February 28, 2004

Note: Robert Waldmann Thinks About Saving Social Security

Robert Waldmann responds to my thoughts about saving Social Security and about the hellish task of having to brief George W. Bush on a complicated issue. He tries to think through some of the issues:

robert's random thoughts: Now for something completely different. Do I (partly) agree with Martin Feldstein, Larry Lindsey, and George W. Bush ?

It seems that Bush was not dishonest when he suggested that private social security accounts could be part of a plan to save Social Security. He really believed something like that because Larry Lindsey told him and Lindsey got the idea from his old prof. Martin Feldstein (and co-author [Andrew Samwick]). The idea was so crazy that it went nowhere in the Bush administration (and that is saying something). However, I am not sure I am totally convinced it is crazy.

Brad DeLong notes correctly that it doesn't really have anything to do with Social Security. The idea is that there is a multi-trillion dollar sure thing for the US Treasury -- issue Treasury bonds and buy corporate bonds and stock. Some of the huge profits from this deal were to be used to save Social Security and others to give people who wanted private accounts to get higher returns.

One crude way to view this is that Bush and Lindsey bought into the bubble just as it was about to burst. The pressure for private accounts came from the idea that stock was a great buy, which, as usual became very strong at the peak of the bubble. The idea vanished as voters suddenly found stocks scary again when the bubble burst.

However, the idea that stocks are, on average, underpriced has considerable support. The equity premium is a puzzle. The evidence is that, since WWII, stocks have far outperformed Treasury bonds over every long period. Clearly most of the evidence is from some time ago. I think it is possible that investors just made a mistake and have since corrected it (so no more multi-trillion dollar sure things). The mistake would not be simply hating stocks but rather failing to diversify and then correctly perceiving undiversified stock portfolios as highly risky.

I am perfectly willing to believe that stock is still underpriced. I am also willing to believe that quality premia on bonds are too high. Now if I think people are making a mistake do I think the government should correct it by selling (safe) bonds and buying stock ? Sounds good to me.

One might argue that rational investors would shift their private portfolios from stock to Treasury bonds to cancel the maneuver. I believe that rational investors are too few to matter.

So what would be the problem ? Well would someone at Treasury decide which stocks to buy ? I don't trust any one team of people to be competent to do that and expect huge corruption. I think just about everyone agrees that it would be a bad idea. Actually I'm not sure about "just about everyone". For all I know all living human beings think that would be a bad idea.

OK so the plan has to be that the Treasury buys say x% of all stock and corporate bonds. Here I see another problem. It is very nice to deal with someone who has to buy x% of your stuff no matter how much and how bad it is.

Let me put it this way. There are two cows. One belongs to Mr A and one to Ms B. A and B, who are very very rich, incorporate and issue shares in an IPO rating each cow as worth a billion dollars. They buy each other's shares. Treasury has to give each of them 100 million dollars for 10% of a cow.

Doesn't sound so good for the honest citizen. Still scams like this exist already: consider the case of Harken Energy or more recently Enron. There are semi sometimes enforceable rules about arms-length transactions.

I personally think the Treasury should issue even more t-bills and buy say 1% of stock and corporate bonds in the USA.

I would like to make two points. First, in Larry's (and Marty's, and Andrew's) mind, the fact that these are private accounts is important: they don't want some Treasury bureaucrat voting shares to choose corporate managers. (Of course, they can't really be private accounts either: we want them properly diversified, and unchurned.)

Second, there is the scale of the operation. When we are talking about Social Security, we aren't talking the measly $150 billion of government asset purchases that Robert is talking about. We're talking something that has a present value of $4 trillion. By 2050 this investment has to generate net income equal to 7.5% of GDP or so--that's $2 trillion of annual income, or a roughly $30 trillion wealth accumulation in these accounts. Even if you do believe (as I do) that stocks are usually substantially undervalued, investments on this scale have the potential to produce huge amounts of price pressure to eliminate the wedges on which the policy is based.

Posted by DeLong at February 28, 2004 07:11 PM | TrackBack

Comments

I'd be grateful if someone could explain to me how a stock can be considered to have any value at all. It is supposed to represent a share in a company, but the proportion that it represents, at least among outstanding shares, can usually be sharply reduced by the sale of more stock. It used to represent a right to a share of the company's proceeds in the form if dividends, but now it seems as if companies can get away with not issuing them. So in what sense can you talk about a stock's real value, beyond "I expect it to go up," which only makes sense if the majority of people feel the same way?

Posted by: Alex on February 28, 2004 07:35 PM

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This may be a frightening naive question, but:

If the US Treasury and/or the Social Security Administration goes shopping on the NYSE with a couple of BILLION dollars, wouldn't that rather inevitably chase up the prices of the finite supply of stock?

And wouldn't anybody who already HELD stock be enriched by this market-driven surge?

So wouldn't 'privatizing Social Security' be nothing but a huge conflict-of-interest for any Congressman who had a portfolio? How could anyone who held ANY stock vote on this question??

Is it really no more complicated than lining their own pockets?
I wish some economist would explain this to me, thanks-in-advance.

Posted by: Bob on February 28, 2004 08:25 PM

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Not billions--trillions of dollars. $3.1 trillion in PRA assets by 2020. Such a reform would push the prices of stock and corporate bonds up substantially (and push the price of long-term Treasury bonds down substantially).

Posted by: Brad DeLong on February 28, 2004 09:10 PM

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And wouldn't the main beneficiaries of all this stock churning be the brokers not the doufusses who thought they were going to retire with a big nest egg?

Posted by: M. Tullius on February 28, 2004 09:32 PM

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Well, yes.

Have we underestimated the depths of corruption of the people advocating the "privatization" of Social Security?

Perhaps their SOLE motivation here is to drive up their own portfolios? Thus, they haven't bothered to think through any sort of public-policy rationale....

Given the large fraction of the public that doesn't even have a bank account (about a third, right?), I've always thought that privatization was a "solution" only for those retirees who weren't actually facing a problem planning for their retirement.

Posted by: Bob on February 28, 2004 09:38 PM

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"Even if you do believe (as I do) that stocks are usually substantially undervalued..."

Don't you mean overvalued? Or, is your view that stocks are undervalued owing to a general under-estimation by investors of potential productivity growth and the concomitant benefits to stocks? Perhaps I'll go digging through some previous blogs to unearth the basis for this belief statement above (or someone could help me out and point to it).

Posted by: monte carlo on February 28, 2004 09:55 PM

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recall my CalPERS analogy from the previous thread. CalPERS is already too big to do much (if any) security selection. a national version of the same is tantamount to nationalization of a nontrivial portion of the public securities market. as a loony leftist, I'm all in favor of a rational nationalization -- but I mistrust that card-carrying neoliberals like DeLong are not.

In re equity undervaluation, while I dig Mr. DeLong's economic assessments, I have to reserve judgement on his valuation calls. Were a Mr. Buffet or a Mr. Soros proclaiming the same, I would instead reexamine my own belief structure. it's not really our business, but I doubt DeLong's trading record has approached that of the US Senate. cf http://www.cba.gsu.edu/news/04/senators.html

full disclosure: my trading record has not beaten the market by 12% a year either.

Posted by: wcw on February 28, 2004 10:12 PM

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ooh! ooh! brad! hand up! answer my question!

why do you believe "stocks are usually substantially undervalued"?

Posted by: c, on February 28, 2004 10:25 PM

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Alex,

value of the market is the value of all the companies put together. the value of a company is the number of shares times the share price. and as you noted, the share priced is based on, well, whatever people pay for it. in the long, long, long run, that's the value of all of the companies future profits, discounted into present dollars.

so when brad says the markets are usually undervalued, that means that he expects companies to be more profitable in the future than the market currently expects.

maybe brad is counting on human ingenuity and technological progress. who knows? c'mon brad, tell us why you think that!

