This evening’s Tea Party Debate in Tampa Bay is once again running into the whole “social security is a ponzi scheme” argument as Rick Perry and Mitt Romney go after one another on this hotly contested subject. Perry has consistently referred to the program as a “ponzi scheme” – a term which has come under harsh criticism from many on the left and right who claim that the term is misleading and hyperbolic. I think they’re exactly right.
First of all, let’s get the definition of a ponzi scheme right. According to the SEC, a ponzi scheme is “an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.” A ponzi scheme is designed to take in more money than it can consistently pay out. Importantly, it has no fundamental underlying driver of its cash flows.
The confusion in the Social Security debate revolves around this idea that there is a “trust fund” that current workers pay into to fund those who are currently receiving the benefits. Due to a multitude of factors, the current beneficiaries are essentially receiving more than they themselves paid into the system. So, this “trust fund” appears deficient. It has the appearance of paying more out than it brings in. But this is a misconception of the way government spending works.
This sort of debate gets right at the heart of the misconceptions regarding the U.S. monetary system and the many myths that persist. This myth that the Social Security Trust Fund might “run out of money” is as silly as the whole debt ceiling debate and this idea that we can “run out of money” that we can literally create out of thin air. Of course, there’s simply no such thing as the government running out of money it can print and the confusion stems from the public’s constant desire to compare government solvency with household solvency. This comparison is apples and oranges as a government goes bankrupt in real terms while a household goes bankrupt in nominal terms.
Now, some people might say “so what, governments just go bankrupt in real terms, that’s the same thing!” But the difference is important because the constraints on a government and the causes of inflation can be quite different from the causes of a household insolvency. For instance, when a government needs money it will simply print more money or government bonds. It can always “finance” those bonds because it has a Central Bank that is a willing buyer at all times. This means that government spending can always be financed in nominal terms. This is quite different from a household because a household that cannot find willing holders of its liabilities will literally run out of money funding sources.
Further, the causes of government insolvency via high inflation are far different from the causes of a household insolvency. For instance, hyperinflations tend to be the result of extreme exogenous forces such as:
- Collapse in aggregate private sector output.
- Regime changes.
- Loss of a war.
- Foreign denominated debts.
These circumstances are specific to the way an aggregate government operates. What this means is that the causes of a widespread inflation are not generally the same as the causes of a household insolvency. I
The question we need to be cognizant of is whether our public spending is causing a real decline in the currency’s value and our living standards? While the Social Security trust fund can always be financed in nominal terms it does not mean it is a good trade-off if it is causing a decline in living standards in real terms. At a time like now when inflation is extremely low and the needs of the elderly are high, this seems like a reasonable item for the government to be spending significant money on. This might not always be the case, but the simple fact of the matter is that Social Security is nothing like a Ponzi scheme because our government obtains funding based on the real fundamental productive output of the private sector and not the ability to sell a false narrative to unwitting investors.
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.