What’s Wrong with the World

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Willful Disregard of Reality

Presidential candidate George W. Bush, following a Republican playbook scripted in the mid-nineties as the party lurched from defeat to defeat, its ambitious agenda for the housebreaking of the Federal Leviathan stymied by Clinton's deft triangulations, said little about Social Security. As President, he proposed an audacious (within the narrow consensus of American politics) partial privatization of the gargantuan entitlement program, whose unfunded liabilities foretell all manner of political and economic upheavals, scheduled to begin once the pig-in-the-snake of the Baby Boom generation reaches retirement age.

For his admittedly desultory effort, he was rewarded with a political rebuke: failure, and falling poll results. Americans cherish all manner of illusions about the nature and stability of the program, and probably even believe in the unbelievable myth of the Social Security Trust Fund; when presented with the dire facts about the future of the program - which become still more sombre when Medicare is incorporated in the calculations - they make quick resort to magical thinking: it cannot happen; things will work out fine; all things will continue as they have since FDR brought salvation to America.

Curiously, financial markets also appear to indulge in magical thought.

A serviceable estimate of the unfunded liability places the figure in the vicinity of $40 trillion, though this figure does not account for the new Medicare drug benefit, and will probably be revised upwards before I finish typing. Jagadeesh Gokhale observes:


So it's a puzzle why the prospect of a negative economic impact from unavoidable fiscal policy changes in the not too distant future aren't already reflected in financial markets.

Certainly, this ought to be puzzling, given our societal faith in the market as an efficient - the most efficient - mechanism for the assimilation and analysis of information. What information could be more relevant than that pertaining to an entitlement crisis that will necessitate wrenching changes such as benefit cuts, punishing tax increases, and/or, in extremis, the devaluation of the currency? Gokhale considers several explanations for this apparent oversight, finding them wanting.

It cannot be that investors are simply wallowing in ignorance; these shortfalls have been widely bandied about, despite originally being buried in the abyssal depths of turgid government reports only three people read, and financial market actors are supposed to be, well, well-informed. Neither could the explanation lie in the temporal horizons of investors; the Baby Boomers will be retiring before my three-year-old hits high school. Investors might also believe that there exists some sort of magic bullet fix for the problems, a fix that shortly will be enacted, despite the sepulchral silence in Washington on the issue; however, there is no magic bullet than can fell hard, demographic and political realities: the population of retirees is about to burgeon, they will resist reforms, and any attempted reforms will either provoke widespread discontent and electoral wrath, or crater the economy. Or both. Then there is this:


A third possibility is that financial markets are flush with savings from foreign, especially East Asian, countries. The primary sources of these funds are trade surpluses that those countries have been running with developed countries such as the U.S. Although these funds are good for U.S. financial markets, the fact that they are largely controlled by a few foreign governments rather than a great many individual investors makes them riskier.

Those governments could more easily coordinate an exit from U.S. capital markets if fiscal imbalances started taking a toll, hitting the U.S. economy even harder. But this prospect means that investors -- mainly the foreign governments themselves -- may be severely mispricing the risks associated with investing in U.S. capital markets.

So, globalization adds an additional layer of political complexity to the problem, as well potentially adding a befogging haze of ignorance on the part of the largest investors. Lovely. In the end, Gokhale does not advance an explanation or hypothesis for the discounting of critically relevant information; the mystery is left to find some other resolution. Perhaps, however, it all comes down to that magical thinking, or, rather, the wellsprings thereof: acknowledging the looming crisis might threaten to deflate the market, and so happy, magical thoughts are invoked to stave off the thought of gloom. In the end, markets embody instrumental reason, the reason of the efficient allocation and application of means to the attainment of ends; this is to say that no market can be more rational than the ends chosen by market actors, that no market can be rational if its actors are less than optimally rational. And perhaps, in that less-than-optimal rationality, they deceive not only themselves, but us as well, concerning what lies in wait for us.

