Brad Setser

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Prepare for the 50 year Treasury bond …

by Brad Setser
January 19, 2005

Since our newly inaugurated President seems intent on partial privatization of Social Security (despite lukewarm support from his own party), I thought I should offer him a bit of somewhat constructive advice.

Fund your plan by issuing 50 year bonds.

After all, long-term investments should be funded with long-term debt.

Is the partial privatization of Social Security — something along the lines of the Commission’s plan 2, even though Dick Cheney is right in that it keeps costs down by only providing puny private accounts, not manly Texas-sized private accounts — the kind of thing that should be financed with ten year bonds? I am afraid not. The plan moves forward the date when Social Security benefits exceed payroll tax revenues from 2018 to 2006. Do nothing and in 2015, an unreformed Social Security system would still be lending a (small) surplus to the rest of the government; adopt the Commission’s plan 2, and Social Security will be paying out more than it takes in.

What about twenty year bonds? Alas, The scale of the net transfer of general funds required under the Commission’s plan 2 is larger in 2025 — even with the benefit cuts — than it would be if we did nothing (1.03% of GDP v 0.64% of GDP). That’s right: the cash flow pressures placed on the rest of the government for the first twenty years of the plan 2 are unambiguously bigger than the cash flow pressures associated with doing nothing.

Maybe we should revive the thirty year bond? Or the other hand, maybe not. The Commission’s plan 2 would exhaust the Trust Fund in 2036, not 2052. A maturing thirty year bond would come due just as the government needs to be gearing up to provide the transfers of general revenue the Commission proposes to keep Social Security cash flow solvent between 2037 and 2050.

Don’t believe me? Let’s see what the CBO says:

CSSS Plan 2 would enable the government to pay the benefits scheduled under that law without transferring additional money from the general fund until 2036. From 2036 through 2050, transfers from the general fund would be required.

These transfers are a form of cheating. The Trust Fund — past payroll tax surpluses — is already depleted at this stage with plan 2. But benefits still exceed revenues, since the shift to inflation-indexing is gradually phased-in. The Commission squares this circle by just giving Social Security the money it needs. Give money to the current Social Security system, and it would be solvent after 2052 too.

Maybe 40 year bonds? Alas, Social Security benefits still exceed payroll tax revenues at that time. That’s right. Under the proposed reform, Social Security benefits, even with large benefit cuts for future retirees, would exceed payroll tax contributions until 2050.

To be totally fair, by 2045 Social Security benefits have been cut to the point where the net transfers from the rest of the government under Plan 2 are smaller than the transfers associated with keeping the status quo (0.43% of GDP v 1.23% of GDP). There is a difference, though. With the current system, the rest of the government is paying the Social Security Trust Fund back for past payroll tax surpluses it borrowed: the CBO says the Trust Fund will last til 2052 without any reforms. Under Plan 2, the transfers at this stage are just a gift.

But with plan 2, there will be small cash flow savings by 2050, and huge savings by 2075. HUGE. Guaranteed (or maybe not). Sounds to be like the kind of proposal that should be funded with a 50 year bond. That would match the costs (years 1-45) to the payoff (46 on) — so long as we keep payroll taxes higher than benefits after 2050 …

The bottom line: The Commission’s plan 2 eliminates cash flow deficits after 2052 (the source of the unfunded Social Security liabilities that so worries Secretary Snow) by creating cash flow deficits in Social Security from now until 2050 …

No way any private investor would fund a project with such an uncertain long-term payoff — at least not without a government guarantee. Imagine the prospectus. We have no clue what the world will look like in 2055, but it is safe to assume it won’t look much like what we say it will look like …

By the way, I love how de facto Treasury Secretary Dick Cheney “worries” about the risk of not cutting taxes enough, or about the risk of not creating large enough private accounts, but he shows no sign of “worrying” about the risks of borrowing too much. Personally, I like Treasury Secretaries who recognize that deficits do matter, and who understand that funds borrowed by the government are funds that are not available for private investment.

I would love to see the CBO’s analysis of the impact of the “Cheney deficits really don’t matter social security privatization plan” — diverting up to 6 percentage points of Social Security revenue into private accounts (with no cap, one assumes) would radically increase the budget costs of the reform. It takes between about 1/2 of the program’s revenues away, and barring a commmensurate cut in near term benefits, implies an enormous need for new borrowing. Plan 2 — which caps contributions to private accounts at $1000 a year, limits the diversion to about 1/6 of program revenue. Sounds like Cheney wants to float lots of 100 year bonds. (note: small edits to last paragraph)


  • Posted by Jesse

    Excellent set of examples of course, but I am afraid they will be wasted for the most part, because the public mind has been hypnotized into believing that red is blue and black is white, at least with regard to economics, if not in many other things as well.

