FWIW #39 - Math Problem

Last week Stan Druckenmiller, one of history’s best investors, appeared on CNBC Squawk Box and reiterated the mantra that “entitlements” are the problem with the budget and deficits. It appeared that he favors changing benefits to reduce the fiscal deficits. I respect this argument from him and from other intelligent and thoughtful people, however, I’m puzzled by the thought reducing entitlements will reduce the deficits rather than allow politicians to spend more where the money is more wasteful. Will cutting Social Security benefits really cut the deficits? Are Social Security benefits the real problem? I looked up the statistics because I’m one of those retired people who feed at the Social Security trough. Here’s what I found.

1. Contributors exceed recipients

The argument goes that there are too many people drawing social security than people paying into the system. So, I googled, “How many individuals receive Social Security each year?” Google came back with the number 66 million. That’s a lot of people. Then I googled, “How many individuals pay Social Security taxes as employed people?” According to the argument of so many educated, intelligent, and thoughtful people, the number should be less, right?

I was surprised to see the number of individuals paying into the system is 182 million. That’s a correct number. Approximately 2.75 times the number receiving Social Security are paying into the system. So, are Social Security recipients the real problem causing the deficits, or are politicians in Washington and their friends having difficulty being fiscally disciplined?

2. Congress has dropped the ball

You may or not be aware that Congress has set up Social Security so that if the trust fund runs out of reserves, benefits to retirees will automatically be cut by approximately 23%. This is their way of avoiding the real problem. The problem with Social Security is actuarial. Actuary science (it is a science since it’s purely mathematical) looks at demographic profiles of a pension program (that’s what Social Security is) and, based on those characteristics, determines the appropriate amount to be paid into the system and the appropriate amount each future recipient should receive from the system. Plug in the parameters, and the program spits out the correct numbers.

The problem arises when the parameters are tinkered with or are allowed to become outdated. This is what has happened to Social Security. How? One reason is the cost of living adjustment (COLA) that was instituted because the irresponsible fiscal spending of the 1960s and 1970s created runaway inflation. When a plan has a COLA based on future inflation, as Social Security does, there is no way to get the actuarial assumptions right. No one knows what future inflation will be.

So, if Congress was doing the job they were elected to do, they would engage one of their standing committees to hire an actuarial consultant to determine the following:

• Whether the Social Security tax should be higher and/or whether benefits should be paid out based on an updated life expectancy.
• The criteria for receiving Social Security, including retirement age and other factors that affect benefits. Keep in mind, Social Security did not have a COLA until the irresponsible fiscal spending by the federal government in the 1960s and 1970s hurt beneficiaries to the point politicians felt they had to act or be voted out of office.
• A formula that responds to a range of inflation but has a cap on benefit changes, which would strengthen the system even though inflation is unknowable.

3. Fed manipulation has starved the system

In the last FWIW, I told you the Federal Reserve was the culprit in the fiscal mess the country is in. Well, let me help you understand how big a culprit it is. The federal government salivates when it sees the flood of money going into the Social Security Trust Fund. In order to tap into this steady stream of cash, Congress legislated a mechanism for the federal government to use the Social Security cash: lending the money to itself by issuing special bonds.

At this point, there is a total of $2.7 trillion of these bonds in the Social Security trust fund. That’s correct: trillions. The government has always paid these bonds when they come due and has regularly paid the interest. That’s the catch—at what interest rate? Well, the law is specific about what interest is due monthly. Here’s what the law dictates according to the treasury website:

Special-issue securities bear a nominal rate of interest determined by a formula specified by law in section 201(d) of the Social Security Act. The current formula was established by the 1960 amendments to the Social Security Act. The formula sets the rate applicable in a given month to the average market yield on marketable interest-bearing securities of the Federal government which are not due or callable until after 4 years from the last business day of the prior month (the day when the rate is determined). The average yield must then be rounded to the nearest eighth of 1 percent. This formula became effective with the October 1960 rate.

Fairly clear, isn’t it? Remember, the Federal Reserve essentially confiscated savers’ rightful interest on their life’s savings for 13 years (2010–2022). What people didn’t know or understand was that the Fed’s suppression of interest during that time was also eroding the foundation of the entire Social Security system. When four years or longer maturity bonds were yielding less than 1% all those years, the Social Security trust fund was starved of earnings that should have been going to pay benefits (that’s what the interest is required to be used for).

The solution

Social Security can be fixed. It can be fixed without cutting benefits. Analyzing the actual factors in the equation will point the way. Currently, younger individuals have no faith in Social Security being anything but a tax since all they hear about is the system is going broke. Think about it: with AI and AGI, the Social Security issue should take less than a half day to solve so that the system can do what it was designed to do: keep Americans from suffering abject poverty in their old age. We can’t keep incompetent and foolish people from being elected to Congress, but in the age of technology, we have the tools to rescue this important social safety net from their incompetence.

Finally, until there is a cap on spending, such as what was in place in the late 1990s, cutting Social Security benefits to free up more money for politicians’ pet projects will be like giving more alcohol or drugs to addicts. Those who sanctimoniously preach cutting benefits should know that.