Posted by: c on February 28, 2004 10:32 PM

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This wouldn't be the "privatization" of Social Security. This would be the nationalization of the stock market.

Posted by: JoXn Costello on February 28, 2004 10:36 PM

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Even if the accounts were private, they would have to have substantial restrictions to cut churniing and ensure diversification. So that means a body of laws and regulations to regulate the accounts and enforce the regulations. Which means there will be tremendous incentive to corrupt the process through the "diversification" or "churning" guidelines which I suspect would quickly become something else. For example, how long would it take for Congress to forbid investment in companies that trade with the enemy somehow? And how fuzzy could that definition be made.
I think even indirect gov't stockmarket investment like this would open up huge opportunities for corruption, you just can't get around the corruption issue unless the accounts are completely private-and then you are back to churning and diversification problems.

Posted by: CalDem on February 28, 2004 10:59 PM

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A good article.

Any privatization idea that has the government purchasing private stock is DOA as far as I'm concerned. Not only is it active socialization in the amounts of money we are talking about, Waldmann is dead right that massive corruption is inevitable. Who DOES get to decide what stocks to buy?

Any privatization idea has to have each citizen decide for themselves what equity to purchase. Government paper is a possibility, but that's where current Social Security funds are going, and while at least that's not really "corruptable," there's no real growth.

If you are fretting about all the citizens making "bad choices," like dumping all their private Social Security funds in Pets.com, some basic rules might be instituted. A certain amount of diversification might be mandated, or stock limited to certain types of equity. It is critical if such rules are implemented that they be restricted to certain CLASSES of stocks (for example, off the top of my head, "a Social Security equity fund must have 15 percent of a generic S&P 500 mutual fund") and never mandate SPECIFIC funds, companies, or bonds, otherwise we're back in the corruption zone again.

We still have the problem of getting over the "hump" when older people are getting their promised benefits, but funds from younger employees directly into the Social Security system are decreasing.

Posted by: tbrosz on February 28, 2004 11:24 PM

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My thinking on the social security problem runs something like this:

1. Stop PRETENDING that the government is a responsible holder is social security monies. It just dropped the entire thing into the general fund to pay for massive tax cuts to the already tax-dodging wealthiest.

2. Remove the social security payroll tax as we know it. Take the same burden and shift it into the income tax system. Rebalance the income tax system into a large number of grades, thirty or more, that are paid in a progressive fashion. The end result is revenue neutral or is pegged to a specific percentage of GDP.

3. Pay ONLY means-tested minimum income supplements. Pay this from the general fund. Social Security disappears as we know it, but you'll ALWAYS have something to fall back on, if you really need it.

4. Because lower and middle income earners will now have more of their paychecks in their pockets (since we spread the burden out across the whole tax curve), they'll be able to save for their own retirements (imagine that!). They might even achieve income mobility by developing their own capital. That, of course, will infuriate the status quo.

Full faith and credit of the US government, my ass. This government's credit will be in short supply soon. And I've had about all the faith-based government I can handle.

Posted by: Ross Judson on February 28, 2004 11:34 PM

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Aside from the reflexive "tax cuts to the rich" hiccup (check the actual numbers sometime on both the tax cuts and who's paying them), Ross has a pretty good idea that could get us past the hump. Recognize that Social Security is welfare, pay for it out of general funds, and means-test it. Naturally, this has to be phased in. It would not work to suddenly drop a means-testing limit on current recipients, for example.

Shifting over to general revenues and phasing out the payroll tax would remove a tax burden than is a lot harder on lower income people.

People investing what they once paid into the payroll tax would result in a much better retirement for them, and be better for the economy, although Democrats would probably insist on this being compulsory.

A means-tested program will get us back to what was the original goal of Social Security: giving the elderly a safety net in financial hard times.

It might be educational to read the original Social Security Act:

http://publicpolicy.pepperdine.edu/academics/faculty/lloyd/projects/newdeal/ssa081435.htm

Posted by: tbrosz on February 29, 2004 12:27 AM

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I suppose one could imagine the Treasury establishing a SocSec index. But then the SS index would become very powerful indeed, and getting on that list would, whoo, be an amazing subsidy for a corporation. Which may be the idea.

Posted by: Randolph Fritz on February 29, 2004 12:30 AM

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Randolph: Again, the Treasury cannot be permitted to buy stocks directly. The resulting corporate/government circle jerk would be very bad. You think lobbying is bad now...

And if there are any restrictions at all on where citizens may invest their privatized Social Security money, they would have to be very generic in nature, as in "an indexed fund of this type, meeting this general standard" and NEVER specify any specific funds, companies, brokerages, or stocks.

Posted by: tbrosz on February 29, 2004 12:56 AM

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1) "stocks are usually substantially undervalued"

Stocks in the US have always had a high rate of return. People realized this and bid up the price. As a result, stock got much more expensive and are no longer substantiallly undervalued. Why should the past high rate of return continue?

2) "don't want some Treasury bureaucrat voting shares to choose corporate managers"

Require that the gov't vote in the same proportion as all other holders. This is a simple easy to implement rule that neutralizes the problem. It's also simple enough that the public could easily notice violations and exceptions.

If private interest groups want something today, they could lobby for it. Why would that be any worse if gov't owned lots of stock?

Posted by: richard on February 29, 2004 04:12 AM

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I thought one of the reasons for even having a socialized retirement system was to smooth out any market failures. What happens if there is a huge stock market crash? Do you want to bet the retirements of millions on such a gamble? I suppose the idea is, over the long term and with lots of capital, you can expect a high return. And, if there is a big enough crash to muck up this arrangement, we have bigger problems to worry about.

I have a wonky question about all this : How good are the models at predicting the effect all these trillions will have on returns and/or the general economy? I suppose that is really the unanswered question, right?

Posted by: heet on February 29, 2004 06:09 AM

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Why is finance so important? It seems to me that Social Security, indexed as it is, is basically a committment to pay to former workers enough to buy a basket of goods and services. This is paid for, in real terms, but current workers. If current workers are numerous enough, or productive enough (or both), to pay the retired that basket as a relatively small proportion of current production, Social Security is cheap. If not, it's expensive, and possibly unbearable.

With this in mind, and given demographics, it seems to me that the main hope to keep SS cheap is that productivity rises enough to keep the goods going to retirees a relatively small proportion of current production.

If this doesn't happen then asset prices will shift to reflect the situation in the real economy. That is, if the SS trust fund holds stocks, and sells them to pay benefits, the result will be some combination of falling stock prices and inflation. Since SS is indexed for inflation, the rest of the population will pay an inflation tax, and see their portfolios decline in value, to pay for retiree benefits. All this seems to me equivelant to current taxation.

Therefore I consider financial arrangements, whether taxes or stock, largely irrelevant. Shifting to progressive taxation, means testing or cutting benefits (which I oppose) would actually help; shifting to stocks wouldn't.

I assume Waldmann and deLong are as capable of the above reasoning as I am. Would someone tell me why it's wrong? TIA

Posted by: Jonathan Goldberg on February 29, 2004 06:23 AM

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Inquiring minds want to know why Brad "believes" stocks are "usually substantially undervalued". But Brad ain't saying. After looking at a chart of the DJIA for the last 75 years or so---

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http://finance.yahoo.com/q/bc?s=^DJI&t=my&l=off&z=m&q=l&c=

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--HERE'S my theory on THAT question:

I think, it COULD be, that MAYBE (out of respect for Murphy's Law, if for no other reason ;-) Brad is simply long-term bearish on the value of the Greenspan ('petro'*) dollar--even if he's loath to say such a blasphemous thing out loud, in public...

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April 11, 2002

US dollar hegemony has got to go

By Henry C K Liu

There is an economics-textbook myth that foreign-exchange rates are determined by supply and demand based on market fundamentals. Economics tends to dismiss socio-political factors that shape market fundamentals that affect supply and demand.

The current international finance architecture is based on the US dollar as the dominant reserve currency, which now accounts for 68 percent of global currency reserves, up from 51 percent a decade ago. Yet in 2000, the US share of global exports (US$781.1 billon out of a world total of $6.2 trillion) was only 12.3 percent and its share of global imports ($1.257 trillion out of a world total of $6.65 trillion) was 18.9 percent. World merchandise exports per capita amounted to $1,094 in 2000, while 30 percent of the world's population lived on less than $1 a day, about one-third of per capita export value.

Ever since 1971, when US president Richard Nixon took the dollar off the gold standard (at $35 per ounce) that had been agreed to at the Bretton Woods Conference at the end of World War II, the dollar has been a global monetary instrument that the United States, and only the United States, can produce by fiat. The dollar, now a fiat currency, is at a 16-year trade-weighted high despite record US current-account deficits and the status of the US as the leading debtor nation. The US national debt as of April 4 was $6.021 trillion against a gross domestic product (GDP) of $9 trillion.

World trade is now a game in which the US produces dollars and [exports jobs while]* the rest of the world produces things that dollars can buy. The world's interlinked economies no longer trade to capture a comparative advantage; they compete in exports to capture needed dollars to service dollar-denominated foreign debts and to accumulate dollar reserves to sustain the exchange value of their domestic currencies. To prevent speculative and manipulative attacks on their currencies, the world's central banks must acquire and hold dollar reserves in corresponding amounts to their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. This creates a built-in support for a strong dollar that in turn forces the world's central banks to acquire and hold more dollar reserves, making it stronger. This phenomenon is known as dollar hegemony, which is created by the geopolitically constructed peculiarity that critical commodities, most notably oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petro-dollars is the price the US has extracted from oil-producing countries for US tolerance of the oil-exporting cartel since 1973.

By definition, dollar reserves must be invested in US assets...

http://www.atimes.com/global-econ/DD11Dj01.html

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...I know I am ;-)

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U.S. Budget Deficit Threatens World Economy, IMF Warns

Thursday, January 8, 2004

A rising U.S. budget deficit and trade imbalance may create such a burden of foreign debt that it could cause financial instability in the United States and the rest of the world, a report released yesterday by the International Monetary Fund says.

According to the report, the U.S. budget deficit last year reached $374 billion, a record in dollar terms, and it is expected to exceed $400 billion this year. In a few years, the report says, the United States could have a foreign debt equal to 40 percent of its total economy "an unprecedented level of external debt for a large industrial country...."

http://www.unwire.org/UNWire/20040108/449_11858.asp

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Trade Deficit Swells 17.1% To Record $489 Bil In '03

Tue Feb 17,10:21 AM ET

By Jed Graham

The U.S. trade deficit widened more than expected to a near-record $42.5 billion in December, bringing the full-year total to a record $489.4 billion, the Commerce Department said Friday...

http://story.news.yahoo.com/news?tmpl=story&u=/ibd/20040217/bs_ibd_ibd/2004217general01

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*See:

"THE END OF CHEAP OIL"

http://dieoff.org/page140.htm

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"Interim Report: Notes on the U.S. Trade and Balance of Payments Deficits"

http://www.levy.org/docs/stratan/stratan.html

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"BUSH'S DEEP REASONS FOR WAR ON IRAQ: OIL, PETRODOLLARS, AND THE OPEC EURO QUESTION"

http://ist-socrates.berkeley.edu/~pdscott/iraq.html

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"The Earth's life-support system is in peril"

http://www.iht.com/articles/125563.html

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**[The words in the brackets in the fourth paragraph of the cited article are mine: NOT Mr. Liu's.]

Posted by: Mike on February 29, 2004 06:54 AM

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In Hong Kong it's privatized. The government doesn't decide which stocks to buy: there are hundreds of funds run by banks and insurance companies and you choose the one you want. And they don't just invest in local stocks. If you leave the country you can get your money back. Otherwise you have to wait until 65 or whenever it is.

I've got this one called a European Growth Fund. They keep sending me brochures about it, but the thought of reading them makes me want to sob with boredom.

Posted by: Matthew Bristow on February 29, 2004 07:42 AM

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The market is inefficient? It's interesting that a privatization plan rests on the argument of market inefficiency.

Posted by: Harold McClure on February 29, 2004 07:44 AM

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Suppose that the reason stocks were significantly undervalued for many years was the "Inflation Illusion" discussed by Franco Modigliani in 1979. Suppose also that the illusion that stocks were expensive in 1980 has been replaced by the illusion that stocks are now cheap or even reasonably priced. What happens if you toss in the certainty of a trillion dollars added to the stock market and taken from the treasury market?

Posted by: anne on February 29, 2004 10:34 AM

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http://www.nytimes.com/2004/02/22/business/yourmoney/22stra.html

A Time-Tested Sign of an Overvalued Market
By MARK HULBERT

A RECENT academic study seriously undermines a popular reason for not worrying about the high price-to-earnings ratio of the stock market today: the idea that the ratios should be high when interest rates are low.

The theoretical basis for this claim is the so-called Fed Model, which compares the interest rate on the government's 10-year Treasury note with the inverse of the stock market's P/E ratio - known as the market's earnings yield. The stock market is considered undervalued when its earnings yield is greater than the Treasury note rate.

If the Fed Model held true, earnings growth should be slower when Treasury note rates are high and faster when those rates are low. Historically, however, that has not been the case, according to the new study, "Inflation Illusion and Stock Prices," by the Harvard finance professors John Y. Campbell and Tuomo Vuolteenaho. The study has circulated this month as a National Bureau of Economic Research working paper and is at www.nber.org/papers
/w10263.

A similar conclusion was reached in a study by the finance professors Jay R. Ritter of the University of Florida and Richard S. Warr, now at North Carolina State. That study, published in 2002, covered 1978 to 1999, but the new one covered a much longer period: 1927 through 2002.

The government's 10-year Treasury note has not traded during all those 75 years, but according to the professors, interest and inflation rates are highly correlated. And over those 75 years, earnings growth has tended to be higher during periods of high inflation and lower when inflation is low.

Put another way, the professors conclude that stocks are a good long-term hedge against inflation. They found that the growth rate of real, or inflation-adjusted, earnings is relatively constant when measured over several-year periods. That means the growth rate of nominal earnings tends to rise and fall with inflation.

Many investors overlook that point, because they assume that changes in inflation will not affect nominal earnings growth. Economists call that assumption an "inflation illusion." If it were true, real earnings growth should be faster in periods of low inflation, justifying higher P/E ratios.

But the assumption has not been true over time, according to Professors Campbell and Vuolteenaho. As a result, they found that the stock market has tended to become significantly undervalued in times of high inflation and overvalued in times of low inflation....

Posted by: anne on February 29, 2004 10:37 AM

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Robert Walmann's arguments as Brad's are excellent, but need ample following up. Perhaps we should look most carefully at the partial Social Security privatization program in Sweden

Posted by: anne on February 29, 2004 10:42 AM

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http://www.nytimes.com/2004/02/05/business/05scene.html?ex=1078203600&en=c86a8e5117033eb9&ei=5070

Retirement Lessons From Sweden
By ALAN B. KRUEGER

"YOUNGER workers," President Bush said in his State of the Union address, "should have the opportunity to build a nest egg by saving part of their Social Security taxes in a personal retirement account."

According to former Treasury Secretary Paul H. O'Neill, the president believes that the reason he was elected was his bold - some would say risky - stance on replacing part of Social Security with personal accounts. If the president holds onto office in November and his party continues to hold Congress, the creation of some sort of personal retirement accounts as part of Social Security seems likely.

Although it is impossible to know what form such accounts might take, in 2000 Sweden instituted a system of personal accounts that holds many lessons for any country seeking to reform its retirement system.

Sweden now has a blended system, an approach Mr. Bush apparently favors. Employers and employees contribute a combined 16 percent of payroll toward a "pay as you go'' retirement system like Social Security, and an additional 2.5 percent toward individual retirement accounts. Those born after 1954 are fully in the new system, while older workers are phased in.

The reform process began in 1991, when a center-right coalition came to power. At the time, Sweden's generous retirement system was expected to exhaust its "buffer" funds in about 20 years, a more dire situation than what now confronts the United States; Social Security will not exhaust its trust fund until 2042, according to the latest projections.

To address its problems, Sweden set up a committee with representatives from all parties in Parliament. Because the reforms were expected to last for decades, there was pressure to devise a plan with broad support, said Annika Sunden, an expert on pensions at Stockholm University. There was agreement back in 1994 that reform would include individual accounts, so beginning in 1995 the government began tucking away 2.5 percent of payroll for employees to invest once the system was set up....

Posted by: anne on February 29, 2004 10:47 AM

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http://www.nytimes.com/2004/02/05/business/05scene.html?ex=1078203600&en=c86a8e5117033eb9&ei=5070

Personal investment accounts were not established until 2000, with a bewildering array of funds to choose from. Some 456 funds participated initially, and the number has since grown to around 600. Most funds invested in stocks, with a quarter primarily in Swedish stocks. Workers could choose up to five funds.

Anyone who did not choose a fund was automatically assigned to the default fund, which was set up by the government. The default fund must invest 80 to 90 percent of its assets in stocks....

The average fee for active choosers was 77 basis points, or 0.77 percent of the funds invested. For the default fund it was just 16 basis points. Chile's mandatory savings plan provides another point of comparison. Fund management fees were much lower in Sweden than administrative costs in Chile's plan, probably because the central pension agency orchestrated rebates and advertised the fee rates....

The consequences of making a bad investment decision in Sweden are much less severe than they would be in the United States if Mr. Bush gets his way and allows workers to divert part of the 12.4 percent of their paycheck that goes to Social Security - half from the employee, half from the employer - into personal accounts.

Sweden devotes 16 percent of payroll to an earnings-linked pension system, creating a strong safety net beneath individual accounts. Sweden also established a "guaranteed pension" that provides a minimum pension amount, in excess of the poverty line, to anyone with little or no pension income....

Posted by: anne on February 29, 2004 10:56 AM

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Assuming no change in overall investment (a big assumption, I know, but bear with me here), wouldn't the government's gains come at at the expense of all the other investors in the stock market?

Posted by: Jason McCullough on February 29, 2004 11:01 AM

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So, I would be quite inclined to look to the sort of partially private Social Security program adopted in Sweden. The stock market bias of the plan would be moderate, but helpful to long term investors, and there would be a decent pension guarantee to the program for lower income workers.

Posted by: anne on February 29, 2004 11:03 AM

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There should be no problem for investors if a steady flow of long term funds enters the market. When the large state pension plans invest, there is no negative effect on my investments. The minor short term negative effect might be an increase in bond yields with less government bond buying. Bond holders would quicly adjust.

Posted by: anne on February 29, 2004 11:10 AM

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Suppose stocks are fully priced when the partially private investment program began. Well, bonds are surely fully priced now. So what? There has been a quite steady long term flow of earnings to American corporations that should insure long term stock returns will be higher than bond returns from almost any possible starting point.

Posted by: anne on February 29, 2004 11:18 AM

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What Alan Greenspan did not explain:

http://www.nytimes.com/2004/02/29/weekinreview/29john.html

The Social Security Promise Not Yet Kept
By DAVID CAY JOHNSTON

SOCIAL Security retirement benefits are going to have to be cut, Alan Greenspan announced last week, because there just is not enough money to pay the promised benefits. President Bush said those already retired or "near retirement age'' should not worry. They will get their promised benefits.

That, in short form, was the story carried on front pages and television news programs across the country.

But there is an element that was forgotten in the rush of news. It dates back 21 years to the events that catapulted Mr. Greenspan into national prominence and led to his becoming chairman of the Federal Reserve.

Since 1983, American workers have been paying more into Social Security than it has paid out in benefits, about $1.8 trillion more so far. This year Americans will pay about 50 percent more in Social Security taxes than the government will pay out in benefits.

Those taxes were imposed at the urging of Mr. Greenspan, who was chairman of a bipartisan commission that in 1983 said that one way to make sure Social Security remains solvent once the baby boomers reached retirement age was to tax them in advance.

On Mr. Greenspan's recommendation Social Security was converted from a pay-as-you-go system to one in which taxes are collected in advance. After Congress adopted the plan, Mr. Greenspan rose to become chairman of the Federal Reserve.

This year someone making $50,000 will pay $6,200 in Social Security taxes, half deducted from their paycheck and half paid by their employer. That total is about $2,000 more than the government needs in order to pay benefits to retirees, widows, orphans and the disabled, government budget documents show.

So what has happened to that $1.8 trillion?

The advance payments have all been spent....

Posted by: anne on February 29, 2004 11:45 AM

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What's all this talk about funneling a bunch of public money into private equities through the payroll tax--or "'fixing' Social Security"--REALLY all about? Well, it's really very simple: Now that stocks are at truly, historically, RIDICULOUSLY high levels:

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http://finance.yahoo.com/q/bc?s=^DJI&t=my&l=off&z=m&q=l&c=

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The TINY little handful of folks who are holding MOST of them...

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"The L-Curve"

http://www.lcurve.org/

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...would dearly love for uncle Alan to figure out a way to force YOU to buy them at (or near) 'the top'. That's what.

----------------

From:

The Economic Policy Institute: Research and Ideas for Working People

"Facts At A Glance...

FACTS ABOUT SOCIAL SECURITY FINANCES

To pay for benefits, Social Security receives income from three sources.
Most of the money that is needed to pay for benefits comes from payroll taxes. Currently, employees and employer each pay 6.2% to Social Security, for a combined tax rate of 12.4% of wages and salaries. Self-employed workers pay the full 12.4% out of their earnings. Taxes, however, have to be paid only up to an earnings ceiling, which is $84,900 annually in 2002. Earnings above the ceiling are not subject to the payroll tax. In 2001, Social Security received a total of $516.4 billion in payroll taxes.

As a result of reforms to Social Security in 1983, a trust fund was specifically set up as a savings account to pay for baby boomers. Since then, Social Security has taken in more money than it has paid out in benefits. Consequently, it has built up a trust fund over the years. Social Security earns interest on this trust fund. In 2001, the trust fund received 6.6% interest on its assets, earning $72.9 billion in interest.

Finally, some Social Security benefits are subject to taxes, which are then paid to Social Security. In 2001, taxes on Social Security benefits amounted to a total of $12.7 billion.

Social Security is building up a trust fund.
Because income is currently exceeding expenditures, Social Security is building up a trust fund. Total income to Social Security was $602 billion in 2001. Its expenditures came to $439 billion, $432 billion of which was benefit payments. Consequently, Social Security managed to increase its trust fund by $163.1 billion in 2001. As a result, Social Security held a total of $1,213 billion in assets at the end of 2001. If Social Security faces a shortfall in income, the trust fund assets can be used to pay for the additional benefits.

Trust fund assets are invested in government bonds.
Social Security trust fund assets, currently worth over $1 trillion, are invested in special, non-tradable government bonds. Each year the U.S. Treasury issues these government bonds, up to the amount of the Social Security trust fund surplus, to be added to the account. The bonds earn an interest rate comparable to the market interest rate for tradable government bonds. During 2001, the effective annual interest rate earned on all bonds held by the trust funds was 6.6%.

Social Security is not going broke.
Each year, in early spring, the trustees of Social Security release their report. As required by law, the trustees present what can be described as their best guesses for three different scenarios for the future of Social Security. In their annual report for 2002, the trustees project that Social Security will take in more in income than it will pay out in expenditures until 2017. Between 2017 and 2027, interest income earned on the trust fund assets is forecasted to make up the difference between income and expenditures. After 2027, Social Security is expected to draw down its trust funds to pay for the expenditures that are not covered by income. Finally, in 2041, the trust fund assets are expected to be gone, and income is projected to be less than expenditures. However, the trustees project that Social Security will still be able to pay for more than 2/3 of its promised benefits from 2041 to 2076.

Social Security is not going broke. The trustees instead project a financing shortfall that may happen almost 40 years from now. These projections, however, are based on pessimistic assumptions. Real growth is expected to fall to between 1.7% and 1.8% over the long-run, which has never been the case for an extended period of time during the post-war years. Similarly, the trustees assume that in the long-run the economy will settle on an average productivity growth rate of 1.6%, which is again too low by historical standards. Higher productivity and consequently faster real wage growth -- which have both historically been about 2.0% -- would be more realistic and improve Social Security's finances.

One solution to the shortfall would be to increase Social Security's revenues.
It may seem prudent to increase the amounts available in the trust funds as long as the trustees provide a pessimistic outlook for the future. Eliminating the cap on earnings that are subject to Social Security taxes can cover three quarters of the shortfall. Currently, the cap is $84,900 per year. Earnings above $84,900 are not subject to the Social Security payroll tax. Eliminating this cap would provide Social Security with sufficient income to cover at least three quarters of the shortfall that Social Security's trustees expect based on their pessimistic assumptions."

http://www.epinet.org/content.cfm/issueguides_socialsecurity_socsecfacts

Posted by: Mike on February 27, 2004 06:13 PM


Posted by: Mike on February 29, 2004 11:45 AM

____

heet, Jonathan Goldberg: Your reasoning is not wrong. That's exactly what will happen in the "hump" that tbrosz wants to get over.

The hypothetical private accounts or government purchases of equity will create a large additional demand driving up stock prices. Conversely, when the "hump" comes, those portfolios will be liquidated at such a rate that prices will be depressed quite a bit.

Although tbrosz has taken quite some heat here and on other boards for the more or less clearly articulated desire to evade having to pay for the "hump", and then being stiffed out of the benefits, we may consider the thought that we may be sitting in the same boat.

The underlying problem is really whether when people retire, there will be enough goods and services (i.e. productivity) to be redistributed to them, by whichever mechanism the redistribution occurs. If not, then the shit will hit the fan big, private accounts or not. All your stock holdings will not help you if the goods and services you are after are scarce, and you have to compete with everybody else. If you have not been in the upper part of the income pyramid and have a lot more stock than others, good luck.

Posted by: cm on February 29, 2004 12:02 PM

____

"c", thanks for your response.

"in the long, long, long run, that's the value of all of the companies future profits, discounted into present dollars."

Why is that, when shareholders have effectively no way to ensure that they will see a share of those profits?

Posted by: Alex on February 29, 2004 12:06 PM

____

Thanks Anne -

By the by, Social Security does not need saving for many years. We can move slowly and moderately as Alan Krueger shows Sweden did. We have been paying far more than needed to support Social Security since Alan Greenspan raised the payroll tax in 1983. To claim a sudden problem is quite disingenuous for AG.

Posted by: lise on February 29, 2004 12:09 PM

____

"The hypothetical private accounts or government purchases of equity will create a large additional demand driving up stock prices."

If private accounts are slowly phased in as in Sweden, there is no reason to expect a stock market problem. There is also no reason to assume stocks are a poor long term investment at present, rather the reverse even if they are not as cheap as they were 20 years ago.

Posted by: anne on February 29, 2004 12:14 PM

____

"...There is also no reason to assume stocks are a poor long term investment at present, rather the reverse even if they are not as cheap as they were 20 years ago..."

It's plain to ME that you haven't read Henry Liu's 'critique' of Greenspan's monumental monetary 'sting', Anne:

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http://www.atimes.com/global-econ/DD11Dj01.html

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But I just HAVE to ask: Have you even LOOKED at the chart?

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http://finance.yahoo.com/q/bc?s=^DJI&t=my&l=off&z=m&q=l&c=

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Posted by: Mike on February 29, 2004 12:36 PM

____

anne: "If private accounts are slowly phased in as in Sweden, there is no reason to expect a stock market problem."

If the private accounts make up only a miniscule part of the contributions, then I don't see how they help much to deal with a benefits shortfall, like, for example, getting $100 in monthly stock sales, but $200 less in other benefits. Otherwise you are talking about quite a bit of money.

"There is also no reason to assume stocks are a poor long term investment at present, rather the reverse even if they are not as cheap as they were 20 years ago."

That's not the point. Depending on which amount is allocated to private accounts, there will be additional aggregate demand up until the "hump", and then there will be aggregate liquidation of the accounts. The laws of demand and supply, as well as arbitrage, will affect prices, reducing the net yield on those accounts. Of course some of this will be countermanded by people restructuring their portfolios in anticipation of the hump, so things will get spread out a bit.

What is your comment on the productivity argument that various people have made? Regardless of how much you can realize in proceeds, you have to compete with aggregate demand for goods and services. And presumably there will be relatively quite a few more retirees vs. workers then than today.

Posted by: cm on February 29, 2004 12:52 PM

____

"After looking at a chart of the DJIA for the last 75 years or so..."

One will note that the inflation-adjusted average real compound growth rate in it has been a tad under 3%. The compound growth rate in the value of stocks has always been close to that of the real economy.

But people are forever conflating the average long-run real simple annual return from stocks of 7% with their compound growth rate and proclaiming dubious conclusions as a result, such as it's unsustainable because it's too high. Though they don't make the same mistake of conflating simple and compound returns on bonds. I don't know why that is.

Also I don't understand the obsessive fixation on privatizing SS only with "stocks" that must be bought only in the US stock market.

The SSA actuaries say returns to today's young workers on SS contribtuions will range from minimally above zero to negative -- and after accounting for the 25% underfunding of benefits, which with a paygo system *must* further reduce returns by that 25% (reduced benefits and/or increased contributions are the only options in paygo and both reduce returns) near everybody is well negative.

A real investment in *anything* (including US gov't bonds) beats a negative return and thus would improve the status of indivduals with private accounts, and an investment in *anything* that pays on average more than US bonds would improve the long-run fiscal situation by more than covering the cost of any near-term government borrowing required in the process. And since US bonds are supposed to be the safest of all investments, diversified investments in *anything* else ought to provide a higher average return than them. Is that a deep mystery?

It ain't just US stocks to talk about. There are coporate bonds, European stocks and bonds, government bonds of all the nations of the world, not to mention all the investment real estate in the world, and much more -- one suspects capital needs and financial markets serving the couple *billion* people in fast-growing economies in Asia might expand somewhat over the few decades ... So what's the reason why the eye does not see farther than US stocks?

Anyhow, criticizing any one proposal on a stand-alone basis is pointless to disingenuous.

What will be the expected economic and political effects of financing SS and Medicare with $45 trillion (current value) of tax increases alone? What's the comparative advantage of *that* relative to a near-term real investment program that would reduce that long-run cost. That's the only meaningful question.

Posted by: Jim Glass on February 29, 2004 12:59 PM

____

I have always loved Samulesons comment on US stock market returns since 1926 -- as far back as we have really good data. He says this is a sample of one, if you take in all of world history and all of the world economies.

Why would anyone make the comment that the market is usually either overvalued or undervalued. Even if you just take a very weak case of the efficient market you would have to conclude that the market is usually fairly valued and that peiods of overvaluation and/or undervaluation are the exception.

I personally believe that the average PE on stocks has trended up since WW II because the risk premium fell because economic and stock market volatility has declined. But given that the risk premium is very low, as are inflation and interest rates the post war trend to higher
stock market valuations has probably peaked.
From 1949 to 2000 earnings growth only accounted for 21.5% of the gain in the S&P 500 -- the rest of the gain was due to higher PEs.

Now, if interest rates and inflation are near
long run secular lows that implies that the stock market PE is near its long run secular peak.
In that case the assumption that the stock market will continue to provide the high rates of return it did over the last 50 years is an extremely questionable assumption.

One quick point on the perception of wide-spread stock ownership. Yet, 50% of the population now owns stocks. But over 90% of the stock market by valuation is still owned by less than 10% of the population.

Posted by: spencer on February 29, 2004 01:21 PM

____

"$3.1 trillion in PRA assets by 2020. Such a reform would push the prices of stock and corporate bonds up substantially"

Really?

Of course we are talking about world financial markets here. My recollection is world stock market capitalization is something like $40 trillion now, and I know the NYSE is $15 trillion by itself. So $3 trillion over 20 years would be less than 1% per year of the NYSE.

What's so staggering about that? When only a portion in fact would be in US stocks, and allowing for portfolio shifting too?

BTW, we've already seen trillions go into new private accounts in the *last* 20 years -- IRAs, 401(k)s etc -- have they had this predicted effect in reality?

Posted by: Jim Glass on February 29, 2004 01:44 PM

____

"...One will note that the inflation-adjusted average real compound growth rate in it has been a tad under 3%. The compound growth rate in the value of stocks has always been close to that of the real economy...."

The 'real' economy? You talking about THIS economy, Jim?

The 'freely trading', 'growing', 'globalized' economy we all hear so much about?

-----------------

U.S. Budget Deficit Threatens World Economy, IMF Warns

Thursday, January 8, 2004


A rising U.S. budget deficit and trade imbalance may create such a burden of foreign debt that it could cause financial instability in the United States and the rest of the world, a report released yesterday by the International Monetary Fund says.

According to the report, the U.S. budget deficit last year reached $374 billion, a record in dollar terms, and it is expected to exceed $400 billion this year. In a few years, the report says, the United States could have a foreign debt equal to 40 percent of its total economy "an unprecedented level of external debt for a large industrial country..."

http://www.unwire.org/UNWire/20040108/449_11858.asp

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Trade Deficit Swells 17.1% To Record $489 Bil In '03

Tue Feb 17,10:21 AM ET

By Jed Graham

The U.S. trade deficit widened more than expected to a near-record $42.5 billion in December, bringing the full-year total to a record $489.4 billion, the Commerce Department said Friday.


The trade gap expanded by $4.1 billion, or 10.8%, from November's 13-month low of $38.4 billion. December's deficit was the second biggest ever, behind the $42.9 billion gap last March.


For the year, the deficit rose $71.3 billion, or 17%, from the old record of $418 billion in 2002..."

http://story.news.yahoo.com/news?

----------------tmpl=story&u=/ibd/20040217/bs_ibd_ibd/2004217general01

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Posted by: Mike on February 29, 2004 01:51 PM

____

This Lindsey/Feldstein plan is very dependent on the idea of the equity premium. The equity premium puzzle is a very contentious issue that keeps many finance professors busy. It is true that, as many studies have pointed out, people who hold a portfolio of stocks have received a premium of about 5 percent over holding a portfolio of treasuries. But the equity premium is not a worldwide phenomenon: Marsh and Dimson have done an extensive study (in "The Triumph of the Optimists") of investment returns in 17 markets over a 100 year period. They found that there was only a significant equity premium in the US and UK. Some markets even have had negative equity "premiums". It is absolutely not certain whether such equity premium will continue to exist in the US market and I'm surprised that Brad buys the idea of a long-term "undervalued" stock market. I would rather implement many of the ideas which have been put forward by Robert J. Shiller. The affordability of social security depends mainly on demographic factors and I think that good child care facilities and an extra child tax credit for children in excess over the natural reproductive rate, for example a tax credit for a third or fourth child (how controversial that might be), would be far better than the plan proposed by Lindsey and Feldstein.

Posted by: Nescio on February 29, 2004 01:54 PM

____

"If the US Treasury and/or the Social Security Administration goes shopping on the NYSE with a couple of BILLION dollars, wouldn't that rather inevitably chase up the prices of the finite supply of stock?"

What is more effective?: An "Endogenous" or an "Exogenous" Economy?When and Why?(Mankiw?)

Posted by: Blani on February 29, 2004 02:08 PM

____

Re: the Economic Policy Institute, and the "Trust Fund."

To really see how this works, take a few people acting as citizens and the government, put a box on the table labeled "Trust Fund," and start moving a handful of dollar bills around according to the way the EPI says Social Security is being financed. Be sure to include the government borrowing that money and paying it back with interest from...where? Notice anything?

A private outfit that pulled this kind of financial shell game would get thrown in jail.

Posted by: tbrosz on February 29, 2004 02:46 PM

____

"If private accounts are slowly phased in as in Sweden, there is no reason to expect a stock market problem."

The political resistance to 2% private accounts isn't based on what they would do to financial markets. It's that Swedish politicians are too well known as right-wing extremists who have been warped by the ideas of Cato for their ideas ever to be considered by U.S. Democrats.
---

"If the private accounts make up only a miniscule part of the contributions, then I don't see how they help much"

SS benefit formula today is slated to give young workers very minimal returns overall, *negative* returns to many -- after the 25% underfunding is factored in, negative returns probably to almost all.

Negative returns for the masses politically will kill SS *as we know it* as surely as the real big risk-free positive returns of the past made it so extremely popular.

But 40 years of positive compounding at say 5% on 15% of one's SS contribution (2 points of tax) is enough to give positive returns to everybody, which is the *political necessity*.

Look, closing SS's funding gap is trivial, financially. They could do it right now by pushing back the retirement age five years, or cutting money benefits 20%, whatever. And closing it can't *not* happen with a paygo system. So it will, the gap will be closed.

The reason it's not done is *political*. Doing so in a way that leaves masses getting back less than they put in will lead to political mutiny -- which is why all the politicians put their heads in the sand about it.

But 2% private accounts, if created soon, will put everybody on track to positive returns from their total contributions before the day of reckoning comes. And if everybody then knows they are going to get back at least what they put in, they'll be able to work out a deal over the rest.

But if the masses know they *aren't* going to get back what they put in, somebody associated with SS is gonna have *real* political problems.

Now, closing the funding gap for Medicare is *not* trivial. So if we can't do it with SS this is not encouraging.

Posted by: Jim Glass on February 29, 2004 02:47 PM

____

Thanks, Mike, for debunking the myth that Social Security is rapidly becoming insolvent and outlining the extent of the problem as it exists.

The only argument that I can see for investing Social Security funds in equities is a tacit admission that future productivity gains will not be reflected in wages; i.e., most of the gains will go to capital and hence taxes based on wages will not increase in a manner that captures productivity gains. If wages do rise to reflect most productivity gains (plus inflation), I fail to see why they are not a proxy for the market.

Certainly the last few years would indicate that wages do not capture much in the way of productivity gains, except at the very high end. This is another argument for raising the cap on FICA taxes but one wonders how long the broad public will sit still for a world where most of the gains from productivity go to a relative few.

Sam

Posted by: Sam Taylor on February 29, 2004 02:51 PM

____

Spencer

Excellent comments, as usual. I completely agree that we can look for 20 year stock returns to be less than those of the last 20. After all, price earnings ratios for the S&P were about 10 in 1983. But, there is no reason to believe stocks will not fare better than treasury bonds.

cm

Fine argument.

"If the private accounts make up only a miniscule part of the contributions, then I don't see how they help much to deal with a benefits shortfall, like, for example, getting $100 in monthly stock sales, but $200 less in other benefits. Otherwise you are talking about quite a bit of money."

I would suggest a solution close to Sweden's would work. We have a minor Social Security problem. Adding no more than 10% of Social security contributions to private stock-bond accounts should be ample.

Posted by: anne on February 29, 2004 02:55 PM

____

"Certainly the last few years would indicate that wages do not capture much in the way of productivity gains, except at the very high end."

This is a serious problem that complicates the lack of job creation.

Posted by: lise on February 29, 2004 03:00 PM

____

"I thought one of the reasons for even having a socialized retirement system was to smooth out any market failures. What happens if there is a huge stock market crash?"

A stock market that behaves more or less normally over the life of one of today's young workers, then has a 50% crash the day before he retires, will leave him with *way more* than will the SS benefit formula (which itself is 25% underfunded) on the same contributions.

It takes a government to remove the risk of the market and *guarantee* negative returns over 40 years.
---

"To claim a sudden problem is quite disingenuous for AG."

Yes, the current value underfunding of SS and Medicare is only $45 trillion. It won't become a "sudden" problem until the cash flow cost of actually *paying* that starts coming due around 2018, when the number will be over $50t on current policy.

Now if you find some day that Snidely Whiplash has tied you to the train tracks, don't start working to loosen those knots yourself. You won't have any "sudden" problem until the train hits you. And Dudley Do-Right may come along before then to save you. Though I doubt he'll have $45 trillion on him.
---

"What is your comment on the productivity argument that various people have made?"

You mean....

"The underlying problem is really whether when people retire, there will be enough goods and services (i.e. productivity) to be redistributed to them, by whichever mechanism..." ?

Non-issue. It's not like US seniors are all there are going to be in the US, much less the world, 40 year from now.

The growth in the demand of US retirees represented by increasing SS expenditures (and other retirement income too) may go up at a rate faster than overall economic growth -- but it is today such a small amount compared to the rest of the economy (i.e., the growth will be from such a small base) that the *dollar amount* of US production per adult (workers and retirees) will go way up, like 40%, after adjusting for it. Lower growth rate, but from a *much* larger base. People are going to get richer, not poorer. Poverty due to a nation buried under retirees' bodies isn't going to happen. We aren't going to have to resort to Soylent Green.

And, of course, it's world production that counts. Markets for produced goods will be far more world-wide than now 40 years from now, unless very bad things happen. And most of the world is a couple generations behind the US demographically and boosting production as fast as they can.

Though when that Chinese/Indian population bulge hits retirement, watch out.

Posted by: Jim Glass on February 29, 2004 03:04 PM

____

Jim Glass

Absolutely, long term compounding works. The matter of lack of demographic does not seem worrisome from a global perspective provided we pay attention to getting our private saving rate up. Still, there is the public deficit we are building.... The need is to have ample investment income returning from world accounts as we age as a country.

Posted by: lise on February 29, 2004 03:29 PM

____

EPI says...

"Social Security is not going broke ... Social Security is building up a trust fund ... that will cover expenditures until 2041."

Wow! And now let's see how!

Starting in 2018 or so the cash cost of SS benefits will exceed SS's payroll tax revenue, creating a financing deficit. Call this deficit for any given year $X.

Now, *without* the trust fund it is obvious that to cover this deficit without reducing benefits the government would have to come up with extra revenue, such as by raising income taxes, in the full amount of $X.

Fortunately, *with* the trust fund the government will cover this deficit by making redemption and interest payments on trust fund bonds in the amount of $X, which will require it to come up with extra revenue, such as by raising income taxes, only in the mere amount of $X!

And as $X = $X we can see clearly that the financial benefit of the trust fund in financing Social Security's future benefit obligations is exactly and precisely $0.

Hey, wait a minute ... we've all paid a heck of a lot of "excess" payroll taxes into this danged trust fund over the last 20 years ... does someone want to e-mail EPI and ask for a clarification of this?

Posted by: Jim Glass on February 29, 2004 03:32 PM

____

With moderate productivty growth, Social Security will be fine for decades. Simply adjusting the upper limit on contributions can add further decades. Unless there is a long term decline in productivity and growth, which we would be foolish to anticipate, the only issue should be adding to the usefulness of Social Security. Private accounts "modestly" developed may well add to the usefulness of Social Security.

Posted by: anne on February 29, 2004 03:49 PM

____

Dear Brad

Thanks for linking to me. I'd like to mention that my argument included a two cows joke. I daid I partly agreed with them. Thanks to your back of the envelope calculation I now know I agree with them about 3.75% If I had done the arithmetic, I would have been less worried about it.

Posted by: Robert Waldmann on February 29, 2004 03:57 PM

____

"Starting in 2018 or so the cash cost of SS benefits will exceed SS's payroll tax revenue, creating a financing deficit."

I've read a lot earlier dates than 2018. For instance, the Concord Coalition says 2013:

" In fact, Medicare has had an operating deficit since 1992. Social Security will begin running a deficit in 2013, seventeen years before its official bankruptcy date."

Posted by: Mark Bahner on February 29, 2004 05:03 PM

____

Note the difference between "tbrosz" and Jim Glass: JG always (well almost always) argues specific numbers, while "tbrosz" almost never does. I was earlier today thinking about posting a comment about why do we have "tbrosz" here when JG was always a much more substantive counterweight; I'm glad JG weighed in. And it's clear that "tbrosz" is nothing but a troll.

Now suppose we admit the facts on the ground and surmise a little about political realities. Wow! We numerate middle classers got snookered by Greenspan in '83 eh? And BDL here has been floating puffs to him all through the last three or four years... and it was all a delicious con? So what if Greenspan can pick and set a felicitious interest rate, that SOB ripped us OFF.

You know what's a bit fun here? By publishing his annual IT at $30K[1], "tbrosz" stuck himself right into the middle class camp, and thus he's a sucker too, but every last one of his posts rests on the libertarian delusion that he's effectively one of Greenspan's "Free Markets, Free Minds" clients.

[1] Hey "tbrosz", what does this numerical range evaluate to: (30/0.3, 30/0.1)?. Look familiar? Given your whining here, I sure hope the actual denominator is a lot closer to 0.3 than 0.1.

Posted by: Russell L. Carter on February 29, 2004 05:59 PM

____

tbrosz: "To really see how this works, take a few people acting as citizens and the government, put a box on the table labeled "Trust Fund," and start moving a handful of dollar bills around according to the way the EPI says Social Security is being financed. Be sure to include the government borrowing that money and paying it back with interest from...where? Notice anything?"

What is the point you are trying to make? Everybody (who thinks) knows that in the aggregate, the combined interest on loans can only be repayed by newly issued money.

As long as the aggregate interest is not larger than the value-add of the economy (a heroic assumption) and the newly issued money is "backed" by goods and services, everything is fine. If the value-add falls short, new money must be injected in excess of production, known as inflation.

This reasoning ignores the effect of writing off bankruptcy defaults. Can anybody explain how (or whether) defaults are written off? If an individual takes out a bank loan and defaults on it, I presume the bank is stuck with the debt. If the bank defaults, _its_ creditors and depositors are stuck (adjusting for deposit insurance, shifting some of the burden to the FDIC). One creditor will be the Fed. What happens there?

Posted by: cm on February 29, 2004 06:09 PM

____

Jim Glass: "But 40 years of positive compounding at say 5% on 15% of one's SS contribution (2 points of tax) is enough to give positive returns to everybody, ..."

Was it not your own contention a few posts back that _real_ compounded returns are below 3%? Nominal returns may be 5% or up, but you have at least to adjust for inflation, right?

And assuming even a 3%, or for that matter, _any_ growth of the assets, is what matters not what this money will buy at the time it will be redeemed for goods and services?

From a macro standpoint, you have two choices: (1) the portfolio proceeds are large enough to be able to purchase the needed goods & services from the entities who produce them, (2) a sufficient amount of goods & services can be confiscated from the producers (e.g. by taxation). Or (3) tough luck for you.

(1) and (2) assume that enough goods and services are being produced to feed, clothe, house, serve, etc. the producers as well as the retirees (and, frankly, "non-producers" of various other categories, like speculators, pork-barrel receivers, unemployed, etc.).

