Brad Setser

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The confused conservatives on the Washington Post oped page …

by Brad Setser
February 21, 2005

The Washington Post put out an oped on the partial privatization of Social Security over the weekend, which Kevin Drum appropriately jumped on.

One item in the oped jumped out at me:

The second risk in personal accounts is that their transition costs might scare financial markets. As we have argued before, investors shouldn’t take fright. The transition borrowing merely swaps government debt to future retirees for government debt to bondholders. Indeed, if personal accounts are coupled with a benefit cut, as they should be, the government’s total debts would fall; if anything, investors should be heartened. But financial markets are not perfectly rational. Coming on top of the president’s irresponsible budget policies, a flood of new bond issues might possibly frighten investors, perhaps triggering a fall in the dollar and higher interest rates.

While the Post oped writers include some appropriate caveats at the end, they basically endorse the White House argument that “debt issued to finance Social Security privatization should not count” because it will be offset by future benefits cuts, and thus will reduce the government’s implicit liabilities.

You have gotta be kidding me.

Let me tell you why:

1) If the markets care about implicit liabilities, they are not showing it. The prescription drug benefit, as Paul Krugman and others (including many conservatives) have pointed out, created a larger “implicit liability” than the current “implicit liability” associated with the Social Security system (the funding gap that arises from a roughly 1.5% of GDP gap between promised benefits and expected revenues after 2052, per the CBO, and after 2042, per the Trustees — the gap is less than 1.5% of GDP in 2052, but it rises over time). I don’t think there is much evidence that the markets penalized the US government for the increase it the government’s implicit liability.

2) Best I can tell, using realistic forecasts, the consolidated government has a gap between its projected revenues and its projected expenditures of 3.5% of GDP from now until eternity, and probably more (expenditures start rising sharply after 2010). Take Social Security’s cash flow surplus – including the interest income from the Trust Fund that Social Security reinvests in governments bonds – out of the consolidated budget and that gap is well over 4% of GDP for the next few years, indeed close to 5% of GDP. The general government’s cash flow deficit, assuming no change in current policies, has a much higher present discounted value than the gap in the Social Security system: the gap is bigger than the gap in Social Security, and it starts today, not in 2052. If the markets want to worry about something, they have plenty of things to worry about that “hit” long before the Social Security funding gap emerges in 2052.

3) No one seems that worried now, whether about the current cash flow deficits of the general government or the implicit liablities created by promised Social Security and Medicare benefits. American investors seem to think that the government will eventually solve its fiscal problems (including problems that are much, much more urgent than the problems in Social Security), and will come up with the revenues to pay its existing stock of bonds without inflating away their real value. I hope they are right, though I suspect that it will take a bit of pressure from the bond market to bring about the needed fiscal policy changes. I don’t quite understand what foreign buyers of longer-term Treasuries are thinking. It is pretty clear that the US dollar will have to fall substantially over the next ten years (in real terms) to bring the trade deficit down, so the real value of their bonds will fall. At least for now, many central banks seems to believe future capital losses are an acceptable price to pay for current export growth. No guarantee this will last though. One risk of Bush’s proposed reform is pretty easy to see: the US might start flooding the market with Treasuries just when the biggest current buyers of Treasuries, the world’s central banks, start to pull back …

4) The notion that the ten year bond has already “priced in” the gap between Social Security revenues and expenditures that develops after 2052 always struck me as a bit ludicrous. Holders of ten year bonds have to worry about the risk that interest rates may rise over the next few weeks, or next few months, or next few quarters. Any rise in interest rates reduces the current market value of bonds — a concern of active traders. Buy and hold investors in the US should worry about the risk that inflation may pick up and erode the real value of their bond between now and 2015; buy and hold investors abroad should worry about the risk of dollar devaluation. Since Social Security payroll taxes exceed expenditures until 2018, the last thing anyone holding a ten year bond needs to worry about is Social Security; the only risk here is that W may come up with enough support for his plan to take money out of the system and flood the market with Treasuries. Even holders of the thirty-year bonds issued in 2000 shouldn’t worry about the gaps between Social Security revenues and expenditures that don’t materialize until in 2052 — though they might want to worry a bit about the need to start issuing new bonds to redeem the Social Security Trust Fund’s existing holdings of bonds around 2028 if the government does not get its overall fiscal act together before then. The bonds held by the Trust fund are real, and servicing them will put pressure on the rest of the government …

5) Finally, let’s talk about the cash flows associated with Social Security reform along the lines the President seems to be talking about.

