Tuesday, September 7, 2010

An Explanation of Social Security, the Trust Fund and National Savings for Those Who Are Still Wondering

A while back, I lambasted Matt Bai of The New York Times for saying that the Social Security Trust Fund, because it is invested in Treasuries, is just a pile of worthless IOU’s the government won’t be able to redeem. I made fun of his suggestion that Uncle Sam is teetering on the edge of default, but there is a deeper issue I didn’t address. Bai, despite his economic confusions, is conveying a mainstream sentiment, endorsed by the broad center of American politics, that the drawing down of the Trust Fund is an impending catastrophe for the federal budget and national savings. Every T-bill sold back to the government is seen as another arrow in the heart of fiscal prudence, and we must somehow find a way to keep the fund at its current level by cutting benefits or raising payroll contributions.

Here I want to shed some light on the overall relationship between pensions and savings.

First, imagine a society with no money at all. Suppose it is an isolated fishing community: early each morning, every able-bodied adult sets off in a boat and dips a net into an ever-renewing fishing bank. Then they come home, unload their fish and eat them. This is the entire economy—fish, fish, fish.

Now introduce retirement. When people grow old, they lose the ability to fish, or perhaps they just want to do something different in the years remaining before they die. (Maybe they want to take up surfing.) How can they do this without starving? There is only one answer: their younger compatriots must eat fewer fish than they catch and divert the surplus to their elders. There is simply no way for people to “save” fish when they are working for consumption in future years, since the fish are perishable. This society may have complicated arrangements, perhaps involving pieces of paper (IOU’s) that convey entitlements to various quantities of fish, but in the end there is no escaping the reality that the working population supports the concurrent retired population at whatever level of abundance is agreed upon. If the ratio of retirees to working fishers rises, or if retirees want to eat more fish in their golden years, either the working population has to increase its fishing efficiency (catch more fish per person) or reduce its own consumption, or both.

Now consider the Social Security system. The Trust Fund has accumulated a huge portfolio of government securities, and in a few years it is scheduled to begin a slow process of cashing-in—selling securities for money that can be used to write checks to recipients. This money will come from the Treasury, which can raise it by selling new securities. This will raise the public debt unless non-SS related deficits are brought down by the same amount, since the ownership of Treasuries will have shifted from the government (the Trust Fund) to the public. That is what the SS alarmists are pointing to.

But, for the sake of argument, suppose that we had no Social Security system at all—that all pensions were privately financed out of the personal savings accumulated before retirement. Upon retiring, individuals would stop accumulating savings and begin drawing them down. Say they had bought only private securities, like stocks, corporate bonds and shares in equity funds. To pay for their retirement consumption, they would have to sell this paper, and those still working would have to buy them. The money for these financial purchases could come from either increased savings (less consumption) by the working population, improvements in productivity (increased real income from work), or increased debt (borrowing by issuing new debt in order to purchase retiree debt). In other words, it’s the same set of alternatives faced by the government in dealing with Social Security.

The moral of the story is that, while the system of paper assets that governs wealth and debt is extremely important for distributional issues at the individual level, the overall relationship between retiree consumption, worker savings and productivity is deeper and ultimately determinate. Our fishing community either learns how to fish better, or its working members tighten their belts in order to feed their elders, or they make their elders tighten their belts. If they have a connection to other fishing communities, they can also borrow fish from their neighbors, with the understanding that this may reduce their living standards in the future. If you follow the money in the Social Security case, you find the same factors. Redeeming a bond is like supplying fish and must be financed through either greater productivity, reduced consumption or debt.

At the level of paper assets, Social Security is healthier than it has ever been in its history. At the level of the division of the national product between working and retired people, the political dimension is unavoidable. Overall, productivity growth has tended to exceed the rate of increase in the dependency ratio (retired to working population), but there will always be a tradeoff between the rate of growth in the consumption of workers versus that of retirees. This is less visible in the arena of private savings, since the claims of retirees upon working-age citizens are made in a decentralized way through financial markets. With Social Security, the process is centralized and guided by public decisions. The tradeoffs remain the same.

