Thursday, February 10, 2005

Oh, That Mythical Trust Fund!

Many of those who wish to preserve Social Security as we know and love it will insist that the Social Security trust fund is real. The usual argument goes like this: Yes, the trust fund holds government bonds. But if government bonds are a real asset to private investors, they must be a real asset to the trust fund. Wrong.

If the Social Security Administration (SSA) had invested net Social Security receipts in stocks, corporate bonds, and private mortgages -- or had stashed the receipts in many, many passbook savings accounts, à la W.C. Fields -- the trust fund could be a real asset. Why? Because SSA would have simply done for individuals what they could have done for themselves, namely, held their savings in the form of claims on real assets (business equipment, homes, and automobiles, for instance) and/or the future income produced by those assets.

But the problem is bigger than SSA's failure to invest forced savings in claims on real assets. SSA is just a branch of the U.S. government. Even if SSA had wanted to take its net receipts to the bank, it couldn't have. A robber would have intercepted SSA on the way to the bank, taken the money, and blown it on booze. Actually, what happened was that the rest of the U.S. government grabbed SSA's net receipts and blew them on this welfare program, that regulatory effort, and other "public services." Unlike the typical thief, the U.S. government then handed SSA a bunch of IOUs.

Now, tell me where the real asset is. It's not to be found in the creation of government programs or even in the physical assets employed by government in those programs. For, the economic benefits that sometimes flow from government activities are far more than offset by the economic disbenefits of government activities (a). A real asset must -- on balance -- add to wealth or income, not subtract from it.

But what about all those private investors who hold government bonds? Aren't they holding real assets? Well, they're holding financial assets, which give them a claim on real assets. Let's take Citizen Kane as an example. Suppose he has scrimped and saved $1 million. He could place that amount in some combination of stocks, corporate bonds, mortgages, and savings accounts, but he chooses to buy government bonds, instead. Now, Citizen Kane has already done his bit for the creation of real assets merely by saving $1 million in the first place. That is, through the magic of macroeconomics, the $1 million that he forbore to spend on this bauble, that bangle, and another bead enabled the creation of $1 million in real capital (plant, equipment, business software, etc.), which fosters economic growth.

Thus, in the first approximation, where Citizen Kane actually puts his $1 million is less important than the fact the he has saved (not consumed) $1 million, so that others (businesses, to be precise) can direct $1 million worth of resources into the creation of capital. If he chooses to put the $1 million in government bonds, that's his lookout. Those bonds have a market value, which will fluctuate just like the market value of all financial assets. But the marketability of the bonds simply means that he can claim his share of the wealth that was created when he saved $1 million in the first place.

Government bonds held by government entities, on the other hand, don't even pretend to be claims on real assets. They're nothing but pieces of paper whose value can be realized only through taxation. Well, government can tax us without going through the charade of creating government bonds. Thus the bonds held by the SSA amount to nothing more than a superfluous excuse to raise our taxes. The power to tax is a real asset only to those who are net recipients of the taxes that are collected. By the same token, the power to tax is a real liability to those who are net payers of the taxes that are collected. Asset = liability = zero.

So much for those "real assets" in the Social Security trust fund.

But I'm not through discussing the shell game that goes by the exalted name of "public finance." There's a lot more to it than the mythical Social Security trust fund.

Government spending, however it is financed, is a way of commandeering resources that otherwise would flow to private consumption and investment (i.e., capital formation). To the extent that government activities fail to pay their own way by yielding goods and services of equivalent value -- and they don't (a) -- the resources used by government are simply wasted -- thrown down a rat hole (b).

Government nevertheless goes through the charade of taxing and borrowing to finance its activities, instead of simply sending goon squads to impress those resources into government service. Thus the total amount of money in circulation remains more or less unaffected by government spending, while the total output of real goods and services (including capital assets) is reduced as government commandeers resources. The result, of course, is inflationary (c).

In particular, the injection of government bonds into financial markets, with the help of the Federal Reserve's authority to create money, means that the total nominal value of financial assets is at least the same as it would have been in the absence of government borrowing, and probably higher (d). At the same time, government spending reduces the output of real assets, thus diluting the value of financial assets. Financial assets are fungible, so the holder of a government bond has the same claim on real assets as the holder of, say, a share of Berkshire Hathaway stock.

Think of it this way: Every time the government issues a new bond because it's spending more money, your real share of stock in America's economy becomes worth less, even if the nominal price of the stock rises. Depressing, isn't it?
a. An official estimate of the annual benefits flowing from federal regulations places the value of those benefits at less than $200 billion. But the annual cost of those regulations -- including the hidden costs not included in the government estimate -- is approaching or has exceeded $1 trillion, as discussed here, here, here, and here. But that's just the tip of the iceberg that rammed into the American economy about 100 years ago, as I will show in Part V of "Practical Libertarianism for Americans."

b. I exclude most expenditures on defense and justice from that indictment.

c. That is, government spending causes prices to be higher than they otherwise would be because total spending remains about the same as it would have been, whereas real output is reduced. Whether or not those nominal prices rise (the usual meaning of inflation) depends on the rate at which government spending grows relative to the growth of output of real consumer goods, services, and assets.

d. The total nominal value of financial assets is approximately unaffected by government borrowing, if you accept the crowding-out theory. The total nominal value of financial assets rises with government borrowing if you don't, if you don't accept the crowding-out theory. I don't.