In broad terms, the current Social Security system takes in about 5% of GDP in tax revenues, and pays out about 4.25% of GDP in benefits (for more details, see the CBO spreadsheet). It also collects roughly 0.75% of GDP in interest on its existing holdings of Treasuries. After 2010 or so, the baby boom starts to retire, and benefits creep up. By around 2018, they exceed payroll tax revenue, and the Trustees will need to use the interest on their bonds to make payments. After 2028, or maybe later, depending on your assumptions, benefits will exceed payroll tax revenue and interest income, and the trustees will have to start selling some of their assets (the bonds) to cover payments. That is why have run a payroll tax surplus for the past twenty years or so — we raised the payroll tax in the 1980s so we could pay Social Security benefits to the Baby boom without raising payroll taxes from 2020 on. After 2042 (trustees), or 2052 (CBO), the trust fund will be gone. Social Security payroll tax benefits of around 5% of GDP won’t cover the estimated 6.5% of GDP cost of promised benefits. That gap lasts from 2052 on, and gets a bit wider over time, but not much.

What happens if you “reform” Social Security along the lines the president is talking about. You take 1% of GDP in revenues out of the system, maybe more (depending on how large the private accounts are), introducing an immediate gap between payroll tax revenues (now 4% of GDP) and Social Security benefits (4.25% of GDP). The system has to draw on the Trust Fund more quickly, or it needs to receive cash infusions from general revenues immediately. Social Security benefits still rise as a share of GDP as a result of the baby boom’s retirement. They go up to say 5.5% of GDP, maybe more, before starting to fall as a result of the phased in benefit cuts. That leads to sustained cash flow gaps in Social Security — substantial gaps, as the CBO’s analysis of the Commission’s plan two makes clear.

Those gaps last for the first 45 years or so of most proposed reforms, and lead to a substantial increase in the stock of outstanding US government debt in the markets. After 45 years, traditional Social Security benefits start to fall substantially in the proposed plan. In the Commission model two plan, they fall to something like 2% of GDP by 2100. It is unrealistic to think that payroll tax revenues will stay at 4% if benefits are less than that, with the difference applied to pay back the bonds used to fund the transition. It is more realistic to assume payroll taxes will gradually be reduced in line with reduced benefits, or the payroll tax will be used to fund Medicare.

What is the basic trade-off then? The reform basically creates cash flow deficits in Social Security (defined as the payroll tax, the money set aside from past payroll tax surpluses, and any interest on those surpluses) where there were none from now until 2050 or so. In exchange, the reforms theoretically get rid of the gap between promised benefits and expected revenues after 2050 (Social Security’s implicit liability).

The only certainty associated with the reform is that it will increase the amount of marketable debt in the near term, and that this increase will lead to a significant increase in the United States “debt to GDP ratio”, with debt here being “debt sold to the public.” Any offsetting cost savings are purely hypothetical — they are no more real that the CBO budget forecasts that assume the budget deficit will go away because the tax cuts expire. Any future benefit cut embedded in the reform could (and, if it is too draconian, almost certainly will) be reversed by future Congresses.

In other words, the proposal effectively takes a government program that is now fully funded, indeed over-funded, on a cash flow basis, and creates a cash flow deficit in that program immediately. After all, if the rest of the government currently operates with cash flow deficits, why shouldn’t Social Security too?

If you hold a 10 year bond, or even a 30 year bond with a residual maturity of 25 years, the cash flows of the proposed reform are negative until after your bond matures, and the reform would involve a substantial increase in Treasury issuance and the overall stock of Treasuries in the market while the bond you hold is outstanding.

What is for the bond market not to like?

(Sorry about the rant; I really do think the Post could have done a bit better on this one)

By the way, I recommend Jason Furman’s work on Social Security for the Center on Budget and Policy Priorities. He hardly needs the plug — David Wessel drew heavily on his work for a Wall Street Journal feature last week. Full disclosure: Furman is an active Democrat, and no fan of the President. He also knows Social Security inside out and produces solid numbers.


  • Posted by steve kyle

    Two things

    1. In nice theoretical models, you get to borrow “at the market interest rate” to do an intertemporal optimization for yourself. What these guys cant seem to figure out is that there are TWO sides to the transaction and when you are talking about $2 trillion you are no longer able to blithely assume you can do anything “at the market interest rate” because you are no longer small relative to the system as a whole. Put another way, if you want to borrow that much you are going to be paying a much higher rate. MUCH higher.

    2. As for prefunding the baby boom, I have yet to see anyone say what is truly pissing me off. I am 48 and so am right in the middle of the boom. Since 1983 I have been prefunding MY OWN retirement by paying more into the system than they need to pay my grandma and my parents. That money they have in the trust fund is money I PAID IN in the expectation that when I retire I WILL GET IT BACK.

    This isnt any “intergenerational compact”. This is the government making ME prefund their eventual payment TO ME. They took my money and put it in Treasuries so they could give it back to me later. There isnt any other generation involved in this. Today’s young folks arent getting off this hook because they were never on it, at least as far as the prefunding goes.

    So when they talk about repudiating the Trust Fund (or imply it since they will never say it openly) what they are actually doing is talking about turning that pre-funding I did into an outright theft. That extra money I paid in was never going to go to some other generation. It was mine all along and now they want to simply take it. And that really really pisses me off.

  • Posted by anne

    Steve, me too me too.

  • Posted by brad

    steve — well said.

    I am a bit younger than you, so for me, the risk is that I will be stuck paying payroll taxes for the current generation of retirees (not your age cohort, but the one ahead of you that gets full benefits), but lose any claim on the next generations payroll taxes (no more social security).

    In return, I get a private account, and the DEBT issued to fund the private account. Leaving aside distributional issues associated with the taxes used to pay off the debt, on net, i only get the different between the returns on my private investment and the debt — that may or may not be all that good a deal, but it almost certainly won’t full make up for paying one generation on a pay as you go basis but not getting a claim on the next generation.

    all in all, i would rather not take on the explicit debt, keep a social security insurance system to protect against a range of risks, and just save outside social security …

    (generations after mine that don’t have to pay off the moral claims accumulated by current generation of retirees and near retirees get a slightly different deal).

  • Posted by JackNYC

    Can I suggest another way of looking at the problem?

    “Increases in legal immigration would provide a significant boost to Social Security. The size of the actuarial deficit would be reduced over 50 years by 10 percent if legal immigration increased 33 percent (an additional 264,000 immigrants a year)….”

    I always loved the lady in the harbor.

  • Posted by MTC

    JackNYC –

    Though demographers would probably scoff, I cannot escape the niggling sense that as the number of disfunctional nations on earth shrinks the number and quality of the individuals wishing to emigrate to the U.S. will also decline.

    Then again, I also believe that most island-dwelling peoples will move to the continents over the next few decades.

  • Posted by JackNYC

    I would hope that you are correct in your feelings. Thus the million or so a year wishing to come to the U.S. would be motivated by desire rather than desperation (as were my ancestors).

  • Posted by brad

    Delong has the (valuable) capacity to take something I write, and make it shorter and better.

  • Posted by dsquared

    The transition borrowing merely swaps government debt to future retirees for government debt to bondholders. Indeed, if personal accounts are coupled with a benefit cut, as they should be, the government’s total debts would fall

    If this “debt to future retirees” in the form of pension fund liabilities can have its coupon unilaterally cut by the government without compensation, then it’s not debt; it’s equity.

    What do bondholders do when they see a company issuing debt to buy back common stock?

    (I did a gang-load of work on “sovereign equity” back when it was a semi-hot-topic in the mid 1990s …)

  • Posted by anne

    March 10, 2005

    America’s Senior Moment
    By Paul Krugman – New York Review of Books

    The Coming Generational Storm: What You Need to Know About America’s Economic Future
    by Laurence J. Kotlikoff and Scott Burns

    Two Problems, Not One

    America in 2030 will be ‘a country whose collective population is older than that in Florida today.’ It will be in ‘desperate trouble’ because the expense of caring for all those old people will cause a fiscal crisis. The nation will be plagued by ‘political instability, unemployment, labor strikes, high and rising crime rates.’ That’s the picture painted in The Coming Generational Storm by Laurence Kotlikoff and Scott Burns, a book that has helped to feed a rising tide of demographic alarm.

    But is that picture right? Yes and no. America does have an aging population, and a responsible government would take preparatory action while the baby boomers are still in the labor force. America also has very serious long-run fiscal problems. But these issues aren’t nearly as closely linked as much of the discussion would lead you to believe. The view of demography as destiny is only a half-truth, and in some ways it’s as damaging as a lie….

  • Posted by anne

    America’s Senior Moment
    By Paul Krugman – New York Review of Books

  • Posted by anne

    America’s Senior Moment
    By Paul Krugman – New York Review of Books

    The best bet, suggested both by a look at the numbers and by basic economic theory, is that prospective returns in the form of dividends and capital gains on stocks are somewhat higher than those on bonds, but not much higher—and that the higher expected return on stocks is offset by higher risk. That’s why prudent investors hold portfolios containing both stocks and bonds, and why borrowing to buy stocks—which is, to repeat, what Bush-style privatization boils down to—is a very bad idea.

    Taking away the assumption that stocks will yield very high rates of return fatally undermines the arithmetic of privatization. Again, consider the analogy of borrowing and using the money to buy stocks: if those stocks end up yielding a lower rate of return than the interest rate on the loan, you’ve made yourself worse off. Even if your best guess is that the return on stocks will somewhat exceed the interest rate, you can’t be sure of that, and you’ll be in a lot of trouble if your guess proves wrong. Most privatizers assume, when selling their schemes, that stocks will yield about 7 percent a year on average after inflation, while the interest rate after inflation will be only 3 percent. If the equity premium —the spread between the average return on stocks and the average return on bonds—really were that large, borrowing to buy stocks wouldn’t be a sure thing, but the odds would be strongly in favor of coming out ahead. But if the expected rate of return on stocks is only 5 percent or less, which many economists think is more reasonable, the chances that borrowing to buy stock will end up being a los-ing proposition are quite high—especially if one takes mutual fund fees into account….

  • Posted by DF

    Hard landing and stocks …

    This is just my usual rant :
    Why bother ? The proposal is that individual investors would get the choice.
    What are the chances of a hard landing scenario for the USA in 2005-2006 ?
    I think I heard huge, foreign central banks won’t finance forever and the US consumer is overloaded with debts.
    How will the US stock markets fare in a hard landing scenario ?
    Well … not well. The bond market might do OK if deflation keeps nominal rate low .. But any way you look at it, there won’t be a lot of money to make on the markets.

    And so here we are :
    1 who will be foolish enough to invest in private accounts ? The stock market has not risen for 5 years … In 2009 it will make 9 years of a declining market.
    2 What will happen to the social security anyway ?
    Can anyone forecast what would be the effect of a depression on social security ?
    There is no depression in any of the forecasts of the federal or social security deficits. HOw come ?

  • Posted by steve kyle

    Well, actually there IS a depression in the forecast – The baseline assumptions for growth in the SS projections are less than 2% over the next 75 years. The actual growth over the LAST 75 years was 3.4%, and that period included the Great Depression. So you could say that the projections for the future include AT LEAST a Great Depression.

  • Posted by anne

    Some Inheritance

    As he stumps for Social Security privatization, President Bush always gets a big round of applause for promising that the money in a private account could be passed on to one’s heirs.

    If those happy clappers only knew the details.

    Under the president’s proposal, when you retired you would not be able to start spending the money in your private account until after you bought an annuity, a financial contract in which you hand over a lump-sum payment and, in return, get a monthly stream of income for life. The upside of buying such an annuity would be that you’d be protected against outliving all of your money. The downside is that even if you died immediately after retirement, the most your heirs would inherit would be the amount that remained in your private account after you had paid for the mandatory annuity. (If you lived longer, of course, you might well need to spend the remainder to supplement the annuity’s low monthly payout. )

    The idea of making the private accounts part of one’s estate is particularly appealing to low- and middle-income earners, who may not have all that much to leave to their heirs under normal circumstances. But those are exactly the people who would have to use the largest share of their accounts to buy annuities. The government would require that annuities be large enough to keep recipients above the poverty line for life. The less you had to start with, the less you’d have left over after buying the mandatory annuity.

    What if you died before you retired? …

  • Posted by anne

    Appeal to Young on Pension Plan Gets the Attention of Their Elders

    CHESTER, Pa. – Almost no one is a more outspoken advocate of President Bush’s Social Security plan than Senator Rick Santorum, the third-ranking Republican in the Senate leadership, who is campaigning across his state this week, trying to get young people to focus on their retirement.

    Mr. Santorum argued, again and again, that the debate over Mr. Bush’s plan for private accounts was really about young people’s futures, because their benefits were at risk and because Mr. Bush had repeatedly promised that he would make no changes affecting Americans over 55.

    This is a key element of the Republican strategy, creating an energized and mobilized younger generation fighting for its piece of an ownership society.

    But there is a problem with that approach: retirees and those near retirement, a legendary political force, refuse to be shut out of the debate. At Widener University in Chester on Tuesday afternoon, people over 50 occupied perhaps half the seats at a forum held by Mr. Santorum and asked many of the questions – most of them negative.

    At one point, Mr. Santorum looked out at the raised hands and said somewhat plaintively: “I’m seeing a lot of older hands. I’m not seeing any younger hands.”

    And still they kept coming, the “older hands,” with questions that were not really questions….

  • Posted by brad

    From Samuelson in the Wapo today.

    “In 2025 Plan 2 would reduce projected Social Security spending from 5.71 percent of gross domestic product to 5.27 percent of GDP, the agency estimates. ”

    Remember, diverting payroll taxes into personal accounts diverts about 1% of GDP of revenue out of Social security, to revenues fall from 5% of GDP to around 4% of GDP (potentially more, if Bush goes for texas sized private accounts), so the gap between revenues and expenditures (the one expected to emerge in 2019 if nothing is done and so worries Bush now), would be about 1.3% of GDP in 2025.

    The benefit cuts in plan 2 are pretty large, probably larger than is politically possible, and the commission i think assumed plan 2 starts in 2003 0r 2004, not 2009-11. If you implement the reform in 2010, and exempt those ten years from retirement from the program, so they get full benefits, there won’t be any cost savings in 2025 (we will have to wait for updated numbers), since you have full benefits for everyone who retired before 2020, and only tiny benefit cuts for those who retire after 2021. the cost savings start showing up in say 2035 … so in 2025, realistically, the funding gap is more like 1.7% of GDP — the 5.7% of GDP in promised benefits, v. the now reduced 4% of GDP revenues.

    Does the post oped page really think this will have NO impact on the market? in 2025, the reform is still something like 25 years away from generating revenues equal to the (reduced) promised benefits …

    If we have overpromised, and have indicated we will give the baby boom more social security and medical care than we can afford, Samuelson is right, we need to cut benefits for the baby boom/ raise some set of taxes. Bush proposed reform does neither — it does not cut baby boom benefits and it reduces overall revenues (to fund the private accounts for the post baby boom generation).

  • Posted by anne

    “If we have overpromised, and have indicated we will give the baby boom more social security and medical care than we can afford, Samuelson is right, we need to cut benefits for the baby boom/raise some set of taxes.”

    We decidedly do not need to cut benefits. The baby boom generation has faithfully worked for America, and paid Social Security and Medicare benefits for their grandparents and parents and accumulated a fine surplus for their own benefits since 1983. The faith of this generation must in turn be honored, and will be.

  • Posted by anne

    Robert Samuelson:

    “Once you’ve done this math, you recognize that benefit cuts in Social Security, Medicare and Medicaid are inevitable. They’re the only other way to limit massive tax increases or immense budget deficits.”


  • Posted by anne

    America’s Senior Moment
    By Paul Krugman – New York Review of Books

    Medicare, Medicaid, and the Health Care Challenge

    If demography is only a medium-sized problem, why do long-run federal budget projections look so scary? The answer is that they assume that the long-term historical tendency of health care spending to rise faster than gross domestic product will continue. That trend has not reflected runaway government spending: private spending on health care has risen almost as fast as government spending. (In 1980, private health spending was 5 percent of GDP, and government health spending was 3.8 percent. By 2003 the numbers were 8.3 and 7.0, respectively.) Nor is it a case of runaway inflation: rising medical costs have not historically been driven by rising prices for existing medical procedures. There is plenty of gouging and waste in the US health care system, but there always has been, so that’s not a big factor in the trend. The main reason health care is continuing to absorb a larger share of the economy is innovation: that the range of things that medicine can do keeps increasing.

    A good example of what drives rising health care spending is the recent decision by Medicare to pay for implanted cardiac devices in many patients with heart trouble, now that research has shown them to be highly effective. Should this be considered a cost increase? Only if we’re careful about what we mean by ‘cost.’ It doesn’t increase the cost of providing the same care as before; Medicare is spending more to take advantage of a new opportunity to save lives….

  • Posted by anne

    An important article on a related aspect of medical costs:

    Behind Those Medical Malpractice Rates

    Speaking before hundreds of doctors and medical workers in a St. Louis suburb last month, President Bush called attention to a neurosurgeon on stage with him in the small auditorium. The doctor, the president said, was paying $265,000 a year in premiums for insurance against malpractice claims.

    Such high prices, ‘don’t start in an examining room or an operating room,’ the president declared. ‘They start in a courtroom.’

    Indeed, at many recent appearances, Mr. Bush has complained about the ‘skyrocketing’ costs of ‘junk lawsuits’ against doctors and hospitals.

    But for all the worry over higher medical expenses, legal costs do not seem to be at the root of the recent increase in malpractice insurance premiums. Government and industry data show only a modest rise in malpractice claims over the last decade. And last year, the trend in payments for malpractice claims against doctors and other medical professionals turned sharply downward, falling 8.9 percent, to a nationwide total of $4.6 billion, according to data compiled by the Health and Human Services Department….

  • Posted by brad

    anne — delong & pandagon clearly agree with aspects of your critique of samuelson. my main point is that the baby boom will increase soc sec and medicare costs (more so medicare), tho in soc sec’s case, 6% of GDP is affordable if we keep the current payroll tax (5% of GDP) and the rest of the government repays the past payroll tax surplus it has borrowed. I am pretty sure medicare is in worse shape — i.e. it requires greater adjustment in benefits or underlying revenue streams.