What people like Matt Bai are saying is that, as the retiree population continues to grow, it will force the rest of us to increase our borrowing because we refuse, on political grounds, to take steps that would impinge on our consumption. To avoid this, we should see to it that the growth in retiree consumption is curtailed. In my earlier post I referred to this as the catfood option, but maybe this was a mistake: cats love to eat fish.


Bruce Webb said...

Oof Peter we need to talk.

We have two terms of art: 'public debt' and 'debt held by the public'. They are not the same and have very different relations to Trust Fund redemptions. I don't want to hijack your important point but keeping them straight is also important.

Don Levit said...

Peter wrote:
The trust fund has accumulated a huge portfolio of government securities, and in a few years it is scheduled to begin a slow process of cashing in - selling securities for money that can be used to write checks to recipients. This money will come from the Treasury, which can raise it by selling securities.
You compared the process of cashing in Treasury securities to the process of cashing in stocks.
In my opinion, stocks are more liquid than Treasury securities.
Why? Well, when I buy a share of stock, I have an asset, and the company has an equal liability owed to me, at whatever the share price is when I cash in. Assuming this is a well-run company, they have reserves in order to redeem my stock.
Thus, an asset is traded for a liability.
In the case of Social Security, the Treasury security was originally offered to the trust fund when the Treasury borrowed a like amount of cash from the trust fund.
An asset was created for the trust fund, and a liability was created for the Treasury.
When the trust fund cashes in the Treasury, if the Treasury sells new securities, an additional liability has been created.
To make this comparison to the private sector, I cash in the stock by the company issuing bonds, for it doesn't have enough reserves to buy back my stock.
That's a company who is in trouble, and whose stock price, by the way, should be pretty low.
Don Levit

Jack said...

Oh, for crying out loud Don, you've been trying to peddle that kettle of fish over at Angry Bear for weeks now. You've been getting your ideological brains beat out there, and the point that you are making here is only a duplication of your positions on AB. Give us a break and recognize that you are not understanding the Trust Fund nor its function.

Jack said...

"The Trust Fund has accumulated a huge portfolio of government securities, and in a few years it is scheduled to begin a slow process of cashing-in—selling securities for money that can be used to write checks to recipients. This money will come from the Treasury, which can raise it by selling new securities."

Peter, This way of describing the functioning of the Trust Fund can lead to comments like Don's, above. I don't believe it to be quite right, and I'm guessing that you're trying to keep it simple. That's not a good idea on this issue.

Would it not be more accurate to say that the Treasury will be replacing new debt in the general budget while it reduces the asset value of the Trust Fund and transfers "funds" to Social Security beneficiaries. Rather than special Treasuries being "redeemed" the asset value of the special Treasury notes is being transfered and that transfer supported by the subsitution of new and equal debt in the general fund.

Yes, the general budget deficit goes up, assuming that nothing is done to off set the new debt (like allowing the Bush lopsided tax cuts to expire), but that's equivalent to haveing created debt by the creation and use of the Trust Fund assets originally. The size of those earlier budget deficits could have bveen counter balanced by never having legislated those Bush tax cuts to begin with. In essence it's not a question of new debt as the Trust Fund assets are utilized to support the benefits of retirees, but only the renaming of the debt.

Bruce Webb said...

'Debt Held by the Public' + 'Intragovernmental Holdings' = 'Public Debt'

Redemption of Trust Fund Special Treasuries, other things being equal, increases 'Debt Held by the Public' while holding 'Public Debt' even.

I don't know who the genius was that decided to make both 'Debt Held by the Public' and 'Public Debt' official terms of art while having them point at different things but I am hoping he is in his own Circle of Hell. Because he didn't make life easy up here on earth.

Debt to the Penny web-app

Bruce Webb said...

And Jack don't confuse 'debt' and 'deficit'. Any shortfall of SS income excluding interest against cost will score as a deficit for 'unified budget' purposes. And this would be true whether or not the actual cash flow was financed by existing taxes or issuing new debt.

In FY 2000 both Social Security and the General Fund ran cash surpluses and as a result Debt Held by the Public was reduced. But total Public Debt actually went up. Weird but true, 'Debt' and 'Deficit' can and have move in opposite directions, the former just isn't the sum of the latter.

