Malinvestment

What is malinvestment? It seems like no one in the media really knows. Most economists probably don’t understand what malinvestment is either because of their Keynesian heritage.

First, let’s look at government investment in general. To Keynes all investment was equal.  Keynes believed that the government building a pyramid was just as economically valuable as building roads or cars or anything else for that matter.  This may seem absurd, building pyramids does not increase the wealth of society, it destroys wealth by taking valuable resources and labor and putting them to use that is not needed.  The thousands of people building the pyramids could have instead added value to society by building stuff that was actually needed like roads.  Unfortunately, roads were not easy for a government to build either.  Though the pyramid contributes no economic value to society, roads do because they provide transportation.  The problem is that government planers are not very good at building roads to meet the needs of society.  How many roads should a community build?  Should a government build five roads for a small town or twenty five?  Should it be on this side of town or that side? When government gets into building roads absurd things happen like the “Bridge to Nowhere”, a three hundred million dollar investment for a town of fifty people.  This is not wise but for a government bureaucrat there is no cost benefit analysis.  Would a one million dollar bridge be worth it?  Or would a fifty thousand dollar ferry be more cost efficient?  There is really no way for a bureaucrat to know, because there is no market pricing system that signals demand for such things.  It is only when a totally ridiculous “investment” like the Bridge to Nowhere is proposed that people take notice but most bad investments do not go noticed because there is truly no way to know if it is a bad investment until it reaches the realm of absurdity.  It should be apparent through these examples that some investments are better than others but ultimately it is still a guessing game because there is no price system.  Governments waste a huge amount of capital on bad investments because they are basically guessing at what the public needs.  It is like throwing a dart at a dart board in the dark.  You hope it hits in the right place but you don’t really know where it will go.  Government spending is the same way, its usefulness will never be known until it is built.  Even then, we still don’t know if the funds could have been used more productively in a different area. Ultimately, bridges to nowhere, pyramids, and roads built where nobody drives might be bad investments but they are not considered malinvestment.

If these are bad investments what are malinvestments?

Malinvestment, a term used by the Austrian economists, have very unique set of characteristics.  To put it simply, malinvestments are created in the private sector during an inflationary boom. They are investments that were made even though there was no or very little market demand for them.  Just like the government infrastructure that served no real purpose because there is no public demand for huge pyramids or bridges to nowhere, the private market can potentially create goods that are not demanded by the public either.  The housing boom that ended in 2008 was a perfect example of this.  The housing sector in the United States created millions of more homes than were not needed by the public.  Keynes never really understood why booms and busts happen and blamed irrational human behavior or “animal spirits” for this.  The Austrians economists were unsatisfied with this reason and wanted to look deeper into the boom/bust phenomenon in the “free-market”.  As the Austrians started studying boom and busts they started to observe unique market characteristics of booms and busts that would later lead to an explanation about their nature. While the Keynesians simply considered booms and busts a natural element of the unbridled free-market without any analysis, the Austrians actually looked at the phenomena in a penetrating way.   The Austrians noticed that booms were characterized by a large amount of investment errors in a small period of time across the economy as a whole.  This is very unusual because the market naturally sifts out entrepreneurs who make poor predictions through the profit and loss system. Poorly run firms incur economic losses and factors in a free-market naturally shift capital to economic actors who make more accurate economic forecasts about future demand.  For entrepreneurs across the economy as a whole to make a series or errors at once in a very small time frame in very odd to say the least and goes against common sense economic understanding of how national economy should function.

The other characteristic that Austrian Economists noticed about booms and busts was that errors seemed to be much larger in long term investment projects that take many years to complete like mines, power plants, and other complex industries.  Short term consumer goods were affected much less by the bust part of the cycle and did not suffer from as large of losses on their balance sheets.  These two observed phenomena that characterized booms and busts lead the Austrians to believe that there was more “going on” than the simple Keynesian explanation of “animal spirits” or today’s term “irrational market exuberance”

If markets naturally move toward equilibrium and market actors in general make good market predictions, what was going on?  Why were booms and busts happening if the free-market should naturally become more stabilized over time?  The Austrians correctly believed that there was another unseen actor on the scene.  Something had to be influencing the system that had been previously neglected by mainstream economists.

This unseen force creating the boom bust cycle was central banking.