Comments (18)

This entire post is premised on the notion that in order to solve the coming Social Security and Medicare funding liabilities, we'll need to double the payroll tax rate of 15.3 percent, or impose some sort of "draconian" benefit cuts. But there are other possibilities, for example, see here:

http://www.usnews.com/blogs/capital-commerce/2007/2/13/bushs-secret-plan-to-save-social-security.html#read_more

Essentially what that post says is we could theoretically grow our way out of the coming "fiscal crisis". Even if that scenario is too optimistic for you, some combination of an increase in the retirement age, small tax increases, small benefit cuts, and/or economic growth will easily solve the coming "crisis". Perhaps our political system is too far "gone" to ensure the above combination from happening, but I'll put my money on the markets being right and the American political system arriving at an adequate solution (since I'm depending to a certain extent on the market for my retirement, I better have faith!)

The fortuitous alignment of all of those little political factors may well be what the markets are counting on - and, while I don't share your optimism concerning the soundness of market judgments in this area, I empathize, since I, too, will rely upon 'the market' for my own retirement. I entertain no illusions of the perpetual solvency of Social Security; neither, for that matter, would I even desire to rely upon it.

My confirmed opinion is that our political system, and the electorate generally, are too far 'gone' for any such combination of reforms to be possible. It is conceivable that the 'modest' (define "modest"...) tax increases will be enacted; but 'modest' decreases in benefit baselines, and any increase in the retirement age, would together, or even singly, constitute a political weapon of mass destruction, which any politician, coalition, or party foolish enough to propose would deploy in a suicidal fashion. And as for the prospect of economic growth, well... while the problem is amenable to overstatement, current account imbalances, both trade-related and federal spending-related, eventually manifest themselves as economic softening of one degree or another. The current weakness of the dollar has something to do with this; and given an economy incapable of exporting its way back to some semblance of balance, this bodes ill for continued, robust expansion.

Gokhale is an economist who has long laboured in the trenches for Social Security and Medicare reform, so I'm inclined to lend credence to his figures, even though it is always possible to quibble about such things.

Ben Stein says that the baby boomers are heading for a time of privation and the "modern equivalent of poor houses". They rode the wave of the big demographic, causing the culture to bend to their ways, but now they'll be the victims of it since the gov't can't take care of all of them.

Was it Churchill who said "God takes care of drunks and the United States of America"? Perhaps that is what keeps it all together...

Jeff Singer presents himself as a case study of what Maximos is saying, by suggesting:

some combination of an increase in the retirement age, small tax increases, small benefit cuts, and/or economic growth will easily solve the coming "crisis"

It's not enough to talk about Social Security and Medicare simply by the numbers. We need to talk about the people. Maybe Singer just doesn't understand the Boomers, who will, in all likelihood, finish stripping the land bare like a cloud of locusts before they pass into the night.

Murray Rothbard, I believe, understood: the government with either repudiate the debt or inflate the currency. Neither is a solution, but the latter buys some more time...for those running things.

Inflate the currency? They're already doing that, gradually; that "liquidity" is the foundation of our economic "growth".

Rothbard actually meant hyperinflate, I didn't make that clear.

I seem to recall Rothbard arguing that hyperinflation would constitute a probable stalling tactic. All I meant was that present policy could be construed as the beginning of a "frog-boiling" strategy; the foundations have been well-laid.

I always find discussions of the solvency of the federal government amusing for the simple reason that nobody has any idea how solvent the federal government is. The US government uses cash accounting, not accrual accounting. It has vast resources which contribute to tax revenues, and vast expenditures which do nothing of the sort. At least it looks like it does. But nobody has ever actually looked at the numbers, because the numbers don't exist.

If the US government had to keep accrual-based books - accrual-based but including detailed cash flows - like any public corporation, then it might be possible to make claims about the level of debt, etc. But it doesn't. We don't know. Can anyone point me to the federal government's historical balance sheets? Its P&L?

Part of the reason we don't know is that a real accounting system for the federal government would bring to light all sorts of interesting things, like the fact that some industry subsidies and tax breaks are enormously profitable for the government while many programs - particulary in education, etc - are pure expense. We might find out, it would be extremely strange not to find out, that reality - the financial reality of government assets, revenues, and expenses - doesn't line up along any particular Republicrat or Demlican ideological line. And politically we can't have that. Politically we can't make the actual cost of our various decisions and value judgements transparent.

Things might be perfectly fine, for all we know. And we might be two minutes to midnight. We don't have any idea. It isn't possible for us to have any idea, the way government accounting systems are set up.

