Social Security as an Interest Rate Swap

If you think of just the interest rate aspects of Social Security as a swap, those who depend on benefits are receiving fixed at 0% mind you (guaranteed interest income from non-existent bonds) and paying floating (COLA) which is rising.  Oddly enough, this hasn't been a disastrous trade (I've heard of far worse swaps) over the past few years as the floating rate was near (and sometimes below) 0%.

Although they are a dying breed (compared to the late 90s) financial market traders (who obviously should have unionized in the early 90s) still pop up at cocktail parties, dinners etc.  If you're not a trader and get caught in a conversation with one you might find the jargon confusing and the reduction of all life's problems into trading metaphors exasperating.  In the case of Social Security, however, a bit of trader reductionism might help sway those wearing rose colored glasses who feel reform isn't a pressing matter.   

Admittedly, given what happened the last few times Social Security has been reformed- regressive tax increases, the proceeds of which were deposited in the Treasury's general fund- I can understand the trepidation with which Social Security supporters approach talk of future reforms. 

Some, like Mark Thoma, proclaim it isn't a problem at all, in the sense of having a major impact on our fiscal health  "Look at the CBO projections," they say.

We'll get to that in a second.

Others, like Robert Reich and Brad DeLong suggest entitlement finance isn't much of a problem, IF taxes are increased (Mr. Reich argues for increasing the cap thus reducing the regressivity of the program) and/or benefits cut.  They both admit, however, that tax increases aren't on the table which, as Mr. DeLong notes requires a ballot box fix. In his words, "What is the solution to our long-run deficit problem? It is simply this: elect honorable and intelligent women and men to Congress."

On reflection he adds, " I guess our long run fiscal problem is really dire and insoluble."

Maybe it is, indeed.

Taking our cue from Mr. Thoma, let's look at the CBO projections, and for more detail, the Board of Trustees Report from which the CBO took many of its assumptions.

Using the CBO's central scenario, Social Security self-finances (removing the fictitious interest earned from non-existent bonds, i.e. restricting income to taxes) through roughly 2016 and then runs modest deficits through 2019.  The total shortfall from 2011-2019 is less than $150B.

I can see Mr. Thoma's point.

Yet, projections are only as good as the assumptions therein, as the financial crisis of recent years attests.  The SS Board of Trustees, in their central scenario, assumes CPI inflation of 2.8% p.a. for 2011-2019 and medium term unemployment of 5.5%.  The CBO assumes 2.5% inflation and 5.0% unemployment in the medium term.

The SS Board of Trustees' worst case scenario assumes CPI of 3.8% and medium term unemployment of 6.5%.  Under that scenario Social Security isn't self-financing in the immediate future with increasing deficits which total $690B from 2011-2019.  To put that in context, President Obama's budget includes a 6-year, $556B surface transportation program.

Thinking a bit about those economic assumptions, I'm starting to wonder if the CBO hired their worst case scenario seers from the banking industry.  Those guys seem to think a stress test is flagging down a cab instead of having a waiting limo.

Let's try to imagine a worse than worst case scenario.  Actually, we don't have to imagine it.  Conditions from the mid 70s to early 80s in the US when inflation raged provides a real world example. 

Doing some very rough spreadsheet analysis using the Trustees' data, if inflation rises at 6%, SS deficits hit $100B in 2014 and $445B in 2019 for a 2011-2019 total deficit of $1.7T.

If inflation rises at 8%, SS deficits exceed $100B in 2013 and by 2019 they are over $700B for a 2011-2019 total deficit of $2.8T, which seems to me like an awful lot of money.

all figures US$Bil

The projections above aren't even a reasonable worst case as I've retained the Trustees' employment forecasts.  If the nation is in the midst of a structural unemployment period, which I (and some at the Fed) suspect, receipts will be lower and payments higher.

Why do others not see what I see?  I might be crazy (and if you knew me personally you wouldn't dismiss that notion easily) or I might just be noticing how a fiction, even one of which you are aware on some level, corrupts thought. 

Most reasonably diligent people who've researched the problem are aware that SS is a pay as you go system.  There are no income generating bonds.  In the relatively low interest rate environment of the past 5 years imputed interest income from the SS "surplus" was roughly $100B per year- small potatoes.  Yet the stock of "surplus" has grown to $2.5T (not really, just in the spreadsheets used for analysis).   What happens when interest rates start to rise, or as some might argue, normalize.

Each basis point of lost income (not including additional deficits) is worth $250M per year.  Each % of lost income is $25B.  If bond yields return to a more normal (over a long run view of the US) 6% we're talking $600B per year which many models assume will appear (from where, I have no idea) as income.

