Recently by Gary North: Invitation to an Anti-Keynes Project

For the same reason that my children will pay for yours: because the government has offered them a deal: it will pay for our retirement.

The problem is, Social Security goes bust this year. If you don’t believe me, click here.

The government has promised to pay for my retirement and yours. How? Congress has stuck a gun in the collective bellies of all of America’s workers and has said, “You owe the IRS the money to fund millions of oldsters. Your turn will come. Trust us.” What if our children ever decide that Congress’s promises are not reliable? What if they decide that their children — our grandchildren — will decide to stiff them? Will they pull the Medicare/Social Security plug?

Let’s think this through. If your children were to sit down with my children and talk through this problem, is it possible that they would come up with this conclusion? “If we take over the funding of our parents’ retirement, will you take over the funding of yours?”

There would be some negotiating. The outcome would depend on how old I am, how old you are, and how old the two sets of children are. If I am in good health but old, while you are in poor health but likely to survive another 20 years through constant medical care, my children would like the new arrangement, while yours might balk.

But there is no way for them to sit down together and negotiate a new arrangement. There are 100 million families in the United States. Almost all of them are either in the Social Security/Medicare tax system, or else they have been before their retirement. There will be no face-to-face negotiations, family by family. Instead, there will continue to be voting blocs. Each bloc will want its members to pay less into the system, while pulling out more.

It’s politics, after all. It has been politics ever since 1935, when Roosevelt’s New Deal proposed this system to my grandparents. They supported it. They did not think about my generation. I was not even born. They did not think about my children’s generation. They thought, following John Maynard Keynes, “in the long run, we’re all dead.” Then they added, “so, before we die, we want the government to pay us some retirement money.” Initial cost: $30 per year per worker, and $30 per year per employer, maximum. A bargain!

It was a Ponzi scheme. They got in early.

What made this Ponzi scheme unique is that almost no one could opt out. It would go on far longer than a private Ponzi scheme. In fact, there is only one way out: to tell Congress to stop funding it.

All those retirees who are dependent on the government’s checks on the day that Congress decides to pull the plug on these programs will be left high and dry. They will have become totally dependent on those checks and the Medicare cards. Overnight, they will be abandoned.

Who will put back in the millions of plugs? Into what plugs? With what additional sources of income?

Will this ever happen? Not the way I have described it. Let me explain why.

MORE INCOME WILL BE NEEDED

What could finally persuade your children and my children to tell Congress it’s time to pull the plug? Only this: a really big financial crisis. It will be a crisis so big that Congress raises taxes, such as a value added sales tax on all businesses. Congress will never eliminate a major tax. It will only add a new one.

By the time Congress pushes for another tax one more time, which triggers a tax rebellion, it will have spent us to the edge of Federal bankruptcy. The voters always grouse, but they do not rebel. This is assumed by Congress. So, Congress will borrow until interest rates rise sharply. It will not cut spending until then. It will increase spending. It always has. Most voters accept this.

A tiny minority of voters knows this by now. The $1.5 trillion on-budget deficit for 2010 will get larger, year after year, now that Social Security’s Trust Fund is pulling out more from the General Fund to pay benefits than FICA taxes are bringing in to the General Fund.

The average voter does not understand any of this. He will not understand it for years. He will never understand the difference between on-budget debt and off-budget debt. It’s Enron on a gigantic scale, and the accountants never figured out Enron until it went bust. There was no warning. The voters will not figure it out

This is why there must be a fiscal crisis for any of this to register on the average voter. We should not expect a groundswell of public opposition against Social Security and Medicare until the U.S. government is facing bankruptcy: no buyers of its debt at interest rates that it can pay. Then Congress will go to the Federal Reserve for money. If the FED responds and buys the debt, then we will get mass inflation. If this continues, we will get hyperinflation.

Hyperinflation destroys retirees on pensions. Prices rise faster than the government’s cost of living escalators are adjusted.

Meanwhile, physicians will be wiped out. Price controls on Medicare payments will do that. There will be rationing. There will be death committees. There are no free lunches in life. Whatever is not allocated by price will be allocated by waiting for treatment.

Think of a waiting room filled with oldsters. Think of a system where the next walk-in or carried-in is given a number. The number is 10,257. If there are no death committees, then it will be strictly by the number. “Hurry up and wait.” Some of these people will die in the waiting room. They will be carried out feet-first.

Congress pretends that it can overcome the laws of scarcity. It can’t.

So, by the time there is enough political pressure from workers insisting that Congress default on Medicare, the budget crisis will be out of control. At that point, the cut-off of Medicare funding will not be part of a tax rollback. It will be part of a desperation cost-cutting measure, not a tax-rollback.

The money saved on oldsters will not be returned to the taxpayers, so that they can take over the funding of their parents. There will be no tax cuts.

So, the children will get back their parents. There will be help from Uncle Sam for the very poor. There will be no help for the middle class.

The scenario in which a successful tax rebellion against Medicare and Social Security is plausible does not make plausible additional tax cuts sufficient to enable work-force families to take over the retirement costs of their parents.

That will be the day of reckoning for America. That will be the moment of truth for children and parents.

Medicare costs run about $11,000 per year per Medicare recipient. Most taxpayers don’t know that Medicare costs this much. The government’s figures reveal this. I have posted the table here.

