Friday, March 25, 2005

WSJ editors acknowledge value of "Worthless IOU's".

In today's Wall Street Journal, the editorial board equates interest on the US treasury assets held by the Social Security trust fund with revenues from payroll taxes.

That is to say, the editors consider the interest from what they call "worthless IOU's" to be real money.
That number is $2.2 trillion, which is the difference between the current size of the Social Security "Trust Fund" ($1.7 trillion) and what it will grow to become over merely a decade through 2014 ($3.9 trillion). More precisely, that is the amount of payroll tax revenue that workers will pay between now and 2014 that exceeds what will be spent over that same period on retiree benefits.

The editors appear to be referencing this table from the 2005 trustees report, where net assets at the end of the year are projected to be $3.964 Trillion at the end of 2014. But if you look at the table, you'll see that $1.4 Trillion of that $2.2 Trillion increase of assets will come from interest paid on the treasury bonds held in the Social Security trust fund.

The editors are now on record equating interest paid on "worthless IOUs" with payroll tax revenues. And hey, so is the Club for Growth

The editor's intent was to justify diverting that $2.2 Trillion to private accounts, since congress will otherwise just spend the money.

How about this advice to Congress: if you borrow the money and spend it, future congresses will have to come up with interest payments and eventually repay the debt, since the bonds held by the Social Security trust are just as real as the bonds held by individuals like George W. Bush. There's already a lock box on the money, according to the WSJ editors. The real problem is that the current President and Congress are spending a whole lot more than they're willing to raise in tax revenue.

Friday, March 18, 2005

Shiller questions private account returns

Today's Washington Post has an article about a paper to be published by Robert Shiller that suggests about one-third of participants, or perhaps as many as 71% of participants, would not expect to match current Social Security benefit payments if they use the appropriate recommended life cycle accounts.

The article quotes Jeremy Siegel:

I'm one of these people who maintain the 3 percent rate is too high a trade-off," said Jeremy J. Siegel, a finance professor at the University of Pennsylvania's Wharton School and a longtime advocate of stock investing. "You can't get 3 percent in the market anymore."

And also quotes an American Enterprise Institute privatization advocate:

But Hassett, another supporter of private accounts, called the paper "a very thorough and interesting piece." The White House's response should not be to dismiss the paper's conclusions but to rethink the life-cycle portfolios or lower the 3 percent threshold, Hassett said. The latter is an action administration economists are already considering, he added.

But this begs an analysis of why a "3 percent threshold" is needed in the first place. The "clawback" is necessary because the money to finance these accounts has to be borrowed .

This is the same 3 real interest rate that is used to show the infinite horizon liabilities of Social Security increasing by $600 Billion a year that privatization advocates have been touting this week.

Maybe we can legislate the real interest rate to be something lower than three percent. But I doubt you'd get Alan Greenspan to advocate for the legislature controlling US treasury debt interest rates. If we let the market set the appropriate interest rate, and decide to finance $6.5 Trillion, or whatever it is for the privatization flavor of this week, required for transition costs, presumably, a study by someone as qualified as Shiller would conclude that there is a chance the real interest rate really will turn out to be 3% or perhaps even higher.

So, we're back to the basic question. Is it really a great idea for the US government to leverage up on treasury debt and gamble that the stock market will outperform US treasuries consistently over the next 50 years?

Is it really in the nation's best interest to try to borrow our way out of a savings deficit?

Wednesday, March 16, 2005

Why Paygo has to include revenue

The GOP like to set up pay as you go voting rules so they only apply to the spending side of the equation. Indeed, have set up rules this way since 2001, leaving the rules in place only for spending.

Witness the outcome. Revenues are way, way down, and not only that, but spending is up, too!

Why would spending go up if the rules are still hypothetically set up to make it hard to approve an increase of spending? It's pretty simple, really.

We've selected a congress that rails against big government, but gets elected by virtue of delivering to favored constituents. Along the way, the evolutionary selection process has adapted the idea of "starving the beast" into an electorally more rewarding form. Cutting revenues masquerades as fiscal conservatism, because it will hypothetically force big cuts later. No elected official ever has to make a hard choice, since cutting taxes will do the hard work for you!

You can see where this leads. Why should an elected official who theoretically has a goal of shrinking government stick their neck out and risk getting voted out of office, or perhaps even worse, losing quid pro quo voting deals and being unable to deliver goodies to big campaign donors, when they can capture the "starve the beast" voting block just by cutting taxes and then just advocate for spending they want without opposing spending they despise?

You simply can't get to a rational form of fiscal conservatism with one-sided PAYGO voting rules. You need to have the same rules on the revenue side as on the spending side to establish the dynamics of winners and losers - one person's spending initiative by necessity is in conflict with another person's tax cut (or even the SAME person's tax cut!).

Monday, March 14, 2005

Interest rates and fiscal policy

Is it a conundrum that long term interest rates would stabilize or fall during a period when government controlled short term interest rates are rising?

Perhaps it could be under normal circumstances, but the interest rate environment of the past four years, and in particular since November 2002 when the Federal Reserve cut overnight lending rates all the way down to 1.25%, followed by another quarter point cut in June 2003, has not been normal. The FED, arbiter of the punch bowl, was accomodating (spiking the punch) because of concern that the economy was so lacking in party spirits that a whole new form of drug might be necessary to bring some life back into the party.

By the spring of 2004, it was clear that the FED no longer needed to spike the punch. The dollar was in free fall, and oil prices were approaching record highs. Wage inflation, which the FED has targeted like a teenager eyeing the punch bowl for the past 23 years, was still nowhere to be found, but other traditional price signals made it clear that it was time for the FED to at least stop spiking the punch, even if it wasn't yet time for the FED to take the traditional role as party pooper.

Five interest rate hikes and an election later, long term rates were as low or lower than they had been in the months leading up to the first of five quarter point hikes in the overnight lending rate. Alan Greenspan coined the idea that it was a "conundrum" why long term rates had not responded to the FED's move.

What was going on? Was the FED really baffled about what HAD BEEN going in the bond market, or was the FED sending a signal to inflewence the FUTURE moves of the bond market? Is there really any question?

It seems pretty clear to me that short term rates were, indeed, accomodative around the 1% range, particularly in light of the uptick in prices. And, the accomodation was more than just a nudge or two. The FED had all the traditional stops pulled out and was just short of resorting to dropping $100 dollar bills in selected neighborhoods. It was rather remarkable that US dollar denominated debt was still in demand as of the spring of 2004. The FED signaled it would bring overnight rates back to a normal range (3% to 5%, perhaps, is a "normal" range within one standard deviation at present) at a "measured" pace.

"Measured", we learned, meant a quarter point at a time and only at scheduled intervals. Hey, bond market, party on! With knowledge that accomodation was being quietly withdrawn, it was rational for long term bond holders to be modestly exuberant in the knowledge that the FED was fighting inflation by cutting back on it's own excesses, but that short rates would stay low enough for a year that rising short rates wouldn't put any serious pressure on demand for higher intermediate and long rates.

NOW we've gotten to a place where short rates are getting closer to normal, and where continued upticks might have some traction in terms of traditional inflewence on the rest of the bond market. From here, the slack has been essentially taken up - or if it hasn't yet been taken up, slack indicates the inflation genie is out of the bag.

Short rates won't be DRIVING the inflation genie - fiscal policy and the trade imbalance are in the drivers seat. But the bond market might look to the FED for "signals", and a "conundrum" is of the same genus if not the same species as "irrational exuberance".

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