Thursday, August 12, 2010

US Government Debt and Social Security: Some Basic Facts

Government debt has constantly been in the news recently. Many claim that the US or UK might face a sovereign debt crisis in the future (despite the fact that they are nothing like Greece or Eurozone countries). The statistic that the US has gross government debt of about $13 trillion is bandied about as if it portends the end of the world. I advise people to beware of this hysteria about government debt.

This post debunks some of the myths about US government debt, with some remarks about social security as well.

First, a fundamental difference exists between (1) gross government debt and (2) the debt that is actually held by, and owed to, the public. This is a crucial issue if one wants to calculate the real burden of US government debt.

To calculate the amount of US government debt held by the public, one has to subtract (1) intra-government debt and (2) Federal Reserve holdings of US treasuries from gross debt. Intra-government debt holdings include bonds held in government programs (e.g., public social security funds).

According to a recent estimate (March, 2010), US gross public debt was $12.7731 trillion (or 90% of US GDP). For all figures, see Ownership of Federal Securities, Treasury Bulletin June 2010.

However, only $7.5133 trillion of the gross debt was held by the public, including foreigners.

The remainder was intergovernmental debt and Federal Reserve holdings of debt, which stood at $5.2598 trillion.

Therefore we get these figures:
total US gross public debt: $12.7731 trillion
Debt held by the public: $7.5133 trillion (58.82% of gross debt)
Intergovernmental debt + Federal Reserve holdings: $5.2598 trillion (41.178% of gross debt)
Intergovernmental debt: $4.3197 trillion (33.81% of gross debt)
Federal Reserve holdings: $0.940 059 trillion (7.359% of gross debt)
Therefore in March 2010, 41% of the US gross public debt (or nearly half) was either intergovernmental debt and Federal Reserve holdings of Treasuries.

This 41% should be removed from the total to calculate the real burden of US government debt. The 7.5133 trillion dollars worth of debt owed by the US government is about 52.66% of US GDP.

Let's move now to some analysis of the various types of debt.

Federal Reserve Holdings
It is notable that nearly $1 trillion of gross debt (or 7.359%) is held by the Federal Reserve. These Treasuries held by the Fed are not a burden to the government, and should not be regarded as “debt” in the accepted sense. Why? The reason is that these bonds have been bought back from the public by the Fed and are essentially “paid back.” The Fed has the power to create money from nothing and uses this money to purchase bonds. That is to say, normally the US Federal Reserve buys back Treasuries from the secondary markets with new money, and such bonds are effectively retired. No taxpayer money is used in these standard open maket operations. Although the Treasury does pay interest to the Fed on the bonds it holds on the asset side of its balance sheet, this money simply goes right back to the Treasury, as the government and central bank are essentially one entity. Thus the interest payments are not a burden at all to the government, nor are the bonds held as assets by the central bank. In fact, central bank purchases of bonds reduce the stock of government debt owed to the public, and hence the burden of such debt.

Intergovernmental Debt
As can be seen above, intergovernmental debt was $4.3197 trillion. This debt is held by government agencies and programs, such as the Social Security Trust Fund (= Federal Old-Age and Survivors Insurance Trust Fund and the Federal Disability Insurance Trust Fund), the Federal Housing Administration, the Federal Savings and Loan Corporation’s Resolution Fund, and the Federal Hospital Insurance Trust Fund.

These public trusts usually receive funds via payroll taxes or other contributions which often have surpluses not needed immediately. The US Treasury therefore provides special-issue nonmarketable treasury securities to these trust funds so that excess revenues can be used in current government spending (nonmarketable treasuries include State and Local Government Series securities, Government Account Series debt, and Savings bonds). The trust funds are usually issued Government Account Series Securities.

Such nonmarketable securities actually account for $4.4788 trillion of gross government debt or 35.06% of it (some of them are also sold to the public). Most of these nonmarketable securities are, however, held by the government trust funds, and they are not traded on secondary markets, which means that bond markets have no power over the government’s ability to issue them.

