Sunday, April 24, 2005

Solvency and the Long Bond: Economic Life after Crisis

Most discussion of Social Security Solvency has been in the context of Privatization and more narrowly on whether private accounts help or not. A certain consensus has shaken out: to the extent that "Crisis" exists it doesn't manifest itself until the 2040's and private accounts in and of themselves wouldn't help anyway. So there is a tendency to agree with the following memorable phrase: "Social Security Privatization is as dead as Bob Dole's dick, let's move on".
But it is not just about private accounts. Sure killing the 70 year dream of the Republican Party of killing Social Security by privatizing it is important for all kinds of reasons, notably 2006 midterms. But there are important macoeconomic implications to Solvency. Assessments of the impacts of Current Account deficits and the impact of Bush Tax Cuts both depend critically on the Trust Fund balance in the year 2025, Solvency will rock our world.

Supporters of Social Security have been playing defense since November, time to play offense. I am going to assume a certain familiarity with the numbers and terminology here, those who want some background can find it on these pages: The Three Alternatives and What is the Low Cost Alternative

For the purposes of this diary I am going to assume Low Cost, that is that economic productivity growth for 2005 will meet or exceed 2.1% and that growth in the outyears will meet or exceed 1.9%. Not a stretch by any means, reported 2004 came in at 3.3% and the average over the last six years has been better than that. 2005 Report: Economic Assumptions

We start with the graph 2005 Report: Trust Fund Ratios Now outcome ( II ) is our old friend Intermediate Cost, Trust Fund Ratio peaks in 2013 and sinks more or less rapidly to 2041. But Low Cost produces outcome ( I ): the Trust Fund Ratio doesn't peak until 2022, sags a minor amount and then sails through the 75 year window maintaining a 4 1/2 year reserve.

This doesn't fully capture the dollar picture, the Trust Funds continue to grow even after the ratio begins to decline. For Intermediate Cost the dollar peak occurs in 2023. Under Low Cost interestingly enough the peak never comes. Operations of the Combined OASI and DI Trust Funds, in Current Dollars, Calendar Years 2005-80 Which still doesn't capture the entire picture, as long as payroll tax exceeds benefit costs interest earned on the bonds is just bookkeeping. The crux is when benefits exceed payroll, which for Intermediate is around 2018. Ironically we start borrowing five years before the actual dollar peak.

The main point for this entry is that the markets and economic forecasts generally have outcome ( II ) built in, 99% of the market assumes that the US will be faced with replacing a $6 trillion dollar bond portfolio with public borrowing to that same tune. What if that portfolio never had to be redeemed? What if borrowing didn't start to around 2023? And never hit an inflation adjusted amount of $150 billion a year until 2060 Estimates in Constant Dollars And all of this assuming just 1.9% productivity growth?

Short answer: Social Security Solvency transforms everything. Your view of the bond market and the role of the Chinese Central Bank may be about to change.

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