On the outflow side, using the CBO 2011 expense figure of $730B, each % increase in COLA (cost of living adjustment) is $7B- tiny potatoes.  Of course, even tiny potatoes add up.  A 5% COLA is $35B.  The other funny thing about potatoes, if you bury them in some dirt and wait a year, they COMPOUND.  Adding insult to injury, the basis of calculation will increase as more people (think Baby Boomers) start taking Social Security.


This is starting to smell like a really bad trade to me.

If you think of just the interest rate aspects of Social Security as a swap, those who depend on benefits are receiving fixed, at 0% mind you (guaranteed interest income from non-existent bonds) and paying floating (COLA) which is rising.  Oddly enough, this hasn't been a disastrous trade (I've heard of far worse swaps) over the past few years as the floating rate was near (and sometimes below) 0%.  Given current conditions, however, I doubt even Goldman could sell such a swap these days, but I'm sure they'd love to take the other side.

On that note, here's a solution for our times.  Wall St. should securitize Social Security cash flows and pawn off the risk somewhere (there's bound to be more semi-intelligent life in the Universe), making a tidy bundle in the process.

On a serious note, if you remove interest income from the CBO's projections and imagine a more inflationary future you'll see the problem I see.  Assuming the US isn't going to pull an Enron or a Madoff, by which I mean leaving those who trusted them holding an empty bag (they've already taken and spent their money) making these people whole is likely to be a significant problem unless economic conditions improve dramatically.

I'll close with a paragraph from a 1988 paper by Alicia Munnell, then FRB Boston's Director of Research, delivered during a Trustees symposium on the build-up in trust fund assets.

What happens if trust fund surpluses do not produce any new saving? That is, if they are simply offset by deficits in the rest of the federal budget. In this case, the surpluses will have contributed nothing to overall saving and capital accumulation and taxpayers will be no richer than they would have been otherwise. The full burden of supporting the beneficiaries will fall on the taxpayers in the second half of the period - just as if the system had been financed on a pay-as-you-go basis all along. The only effect of accumulating Social Security surpluses would have been to alter the composition of federal revenues over time. General government expenditures during the first half of the period would be financed by the relatively regressive payroll tax rather than the more progressive income tax, and future benefit payments would be financed by general revenues.

US Budget: Entitlement Funding Inflection Points

Within a decade there will no longer be additional surplus funds to be used to purchase US bonds which will have to then be sold on the open market. Call it peak SS Trust Funds, although peak trust might be even more apt. Captive Bidding at the auction: How Bond Vigilantism was swamped
 
A few years ago, I shared my concerns about Social Security and other entitlement program funding (see above and A New Head: Imagine there's no Social Security Fund).  Mine was no voice crying in the wilderness (I'm not that clever), but one of a chorus singing to an audience of deaf policy makers (perhaps my off-key voice was disturbing).  These underfunded entitlement programs, according to those in charge at the time, wouldn't be an issue for 10 or more years.

While it has only been 3 years and 4 months since I shared my concerns, the underfunding, in my view, is likely to become a big issue, not just amongst TV's talking heads, but in trading rooms around the world, this year- we are near to reaching an entitlement funding inflection point- mainly due to the sharp rise and long duration of unemployment, which will have, I believe, a profound effect on the US bond market. 

The inflection point- when the lack of surplus entitlement funds forces the Treasury to fund the entire deficit in the open market- will force bond investors, if they haven't already, to take a fresh look as US Federal finance at the worst time- a look that will include concerns like the following:

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

In an earlier post on the topic I argued (facetiously):

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 intergovernmental holdings are essentially fictitious accounting entries, the US Federal Public Sector debt to GDP ratio is actually 37%

While the Trust Fund doesn't exist except as fictitious accounting entries, the liabilities thereof most certainly do (assuming we don't want a replay of recent Egyptian protests here in the US).  Just as entitlement surpluses reduced borrowing requirements and kept US bond yields much lower than they would otherwise have been, entitlement deficits will increase borrowing requirements and, I believe, push US bond yields much higher than they would otherwise be. 

At this key inflection point, instead of subtracting "intragovernmental holdings" (the euphemism for the fictitious trust fund assets, now totaling some $4.6T) from total debt (leaving a 65% debt to GDP ratio), the total debt figure (nearly 100% of GDP) must be used to perform credible analysis, like calculating interest payments.  This may explain the rather curious (to my mind) forecast of entitlement surpluses for many years ahead in the President's Budget.  Once the surpluses become deficits the unfunded liabilities previously hidden by cash accounting methods become active just as an option, which wasn't delta hedged- option lingo for net present accounting- becomes active when its strike price is crossed.  (a wonderful description of the different accounting methods can be found here)

Call it "Fiscal death, Derivatives-style."

Entitlement Funding, Long Term Unemployment and Bond Yields

As noted earlier, the rise and duration of unemployment has brought the "moment of truth" forward by reducing entitlement receipts (unemployment reduces tax receipts) and increasing outlays (formerly employed retirement aged people begin receiving SS).  Fiscal Year-to-date, the off-budget surplus is just $25B, a 50% reduction from the same period last year.  