The Austrians knew that there had to be something that was influencing how entrepreneurs were making investments. Entrepreneurs, by their nature, take risk in the hope of gaining profit down the road.  Entrepreneurs also take out loans from banks to finance their projects.  Banks charge an interest rate and this interest rate is very important key to whether a investment project will be profitable or not.  Even small change in the interest rate can mean the difference from a profitable investment or an investment that will incur losses.  One way to think about this is to think about the housing market.  When interest rates are very low, a home becomes much more affordable.   A one or two point drop in the interest rate can save a home buyer hundreds of dollars a month. A home buyer that could originally afford a $150,000 house could potentially own a $180,000 or a $200,000 house.  This drop in the interest rate literally changes human behavior because now people can afford a much more expensive house than they could before.  Human beings, being what they are, want the biggest house they can afford and will buy the bigger house.  Entrepreneurs make similar decisions as well. They make investments that are similarly more expensive than they otherwise would have if the national interest rate was higher.  Higher interest rates would have signaled that the investment would not be profitable.  If I can build a property or a factory the can produce a certain amount of income per year, I would need the cost of building the property to be less than the income generated by the developed property to make a profit.  For example, if I built a car factory for ten million dollars because of low interest rates and the cars that were finally produced by the factory produced an income of one million dollars a year then the company would be profitable in ten years. If interest rates were high, the factory could cost twenty million dollars or more to build and this would not yield a profit for twenty years or longer.  Such a long time frame to reach profitability means much more risk because there is no guarantee that the model of cars produced or any product for that matter will still be in demand twenty years down the road.  This could mean the difference from a potentially profitable business and a business that will go totally bankrupt.  A small tinkering with interest rates can potentially have wide range impact that is hard to precisely predict.

As you can see, interest rates can have a profound impact on business and the economy but what are interest rates?  Well, let’s take a closer look. When central banks lower interest rates, money is “cheap”.  When a person takes out a loan the interest rate is the “price” of money.  This can be easily understood with a little critical thinking.  Human beings naturally prefer to have their money in the present.  This should be obvious if someone asked you if you wanted a million dollars now or a million dollars fifty years from now, which would you choose?  People obviously prefer money in the present not to mention that a person could make their fortune much larger if they had fifty years to be more productive with it. People naturally want to have money in the present and want to consume goods in the moment.  Investors have to give people an incentive for people to part with their money.  This incentive is interest; people defer present consumption by giving money to an investor in hopes that he will get more money back in the future. Banks are the intermediary between investors and savers.  Both sides of this transaction gain from it.  The investor gains because he is able to start his project with the capital he received from the saver and the saver gains because he will be able to consume more goods in the future with the extra capital he receives in interest from the investor.  This transaction happens millions of times in an advance economy and is responsible for most modern economic growth.  The lower the interest rate is a signal that there is a large amount of savings in the economy.  Just like any market, the larger the supply of a good, the lower the price.  The more savings there is in the economy as a whole, the lower the cost to borrow savings.  The interest rate is a critical price signal in the economy.  Just like all prices, it creates incentives.  When interest rates are high because there is little savings in banks or because of high demand for capital investment, people are more likely to save because they will get larger returns on their savings.  When interest rates are low because of a glut in savings or little investment demand, people (entrepreneurs included) are more likely to take out loans.  When banks and interest are left unfettered, the market tends towards equilibrium and money is allocated efficiently.  The problems start when central banks artificially lower the interest rate through open market functions (the details of which are not important to this article.)

When central banks artificially lower interest rates across a whole economy it creates false price signals.  Entrepreneurs take huge loans for projects that they would have never done otherwise because money is “cheap.”  Your average person will also often take out very large loans that they use for consumption like buying a car or a large house because they can now afford it. Even worse, people are much less likely to save money because they will receive less return on their capital.   This creates a two fold problem where people are taking out very large loans even though there is very little capital in banks and capital is reduced even more than it would have otherwise because less people are saving because of low interest rates.  This creates an unsustainable boom that will eventually result in a bust.  Simply put, the money simply is not there.  People do not consciously think about how much money is in an economy but instead act upon what the given interest rate is.  It is a price, and like any good, the lower the price, the more people will want it.  When the cost of money (interest) is low, people will demand more of it but as discussed above the money is simply not there.  This is where malinvestment comes in.

