Approaching Fast

Although I spend a lot of time at this blog covering issues related to debt and derivatives, those two represent just half of the four "impending catastrophes" that I discuss in my book, which was first published a year ago.

However, the other two topics, government guarantees and the retirement system, are equally important, because they also represent claims and obligations that far exceed the resources we have available to meet them.

In "Social Security's Running Out of Time," Fortune's Allan Sloan goes into greater detail about a problem that doesn't seem like a big deal now, but which will become one in the not-so-distant future.

Because the trust fund is invested in Treasuries, the real problem starts not in 2040, but a decade or so from now.

One of Washington's rites of spring is almost upon us. It's the wonks' version of the Cherry Blossom Festival - the release of the annual Social Security trustees' report showing the health of our nation's biggest social program. Each year the report touches off a debate, mostly misguided, about Social Security's financial status. Given the political environment this year, you can expect more heat than usual when the report comes out. But you're unlikely to see much light.

So let me try to illuminate things for you. Forget all the talk you'll hear about how Social Security is okay until 2040 or thereabouts. That is, as we'll soon see, utter nonsense. The real problem starts only a decade or so from now, when Social Security begins to take in less cash than it spends.

How can I say that, given Social Security's $2.3 trillion (and growing) trust fund? It's because the fund owns nothing but Treasury securities. Normally, of course, Treasury securities are the safest thing you can hold in a retirement account. But Social Security's Treasuries won't help cover the program's cash shortfall, because Social Security is part of the federal government. Having one arm of the government (Social Security) own IOUs from another arm (the Treasury) doesn't help the government as a whole cover its bills.

Here's why the trust fund has no financial value. Say that Social Security calls the Treasury sometime in 2017 and says it needs to cash in $20 billion of securities to cover benefit checks. The only way for the Treasury to get that money is for the rest of the government to spend $20 billion less than it otherwise would (fat chance!), collect more in taxes (ditto), or borrow $20 billion more (which is what would happen). The spend-less, collect-more, and borrow-more options are exactly what they would be if there were no trust fund. Thus, the trust fund doesn't make it any easier for the government to cover Social Security's cash shortfalls than if there were no trust fund.

Social Security's negative cash flow becomes so horrendous - hundreds of billions of dollars a year - that our nation's twenty- and thirtysomethings aren't going to let the government cover it, regardless of how many Treasuries the trust fund holds. So forget about 2039 or whenever. Starting worrying about 2016 or 2017.

You can see this for yourself in Table VI.F8 in Social Security's 2007 trustees' report. Compare "income excluding interest" with "cost," and you get cash flow numbers. (I'm ignoring interest, because it's paid with Treasury IOUs, not with cash.) You see that the system's cash flow is projected at about positive $92 billion this year. Nice. But by 2020 it's negative $96 billion, rising to about negative $280 billion in 2025, half a trillion in 2030. That is unsupportable, unless we plan to devote the federal budget to baby-boomers' retirement. Which I hope we don't.

I'll spare you the history lesson about why no one worried much about how to invest the huge - albeit temporary - surpluses that Social Security began to rack up in the 1980s, when Social Security taxes were raised and future benefits trimmed as a result of the famous Greenspan Commission report. It would be nice to have $2.3 trillion in useful assets in an equivalent of a sovereign wealth fund - but we can't turn back time.

We can still buy time by investing current cash surpluses in non-Treasury assets. But that would require a change in the law and a change in the Washington mindset, neither of which seems to be in the offing.

The bottom line: If you hear a presidential candidate talking about 2030 or 2040 when the report comes out, ignore it. But if one of them starts talking about 2016, pay attention. It means that he or she is seeing the big picture, not just sniffing cherry blossoms. 

Comments

[Rocky]

Don't be surprised if Social Security is means tested in a few years. It's either that or drastically cut back on US defense commitments and cancer operations for senior citizens on Medicare (that may come to). Maybe we'll even get a national sales tax. Any way you look at it, things look kind of grim a few years down the road.

[Barbara Ann]

Well at least it saw my Mother through her golden years. In a way it's fitting that those who voted for Reagan will come up short. However, I never voted for the scam, or the war, so I'm a little annoyed.