In effect, when the US government uses the excess tax revenues in the Social Security Trust Fund, it writes itself an IOU and places it in that trust fund. These securities are neither debts nor assets. The future spending for social security will simply come out of future tax revenue or deficit spending. Since the government can raise or lower tax revenues by fiscal policy, these future spending promises can be dealt with by comparatively minor fiscal adjustments, such as raising taxes or cutting government spending in other areas (in the case of the US, think of the bloated military budget) and re-directing the money to Social Security.

Many people believe that the government needs to “save” money (that is, in its own domestic currency) now for funding its future spending on social security for the elderly. This is in fact utter nonsense. Modern Monetary Theory shows us that the government has the power to create and destroy money. An entity with the power to create money has no need to “save.” A government budget surplus drains money and destroys it. How can the government “save” such money for the future when the act of running a budget surplus essentially destroys money? The belief that the state should “invest” budget surpluses in private financial markets for future spending is also utterly ridiculous. What guarantee is there that the financial assets the government buys will be worth anything 10 or 20 years from now?

Many governments are accused of having “unfunded liabilities” in the form of obligations for Social Security payments to future retirees. The contrast to “unfunded liability” is a “funded liability.” But a “funded liability” is normally nothing but paper wealth in the form of financial assets. Such “wealth” often consists of stocks and shares, assets whose value might completely collapse tomorrow. When we look carefully at such private “funded liabilities,” we can see that many of them are tenuous indeed. If US retirees invest their savings in government bonds, then their “funded liabilities” are really just the functional equivalent of the intergovernmental debt called Government Account Series Securities, the IOUs held by the Social Security Trust Fund. This point has been made by Richard L. Kaplan, a US Professor of law:
an ‘unfunded liability’ by the [sc. US] government to make good on some financial commitment in the future is functionally no different than a ‘funded liability’ that consists of the only dependable asset around – namely U.S. Treasury obligations …
“Unfunded liabilities” a Financial Myth.
Social Security Crisis?

It is alleged by conservatives that US Social Security is “bankrupt”, because payroll taxes will not fund social security payments after about 2020.

The US can fix this alleged “problem” with Social Security simply by ending the peculiar and unnecessary accounting practice that says that US social security must be funded by a specific tax (i.e., the payroll tax). As L. Randall Wray argues,
today … [sc. Old-Age, Survivors, and Disability Insurance] benefits equal 4.5% of GDP; that grows to 7% over the next 75 years. Does anyone doubt that we will be able to afford to devote 7% of our nation's output to provide a social safety net for retirees, survivors, and disabled persons? That leaves 93% of GDP for everything else. We have easily achieved larger shifts of GDP in the past without lowering living standards of the working generations.
Wray, L. R. 2009. “Social Security: Truth or Useful Fictions?” Tuesday, August 11, 2009
Professor Bill Mitchell has also identified the fatal problem with the idea that the government needs to “save money” now for future payments to the retired:
The idea that it is necessary for a sovereign government to stockpile financial resources to ensure it can provide services required for an ageing population in the years to come has no application. It is not only invalid to construct the problem as one being the subject of a financial constraint but even if such a stockpile was successfully stored away in a vault somewhere there would be still no guarantee that there would be available real resources in the future.
Another Intergenerational Report – another waste of time.
The real issue with future social security benefits for retired generations is whether output in the future will support both retirees and the working population with rising living standards for all. Frankly, I think that the continuing advancement of science and technology will provide productivity increases in the future sufficient to allow rising standards of living for all segments of the population. The attack on social security for the elderly reminds me of Malthusianism, the wretched and anti-human ideology that was utterly discredited in the 19th century. Some miserable modern conservatives are convinced that welfare for the elderly will bankrupt future governments. Like them, Malthus was convinced that charity for the poor would bankrupt his nation. Malthus was completely wrong because he simply did not understand the power of modern science and technology to increase output and productivity (although I don't think much of Marx, here he was an astute critic of Malthus).

The conclusion from all this? The current hysteria about US social security going “bankrupt” should not be taken even remotely seriously.

Appendix 1: Net Government Debt

I also note that the difference between gross government debt and net government debt is important.
Net government debt can be calculated in this way:

Net government debt = gross debt – intra-government debt holdings – other government assets.

Intra-government debt holdings include bonds held in public social security funds and government bonds held by the central bank.
Government assets include monetary gold, SDRs, and foreign exchange.