 

The distortions created in the interest rates lead entrepreneurs to invest in unsustainable projects.  Consumer goods are produced when there is not enough demand.  These are the malinvestments.  The houses that were over built in the housing boom where the most obvious types of malinvestments during the last boom but the houses themselves were by no means the only part of the economy that was over built.   Anything associated with housing, like home improvement stores, where built in overabundance.  Also, millions of jobs went into the housing market that otherwise would not have if there was no central bank fueled bubble.  Potentially millions of people are in career fields where there was never the level of demand that they thought.  Construction workers, home loan bankers, real-estate agents and the dozens if not hundreds of other jobs associated with the housing market will have to be reduced.  As you can see, the central bank driven boom and bust cycle not only wastes a tremendous amount of physical capital but it also wastes a huge amount of human capital as well.  The time spent training workers, the energy used to build building/goods and the materials used to build the capital and goods are all lost. This is malinvestment, mostly unrecoverable investment made in the wrong areas of the economy.  Trillions were lost during the housing boom.  Not only were these trillions lost, but if they were invested in the right areas of the economy trillions more of capital could have been produced on top of it.  So not only was there an immediate loss of capital but there was future capital lost as well.  It is kind of like taking away a foundation of a house.  If the foundation was built correctly, the rest of the house could have been easily been built on top of it but if it is not built correctly than the builder also loses the future house as well.  This is what was happening millions of times over during the housing boom, the economy as a whole not only lost present wealth but future wealth as well because foundations were built in the wrong places.  Multiply this process over and over again since the creation of central banking and the losses are incalculable.  Maybe without a hundred years of the boom bust cycle the average American citizen would be able to buy a new car for $5,000 or maybe we would be colonizing the moon, we simply don’t know.  As much as central bank inflation steals money from the people, the distortions caused central banking likely steals much more.  The only solution is sound money and free banking.

Where to go from here?

Many people worry about elections and think that liberty can simply be voted into office.  Many people looked at the candidates last night and noticed that the only one who believes in liberty garnered little national support.  Many people think that this is it, this election is the last shot to have liberty in our lifetimes, and that last night was a large set back.  I would like to advise people that these things are simply not true and here is why.

 

1.  To place such a large weight on one night of voting is something that the news media promotes to up viewership.  Last weekend the media claimed that we would have a clear frontrunner and that after Ohio we would know who is going to win the nomination.  The day after the election the media is already saying that it is going to be a long battle and that this could continue for months more.  This has been true for every state in the primary season so far, think Florida, or Michigan.  After both of those we were supposed to have a clear front runner  and a win would be a knockout blow to the other candidate.  Well the primary season goes on as normal after each election with no clear frontrunner. Why?  Well, they like ratings.  Each primary is pumped up to be some sort of landmark event to increase viewership.  After each primary the race drags on.  There are many states to go and as we have seen with other candidates in the last six months, a candidate could look like a sure thing like Rick Perry, Herman Cain, or even Newt and fall dramatically in the polls.  This race is far from over and anything could happen.  The media claiming that this is locked up or is a two man race is naive and insulting.  They have been trying to make it a two man race for the last six months with other candidates (example Perry and Romney) and voters have simply not let the media have such a neat narrative.   Whatever your thoughts are about Rick Santorum are, no one in the media thought that he would have such a meteoric rise.  Crazy things happen in politics and so far the media narrative has not even been close to correct. So why believe them now?

2.  The media is purposely trying to dishearten those who believe in liberty.  They try to frame politics on simple voting totals and then ignore or smear the one candidate that would make any serious changes.  They want to make people believe that a liberty oriented candidate would never win.  Every debate and election they try to reinforce this view.  This has the effect of making a candidate appear illegitimate in the eyes of the voting public.   Don’t let them!  You know your views are valid.  You know what is true and what is not.  Yes, the media and to a large amount the public, think our views are foreign or alien when they first hear them but this doesn’t mean that it is hopeless.  We have seen great progress since 2008.  Our numbers are in the millions. We may not be a majority but a tireless, enthusiastic minority can change history.   It has changed history, and it will again! The money bombs that have taken place should be a national story every day.  The mere concept that a campaign could put ads up and be competitive in every single state with mere grassroots support  and small contributions from the middle class is amazing in itself.  The media might not recognize this feat but it does not mean that we should not.   Furthermore, I would bet a lot of money that the media does recognize this and that is why they are so afraid.  As lovers of Liberty, we don’t believe much of anything the media says anyway, so why take their word that our candidate is down and out?