Posted by: cm on February 29, 2004 06:22 PM

____

Sam Taylor: "The only argument that I can see for investing Social Security funds in equities is a tacit admission that future productivity gains will not be reflected in wages; ..."

Good point, but I don't think this is what Greenspan et al. meant to say.

After Greenspan's testimony I started growing more sympathetic to arguments to fold social security financing into general revenue. Originally, I was arguing that other sorts of income should be SS taxed (and of course define an entitlement, for the sake of fairness), precisely _because_ wages are not reflecting productivity growth already for some time. The past and current offshoring of labor is just one aspect of this.

And I'm generally opposed to the idea of routing everything through one big "anonymizing" account, as it provides for various shenanigans to secretly spending the money on other things and evading accountability.

Posted by: cm on February 29, 2004 06:29 PM

____

anne: Not to be rude, but I'm missing your response to my demographic aggregate demand/supply argument.

Posted by: cm on February 29, 2004 06:31 PM

____

Jim Glass: Demand from retirees

I was thinking more about medical services, drugs, and other social facilities specifically tailored towards elder citizens. Aside from monetary considerations, for the supposedly large number of retiring (and aging!) boomers, some number of people and production facilities has to be allocated to produce them, presenting an opportunity cost (these people cannot produce other goods and services).

That is, if not enough people desire to become nurses, they will either have to be coerced (e.g. by introducing a "nursing draft", or nurses have to be imported from abroad, or, well, some people will have to go without medical services!).

Then there are other issues -- speaking freely, can you imagine magnitudes more seniors on the road with the obvious consequences? You will have to provide for adequate transportation or create facilities to avoid forcing them onto the freeways, etc.

Posted by: cm on February 29, 2004 06:43 PM

____

Jim Glass: "But 40 years of positive compounding at say 5% on 15% of one's SS contribution (2 points of tax) is enough to give positive returns to everybody, ..."

Was it not your own contention a few posts back that _real_ compounded returns are below 3%? Nominal returns may be 5% or up, but you have at least to adjust for inflation, right?
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No, that's not what I was talking about at all.

You have simple interest annual return and to the extent you reinvest it you get compound return. E.g. on corporate bonds you might get 5% simple interest annually. If you reinvest all that you'd get 5% compound. If you spend all that you'd get 0% compound and just keep your principal.

It's the exact same thing with stocks. Historically for almost 100 years stocks have provided 7% simple return and 3% compound (by the DJIA) because investors have cashed out 4% in dividends and share redemptions.

But for some reason while people easily see the difference between simple and compound returns in bonds they mystifyingly often miss the difference in stocks and think stocks have compounded at 7%.

Then they make errors like the "Dow 40,000" or whatever prediction, or go around saying "the stock market can't possibly return 7% forever when the economy grows only 3%, it's *got* to stop!"

But when I've pointed out the difference between simple and compound return, nobody in that latter group has ever been able to tell me why it's got to stop. Any more than why corporate bonds can't return more than the annual growth rate of the economy -- in simple, not compound, interest.

Some people reinvest all their stock returns to save for the future and have gotten 7% compound over the long run. Others invest for and spend dividends and have gotten 3% compound. Others cash out and get 0% compound. They've all averaged to 3% compound over the long run, basically matching the growth rate in the economy. While people have tried to explain to me that this 100-year relationship has suddenly become unsustainable, I've always been too dim to understand why.

Posted by: Jim Glass on February 29, 2004 09:16 PM

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Jim Glass: compounding

In hindsight, when talking about the past, your description sounds reasonable. (There is one element that you don't mention, taxation of proceeds before reinvestment at, let's say, somewhere around 30% marginal rate plus minus -- probably rather plus. This does not apply directly if the investment is held an a tax-free or tax-deferred account.)

Ignoring reinvestment taxes for the purpose of looking at presumably tax-sheltered retirement accounts, all compounding is in nominal dollars, but inflation (or, for that matter, rising cost of living) is also subject to compounding.

Inflation is essentially the proportion of new money injected into the economy (by the Fed's Treasury purchases and bank loans) in excess of new production. The market will form an equilibrium, where the new money is "neutralized" by rising product and service prices. (Viewed from the other direction, vendors can increase their prices in the aggregate only if "more" money is available.)

Anyway, this is known, but the important thing is that stock prices are essentially commodity prices as well -- they can rise in the aggregate only if more money is available to market participants to pay higher prices. Unless you are in a position to pick just the winning stocks, a broader portfolio will grow roughly in proportion to money supply growth.

So the reason why people are cashing out, reducing potential gains, is that they want to use the money for other purposes -- they don't want to eat stock. It's a crowding-out thing. For retirement accounts, where you can't take out money, you can reduce your contributions accordingly if you need money for other purposes. So in the end you may get a higher return, but on a lower principal.

In the aggregate, you cannot beat productivity growth (in real terms, that is, but inflation will always catch up with you). Relying on your getting higher returns than others because you are smarter, less profligate, or whatever than others is a heroic assumption. It's nice when it happens, but you may not want to bank on it.

Posted by: cm on February 29, 2004 09:44 PM

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Mr. Feldstein's original reason for putting SS in private accounts was that he did not trust the government not to spend the surplus. He was correct not to trust the government, especially with GW Bush as president.

http://www.nber.org/feldstein/bg042799.html

"Clinton gives the impression he is committed to saving future Social Security surpluses and not using them to finance other spending or tax cuts. But his actual five-year budget does the opposite. Over the next five years for which the President has submitted an explicit budget he proposes to divert more than $30 billion of Social Security surpluses to finance a variety of other forms of government spending. His claim that this will be made up sometime after those five years is not backed by details. That's one reason why we favor a Social Security reform that would transfer some of these surpluses into individual investment accounts. Although using budget surpluses to build up such accounts would not buy back government debt explicitly, they would add directly to national saving just as they would if they remained in the Social Security trust fund. And by taking the funds away from the government and putting them into individual accounts, the government's temptation and the ability to spend those funds would be eliminated."

Posted by: bakho on March 1, 2004 08:34 PM

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bakho: not trusting .gov (esp. GWB)

While your statement appears a bit tendentious, I don't want to contradict it. While the GWB part is undisputed, I'm not sure a different administration would have stood to previously alleged or pronounced principles, given the current economic problems, with the qualification that things might have worked out otherwise, which we will never know. (And don't construe this as a defense of GWB, please. I'm far from that. I think the alternative administration I'm referring to would have performed much superior on many things.)

However, as I regurgitated often enough already, private accounts or not, any trust fund scheme will hit the problem that in underlying real-economic terms, SS is necessarily pay(receive)-as-you-go.

I would like to read your response. (Given your track record of generally making well-reasoned remarks; hopefully this flattery appeals to you :-).)

Posted by: cm on March 1, 2004 09:01 PM

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note the account on page c1 of 3/3 WSJ of the Morgan Stanley broker who gave the Lindsey arbitrage a go

Posted by: David on March 3, 2004 01:39 PM

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Just as a note here. People who complain out all that Social Security being diverted over the years need to read some tables. From the 1996 report we can see that the entire accumulated Trust Fund at the end of 1987 was $68 billion (p 107). A big chunk of change to be sure, but is not like we funded the Cold War out of the payroll tax. The big surpluses didn't start rolling into until the mid nineties, and they actually did exactly what you would have wanted them to: started paying down the public debt. That is the vast bulk of the $893 billion sitting in the Trust Fund at the end of 2000 was not diverted anywhere, it replaced then outstanding Public Treasuries. By paying off Treasuries that otherwise would have been rolled over, they directly eased the task of redeeming the Trust Fund bonds in the next century.

The only President who has ever looted the Trust Fund on a large scale is a certain GWB.

Posted by: Bruce Webb on March 6, 2004 06:24 AM

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