    I think we are going to have one of our occasional deflation fears, and it never ceases to amaze, if not astound, at what a marvelous job the Fed and the government have done in getting so many otherwise intelligent people to worry about deflation and zero interest rates, while they debase the currency on a truly epic scale.

  • Posted by Tom DC/VA

    50 year treasury bond? Don’t go around making jokes like this, someone might take you seriously.

  • Posted by DF

    That some still talk of “deflation fear” when it is at the door is even more surprising.
    Money growth is fuelled by debt expansion. Debt shrinking will lead hitherto money shrinkage… WHatever the fed’s policy.

    There’s a living example in front of us to see. Japan has been “debasing” its currency as fast as it has been able. But to no avail. The reason ?
    Wages lag way behind productivity, and pull down prices.
    Inflation times are times of strong union power.
    These times are over.

    The federal bank can create as many dollars as it likes … NO one is spending them on consuming goods. Inflation does not prop up.
    More over, those dollars will be shortlived.
    Bankrupcies will erase cash faster than the central bank can increase them.

    What good is it to create cash, when people store it ?
    Jesse can’t you see a liquidity trap when it’s right there in front of you ?

    And this for brad :
    What private investment ?
    Private investment is still low, very low. There’s not enough profitable investments around. Not enough spending power to justify them in fact. Companies save (pay their debts and lend to consumers). So it’s hard to say that deficits crowd out private investments.

    It might be that deficits would be a good thing in the present situation, if they were used to invest, some solar reasearch in place of tenessee valley authority would have been useful in these times. Instead the deficits go to the military spending.

    Right now with this situation of profits being reliant on ever falling wages ever increased debt … With a tipping point being somewhere near now… Profits will be hard hit if debt does go up. Will the consumer saving ratio become negative in 2005 ?
    The government has a choice, it can boost consumer spending by increasing its debt, thus crowding out not private investment, but private lending to the consumer .
    Or it can boost public investment and suck up excessive present profit of companies. In so doing it would provide high paying jobs, allow future productivity gains, build the future…

    Don’t you think the choice has been made ?
    ANd it leads us right into deflation.

  • Posted by glory
  • Posted by L

    Prof, you are a genius. Your focus on the SS Trust Fund has shown the way to a solution.

    Problem: Boomer’s retirement will exhaust the special Treasury bonds in the SS Trust fund.

    Solution: have the Treasury issue more special bonds, enough to fully fund Social Security. Both are just different forms of future obligations of the US Gov’t, moving the liability from one “pocket” to the other.

    Bingo! No SS problem.

    Why stop there? Issue these non-negotiable bonds, which do not count as part of the Public Debt, to secure Medicare. That’s two problems solved!

    We can even reduce worries about the Public Debt itself by creating a Trust Fund to secure the regular Treasury Bonds issued to citizens and foreigners. With the debt no longer a worry, we can really let the deficit zoom!

    Let’s go all the way! Allow households to create their own Trust Funds. Each family issues special, non-negotiatable bonds to itself, funding all revolving and mortgage loans — secured by future earnings of that family.

    For those that think these ideas less than brilliant, they can continue to ignore the Trust Fund — and analyze the mix of Gov’t future liabilities vs. its likely income and borrowing power. Ignoring the Trust Fund, trying to ignore political games, focusing on the basics.

  • Posted by anne

    The Free Lunch Bunch

    If people are rightly skeptical about claims that Social Security faces an imminent crisis, just wait until they start looking closely at the supposed solution.

    President Bush is like a financial adviser who tells you that at the rate you’re going, you won’t be able to afford retirement – but that you shouldn’t do anything mundane like trying to save more. Instead, you should take out a huge loan, put the money in a mutual fund run by his friends (with management fees to be determined later) and place your faith in capital gains.

    That, once you cut through all the fine phrases about an “ownership society,” is how the Bush privatization plan works. Payroll taxes would be diverted into private accounts, forcing the government to borrow to replace the lost revenue. The government would make up for this borrowing by reducing future benefits; yet workers would supposedly end up better off, in spite of reduced benefits, through the returns on their accounts.

  • Posted by brad

    the trust fund represents an obligation to use the income tax to repay the social security system for past payroll tax surpluses. payroll cash flow surpluses now are used to cover payroll tax deficits in the future. some other taxes have to go up, true. that’s what happens if you borrow to cover current spending, and the rest of the government is borrowing from the payroll roll tax now.

  • Posted by Billmon

    “After all, long-term investments should be funded with long-term debt.”

    I guess they don’t teach you that at the Harvard Business School.

  • Posted by Billmon

    Or maybe Shrub just skipped that class…

  • Posted by New Economist


    Calculated Risk has pointed out that you predicted 50 year Treasury bonds in January.

    Today’s story in the FT suggests (see my blog link) we aren’t far off from that – or at least from the revival of 30 year T-bond issuance. Good call!