3.  Lastly, this battle will not be won in elections.  It will be won in the hearts and minds of the American people.  I read somewhere that we are “not simply voters but activists”.  In a way this is true and it is truly an awesome thing.  All revolutions were started by activists.  A revolution has never been started by your average voter that does his “civic duty” and votes once a year and occasionally follows politics on TV.  This is a revolution of ideas. Ideas have power.  Human history is a slave to ideas.  Most people don’t realize this because human existence is very placid with very little change for a very long time.  Then, all of a sudden, great change happens and most people have no idea what is going on.  These changes happen because of new ideas and the revolutions they cause are often unexpected by most of the public.  The truth is that every revolution had ideas percolating under the surface for years beforehand but no one really notices because it is so foreign to what they consider normal. Then great change happens all at once and a society is changed forever.  Ideas are often the hardest to quantify but their effects, for good or ill, change the course of human events more than any other factor.  Pagan Rome thought ideas did not matter, then came a thousand years of Christian dominance.   The British Empire thought that ideas did not matter, then came the American Revolution.  Czarist Russia thought that ideas did not matter, then came the Bolsheviks.   Ideas have power and Liberty is the most powerful idea that mankind has ever produced.  This is why we will win.

 

The Super Class

David Rothkopf was an insider in the Clinton Administration.  He is well respected in the academic community.  Politically he leans to the left.   He explains how the “Super Class” runs the world.  This should be watched by anyone who cares about the nature of power in society.

 

 

 

 

 

 

 

Congressional Insider Trading?

Surprise, surprise, congressmen can engage in activities that make them millions but, the same actions by your average citizens would land them in prison.  Some more naive readers might think that the law is designed to protect society from criminals even though the exact opposite is true.  The law is actually designed to expropriate wealth from the population by favoring big business/government insiders against the rest of us.  Those who write the laws (corporate lobbyists, big business, and government officials) are the real 1%.   They are the real beneficiaries of state coercion, you are the host, they are the parasites.   While the rest of us have to acquire wealth through economic means, the beneficiaries of the state apparatus acquire wealth by what Franz Oppenheimer called the “political means.”  There is no better example of the total disregard for the people that they are elected to represent than congressional insider trading but, in the end this is just a symptom of a much larger disease.

People are complaining about congressional insider trading but they are missing the bigger picture.  Why do politicians get to buy stocks at all?   The system is obviously rigged with political power!  Politicians know what new laws and regulations are going to be passed and can make huge amounts of money from the knowledge.  They also decide the funding for the SEC and it turns out that the SEC has decided that congressmen are immune to insider trading.  Well isn’t that just great!

 

Well, to start off, insider trading laws are ridiculous because they actually hurt the middle class the most by allowing bubbles to build to much higher levels.  It is the guys on Wall Street that buy early but, it is usually the middle class that buys at the top.  Any information to pop that bubble earlier would help the middle class but, if such laws exist why is congress exempt from them?  I think congress is exempt for two reasons.

 

One, the whole point of political office is for power and privilege over the rest of the population despite noble campaign rhetoric.  The goal of almost all congressmen and senators is to land some kind of big lobbying job after their term that will make them millions due to their insider connections…  so why wait until their term is done to cash in?!  They want to use their political connections in the present to make some big bucks. That is the whole point of going to congress besides some kind of twisted urge to rule over your fellow human beings.  That is why so many go into office with a moderate amount of wealth and leave very rich. This should not be surprising considering they are all egomaniacs and sociopaths, so any thought that the rule of law should be applied equally to the whole population does not even cross their minds.

 

 

Two, if they applied the laws of insider trading against congressmen it would demonstrate the absurdity of the law.  Every bill that congress passes could have some potential affect on the stock market.  Even a small change in the FDAs food period could have a significant impact on agricultural stocks not to mention all the subisidies and trade restrictions that could literally make or break a business over night.  The SEC prosecuting a bunch of congressmen every other day would be ridiculous and more importantly strike at the credibility of the political system which would be the very worst, harming the power structure.  People have to genuinely believe the lie that their politicians generally care about them, at least a little bit, or the whole system falls apart.   It is for every ones best interest, congressmen, senators, and the SEC itself, that no congressmen ever gets prosecuted for insider trading.

 

Solution-  Make all congressmen put all their assets in savings accounts!   The economy and the dollar would be saved! The American people would force congress to pass a law that all their money needs to be in savings accounts except for their house and their car. The law could be written something like this:

 

“This congress chooses to place all their assets into savings accounts to show solidarity with the American people.  The middle class and the poor are the largest holders of cash and most vulnerable to monetary devaluation so it is only right that this congress stands with the people and puts all of their holdings into cash as well.  (except for a single house and two cars per congressman).”

 

 

Whatever savings account they want, they get to choose because the American people are a fair bunch!  We would even let those creeps have two cars and a house!  Just imagine what this would do!  All of monetary and economic problems would be solved overnight.  Can you imagine Ben Bernanke trying to pitch QE3 to a congress that had all their assets in savings accounts?  Congressmen would go ballistic.  I would not be surprised to see rotten vegetables thrown during a congressional session for the first time in a hundred years.  It would be like marching into a den of lions for old Ben, I doubt he would even show up.  Congress would likely reign in the Federal Reserve over night.  End the Fed would no longer be a motto for the few in the liberty minded minority that actually understand money and credit but it would instead be shouted from the halls of power in Washington DC.  Ben Bernanke walking onto the congressional floor might look more like  Caesar walking onto the floor of the Roman Parliament on March 15th if he was really unlucky.  The Great Savior, Time Magazine’s man of the year in 2009, Ben Bernanke would become enemy number 1 of the people in a day.  The 100 year reign of the evil Federal Reserve would finally end and the power over money would finally be restored to the people.

 

Ahh, well, maybe I day dream too much.  Nothing like that will happen anytime soon.  Congressmen will remain corrupt and make massive amounts of money through insider trading through the huge loop holes in the law made to supposedly prevent such action.  Ben Bernanke will continue to inflate the dollar because that is all he can do and America will get closer and closer to fiscal and economic oblivion.  Its like watching the crazy drunk whose life is careening out of control and his only solution is to drink more booze.  The only problem is that he is in the driver’s seat and we are the passengers.  Sit back and enjoy the ride, there is no jumping out of this car, we have already passed the point of no return…   but buckle up (buy some gold and silver) because the crash is coming…   the only question is how bad.

High Oil Prices?

Why are oil prices shooting through the roof lately?  Well, it seems like TV pundits blame everything except the single institution that has the largest influence on what oil is traded at, and that is the Federal Reserve.  Some things might cause brief spikes in the price of oil, like shortages in supply, but the main cause for gas at the pump getting more expensive over time is the Federal Reserve. The real frustrating thing is that TV pundits seem not to have a clue and have not mentioned monetary policy at all.  Left or Right, the mainstream media seems totally clueless.  Bill Orielly had a discussion with Lou Dobbs about oil prices and not only did the two not mention the FED once but, they don’t seem to understand basic economics either.  The conversation went something like Dobbs telling O’Rielly that the oil refined in the United States is being sent overseas.  Well, this should not be surprising considering that oil refining is a highly complex process that third world countries often do not have the industry to refine themselves.  Therefore many countries ship their crude here and when it is refined it is shipped back overseas.  This is not some kind of complex plot where oil companies are taking advantage of American customers.They are simply selling refined oil on the world market at it’s commodity price.  O’Rielly seems to think that there is some kind of price fixing going on because gas is at such a similar price between different gas stations.  This is pretty easy to understand when you realize that oil and gas are not consumer goods like tennis shoes. They are instead commodities like beef, gold, copper, and many other industrial products.  The margins are very small when looking at any commodity because commodities by definition are homogenous, unlike two pairs of shoes that are likely very different.  If you went around town trying to buy gold or silver bullion at different coin shops, you would notice that the prices are pretty similar if not almost exactly the same.  Same is true for industrial metals like copper, the going rate is the going rate.  Additionally, oil, gas, gold, and copper are in a world market, the price of each is nearly uniform around the world, gold costs the same in Shanghai as it does in New York.  Oil, before taxes, has a very similar cost as well.  The real variable here is the dollar. When the dollar loses value, the price of oil goes up.  If you want someone to blame for high gas prices look no further than the Federal Reserve.

