not the only fund ( institution) which is un (or under) funded.

Far, far more now than in the 30s, when the currency still had some real backing, faith in the health of the system is paramount. The assumptions underlying the system cannot be questioned for if they were, the recent queues around Northern Rock would become wide spread and the waves of selling would become too powerful for the CBs to contain- cascading defaults, here we come.

What a dilemma. It's a good thing the old economic tool used to get around the problem of sticky wages (in this case sticky pension expectations seems more apt) is still available- inflation.

In my view, the inability of the Bush administration to pass SS reform in 2005, when the housing bubble was still inflating, general economic growth expectations were high, and public faith in his administration, and the Republican Party, was still high, set the stage for (but did not cause) a great inflation ahead. Perhaps the defeat of SS reform in Congress and the peak of the housing bubble are more than just coincidental? If the loss couldn't be faced, it would have to be hidden, and the resolution phase begun.

Regardless, the stage, in my view, is set. If SS reform was a non-starter in 2005, it's truly dead now. The idea of taking ownership of one's retirement savings (a clever way to get around the unfunded liabilities) which seemed so alluring in the late 90s when the equity bubble made geniuses out of dart throwers, and, to a lesser degree, more recently, when faith in the greater real estate fool was still strong, will seem, more and more over time, downright scary. I wonder how many people across the country have said, "well, at least I can depend on Social Security (or should I write Santa Claus?)."

Assuming the War on Terror is going to continue and perhaps even expand, I find it hard to believe that a public already dissatisfied with the war will accept a breech of trust of this magnitude gracefully, or that the financial world could withstand the scrutiny that would follow such a breech.

A quick check of the St. Louis Fed site, recommended by Gary North, tells me (to the extent one can draw a meaningful conclusion from one data point, and I don't think you can) that the most recent flirtation with "monetary tightness" might have come to an end- the adjusted MBase rose by 1% over the past 2 weeks. The recent strength in the price of Gold, which seems much more able to withstand the curiously timed selling, also, perhaps, speaks to a growing realization that inflation is the only way out, and Gold then a most useful protection.

As an aside, I'm eagerly awaiting the realization that the inflation rate for TIPS is absurdly low, which should really give the precious metals complex a shot in the arm.

In sum, if the authorities want to maintain a degree of control as the losses of the unfunded pension liability problem, which, I suspect, extends far beyond SS, are apportioned, a controlled inflation will be required. Such are the costs of maintaining illusions.

I'm quite interested to see if they can control it.

I hope to write a bit more regularly this coming week.