Bruce Webb said...

And now you got me confused.

Any shortage of SS income INCLUDING interest against cost will score as a deficit.

Peter Dorman said...

Geez, you guys! I think one reason the SS debate has become so unnecessarily muddied is that too much ink has been spilled on budgetary technicalities. Yes, we don't want to get this stuff wrong, but the main point is that (1) retiring a portion of the trust fund essentially means honoring a claim on the consumption (liquid resources) of the rest of the population, (2) this is true whether cashing in occurs in the private or public sector, and (3) it all comes down to what working folks are prepared to pony up for their elders.

The only difference is that SS is public and visible: it's a transparent political decision, or should be. The logic of building up the trust fund was political: we were creating claims on future income that we would be compelled to honor in future years -- so let's honor them. (We could have gone with a pay-as-you-go model, which would be more or less the same in economic terms but would not entail the same political precommitment.) But private saving for retirement is no different: it's also the accumulation of claims. From a macro standpoint the process is the same.

Incidentally, this is one reason why hyperinflation is so awful: it is a repudiation of those claims and therefore a fundamental breach of the social contract.

Don Levit said...

Jack wrote:
Yes, the general budget deficit goes up, but that's equivalent to having created debt by the creation
and use of the Trust Fund assets originally.
Not really, Jack. The trust fund assets were created by the FICA credits to the trust account, so a legitimate asset was indeed created.
However, that asset was spent years ago, hopefully, for productive purposes.
Now, we are introducing a different type of debt, debt held by the public to replace intragovernmental debt, so your writing of the renaming of the debt is correct.
Instead of the debt decreasing, it is staying the same.
However, now that intragovernmental debt has been transformed into debt held by the public, 2 events occur, which did not occur with intragovernmental debt:
1. The deficit in the unified budget is no longer reduced.
2. Debt interest now becomes a current budget expense. Heretofore, interest on intragovernmental debt was "paid" by issuing additional Treasury securities (interest was "paid" by issuing more debt).
Don Levit

Jack said...

"However, that asset was spent years ago, hopefully, for productive purposes."

Spent, but lent. That's the crux of the matter. What was spent had been lent. As a result what was spent had been borrowed making it far easier to spend while reducing taxes at that time. So now we may have to raise tax revenues in order to pay back what was borrowed. Think of it as deferred taxation. Now is the time for all good men to come to the side of their country and pay their fair share of the tax burden from which they have been sheltered these many years. It's the only patriotic thing to do.

Jack said...

Sorry, that should read "..the aide of their country..."

Don Levit said...

I agree with you.
The money was borrowed and needs to be paid back.
I think the government could have placed itself in an easier position to do so, along with its other Treasury security obligations.
I am concerned about how all this debt will effect the generations to follow.
I assume you, Peter, and Bruce have the same concerns.
Don Levit

Jack said...

The paymebnt of debt has an easy solution which I am sure you and your owbn creditors are well aware of. In fact the Treasury knows about this self evident process. For example, if you neglect to pay your income tax in the year 2010 you will then owe to the Treasury the amount of that tax plus some penalty. That is a debt. You pay that debt by attending certain daily activities for which some entity transfers to you, or your account record, a monetary value. You in turn do likewise with that value and transfer it to the Treasury's account record. In that way the debt is paid.

The Treasury has similar methods available to reduce its debt. With the assistance of the Congress the Treasury Dept can put an assignment on the assets of its citizens. It can do this, again withh the assistance of the Congress, in a differentiated manner. That differentiation can be based upon the level of monetary assignments "earned" by the citizen population. It is a form of indexing. In effect, the greater is the monetary assignments that are made to individual citizens, the greater might be the assignments expected by the Treasury to be made by those citizens. This is similar to the debt payment example from above. The term in popular use is taxation. Governments, through the wisdom of its elected representatives, differentially assigns monetary values to be transfered into its Treasury Dept in order to then assign those transfers to the reduction of its debt.