The baby boomer rush to retirement has not only begun, it has been accelerated by the employment recession.  Moreover, the cap on SS taxes means that an income surge among high earners, which might raise GDP, will do little to raise entitlement receipts.  The only solution to that problem is employment, and lots of it.

That solution, however, carries its own fiscal risks.  Rising employment means rising consumer demand (especially for gas to drive to work again) and thus, in all likelihood, higher inflation.  Higher inflation (the President's Budget forecast assumes inflation remains at or under 2% through 2016) means higher interest charges on the debt stock and increased SS outlays as COLAs rise.  This sunny forecast assumes no disruptions in foreign appetite for US debt.

Interestingly we may have reached a "damned if you do and damned if you don't" point with respect to employment data driven bond market reaction.  If unemployment remains the same or rises, and trust fund deficits need to be financed from general receipts, bond yields should rise due to increased supply.  If unemployment starts to fall as one would expect in a normal recovery, bond yields should rise as inflation pressures increase.

Geez, maybe that's why bond yields have been rising lately?

Full Disclosure: Short US Treasuries

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 connotation...now 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 (bank..financial 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.

Captive bidding at the auction: How bond vigilantism was swamped

Time flies when you're making money: 19 years have sped by since the start of the great bond bull market. So traumatic was the preceding bear market (it spanned the administrations of U.S. Presidents from Harry Truman to Ronald Reagan, 1946 to 1981) that fixed-income investors took a pledge: Never again would they be the dupes of a central bank. They would henceforth sell at the first sign of inflation.

So market interest rates would increase before the U.S. Consumer Price Index could spurt. The Fed might nod off, but the bond market vigilantes pledged they would never sleep again.

Now look at them. With a generation's worth of capital gains tucked under their ample belts, they are snoring in hammocks or swatting golf balls. Financial markets the world over are worse off for their unannounced retirement. James Grant

Many financial commentators have opined on the absence of the "bond vigilantes" from the US Treasury market. Bond traders now willingly accept low yields in the face of broad based commodity inflation, which hitherto would have, according to Mr. Grant, whose views I highly respect, above, inspired significant selling from the now "sleeping" bond vigilantes. I've been doing a bit of checking on the US bond market and think I have a few answers to the question, "where did the bond vigilantes go?," although a better question might be, "whose efforts have swamped bond vigilantism in the Treasury markets?"

The good old days

In 1955, US federal debt totaled $234B, of which $163B (70%) was tradable on the open market. The biggest single player was the Fed, which, in 1955, carried $24.4B worth of Treasury Securities on its balance sheet, or just under 15% of marketable debt.

Is the Fed the culprit?

Federal Reserve acquisitions of debt rose steadily from 1955 to 1970, when holdings peaked at just over 25% of marketable debt. But, as standard closed system economic theory argues, Fed purchases, i.e. debt monetization, did not keep yields down. 10 year yields rose from under 3% in 1955 to well over 7% in 1970 while consumer price inflation rose from -0.4% in 1955 to 5.7% in 1970. Bond vigilantism was apparently alive and kicking back then and Federal Reserve debt monetization led, as it should, to inexorable inflation.

Thus, we can chalk off the Fed as player whose efforts swamp bond vigilantism.

Are the foreigners to blame?

Of late, the presence of foreign purchasers, in particular, foreign official purchasers, have been cited as a reason behind the lack of bond vigilantism, even (in hindsight, partially erroneously) by me.

In 1955, foreign official holdings (the foreign private sector was not yet involved) of Treasury debt totaled $5.8B, or 3.6% of marketable debt. Foreigners were not yet players.

By 1980, this had changed. Foreign official holdings rose to just under 18% of marketable debt, while total foreign holdings rose to 20.4% of marketable debt. Despite this support, 10 year yields rose from 4.2% in 1965, when foreigners began to ramp up their purchases, to well over 12% by 1980. Consumer price inflation rose from 1.6% in 1965 to 13.5% in 1980. The decline in real yields at the back end of the curve, excluding other factors (which is rarely wise), suggests that foreign buying might have kept rates lower than they otherwise would have been, in a closed system.

Foreign acquisitions of US debt have increased dramatically since 1980. As of Q2 2007, 44% of marketable US Treasury securities are in foreign hands. 31.3% of marketable US Treasury securities are in foreign official hands. The coincident rapid increase in foreign holdings of US debt with a multi-decade decline in yields suggests that these purchases kept yields lower than they otherwise would have been. Yet, the data from the 70s, when bond yields rose despite foreign inflows, suggests that this is not the whole story.

Enter the captive bidders

Something besides increased foreign acquisitions of US debt, happened between the early 80s and the present day which slowly but inexorably swamped bond vigilantism. That something was an increase in social security (and related programs) net income which, I argue, dramatically changed the US bond market.