 

Some people might say that the government owning so much land and preventing drilling is pushing the price of oil up.  This might be true to some extent, and I would agree that opening up more land for oil exploration would be a good idea but, this does not explain how a gallon of gas used to cost a dime and will now likely be five dollars by summer.  The reason that gas is so high this year should be put into consideration of what the Federal Reserve’s actions have been over the last four years.  The FED has pumped trillions of dollars into the economy but, this has been mostly absorbed by the big banks where they have kept the money preventing it from being pushed into the economy.  We are begging to see the affects of this money as it enters the economy, for food and many other commodities have been inflated up 10% in 2011.  The drive up in the stock market to 13,000 has also been a result of inflation because Wall Street is always one of the first in line for newly printed money.  We are finally starting to feel the beginning of the price inflation that comes about when the Fed doubles the monetary base.  If the economy shoots up to full employment we might even see ten dollar gas but, to be honest we truly do not know because monetary inflation affects different sectors of the economy in different degrees.  Oil, though, is one commodity that is almost always affected by monetary inflation (so is food for that matter, interesting how neither is included in the official CPI).  When oil starts going up in price for long periods of time, it is likely that we will see inflation in other areas as well.

 

In conclusion:

 

The Federal Rerserve is the most to blame for oil prices going through the roof.  Someday the media might catch on to this too but, don’t hold your breath, they have been blaming everything else for 50 years.

What Happend to the Left?

The left used to be against unconstitutional war.  The left used to defend civil liberties against an out of control executive branch.  What happened?  Polls now show that self identified “liberals” approve of drone strikes by 55%!?  This seems crazy, I always thought the left to be more sincere in their convictions than conservatives who blindly follow “small government” rhetoric even though none of their leaders have ever reduced the size of government in a hundred years.  Sincere leftist Cenk Uygur explains how the left is caught up in the same personality cult that conservatives were caught up in under Bush.

 

This is why I like Cenk Uygur so much, he never strays from ideological purity to kowtow to his own “liberal” establishment.  I might disagree with him on many things but I certainly enjoy watching him.  Cenk Uygur gives me hope that the sincere left (that includes others like Denis Kusinich and Glenn Greenwald) will hold their own leaders accountable.

What happened to Iceland?

Iceland let their banks default.  Every other country on both sides of the Atlantic bailed their banks out.  The people are on the hook for trillions of dollars on both sides of the Atlantic and their economies are still in the dumps. Iceland on the other hand is on the way to recovery and the tax payers do not owe anything.  This makes perfect sense from the Austrian perspective.  Markets need to clear out and reach a bottom before a recovery can happen.  Massive bailouts prevent this.  Bailouts “keep the boom going”.  Not only have the bailouts in the U.S. and Europe not helped the man in the street, they have guaranteed a much larger crash in the future.  The U.S. and Europe are still kicking the can down the road while Iceland is on its way to recovery.

During the next financial crisis, Americans need to look toward Iceland and take note of what they did. In the interview posted below, the Prime-minister of Iceland explains why he did not bailout the banks and instead left it up to the people in a popular vote.  This is the exact opposite of what American politicians did in 2008.  When American politicians were receiving phone calls that were 10 to 1 against bailing out the banks, the American congressman sided with the big Wall Street banks instead.  It turns out that Icelandic politicians have backbones and will stand up against the financial interests in their country in order to protect the people.  American politicians instead stand up for the corrupt government/Wall Street alliance at the great expense of the American people.

Here is the interview.  The relevant info starts at about 9 minutes.

 

Is Social Security a Ponzi Scheme?

They used to call Social Security the third rail of politics.  To question the program at all was politcal suicide.  Times of economic crisis have a way of putting issues on the table that were once taboo.  Today that issue is social security.

To start off, my view on Social Security is that it violates the Constitution and any kind of social security program should be done on the state level.  This is not a very radical idea, considering that before the New Deal many states did have social security programs and other safety net programs that worked fairly well.  From a philosophical point of view, I am against any kind of social security.  But social security by the states, if they so choose, is legal under the constitution.  That being said, the government has made a contractional obligation to pay Social Security, so the program as it is today cannot be ended over night.  All this being said, this article has nothing to do with what we should about reforming Social Security but, instead attempts to analyze whether Social Security is a Ponzi Scheme.

 

Is Social Security a Ponzi Scheme?  Pundits from Bill O’Rielly to Rachel Maddow say no.  Bill O’Rielly says social security is not a Ponzi scheme because it can be salvaged.  Rachel Maddow says that Social Security is not a Ponzi Scheme because “it works” and has protected the elderly during the recession.  I would conted that O’Reilly and Maddow are missing the point entirely. Both Maddow and O’Reilly can be competely right about the system being salvageable and “working” to protect the elderly but, this has nothing to do with the system being a Ponzi scheme.

