Social Security and Future Pressure on the Fed to Monetize Debt

Don Roper
April 2004
Each spring the Social Security Trustees' Report appears with its annual projection of the number of years before SS benefits will have to be reduced. This year they estimated that social security benefits will be fully funded until 2042. Picking up on the upbeat forecast, Jane Bryant Quinn argued in her article, "Social Security Isn't Doomed," for 29Mar04 Newsweek, "benefits can be paid for nearly 40 years, without skipping a beat."

Social Security is currently running a surplus and the accumulated holdings of SS are suppose to reach something like $4trillion in the late 'teens. As the baby-boomers begin to draw SS benefits, that $4tril will be depleted over a quarter of a century -- the accumulation will reach zero around 2042 -- thereafter, outpayments will be limited to inpayments.

At least that's the usual catechism. But there's an ambush awaiting SS recepients and it's not the political Right trying to dismantle the program. The force that is going to dismantle this program is greater than Republicans acting alone -- it's unfortunately bi-partisan.

The Fed holds about $700bil of Treasury securities -- that's about 10% of "total" Treasury debt and about 17% (= 700/4000) of the Treasury $4tril debt "held by the public" where "public" includes holdings (of US Treasury securities) by central banks (Fed, BoJ, BoC, BoE, Bank of Mexico,...).
Treasuries held by the "public" are traded in the market whereas intragovernmental holdings (such as Soc Sec) are not traded in the market -- they hold bookkeeping entries or 'non-marketable Treasuries.'

Click for the source at the US Treasury

We hear a lot about "the federal budget deficit" where deficits are calculated, of course, as the change in the stock of debt, i.e., Debtt - Debtt-1
But from WHICH debt series -- total or (the 2nd column above) public ??? --   do we calculate "THE" federal deficit?
Like where does one see anything like the current half-trillion/yr budget deficit -- in the total or public debt series?
And where does one see the (small but) famous "budget surplus" of the late 'nineties -- in the total or public debt series?

It is tempting to conclude that politicians merely look at the debt series which suits their interest -- they point the press towards the total series when it is rising least rapidly and they point towards the public series when that one looks best.

But why should Republicans have been willing to recognize the budget in the last years of the Clinton Administration as being in 'surplus' when, in fact, the total series was rising?
Answer: Because a decision had to be made -- what should they do with that excess cash flow in the late 'nineties? The Democrats wanted to use the 'surplus' to retire Treasuries held by the public and the Republicans wanted to use the 'surplus' to lower taxes.

As the Bush deficit became large in 2003/04, the Republicans have, indeed, tried to shift attention back to the 'public' series -- which is rising less rapidly -- by arguing that the total national debt which

" includes borrowing from government trust funds ... involves intra-government interest payments,
an essentially meaningless bookkeeping exercise."

The point of this essay is to argue that the essential meaningfulness of the intragovernmental trust funds is exactly what undermines the notion that SS is "fully funded" for multiple decades.

The blue bars below represent Soc Sec Treasury holdings: SSt.

Click for source
www.ssa.gov/finance/2003/FinPosition.pdf

The change in SS holdings, ΔSSt, averaged about $250bil/yr over the 10 years shown in the chart on the left. This quarter-of-a-trillion cash flow feeds into general Treasury revenue each year -- it is pure gravy for the national political process to allocate.

But sometime in the late 'teens, the $4 tril or so of SSt is expected to peak and start its long decline. When a sufficient number of baby boomers have retired the $4tril SS accumulation will begin its long decline. Over a quarter century it will decline at the approximate average rate of $160bil/yr (= 4000bil/25yrs).
I.e.,   ΔSSt ≈ -$160bil/yr from say 2015 to 2040.
When ΔSSt turns negative, the government will have to feed SS something like $160bil/yr of cash rather than receive the current quarter-of-a-trillion/yr cash from SS. Cash flow between the Treasury and SS will reverse by $400/bil/yr or so. To meet this reversal of cash flow the federal government will have to

  1. raise taxes
  2. borrow from (peddle more Treasuries to) "the public"
  3. cut expenditures
or iv. Rather than being turned into SS's cash cow, national political leaders might take action like cutting SS recipients' checks -- perhaps by de-indexing SS payments. This may be the long-awaited "reform" of SS which could, if payments are cut sufficiently, extend the life of the SS accumulated holdings by decades. Retired baby-boomers could take a hit so their children could get more.
Other than the current SS surplus, the Treasury's other great 'cash cow' is the Federal Reserve since the Fed kicks back over 95% of the interest income they receive from the Treasury (currently about .04/yr on $700bil). The Fed-cash cow ($28bil/yr) is worth only a fraction of the current value of the SS-cash cow ($250bil/yr), but this could be reversed. Sometime in the 'teens, the Treasury needs to come up with about $400bil/yr when $250bil/yr payments from SS are reversed and become $160bil/yr payments to  SS. The Treasury could, at least from a technical/financial perspective, get this entire $400bil/yr from the Fed: If the US government were to follow path (ii) and sell $400bil/yr of Treasuries to the Fed, the resulting hyperinflation would quickly eradicate the real value of SS holdings of non-indexed Treasuries and the Treasury could easily afford to pay SS $400bil/yr worthless dollars each year.

Decades spiraling US public government debt outstanding caused by

will lead to 

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If economic history gives us a basic lesson applicable to the issues today this is it: