Russell Roberts's Blog, page 1432

The Fraud of the Social Security 'Trust Fund' Exposed by a Most Unlikely Source

Today's Wall Street Journal exposes the lie that is the so-called "Social Security Trust Fund" – and further reveals the disgraceful flippancy with which politicians and their go-fers mislead the public about it.  Here's a slice:

President Obama famously played to grandma's Social Security fears this week, saying in an interview about the debt-ceiling talks that "I cannot guarantee that those checks go out on August 3 if we haven't resolved this issue because there may simply not be the money in the coffers to do it."

To which a friend of ours replied, whatever happened to the trust fund?

That's the fund that, according to our politicians, is holding all those Social Security taxes that workers pay. Why can't Congress or Mr. Obama dip into that $2.6 trillion cash hoard to pay benefits until this debt-limit business gets sorted out? After all, as White House budget director Jack Lew put it in a February USA Today op-ed, "Social Security benefits are entirely self-financing."

Not quite. As everyone in Washington knows, the trust fund contains not cash but IOUs. Payroll taxes don't go to some vault in Fort Knox, and they certainly aren't invested. When Social Security runs a surplus, Congress spends the money immediately on something else and then the government claims its owes a debt to itself. Where the money will come from to pay these IOUs is anybody's guess—though Mr. Obama is hoping it will be higher taxes.

Trust fund balances only exist in "a bookkeeping sense," as Bill Clinton's budget director put it in 1999.

Ignoring the question of whether or not failure to raise Uncle Sam's current statutorily set debt ceiling will oblige him to default on paying creditors (or, what is a different thing, to reduce his spending), clearly and unquestionably fraudulent (or inexcusably reckless) are the many claims made over the years that the bonds in the Social Security 'trust fund' are real wealth held by the Social Security Administration, thus protecting it and its beneficiaries from any fiscal problems that might beset Uncle Sam.

An I.O.U. that you write to yourself and that you yourself hold might be a useful accounting device, but it is not wealth.  Unfortunately, many politicians and bureaucrats enamored with Social Security lie (the word is not too strong) repeatedly about the nature of these bonds and what they imply about the solvency of Social Security.

Here's more of what Pres. Obama's Director of OMB, Jacob "Jack" Lew, wrote this past Spring in the pages of USA Today about the 'trust fund':

Social Security benefits are entirely self-financing. They are paid for with payroll taxes collected from workers and their employers throughout their careers. These taxes are placed in a trust fund dedicated to paying benefits owed to current and future beneficiaries.

When more taxes are collected than are needed to pay benefits, funds are converted to Treasury bonds — backed with the full faith and credit of the U.S. government — and are held in reserve for when revenue collected is not enough to pay the benefits due. We have just as much obligation to pay back those bonds with interest as we do to any other bondholders. The trust fund is the backbone of an important compact: that a lifetime of work will ensure dignity in retirement.

Mr. Lew is either a liar or he is incompetent at understanding even the most basic tasks and features of bookkeeping, finance, and clear thinking.  His own boss earlier this week inadvertently gave strong evidence to this effect.

See here.

Quotation of the Day…

… is from page 19 of Hayek's 1933 essay "The Trend of Economic Thinking" (reprinted in F.A. Hayek, The Trend of Economic Thinking: Essays on Political Economists and Economic History (Chicago: University of Chicago Press, 1991), pp. 17-34:

Indeed, it is probably no exaggeration to say that economics developed mainly as the outcome of the investigation and refutation of successive Utopian proposals – if by "Utopian" we mean proposals for the improvement of undesirable effects of the existing system, based upon a complete disregard of those forces which actually enabled it to work.

Smoke and mirrors

The focus on the size of the spending cuts is a red herring.

What matters is spending.

According to Paul Ryan:

The President's proposing we spend $46 trillion over the next ten years. With the debt limit increase, we're saying 'let's spend 43 and a half.' That's not asking a lot over a 10 year period. And it will be a small down payment on what will be necessary to prevent a debt crisis. And the President won't even do that.

Is Paul Ryan right? Is the President really proposing to spend FORTY SIX TRILLION DOLLARS OVER THE NEXT TEN YEARS? I don't know. Haven't seen that number before which either tells you a lot about Paul Ryan or how easy it is for politicians to manipulate us.

The federal government spent $3.5 trillion in 2010. That's up from $2.5 trillion in 2005. Going to $4.3 trillion (43 trillion over ten years) IS NOT A CUT.

Paul Krugman writes in yesterday's Times:

President Obama has made it clear that he's willing to sign on to a deficit-reduction deal that consists overwhelmingly of spending cuts, and includes draconian cuts in key social programs, up to and including a rise in the age of Medicare eligibility. These are extraordinary concessions.

Draconian? Where? Either Krugman or Ryan is wrong. And the debate is all theater.

Quotation of the Day…

… is from Hayek's 1974 Nobel Prize lecture, "The Pretense of Knowledge":

This brings me to the crucial issue. Unlike the position that exists in the physical sciences, in economics and other disciplines that deal with essentially complex phenomena, the aspects of the events to be accounted for about which we can get quantitative data are necessarily limited and may not include the important ones. While in the physical sciences it is generally assumed, probably with good reason, that any important factor which determines the observed events will itself be directly observable and measurable, in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process, for reasons which I shall explain later, will hardly ever be fully known or measurable. And while in the physical sciences the investigator will be able to measure what, on the basis of a prima facie theory, he thinks important, in the social sciences often that is treated as important which happens to be accessible to measurement. This is sometimes carried to the point where it is demanded that our theories must be formulated in such terms that they refer only to measurable magnitudes.

It can hardly be denied that such a demand quite arbitrarily limits the facts which are to be admitted as possible causes of the events which occur in the real world. This view, which is often quite naively accepted as required by scientific procedure, has some rather paradoxical consequences. We know, of course, with regard to the market and similar social structures, a great many facts which we cannot measure and on which indeed we have only some very imprecise and general information. And because the effects of these facts in any particular instance cannot be confirmed by quantitative evidence, they are simply disregarded by those sworn to admit only what they regard as scientific evidence: they thereupon happily proceed on the fiction that the factors which they can measure are the only ones that are relevant.

The correlation between aggregate demand and total employment, for instance, may only be approximate, but as it is the only one on which we have quantitative data, it is accepted as the only causal connection that counts. On this standard there may thus well exist better "scientific" evidence for a false theory, which will be accepted because it is more "scientific", than for a valid explanation, which is rejected because there is no sufficient quantitative evidence for it.

Keynes vs. Reality-2

In this earlier post, I noted this 1943 Paul Samuelson prediction:

When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs may be great. Nor will the technical necessity for reconversion necessarily generate much investment outlay in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the last war is inescapable–were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties–then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.

From Paul Samuelson, "Full Employment after the War," in S.E. Harris, ed., Postwar Economic Problems, 1943.

Samuelson was wrong. When the war ended, there was massive demobilization of the armed forces and a large reduction in government spending. Yet the economy thrived, unemployment remained very low and there was a huge expansion of private sector employment.

One defense of Samuelson is that this quote is mainly about the dynamics of the labor market–it doesn't say much about aggregate demand. It doesn't focus particularly on the drop in government spending. But if you go back to the original article (which you can find by taking a line or two and using Google books–I hope to post more on this later) you will find other passages that make it clear that he saw this as a problem caused by a sudden drop in aggregate demand.

There were a number of interesting comments on the post. Some noted the drop in GDP after the war but forgot that wartime price controls and large amounts of government output made measuring of GDP during the war quite difficult. There was a mild recession in 1945–during the war. The most dramatic change was the one I highlighted–a large expansion of private sector employment with very little unemployment. It was an incredible transition achieved with surprising speed.

I'd like to highlight one comment by Daniel Kuehn:

Samuelson was wrong in forecasting. Keynes wasn't wrong in theorizing.

Why did Samuelson end up being wrong? Have you ever thought that through?

Because post-war demand was substantial and he didn't expect that.

High levels of private sector demand and a full employment economy… where the hell do you get "Keynes vs. Reality" from that? That has Keynes written all over it.

All you're demonstrating is that Samuelson didn't have a crystal ball. That isn't exactly a news flash.

This defense of Keynes unintentionally highlights a flaw in Keynesianism at least as practiced by Daniel but I don't think he's alone or I wouldn't single him out. (And I would add that I usually appreciate Daniel's comments, particularly their tone in the face of criticism from the rest of you.) One, would an economist presume that a change in government spending would have no effects on other types of spending? If government spending shrinks and there is suddenly more resources available to the private sector, why would you not foresee a change in private sector spending? Secondly, the fact that full employment corresponds to high levels of spending (regardless of their source) is very close to a tautology. The challenge is to understand causal linkages and the direction of causation.

In the last few sentences of the previous paragraphs, I had originally referred to private demand. I changed it to private spending. I don't know what private aggregate demand means, or the phrase "pent-up" demand. The usual way that Keynesians explain the post-war expansion despite the huge cut in government spending is to say, well of course the economy boomed, there was a lot of pent-up demand. What does that mean? There is always pent-up demand in the sense there is a stuff I wish I could have but can't. But the standard story is that people couldn't buy washing machines or cars during the war–they were rationed or simply unavailable or unaffordable. So when the war ended, and rationing and price controls ended, people were eager to buy these things. But the reason these consumer goods were rationed or unavailable is because all the steel went into the tanks and planes during the war. So when the war ended, there was steel available to the private sector. That's why cutting government activity can stimulate the private sector. Fewer resources are being commandeered by the public sector. As the Hayek character says in the Fight of the Century when answering the Keynesian claim that WWII ended the Great Depression:

Wow. One data point and you're jumping for joy
the Last time I checked, wars only destroy
There was no multiplier, consumption just shrank
As we used scarce resources for every new tank

Pretty perverse to call that prosperity
Rationed meat, Rationed butter… a life of austerity
When that war spending ended your friends cried disaster
yet the economy thrived and grew faster

This earlier post where I discuss Krugman's claims about rationing and the austerity of the early 1940′s may also be of interest.

It's the PSST, Stupid!

Ultimately it's an empircal question – or, rather, a series of empirical questions.  The most germane of these questions is this two-part one:

Is the decline in demand for the outputs of many industries throughout the economy (1) chiefly the consequence of an increased demand for money, an increased demand (2) caused not by any structural mal-adjustments in the economy or by actual or anticipated destructive government policies but, instead, simply caused by an intensification of people's desires to hold larger money balances?

If the answer to this question is "yes," then the economy will indeed suffer a problem that can fairly be described as "inadequate aggregate demand."  A better term, though, is "excessive demand for money."

As my great teacher, Leland Yeager, explained – for he is an able advocate of this "monetary disequilibrium" theory – because money "has no market of its own," attempts by people to satisfy their demands to hold larger money balances have economy-wide repercussions in ways that people's attempts to satisfy their demands to hold, say, larger inventories of apples do not.

Overlooking the important question of to what extent should consumption patterns, and patterns and techniques of production, in the "real" economy change as a result of people's increased demand for money, we can nevertheless reasonably conclude that, ceteris paribus, a simple taste-driven increase in the demand for money does not imply that patterns of resource allocation, production plans, and consumption plans are seriously out of whack.

The microeconomic conditions in this scenario are, by assumption, healthy.  All that must be done to avoid the negative external effects of each of us attempting to increase the real value of our money balances is for the nominal money supply to grow in order to accommodate this increased demand.  (In a fairytale world, prices of all goods and services and inputs would all adjust in unison downward to achieve the same goal.  But coordination problems make such price declines too unlikely to rely upon.)

In principle, increasing the supply of money will avoid the problem of inadequate aggregate demand.  I say "in principle" because the practical problem of how to get the increased supply of money into the market is real, although typically overlooked.

If the central bank simply injects this new money, (1) how do the central bankers know how much to inject? and (2) how do they avoid what Hayek called "injection effects"?  [The new money must enter somewhere, at least potentially distorting relative prices and then causing genuine resource misallocations and malinvestments.]  Indeed, how do central bankers know (with reasonable-enough certainty) that the observed declines in demands-for-output economy-wide are in fact the result of a taste-driven increase in the demand to hold larger money balances rather than a reflection of serious microeconomic misallocations and malinvestments, or of greater concerns that government's economic policies have taken a turn for the worse?

So back to my starting claim that it's an empirical question.  Only if the above conditions – along with some other, smaller and not-worth-mentioning conditions – hold true does it make sense to talk of restoring "aggregate demand."

But if the decline in GDP growth and in the rate of employment are caused, not by a taste-driven increase in the demand for money but, instead, by a large enough disruption in what Arnold Kling calls "patterns of sustainable specialization and trade," then kicking up aggregate demand won't solve the problem.  Neither kicking it up, or trying to, through monetary policy or through fiscal policy will work.  The problem is not originally one of widespread inadequate demand.  In this case, inadequate aggregate demand is a symptom; treating the symptom will not cure the disease and, indeed, will only worsen it.

Without venturing here an opinion on the underlying source of each and every recession throughout American history, I will express an opinion about the current recession: it is clearly the result of distorting government policies, regulatory and monetary, leading up to 2008 as well as of the symptom-treating policies since then that only worsen matters.  (And not to mention yet other actual and threatened policies – e.g., Obamacare -  that distort microeconomic patterns of sustainable specialization and trade.)

Curing the current recession simply with more money or more stimulus spending is as likely to restore the U.S. economy to health as would dumping more money on Chadians, and raising government spending in Chad, to start that nation on the path to genuine economic growth.

Aggregate Healthiness

A team of the world's finest physicians and pathologists combine to create a measure of "Gross Bodily Health" (GBH).  The higher is a person's GBH, the healthier he or she is.

GBH is an aggregate measure made up of measures of heart health, digestive health, pulmonary health, blood-pressure health, and a few others.

The main determinant of GBH is called "aggregate healthiness" (AH).  Aggregate healthiness changes for any number of reasons – for example, a change in the frequency of a person's exercise or a change in a person's diet.  Higher AH, common sense tells us, causes higher GBH.

A diagnostic machine is developed to measure GBH.  The patient steps into the machine and, within seconds, that patient's GBH figure is spit out to the attending physician.

Jones goes to his physician and finds that his GBH is dangerously low.  "What should I do?" Jones asks his doctor.

"Increase your AH – your aggregate healthiness" the doctor helpfully responds.

"How?"

"Oh, it doesn't matter.  Jog, take blood-pressure medication if you think you have high blood-pressure, stop smoking if you smoke, exercise more.  Anything to raise your AH.  What's important is that you get your AH up!"

"But can you tell me WHY my GBH is so low?  Can you give me any details on just what I should do to improve my GBH?"

"No can do.  But not to worry, for it doesn't matter.  The use of aggregates is methodologically justified in many cases.  GBH and AH are aggregates, and we physicians have determined that GBH and AH are indeed very useful aggregates.

"We understand that the specific values of these aggregates for each patient at each moment in time are determined by literally billions of different things going on in that patient's body and with that person's diet, exercise, stress, etc.  And there are other physicians – such as Drs. Alchoan, Demsitz, Hayuk, and Klang – who are great experts at looking at these more-detailed aspects of your body's inner workings.  You can consult them, if you like.

"But be aware that the Best Expert Opinion among practioners of what we call the 'New Medicine' is that the phenomena studied by physicians such as Drs. Alchoan, Demsitz, Hayuk, and Klang – while important – are phenomena each so sufficiently distinct from AH that we can, and should, treat deficient AH separately from any ailments that might be diagnosed by the likes of Drs. Hayuk and Klang.