[D.D.Grant]

The real obstacle to understanding the situation with Social Security is approaching it from a monetary point of view. The way things work in economic reality is that each year a portion of the total production is devoted to the support of the retired population, just as a portion is used up by the part of the population that works, a portion (which in general cannot be 'consumed' at all) goes to replace the capital goods due for replacement in the current year and portion goes to the support of the idler rich squanderers and social parasites.

It is nonsense to suggest that the richest economy that has ever existed on earth will be unable to support its retired working population. Yes, it can be asserted with the smoke and mirrors of the monetary conception, the point of view of the petty shopkeeper elevated to the dizzy heights of fiscal 'theory'. And indeed this absurd conception is actually so rarified as to propose without irony that the population would actually put up with an arrangement of social economy that would see its elders dying on the streets. Yeh, sure, just try it.

[A. Zarkov]

It’s a common assertion among academic economists that the Social Security Trust Fund has real assets because the bonds it holds are backed by the full faith and credit of the US government. Here is what they don’t want to talk about. Those bonds are “special issue” bonds and not tradable. As such they are simply claims against future revenues of the Treasury. In reality the US Social Security System is no different than France’s retirement system. The French government pays benefits from current tax revenues. On the other hand, if the Trust Fund had a portfolio of tradable assets like the University of California has it would have a claim against non-tax revenues. It would be nice if the Trust Fund held foreign bonds, then foreign taxes would pay for our retirees. Of course we know why they don’t have tradable assets—they would have to pay for them, and the US budget deficit would look much bigger. These academics keep trying to kick sand in our faces. Are you listening Paul and Brad?

We all know what’s going to happen. Social Security will curtail benefits. It will raise the retirement age, and cut back on the payouts. It’s only a question of when, not if. The effective return to people currently paying FICA taxes will be very negative. If young workers knew how badly they are getting stiffed, they would scream. Of course Medicare is even in worse shape. We all know what’s going happen to this system in the near future. Managed Care. That’s what you get with outfits Kaiser, and it’s not very pleasant. Let’s say you hurt your knee and need a MRI scan. Managed Care will put off doing the scan for months hoping you will get better. It’s a game of service denial. That’s the unpleasantness waiting for retired baby boomers.

[A. Zarkov]

"And indeed this absurd conception is actually so rarified as to propose without irony that the population would actually put up with an arrangement of social economy that would see its elders dying on the streets."

Elders weren't "dying on the streets" before 1937 when there was no Social Security. They weren't "dying on the streets" before 1967 in the days before Medicare. How come? For one thing children took care of their parents.

I do agree that the monetary approach is deceptive. Retirees need the goods and services that money buys. No matter how well funded the retirees are, there has to be someone around to do the work to produce these good and services. If you don't have enough workers inflation will wipe out retirement income. This is why one way or another the retirement age must go up.

[roger pasa]

Global systemic crisis – End of 2008: Pension funds go off the rails
According to LEAP/E2020, by the end of 2008, a formidable debacle will affect pension funds all over the world, endangering the entire system of capital-based pensions. This financial calamity will bear a particularly dramatic human dimension because it will come at the precise moment when the first wave of baby-boomers phase out of the labour force in the US, EU and Japan: pension fund revenues are collapsing at the very moment when they should be making their first large series of payments to pensioners.

GEAB N°23 is available ! Read public announcement
(Interesting & scary) Leap/E2020 also a source of good info

[Concerns4Retirement]

Again...it's so cruicial to understand this info and how fixed annuities are positioned in the market moving foward...my computer crashed recently. It's very crucial to understand how the Robber Barons positioned annuities in light of other financial vehicles. They basically utelized European economic platform to establish ours. Fixed annuities' safety has been conservatively guarded historically and now by the shakers & movers like a mother guarding her new born. Annuities have automatic tax, legal & creditor advantages. This historically has served as a safety-net from the "fall from grace" from other financial vehicles and prudent accumulation to distribution mechanism. Europian royalties and their loyalists have utelized annuities for nearly two thousand years to date. We set the similar grounds for annuities in 1913--the same year the Fed was established. i.e. Ken Lay of Enron, OJ and Babe Ruth's liquid assets survived lawsuits and/or Depression becuase of the immunity and safety available to annuities. Also, understand your states favors on annuities--certain states have more legal immunity than others. TX & FL have maximum immunity.

