Tuesday, January 15, 2008

More about Social Security Trust Fund.

My previous post about SS fund being whole was a little misleading. It was interpreted by some people as meaning that "there is no problem, nobody panic". But the correct interpretation should be slightly different. What the analysis done by Bruce Webb shows is that the trust fund has enough assets in it right now to remain whole indefinitely if those assets remain at their expected values. The catch here is that fund's assets are mostly invested in US government bonds rather than in cash. In other words, US government borrowed money from the Social Security Trust Fund. The Fund therefore has direct exposure to US debts, and therein lies the problem. While US government debt is still (officially) AAA-rated, some economists have argued that US has amassed such a huge debt burden that it cannot possibly repay it in a normal way, so some kind of default has to happen. Since outright default of the government (like in Russia or Argentina) is unlikely, debt will be dealt with in a combination of other ways. Some of it will be devalued through inflation and dollar devaluation, some may be paid off through tax increases, and some through budget cuts. None of these three ways alone will be sufficient to deal with the debt. For example, if US lets inflation climb too high, it will devalue some debt that is sitting in things like non-inflation-indexed 10 and 30 years bonds but it will only make harder to pay other debts, such as the ones in short-term bonds that are getting rolled over and on which the interest rates would climb very high. Tax increases are very unpopular and extreme (read impossible) hikes would be needed to fix the budgets. Therefore the most likely course of action by the government would be to slash the spending, and some of the biggest items in the budget are Social Security and Medicare. Essentially, government may have to cut pensions to pay off the debts.

And this is the real threat to Social Security, not the lack of assets in the Trust Fund. The source of the problem is in the unbalanced federal budgets, not the Social Security structure. The reason we hear so much talk in the media about Social Security being broke is twofold. First, politicians want people to start getting used to the idea that Social Security is not guaranteed and will be scaled down. It is much easier to negotiate pension payments down if you can make people believe that they should expect no pension at all. The second reason is that government tries to divert people's attention from the real problem. If people understood that the root of the problem is in unbalanced budgets, not in Social Security itself, they would demand that budgets are cut by reducing things like military spending, and politicians don't want to hear that. It seems safer to convince people that their pensions are slashed because the Social Security system was broken rather than tell them that it's because the money was spent fighting a set of unpopular wars.

So no, Social Security is not broken. The government spending habits are.

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