From 1955 through 1980, the US Treasury market was a mainly open affair, by which I mean, most of the issued debt was marketable. In 1955, non-marketable debt made up 30% of the total and in 1980 non-marketable debt made up 33% of the total. Bond prices were, in the main, set in open markets.




Captivating the Trust Funds

In the mid 80s, in accordance with the recommendations of ex Fed Chairman Greenspan's Commission of Social Security (boy this guy's fingers are in a lot of pies), social security taxes were raised which raised the percentage of national income flowing into social insurance programs from 7.2% to 8.5% (source BEA). While a 1.3% increase in national income flow (it amounts to an increase in income from 4.8% of GDP in 1987 to 5.6% of GDP in 2006) is substantial, it doesn't fully explain the substantial rise in social insurance assets.

If changes to the income side don't fully explain the dramatic rise in social insurance holdings, something must have coincidentally reduced the outflow, which fell from 4.6% of GDP in 1993 to 4.1% in 2006. That something was a change to inflation calculations upon which cost of living adjustments (COLAs) in social security payments are made.

According to John Williams' Shadow Stats site:
In particular, changes made in CPI methodology during the Clinton Administration understated inflation significantly, and, through a cumulative effect with earlier changes that began in the late-Carter and early Reagan Administrations have reduced current social security payments by roughly half from where they would have been otherwise. That means Social Security checks today would be about double had the various changes not been made.

Assuming Mr. Williams' estimate is correct, a doubling of SS outflow from the actual $549B, which produced a SS surplus of $185B, to $1,097B, assuming no changes on the income side, would have created a deficit of $363B. In turn, this would have forced the US Treasury to sell about $800B of securities into the market instead of the $250B they actually sold in 2006. I doubt current US Treasury yields would be at such low levels if such was the case.

But it is the case. Non-marketable debt has risen from the afore noted 33% of total debt to 49%. That's right, half of Treasury bidding comes from captive bidders. So much for a free and open market in US Treasuries.

In sum then, the cumulative effects of SS tax hikes, which inflated SS income, and reductions in outflow due to recalculated COLAs are, I believe, the primary cause of our strangely low bond yield environment in the US. As one who has cited with alarm the growth of Chinese reserves to and above the $1Tln mark, I was amazed to find that Social Security holdings have grown even faster, and now total some $2Tln.

Forget about China's, here's a sovereign wealth fund just waiting to happen.

But, as the saying goes, it isn't just the size of the ship that matters, the motion of the ocean does as well. Many financial commentators have (rightly so, in my view) worried about diversification out of $s among foreign countries with large reserves, yet few worry about a similar risk consciousness coming from within the US.

Imagine a financial world in which the managers of the SS Trust were able to diversify out of US assets. Minimally imagine a financial world in which the managers of the SS Trust were able to pick and choose amongst domestic investments. In that world, I doubt the chosen mix would be (as is currently the case) a virtually all US Treasury portfolio with an average interest rate of 5.2% and duration of 7.2 years. Simply shifting to a much shorter duration fund would cause the US yield curve to steepen dramatically.

Captive bidders and the Enron effect

That is, I argue, the captive nature of the SS Trust fund in conjunction with its size has been the main cause which engendered our low and reasonably flat curve yield environment. For it is the US Treasury itself which manages these funds. As those who lost all their retirement funds at Enron could tell you, captive trust funds invested in the company itself does not a diversified portfolio create- just the opposite effect is, in fact, created. When foxes (invariably from Goldman Sachs these days) guard the chicken coop, ultimately you have no chickens.

This too, however, shall pass. According to the SSA (Social Security Administration) by 2017, barring any further increases in taxes or calculation changes in COLAs, outgo will exceed income for SS and DI (Disability Insurance). National Health Insurance (HI) costs will deplete the funds even more rapidly. By 2041 SS and DI will have exhausted their funds and by 2019 HI funds will be depleted. So, within a decade there will no longer be additional surplus funds to be used to purchase US bonds which will have to then be sold on the open market. Call it peak SS Trust Funds, although peak trust might be even more apt.

In Greenspan we trusted

It is, perhaps, fittingly ironic that the same Greenspan who bemoans increased federal spending, recommended and oversaw the conditions which allowed such spending to occur outside of a free market mechanism. The same man who proclaimed, in his oft cited, Gold and Economic Freedom: 

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.


oversaw a tremendous confiscation of wealth, but not from the wealthy, from the common man. He has repeatedly said that he still stands by the views he expressed back in 1966 and I believe him. He (and others) used the lack of a monetary standard to confiscate wealth from us- wealth which was used, inter alia, to finance the current wars. Atlas, in this case, didn't shrug, he stole.

I expect, as increases in trust fund surpluses slow, US interest rates will rise, most likely dramatically in the years to come.