Think of the financial burden on a typical middle-class family of two adults and two children. Maybe one child is in college. Medicare is then cut off. Without warning, the family must pony up $11,000 per aged parent. There are two parents. So, the family must pay $22,000 a year after taxes. This does not count Social Security payments.

Some parents will be very ill. The insurance industry will not take them back.

What then?

You see the point. There will not be a cut-off of Medicare and Social Security through normal default. Politically, that is impossible. The default will come through monetary inflation followed by price inflation, plus rationing of medical care. The only way for an outright default on Medicare to take place is through default on the entire debt: off-budget and on-budget. That would involve a default on all Treasury debt. The whole structure would topple at once.

This has not happened to any modern government. Always the default has come through inflation. The politicians lie about their promises. Then the central bank lies about the future value of the currency.

MARGINAL CHANGES

In the free market, prices adjust upward when a shortage begins. Prices allocate the shrinking supply of a scarce resource. People adjust to the new conditions. There is negative feedback: rising prices. There are incentives to find substitutes or new supplies.

In government, there is no comparable system of negative feedback. Prices do not register mentally with elected politicians. Politicians just have the government borrow more. They make more promises. They promise that there will be no default. Voters and bond-buyers believe these promises. They do not believe that there will be a day of reckoning. They all kick the can.

Then the crisis hits without warning. The best example is what happened to Fannie Mae and Freddie Mac in September 2008. There had been warnings that their capital structure could not withstand a turndown in the residential real estate market. No one paid any attention. The game went on. Then, overnight, they were both bankrupt. It has taken $1.25 trillion in Federal Reserve purchases of their debt to preserve the illusion of solvency.

This is how government works. There are warnings by a few people on the fringes. These warnings are ignored. Prices do not adjust, because the government funds the operation, or promises to, or is expected to. This turns out to be true. The outfits really are too big to be allowed to fail.

There is no price response at the margin to persuade people to seek substitutes. The public accepts promises. Then it accepts nationalization. Henry Paulson nationalized 95% of the new mortgage market in September 2008 without consulting Congress. Bush was a lame duck President. He said nothing. Congress said nothing.

There was no warning, no fall-back position short of nationalization and a $1.25 trillion bailout by the FED.

This is why Social Security and Medicare will not be allowed to default. They will not be allowed to shut down. The checks will still go out. Congress will see to this.

Who will tell Congress not to do this? The voters? What power do they have? Did they want the $787 billion bailout by Congress in late 2008? No. Did Congress pay heed? No. Did the economics profession cheer? Of course.

There will be no default through self-conscious legislation. The oldsters have too much clout. They vote as a bloc.

There will be a default. There has to be. The system is not sustainable demographically. This default will come in the familiar form: inflation. Only if the Federal Reserve finally refuses to buy the government’s debt can this be avoided. But if the FED refuses, Congress can nationalize it as surely as Paulson nationalized Fannie and Freddie. Then Congress can force the central bank to buy its debt.

I think the FED at some point will cease buying Treasury debt. That will be well into mass inflation, with the CPI rising above 20% per annum — maybe even 30%. But the FED must put on the breaks at some point if it is to save the dollar. At that point, if Congress intervenes, we will get hyperinflation: prices rising at 50% per annum or higher.

No large industrial economy has faced this except after a defeat in a World War.

The nation of Israel went through hyperinflation in 1984. Prices rose at 450% per annum. The government froze prices, and the central bank slowed the expansion. Prices rose at 185% in 1985. The country’s economy did not collapse. The central bank pushed the nation to the limit, but then sanity revived.

Israel sells into a world market. It is a very small nation. It could recover because it did not lose its markets. It also stopped in time. In contrast, the United States is the world’s largest consumer and largest debtor. The dollar is the world’s reserve currency. If the USA ever becomes Israel in 1984, the international economy will cut off its loans to our government. The U.S. economy will then suffer a crisis far worse than in 2008.

Wall Street does not care about the long-term numbers. It cares only about the marginal return next quarter. It believes that kicking the can is a reasonable strategy. It defers the day of reckoning.

Marginal changes are ignored. Keynesian economists refuse to issue a warning. All schools of opinion except the Austrians and the Marxists say that kicking the can is a valid temporary solution. They do not say when this must stop. They mumble about “one of these days,” but no one in Washington except Ron Paul takes the numbers seriously enough to recommend biting the fiscal bullet today. No one pays much attention to Ron Paul in Washington.

CONCLUSION

My children and your children will consent to mass inflation. They will accept it because Congress will blame price gougers, not the Federal Reserve System.

More voters than ever before are now aware of the FED. But these voters are still a tiny minority. They must learn to identify cause and effect. Who will teach them? Not the public school system.

If Congress can keep the illusion of Federal solvency only by inflation, it will inflate. This is as sure a thing as there is in politics.

If the FED finally balks at hyperinflation, as I think it will, and Congress does not nationalize it, then there will be the other kind of default: the across-the-boards default. This will take down all of the programs. I think this is what will happen. I think we will avoid hyperinflation. Call me an optimist.

When the great default pulls the plug on Social Security and Medicare, what will you do? Do you have a plan?

March 19, 2010

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2010 Gary North