It's a really simple process though it seems that most citizens understand it best when their personal assignment shares are kept to a minimal level via the increased assignment shares to others. While it might seem most logical to have such assignments from citizen accounts into Treasury Dept accounts to be based upon the value of assignments between citizens and those entities that generally transfer value into such citizen accounts, that is not generally what is expected to occur by those same high value in citizens. That sector of the citizen population seems to put greater value on their accounts in than the need to transfer value out of thier accounts. They hold the misguided view that less value out of their accounts results in more value generated genrally and then made available to the other sectors of the citizen population. This concept was demonstrated, both in theory and conflicting reality, by the continuous reduction of value transfer requirements from high value accounts into the Treasury Dept accounts while at the same time value was transfered from the Social Security Trust Fund account into Treasury Dept accounts as a means of counter balanced value. As a result there is now an imbalance between those accounts and a need for that discrepency of values to be addressed. It's not that complicated and can be accomplished by reversing the process of monetary value transfers. If you get my drift.

Debra said...

I'm a neophyte, and I don't understand a lot of your discussion above on.. "budgetary.. TECHNICALITIES" ??
But I DO know that words are VERY important.
Two of the most important words that are pitted against each other these days are... PRIVATE and PUBLIC.
It would appear these days that government is supposed to be run like a "private" business without taking into account its PUBLIC mission, (by the way, this is a total crock of shit in my book, a TOTAL crock of shit..).
Bottoming out the difference between "private" enterprise and "public" government is.. FATAL to the IDEA of government.
Should we be surprised ??
The very IDEA of government is under attack right now.
I agree that the PROBLEM is SOLIDARITY between the generations.
I don't see much solidarity going on in the U.S these days, AT LEAST IN THE PUBLIC marketplace, or the public speaking places.
Is it going on in PRIVATE homes, maybe ?...

Jack said...

"The very IDEA of government is under attack right now."
Well, not quite. Those who are making the loudest noice regarding the "evils" of their government are only complaining about those governmental activities that they aren't happy about. One has to wonder how their government would carry out the activities that they do enjoy the fruits of given their expressed preference for "drowning" that government.

In fact the loudest "leaders" of the shrink the government movement are little more than propagandist proponents of the wealthiest sectors of our society and the only government activity that they genuinely seek to reduce or eliminate are the taxes levied on the highest earners and the worst business practices of that same group in corporate form. In fewer words, shrinking the government is a canard. What Grover and Peter P. really mean is "we don't desire to pay any taxes, nor do we want any limitations on our most avaricious behavior patterns.

Don Levit said...

I am curious if you believe government should be run like a business, from the standpoint of limiting its debt to the amount it can realistically service, including paying down some of the principal?
Jack seems to take the position that the power to tax gives the government pretty much free reign to run deficits, for they are merely taxes deferred, which the government can always accelerate.
And, the taxes deferred are upon the wealthy elite, not the bottom 90%.
I agree with you about the lack of solidarity.
The more people feel insecure, partcularyt financially, the more we seem to regress to our basest instincts of survival, and to heck with the other guy.
Don Levit

Jack said...

"Jack seems to take the position that the power to tax gives the government pretty much free reign to run deficits, for they are merely taxes deferred, which the government can always accelerate." Don Levit

No Don, Jack has never said any such thing. You have misinterpreted some things that I may have said. I have used the words tax and government spending in the same breath, but not in the order you've chosen to attribute to me. I have said that we choose the government that does the spending. It does that spending in a variety of ways that are necessary and in other ways wasteful. Let's think of government not as spending money, but as carrying out activities that result in expenses. Taxes are only one source of meeting those expenses. The Fed can simply "print" more money to cover expenses. That's similar to a flat tax since it reduces the value of all of our money in an equal manner. The Treasury Dept of the government can also sell bonds. That is debt. All of these are means of reducing the deficiency of the budget, but not the reduction of the debt. A tricky circumstance.

As for the rich, they benefit most from all government activities so whatever is the wasteful aspect of government spending, the rich have little basis for complaint. And that includes their complaints about taxes. They pay a large share of the total taxes collected, but it is a much smaller share than the portion of the total income which they happen to earn. It's not that complicated, but it is complex enough to fool most of the people all of the time. The result being that most tax payers seem to think that the government should leave the rich to their riches.