  • Posted by glory

    Global Aging
    By Pete Engardio and Carol Matlack
    With Gail Edmondson in Helsinki, Ian Rowley in Tokyo, Colin Barraclough in Buenos Aires, Maureen Kline in Milan, William Boston in Berlin, and Rachel Tiplady in Paris

    Fewer Japanese

    The future has arrived slightly quicker than expected in Japan, with the news that last year, for the first time since records started in 1950, the country’s male population fell. The decline was fractional, and could be totally attributed to more men moving out of, rather than into, Japan, probably because of company transfers. Nonetheless, this was a demographic outcome waiting to happen because of the country’s falling birth rate, which set a record low in population growth of only 0.05 per cent last year. Japanese experts are now predicting that next year will see the first decline in the country’s overall population.

    The shrinking of the workforce and the swelling number of pensioners is a trend occurring across many developed, and some developing, countries. Indeed, thanks to its one-child policy, China is forecast to see the ratio of working age people to pensioners collapse from more than 6:1 in 2000 to fewer than 2:1 in 2050 as that country ages faster than any other in history.

    But the drama for Japan is that it is in the van of this movement, and therefore first to face its consequences. The most obvious are for Japan’s fiscal situation. There will be fewer workers to shoulder pension costs and the burden of government debt. However, the economy is in no position to sustain serious tax increases. So the solution must be found elsewhere.

    Demography will itself hit the growth rate, which is a multiple of a country’s population and productivity increases. However, a fall in the first of these factors could be offset by higher growth in the second. And Japan does have scope to increase productivity, especially in the domestic services sector, which outside bodies and experts are constantly telling Tokyo should be further deregulated.

    If Japan were to adopt Scandinavian-style policies that cater for working mothers, it could raise both its female worker participation and birth rates. If it cannot, however, it may have to relax one of the world’s most restrictive attitudes towards immigration.

    But, provided it does not trigger irreversible social implosion, a declining and ageing Japanese population should not be regarded as a tragedy. An easing of population pressures in the crowded Japanese island chain would benefit the planet. It might also help Japan meet its Kyoto emission targets. Nor, in the shorter term, is it clear that the Japanese economy would suffer. Some economists argue that consumer demand would be sustained by the fact that the working population will remain stable for a fair number of years after the overall population starts to decline and by the propensity of swinging singles and childless couples to splash out on consumer goods.

    Finally, it might reassure those of Japan’s Asian neighbours that are still nervous about the thought of a revival of Japanese nationalism. It is hard to be too worried about such militarism if the samurai are getting greyer and fewer in number.

  • Posted by glory

    Long bonds

    The longer life of western pensioners is an issue that is taxing governments. One of the most pressing problems is how to finance a retirement that could last longer than a working life. This is why France’s decision last week to issue 50-year bonds is to be welcomed. In fact, it has proved so popular with investors that the Agence France Trésor, which manages the country’s debt, has already seen demand for €5bn (£3.4bn) of the bonds – the upper limit of the amount it said it would issue. Germany, Italy and the UK are watching the French experience with interest. All are considering the launch of 50-year paper. The US government is coming under pressure to sell 30-year bonds again, having stopped issuing them four years ago.

    There are some longer-dated bonds in the market: even companies such as the UK’s United Utilities have recently been issuing 30-year bonds. Governments have in the past also issued so-called war loans, which are perpetual bonds. But there is a big gap between supply and demand – some banks put this at tens of billions of dollars.

    So great is the current investor interest in long-dated bonds that the yield curve is depressed partly by lack of supply. Yields on long bonds have fallen sharply, with eurozone 30-year yields at a record low of 3.83 per cent last week. Hot money is chasing long-dated and index-linked bonds as speculators bet on increasing pension fund interest in the asset class.

    It is very hard for pension funds to find the right assets to match their long-term liabilities. Pension funds essentially face three risks: associated with duration, inflation and longevity. While 50-year bonds can meet the problem over the mismatch between a fund’s long-term liabilities and the duration of its investments, long-dated index-linked paper would provide for pension funds’ inflation needs as well.

