77 years ago Barron’s magazine wrote the following about Social Security:
“Yes sir, Uncle Sam is going to collect money in the form of social-security taxes and use it to run his business and set aside a ‘reserve’ of his own promises to pay, in order to make it look as though the social-security taxpayers are getting something for their contributions.”
The purpose of the article in 1936 was to scare readers silly about the government’s ability to fund the Social Security program. Of course, there hasn’t been a funding crisis in Social Security, but Barron’s decided to double down this weekend writing:
“From that day to this, Barron’s has tried to explain to readers that Social Security is a scheme worthy of the unlamented Charles Ponzi, who gave his name to the recurring fantasy that a growing fund of investments can pay high returns to early investors by using the deposits made by later investors.
Sooner or later the Ponzi fund runs out of new investors to be suckered. It cannot continue to pay those generous dividends and the fund manager leaves town, commits suicide or goes quietly to prison—unless the government is the fund manager.”
Describing Social Security as a “Ponzi scheme” is extremely misleading. And it should be obvious why. So let’s make this dead simple to understand:
1) The US government has the potential ability to print US dollars if it needs to meet obligations.
2) The entire US debt is denominated in the currency it has the ability to create.
3) You can’t “run out of” something you can create out of thin air.
4) So the US government has no real funding constraint, as in, it doesn’t have enough dollars to pay the debt.
5) There’s no free lunch there though! But the fact is, the US government has a different constraint. Its true constraint is inflation. In other words, since it can’t “run out of dollars” its real risk is actually creating so many dollars that inflation ensues.
6) But inflation is at record low levels. Which makes sense since 10%+ of our workforce is unemployed, capacity utilization is at record low levels this deep into a recession and the economy remains very sluggish.
Anyhow, if you do the math on all of that one thing becomes clear. It’s illogical to compare Social Security to a “ponzi scheme”. Ponzi schemes run out of funding at some point. But the US government can’t run out of dollars so that’s clearly wrong. Now, it could make the dollar worthless by creating too many of them, but that’s very different than running out of dollars. Hyperinflation is the opposite of running out of money. It’s creating too much money.
So, could hyperinflation happen in the USA? You bet. I’ve said it won’t happen for years (despite the many predictions otherwise), but it certainly could. But we should first understand that the ability to meet our obligations on Social Security is not about whether we have the dollars or not, but whether we’re willing to use our government to allocate resources in specific ways that MIGHT contribute to higher inflation in the future. That’s a debate about efficiency of government spending and not about having the ability to create money.
Don’t get me wrong. I am not saying there’s a free lunch here. Absolutely not. But if we’re going to have an intelligent debate about all of this we should at least start by understanding what the real debate is about. This isn’t about whether we have the ability to fund Social Security. This is is about understanding the real constraint on our government (the inflation constraint) and how we are going to balance government spending with the side effect of inflation. It’s a debate we should certainly be having. And after 77 years of being wrong, I hope that more and more people are beginning to question those who constantly inject fear and misconception into the discussion while failing to put this all into the proper context. Relying on them year after year is the very definition of insanity and will get us nowhere.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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