Ponzi Scheme definition: “an investment swindle in which some early investors are paid off with money put up by later ones”

The true question is whether Social Security is set aside for the individul for later use or whether social security payments are spent by government immediately.  If the government spends the social security money immediately upon receipt and relies on future social security payments from workers to pay of retirees down the road, this would qualify as a Ponzi scheme. This is exactly how Bernie Madoff was able to pay his investors massive yields, he simply paid early investors with the money from new investors entering into his Wall Street firm attracted to the high yields.  Little did investors know that their money was almost immediately used to pay other investors that were previously involved.  Such an investment scheme is a giant pyramid with the diverted investors’ money used to make payments to earlier investors.  Such schemes in the private economy are always destined to collapse. Government ones will as well but, the collapse will take longer.

The Social Security Trust Fund

Defenders of Social Security point to the “Social Security” trust fund to claim that Social Secuirity is in fact sustainable for a very long time.  Upon the most minimum evaluation this claim falls short.  It is a well known fact that the Social Security trust fund does not really exist, the money has been spent and has been instead replaced with government bonds (promises to pay in the future)  Social Security is called insurance but, there is no money that it holds.  This would be similiar to private insurance company having a massive amount of debt with no capital at all.  It could only pay insurance claims by creating new debt. Obviously, at some point, lenders will stop lending an insurance company that is so deep in the hole. The insurance company would have to defualt on its contractual agreements.  The obvious problems with the social security system have been known for a very long time.  Frank Chardov wrote in 1954,

“To give some plausibility to the “insurance” advertisement, the government sets up a so-called reserve fund. In place of the money it collects, it piles up its own bonds, or IOUs, in an amount equal to the collections. The interest on these bonds, it says, will be adequate to meet the old-age obligations when due. But the interest on these bonds is paid out of what it collects in taxes; where else can the government get money? Since the so-called premiums are only taxes, and since the benefit payments are also taxes, the operation is the same as if an insurance company used up its premium collections in salaries and cocktail parties and then paid out benefits from new premiums. For doing that, the directors of the company can be sent to jail. However, the laws made for ordinary citizens are somewhat different from the laws made for public officials.”

So is Social Security a Ponzi Scheme?  When considering the dictionary definition, I think the obvious answer is yes.  If the Social Security trust fund truly existed, it would not be a Ponzi Scheme but unfortunately the fund has been raided by greedy politicians for the last 60 years and there has been nothing there for a long time. The only way Social Security can be “saved” is by a massive injection of funds, likely in the tens of trillions, from another source.  If such a course of action is taken, (if it were even possible which is highly unlikely), this would not mean that Social Security is not a Ponzi Scheme because the program would still be in default.  This would be similar to the government ordering liquidation of Apple Computers to pay off Bernie Madoff’s investors, the orginal program still defaulted.

Other moral problems with social security:

Social Security is a transfer from the poorest age demographics in society (the young) to the wealthiest age demographics in society (the old).  As long as the program exists, the young are getting exploited by the elderly.  This is even more pernicious when considering how much wealthier the old are compared to the young.  The numbers are staggering, the average net worth for people under 35 in 2009 was $3,662.  The average wealth for those over 65, $170,494. See here for more details.  Simply put, the elderly on average do not need social security checks, the young on the other hand need every penny they can get.  Especially when considering how social security deduction will dramatically lower their wealth over time.   For as long as the program exists in its current form, it will get worse and worse.   Frank Chardov, once again goes into more detail:

“One of the arguments which helped to sell social security is that the “contributor” will not be dependent on his children for a livelihood when he can no longer work. Let’s see if that is true. We must keep in mind that taxes are part of production; they are levied on what is being produced currently, not in the past. The payments to the nonproductive aged therefore come from what the government collects from those who are producing, their children. The government cannot get the money from anybody else. So that, in effect, the children are supporting their parents, collectively and without love.”

 

The government has already defaulted those dependent on social security by inflating the money supply year over year.  The government does not count food and fuel and other commodities when calculating inflation, so each year when social security payments are “adjusted” to inflation, the govenment shorts social secuirity recipients.  Each year Social Security recipients buying power becomes less and less.  It is not an outright default but a gradual one instead.  Each year, those dependent on social security find it harder and harder to make ends meat.  This has been especially true since 2008 where government calculated inflation has stayed flat but food prices have gone through the roof.  In the end, Social Security is actively defrauding the very people it is trying to protect.

Finally, it should be recognized that Social Security is not the third rail of American Politics that it used to be. Americans need to start talking about it and making tough choices because in the near future, those choices will be made for us as the Social Security system completely collapses.