For more info you can view my show at www.concerns4retirement.com.

[Lady From Middle America]

Of course the elderly weren't dying in the streets before 1937. They were dying in county poorhouses and TB asylums. Older people didn't want to end their days like that, and younger people didn't want to throw their careers and independence away by taking care of their elders. People wanted to get off the farm and improve their positions in life. Selfish? Perhaps, but we can't throw away legislation and expect people to cheerfully go back to the old ways of life.

I challenge anyone who wants to do away with Social Security and Medicare to be the first to quit their jobs and devote their lives to taking care of their bed-ridden elderly relatives.

[D.D.Grant]

"Elders weren't "dying on the streets" before 1937 when there was no Social Security. They weren't "dying on the streets" before 1967 in the days before Medicare. How come? For one thing children took care of their parents."

Exactly. This only goes to show that in those periods the wage level was sufficient to fund the situation you speak of. I have been around long enough to recall a period when the average workers income was sufficient to support a family which included a non-working mother and the same worker could look forward to having some kind of holiday home etc. Your comments only highlight the enormous cut in wages that has occured since the Regan-Thatcher 'revolution', i.e., in the period that followed the last great upsurge in working-class militancy of the 60s.

Of course an abstract monetary view always fails to take into account that political attitudes are not static and that what the masses will tolerate today is no indication of what they will tolerate tomorrow.

Incidentally, the 'flood of liquidity' of the same period is nothing but the manifestation in the financial sphere of this very wage reduction. But of course the marginalist nonsense, bereft of a scientific theory of value, is utterly incapable of appreciating this. For it 'value add' always emanates from some mystified and psychologized utilitarian sphere. And indeed it is absolutely barred from a scientific conception since it would be led by such to an admission that profit, interest and rent are nothing but the appropriated part of the the total new labour added.

[D.D.Grant]

" No matter how well funded the retirees are, there has to be someone around to do the work to produce these good and services. If you don't have enough workers inflation will wipe out retirement income. This is why one way or another the retirement age must go up."

I recently came across a reputable study, (unfortinately I didn't bookmark), that indicated that the amount of value (real terms) produced per worker in the early 21st century was 1,500 that of 1900.

The number of worker argument is another smokescreen. The rate at which today's production is able to pump out goods is tantamount to a fabulous horn of plenty. The only thing to be resolved is the determination of what portion of this goes into further capital accumulation. The dymnamic under which this question is resolved under the capitalist form of production is tendentially such that a maximization of profit always implies a minimization of the share that goes to the producers, profit of course being the source of the expansion of production, i.e., the actual accumulation of capital.

Thus increasing pauperization even as the capacity of the production apparatus develops in leaps and bounds.

[Rocky]

Re: Concerns4Retirement Fixed annuities are good for the person that sells them, but if the $US goes into the toilet, what good will a fixed annuity be, even if the insurance company miraculously survives? This is a particularly bad time to buy annuities since US interest rates are so low, as they are being artificially held down by foreign central bank buying of US bonds. An immediate annuity purchased by a 60 year old male for $1 million would produce less than $6,000 in monthly income for life, with nothing for your heirs. Not very appealing is it? The monthly payout would even be less for a female. (Variable annuities, with their high fees are probably even worse for the purchaser.) A few years of high inflation would largely wipe out the purchasing power of a fixed annuity payments.
Commodities may or may not be an answer to your prayers. Don't forget that in 1980, silver was selling for around $50 per ounce when the Hunt Brothers were trying to corner the market. Today, it sells for around $17US per ounce. Gold took almost 28 years to get back to its 1980 highs in $US.

[Rocky]

"It is nonsense to suggest that the richest economy that has ever existed on earth will be unable to support its retired working population." DD Grant.
We have the ability to support our retired population, but do we have the willingness? Walter Mondale ran on a platform of raising Federal taxes to balance the budget in 1984, and he lost big time to Ronald Reagan. American voters don't take kindly to fools who want to raise their taxes. The Democrats in 2008 are being rather evasive about supporting tax increases on most Americans, claiming that they would only impact the rich. Don't you believe it. If the Democrats control both houses of congress in 2009, along with the presidency, taxes will be go up for middle income singles in New York and other major metro areas. But the proceeds are more likely to go to more pork barrel spending than to shoring up Social Security and Medicare.