    Pension funds have tended to rely too much on equities for superior returns in recent years. Now many are moving into bonds just as yields fall. Low interest rates have exacerbated the deficits in many corporate pension schemes because the rate at which liabilities can be discounted has fallen. A large shift into bonds makes it more difficult for schemes to recoup their pension deficits. But if part of a fund’s portfolio were underpinned by secure long-dated and inflation-linked paper, it could seek out higher-yielding assets uncorrelated to equities and bonds.

    With interest rates so low, it is not expensive for governments to issue long-dated debt. If they were to lead, companies and other supra-national bodies would follow, since it would be easier to price longer-dated debt. Governments worldwide should consider the launch of long or even perpetual index-linked bonds. This would give the added advantage of imposing an inflation discipline on ministers. It is the least many governments can do in return for offloading much of their pension risk on to the private sector.

  • Posted by anne


    With your post and comments, I agree completely. We can afford Social Security benefits for baby boomers. The actuaries project growth of 1.9% in revenue and benefit analyses. With 2.2% growth however there may be no adjustment needed in benefits or revenue. Happily assuming drastic changes are needed for the Social Security system to be viable through the baby boomer years is nonsense. Though an economist can certainly wish for change, distorting the revenue limits the program may develop speaks to wishing to set aside Social Security.

    Medicare is a larger problem, but not because costs of current medical needs will necessarily be beyond control, rather because there is continually more to be done in medical care and there is no trust fund surplus to provide.

    Medicaid is a more moderate though growing problem. However, where Social Security and Medicare have powerful advocates, Medicaid has the poorest as prime advocates and is most vulnerable.

  • Posted by anne


    These Financial Times articles are important. Thank you, as always.

  • Posted by glory

    here’s another one! off of nouriel’s globalmacro site 😀

    Lex: Inflation targets

    Power can be addictive. During Alan Greenspan’s 17-year tenure as chairman of the Federal Reserve committee, he has dominated US monetary policy. Unsurprisingly, he has also resisted anything that could curb his freedom to act such as an inflation target.

    But with Mr Greenspan departing in 2005, could the Fed be about to adopt such targets? Clear indications will not emerge until this week’s release of the minutes of a recent Fed debate. However, last week the Fed published inflation forecasts for the first time, which suggests that it may be inching towards price objectives. If so, it would be thoroughly welcome.

    The reason is that US monetary policy is dangerously dependent on personalities and market management games. This has not harmed the core consumer price index yet: last year’s rise was just 2.3 per cent. However, last week’s producer price data show that inflation risks cannot be entirely ignored. More immediately, the real costs of the Fed’s approach can be seen in capital markets, where its efforts to both massage and react to market signals are creating a type of feedback loop. The current low long bond yields, for example, are being cited as proof of low inflation expectations, prompting the Fed to sound relaxed about inflation, which keeps yields low. Meanwhile, the Fed’s commitment to “measured rate rises” is fuelling investor risk-taking, creating distortions that the Fed deplores.

    An inflation target cannot solve all these problems. And it does have drawbacks, most notably that it can prompt officials to ignore other important factors such as asset prices. However, this danger can be mitigated by adopting a broad inflation objective, rather than a legalistic target. And the disadvantages are outweighed by the benefits of enhanced policy transparency and consistency above all, decoupling this from individuals. That is why the Fed should act now. The world can ill afford a market jolt created by Greenspan’s departure.

  • Posted by DF

    OK for the projection of 2% growth instead of 3,4%
    But I still think that growing 2% annually has not the same impact as falling 20% and then growing 5% annually.

    During those years when the GNP falls … Where will the money come from ?

    I simply state : there’s never been a major depression after the new deal and the creaction of the social security programs in all western countries.

  • Posted by Movie Guy

    I like good humor. But then it comes back to mind that I’m reading economic and market projection information….

    Yeah, you gotta be kidding.

  • Posted by Gerard MacDonell

    Good point. One reason for this may be that implicit liabilities may not be inflated away, so the time inconsistency problem is not relevant to them.