"Trust me.  Get your AH up and you'll be fine.  Don't bother yourself with just why your GBH is low.  Those details aren't nearly as significant as is the fact that your GBH itself – for it's kinda, sorta like a real phenomenon (it is measurable!) – is too low."

"But….!"

"Please calm yourself!  I'm a candidate to win a Nobel Prize in medicine.  I know what I'm doing.  Can you deny that a higher AH will result in a higher GBH?  Of course not!  Healthiness is the main determinant of GBH, so the trick to raising your GBH is really rather simple: increase your AH."

"But suppose I take blood-pressure medication even though my blood-pressure is fine.  Won't that hurt me?  And what if my GBH is low because of a lung disease.  How will I help myself by improving my diet?  Shouldn't I know the details of what ails me?  And isn't it the case that the specific causes of my low GBH should be treated individually.  Increasing my 'aggregate healthiness' seems like a hamfisted way to go about improving my health.  I have SPECIFIC things wrong with me; what's wrong with me isn't helpfully described simply as inadequate 'aggregage healthiness.'"

"Look.  I'm the expert.  I know what I'm talking about."

UPDATE: From Mark Perry's Carpe Diem.

Quotation of the Day…

… is another from the superb economic historian Gavin Wright.  This one is from page 10 of his paper "The Myth of the Resource Curse" (co-authored with Jesse Czelusta) in the March/April 2004 issue of Challenge:

There is good reason to reject the notion that American industrialization should be somehow discounted because it emerged from a setting of unique resource abundance: On closer examination, the abundance of American mineral resources should not be seen as merely a fortunate natural endowment. It is more appropriately understood as a form of collective learning, a return on large-scale investments in exploration, transportation, geological knowledge, and the technologies of mineral extraction, refining, and utilization.

Wright and Czelusta here make the Julian-Simonesque point – and back it up with data from the empirical record – that the size of resource 'endowments' is variable and, more importantly, largely a function of human ingenuity.  Human beings – and not molecules buried in the ground – are the ultimate resource.  The latter become resources only through the creativity, choices, and actions of the former.

Keynes vs. Reality

Here is Paul Samuelson in 1943 (HT to David Henderson):

When this war comes to an end, more than one out of every two workers will depend directly or indirectly upon military orders. We shall have some 10 million service men to throw on the labor market. We shall have to face a difficult reconversion period during which current goods cannot be produced and layoffs may be great. Nor will the technical necessity for reconversion necessarily generate much investment outlay in the critical period under discussion whatever its later potentialities. The final conclusion to be drawn from our experience at the end of the last war is inescapable–were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties–then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.

From Paul Samuelson, "Full Employment after the War," in S.E. Harris, ed., Postwar Economic Problems, 1943.

And now a quote from the The Economic Report of the President, page 1, issued by Harry Truman on January 8, 1947:

During 1946, civilian employment approached 58 million. This was the highest civilian employment this Nation has ever known— 10 million more than in 1940 and several million higher than the wartime peak. If we include the military services, total employment exceeded 60 million. Unemployment, on the other hand, remained low throughout the year. At the present time it is estimated at about 2 million actively seeking work. This is probably close to the mini- mum unavoidable in a free economy of great mobility such as ours.

Thus, at the end of 1946, less than a year and a half after VJ-day, more than 10 million demobilized veterans and other millions of war- time workers have found employment in the swiftest and most gigantic change-over that any nation has ever made from war to peace.

Dudley North on Free Trade

One way to state the case for free trade is to note that government has no business protecting politically influential producers from consumers who spend their money in ways that naturally enhance their (the consumers') satisfactions rather than in ways that artificially enhance others' (the privileged-producers') profits.

As the 17th-century champion of free trade Dudley North observed,

That to force Men to deal in any prescrib'd manner, may profit some as happen to serve them; but the publick gains not, because it is taking from one Subject, to give to another.