What's Really in the Social Security Trust Fund?

“You’re kidding, right?” a Daily Reckoning reader wrote after our briefing from last week: “The End of Social Security As We Know It.” “Are you the only ones who believe in the accounting farces that are the Social Security and Medicare ‘Trust Funds’? Every dollar in both of those funds has been spent by the US Treasury…”

We weren’t kidding, dear reader… There’s only so much reckonin’ we can do in one day. Last week we chronicled a turning point for retirement in America: On September 30, the Social Security Trust Fund will officially begin paying out more than it’s taking in. Now, you – and many others who wrote in – provide an inadvertent introduction to our final question in this Social Security Series: What, exactly, is in that fund?

The quick answer is this, as we noted Saturday. “With $2.6 trillion left in the Social Security war chest, there is no immediate threat to the status quo.”

The Social Security Trust Fund is, in fact, worth roughly $2.6 trillion. The status quo is safe at the moment. But as you hinted, there isn’t a single US dollar in that fund…and anyone who thinks the money they’ve been sending the government to pay for retirement is neatly stacked in a giant vault – some super-sized swimming pool of money – has the wrong idea.

Indeed, your government-sponsored retirement fund has all been spent already. Didn’t you get your receipt?

The World’s Biggest Bond Investor – You

You, loyal taxpayer – not the Chinese – are the biggest US Treasury Bond investor in the world. The entire balance of the Social Security Fund, all $2.6 trillion of it, has been borrowed by the US government. Upon receipt of your payroll taxes (those are the ones that fund Social Security) the Treasury instantly converts them to special issue Treasury bonds. In simpler terms, money is taken out of the Social Security “vault” and replaced with an IOU.

That’s not necessarily bad. Many sovereign states purchase debt from other nations, government owned companies or private institutions, and for good reason. If that money is not needed right away, the interest on the bond will help guard the fund against inflation. Those bonds might even make some extra money.

But such an investment doesn’t work when a debt-burdened government borrows money from itself. While the American Social Security scheme is not quite as simple as taking money out of one pocket and putting it in another, it’s darn close.

“Since 1983, the money from all payroll taxpayers has been building up the Social Security surplus, swelling the trust fund,” the LA Times’ Michael Hiltzik neatly explained in August. “What’s happened to the money? It’s been borrowed by the federal government and spent on federal programs – housing, stimulus, war and a big income tax cut for the richest Americans, enacted under President George W. Bush in 2001.”

The government is not using your payroll taxes to build retirement nest eggs or to insure the elderly and disabled. Rather, the SSTF is used to sustain government itself. Not a dollar is set aside for you…just debt. Given the current state of US affairs – $13 trillion in public debt, weak economic growth and a $1.3 trillion budget deficit for 2010 – this is not the kind of sovereign debt most investors want to own.

We should note, this is no conspiracy theory. On the SSTF website, the Trustees offer to-the-month spreadsheets of fund holdings, each and every one revealing nothing inside but US Treasury bonds. President Bush himself laid it out quite simply back in 2005:

Some in our country think that Social Security is a trust fund – in other words, there’s a pile of money being accumulated. That’s just simply not true. The money – payroll taxes going into the Social Security are spent. They’re spent on benefits and they’re spent on government programs. There is no trust.

There is No Trust… So Why Trust Social Security?

This bookkeeping scheme known as the Social Security Trust Fund is not the biggest issue in America for one reason: US Treasuries are currently as good as cash. In fact, since they pay a paltry yield and are accepted everywhere, they might even be better than dollars.

But in a real, utilitarian sense, T-Bonds in the SSTF are way, way worse than cash. They are a liability, not an asset. The SSTF can exchange them for dollars, but those dollars must come from the very government that’s on the other side of the exchange. As President Clinton’s Office of Management and Budget once explained:

Balances are available to finance future benefit payments and other Trust Fund expenditures – but only in a bookkeeping sense…. They do not consist of real economic assets that can be drawn down in the future to fund benefits. Instead, they are claims on the Treasury that, when redeemed, will have to be financed by raising taxes, borrowing from the public, or reducing benefits or other expenditures.

This is a similar situation to what China has called its “nuclear option.” As the largest foreign holder of US Treasuries, China could cripple the US by cashing out its bond holdings. The Treasury would be forced to either redeem the bonds or default, both of which would send American interest rates through the roof…maybe even destroy our economy altogether.

The SSTF isn’t that different, except China holds “just” $846 billion in US bonds, about a third of what’s owed to the Social Security Trust Fund.

So add up the American fiscal condition as we know it, dear reader, and tell us what you get:

76 million Baby Boomers about to retire
+ Life expectancies increasing
+ A Social Security Administration that’s now paying out more than it’s taking in
+ The Social Security Trust Fund holding nothing but $2.6 trillion in US debt
+ A national debt over $13 trillion
+ The worst US economy since the Great Depression
+ Unemployment near generational highs
+ Stagnant wages for over a decade
+ Average personal savings rate of 6% of disposable income
+ Minimal interest rates on those savings
+ Home prices (most people’s largest investment) down 20% from their peak
+ Stock indexes (and most private retirement funds) down 25% from their peak
+ Rising energy and healthcare costs

The sum of these parts, among other things, equals a lousy retirement landscape in America. Like so many other economic matters these days, it’s hard to picture a worse scenario for retirees since the Great Depression.

It Could Be Worse

One cliché has been working overtime lately: The night is always darkest before dawn. No one really knows how long this “night” will last in America. It’s running about 20 years strong in Japan, an economy eerily similar to our own. But just the same, most people felt like nothing could possibly go wrong in early 1999… and by September 11, 2001, just about everything had. Maybe now, as most of us are choking in the dark smog of this economy, a breath of fresh air might blow our way. Who knows?

But to bank on that is a bad move. If America doesn’t return to booming prosperity, the Treasury and Social Security Trustees will have to do something to keep the program alive. In the past, that’s meant raising payroll taxes and reducing benefits. Not only will the government have to accommodate Social Security operating at a deficit, but they’ll have to deal with all these bonds… the trillions owed to the American public and trillions more to foreign investors. Either income or sales taxes will have to rise dramatically, or the Fed will have to print money. Both “solutions” would seriously impact American purchasing power, particularly retired Americans living on a fixed income.

Even the rich ought to devise a retirement Plan B. The richest 1% of US population now accounts for 24% of the country’s income, the highest ratio since just before the 1929 market crash. Most of the other 99% is understandably bitter about that, and especially given the tendencies of the current administration, we expect the rich to get soaked good and hard over the next few decades. As we’ve forecast before, expect a Social Security means test in the near future and a hike in the SS taxable wage base even sooner.

Thus, all economic classes in America could feel the sting of imminent Social Security reform. Those that need it will likely receive fewer benefits, and those wealthy enough to retire on their own will likely be forced to pitch in for those that can’t. Meanwhile, all government welfare programs will likely be reduced, as one day – who knows when – Uncle Sam will have to start paying back money borrowed from the Social Security Trust Fund.

Your choice is to wait for that day and see what happens…or start preparing for it now.

Good luck,

Ian Mathias
for The Daily Reckoning