It isn't just a matter of disregard of reality. It is a matter of having set things up structurally to make it impossible to even know reality.

Why doesn't that level of uncertainty result in a shakier, or more cautious, market?

Honestly, I know next to nothing about this stuff. But I can't say I expect Social Security to be around when I'm old.

That's a fine piece of rhetoric, Zippy. And a fancy move from knowing about government accounting practices to knowing reality.


In the Constitution of Liberty Hayek compared England and France. The one is empirical and unsystematic, the other speculative and rationalistic. Perhaps it applies to their economics. Von Mises knew that economics wasn't just empirical and rationalistic, but he kept that structurally on the back burner.

All the same, it's easy to tire of knowing in part.

Why doesn't that level of uncertainty result in a shakier, or more cautious, market?

My guess would be because the current level of uncertainty (ignorance may be a better term) is a baseline since the founding of the Republic. So it is already priced into the market, both in terms of price and volatility.

When I review investment proposals these days they often come with market crash, terrorist attack, and other "doomsday" scenarios and combinations thereof. But that is only part of the story.

Two men in the woods come across a bear. One man looks at the other and says "I hope we can outrun the bear." The other replies "I don't have to outrun the bear, I just have to outrun you."

I think a lot of the attitude in the market is that a civilizational meltdown just isn't the sort of thing you can plan for without being a Montana survivalist: that if you've got things figured such that the rest of the world melts down before you do, then you'll probably be OK with a billion or so first-worlders well motivated to keep it from happening.

I suggest no judgement on the merits, moral or otherwise, of that approach; I merely report it as an observer.

KW: allow me to make an even more subversive suggestion. I make the suggestion solely for the sake of opening minds.

Proposition: there is no excuse for a 200+ year old institution with trillions in assets and which establishes the rules for commerce in the largest economy in the world to require any coerced tax revenue from individuals at all.

Thanks, TSO. Very comforting. At least I'll finally have victim status. And then Gintas turns me into an insect.

It is hard to conclude that Willful Ignorance is anything but a way of life for most Americans, including those in postions of social, economic and political power.

On the very near horizon we can see such Ponzi Schemes as Social Security, sub-prime loans and private pensions (300 of the S&P 500 are unable to meet their projected obligations) are coming due. At the same time, our dependence on the foreign entities holding US Treasury notes and furnishing our cheap energy has left us almost fatally vulnerable to some very bad actors.

We have been bred to believe in Yankee ingenuity, American Know-How, American Exceptionalism, the miracle of the markets and the power of technology. Yet, these notions unleavened by humility and self-restraint have grown into mass delusions that in turn produced terrible policies and practices.

Reality ultimately intrudes on even the most elaborate deceptions. And the routine scandals in Washington DC and Wall Street indicate that those "in the know" see the storm ahead and are feathering their own nests in advance.

It is time for those of nobler stuff to begin the groundwork for a saner socail order.


Proposition: there is no excuse for a 200+ year old institution with trillions in assets and which establishes the rules for commerce in the largest economy in the world to require any coerced tax revenue from individuals at all.

I like the thrust of this subversive suggestion. Perhaps you will elaborate sometime...

Social Security insolvency, the Islam problem & America's ruin through mass third world immigration = disavowal, denunciation & denial.

"I think a lot of the attitude in the market is that a civilizational meltdown just isn't the sort of thing you can plan for without being a Montana survivalist: that if you've got things figured such that the rest of the world melts down before you do, then you'll probably be OK with a billion or so first-worlders well motivated to keep it from happening."

I think you guys are being too harsh on plain folks.

Those of you who are 30+ might remember a small matter of Long Term Capital Management.

It is an example of how Noble Prize winners and Masters-Of-Universe are able to deal of slightly unusual events in their area of expertise.

See en.wikipedia.org/wiki/Long-Term_Capital_Management

I think you guys are being too harsh on plain folks.

Well, I was specifically talking about actual money managers, brokers, etc not plain folks. I have no way of knowing even anecdotally what everyday Joe thinks of all this. But I have some idea about how investment proposals are structured; what they take into account, what they set aside as beyond the scope of planning.

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