Original story at: Gary North
David Sadler For Congress 12th CD/Illinois

Accounts Overdrawn: The Bankruptcy Of The Social Security And Medicare Systems
Gary North, Ph.D. (former research assistant to Congressman Ron Paul, R-Texas)
2002.02.20

There are a hundred million households in the United States. The vast majority of the people who live in these households have never heard about the information I cover in this report. They will not see what is coming at them like a freight train until they are helpless, unable to protect themselves. You are about to be given a head start. Don't waste it.

What you are about to read will confirm your suspicion that the Social Security/Medicare system will run out of funds before you run out of time. I will prove this to you later in this report with a standard amortization calculator on the Web.

If you finish reading this report, you will have better information on this problem than 99% of American voters. But this is not just an American problem. Every Western industrial nation faces it, including Japan -- especially Japan, whose aging population will force a budgetary crisis before 2005.

I am asking you in advance not to ignore the implications of this information after you are convinced that it is true. Don't sit there, like the mythical frog in the pot, waiting for the water to boil you.

UNFUNDED LIABILITIES When I became a research assistant for Congressman Paul in 1976, I already knew that the Social Security system was doomed. Congress has always known, too, which is why Congress's employees when I was on staff were not under Social Security. We did not have to pay into the system.

The law was later changed to put newly hired staffers under the system, but not the ones who had gotten onto the payroll early. Congressmen and Senators still have a completely separate retirement program.

Social Security and Medicare are not funded. Their so-called Trust Funds are filled with nothing but government IOU's. These are not even marketable IOU's.

The tax money rolls in, payments to existing retirees or sick oldsters are made, and whatever is left over is spent by Congress. The Treasury then issues non-marketable IOU's to the Trust Funds. Maybe you knew this before. Maybe you didn't.

What this means is that there is no funding for these two programs. The IOU's will have to be sold back to the Treasury when it's time to pay off the beneficiaries.

Where will the Treasury get the money to redeem these IOU's? There are only three possibilities: (1) raise taxes, (2) borrow the money, (3) tell the Federal Reserve System to buy replacement forms of U.S. government debt with newly created money. In short: (1) create a tax revolt among workers, (2) raise interest rates and slow down or even collapse the economy, or (3) create mass inflation.

There is a fourth possibility, of course: default.

The politicians can " stiff the geezers. "

One way or another, the government will have to pay the economic and political piper. Someone's ox is going to be gored. You had better begin making plans soon to see to it that it will not be your ox.

ESTIMATING THE SIZE OF THE UNFUNDED LIABILITIES What is the present unfunded liability of the two systems? This information is not readily obtainable. The politicians are not interested in giving publicity to this figure. There are disagreements on how large it is and how fast it is growing.

In 1999, an important book appeared, GRAY DAWN: HOW THE COMING AGE WAVE WILL TRANSFORM AMERICA -- AND THE WORLD. It was published by Times Books, the book publishing division of the NEW YORK TIMES. This is what we can safely identify as an Establishment publisher.

The author is Peter G. Peterson. Mr. Peterson is one of the most influential private citizens in the world. He is the chairman of the Council on Foreign Relations. He is also the chairman of The Blacksone Group, a leading investment bank. Ever since 1982, he has been writing about the funding problems of Social Security and Medicare.

On page 100, he revealed that the estimated unfunded liability of the Social Security retirement program in 1999 was $10 trillion. On page 72, he pointed out that, according to the ERISA law that governs private pension plans in the United States, there must be an amortization schedule. The U.S. government should be investing money each year in the private sector, so that retirees can be paid the promised benefits without taxing younger workers.

This is not what the present pay-as-you-go system does. It taxes existing workers to pay for retirees.

How much money would the U.S. government have to set aside each fiscal year to invest for future retirees, if it adhered to the law governing private pensions? This is where the rubber meets the road. Almost no voter knows this figure. I have known about the problem of funding the system all of my adult life, but I never asked this obvious statistical question.

As of 1999, the figure will amaze you: $750 billion per year for the next 30 years. That was at a 7% interest rate.

Also on page 72, Peterson reports that Medicare amortization payments would also have to be $750 million.

That's a grand total of $1.5 trillion a year. This estimate means that Medicare's unfunded liability is also $10 trillion. This means that the combined unfunded liability for the two programs in 1999 was about $20 trillion.

In fiscal year 2001, the total U.S. government budget is expected to be $2 trillion. In other words, it would take 75% of the government's budget to fund these two unfunded systems.

You can check this for yourself on the Web. You can use any amortization calculator, but I like this one because it calculates the annual figure.

http://www.calculatorweb.com/calculators/amortcalc.shtml

Use the figure 200000. There is not room in the box for $20 trillion in unfunded liabilities. You must first knock off 8 zeroes. You will add them back later. Use 5% as the annual interest rate -- probably too low for 30 consecutive years. Use 30 for the number of payments. Use Yearly for the compounding period. The calculator gives you this figure: $13010.29 Add back the 8 zeroes: $1, 301, 029, 000, 000 That is $1.3 trillion. The figure is lower than Peterson's because interest rates have dropped since 1999.

But this figure is too low. Here's why.

The government in 1999 did not invest $1.3 trillion to fund that year's required payment. It is the same as if you were to skip paying your monthly mortgage payments for a year. This debt is not forgiven. The money that you failed to pay gets tacked onto the principal owed. (This is unofficially called a backward-walking mortgage.) In 1999, the money that the government did not pay to fund Social Security and Medicare got tacked onto the principal owed.

$1.3 trillion + $20 trillion = $21.3 trillion So, in fiscal year 2000, the government should have made a larger payment: $1.38 trillion. But it did not do this. So, this got tacked onto the unfunded liability: $21.3 trillion + 1.4 trillion = $22.7 trillion This is what is owed in fiscal 2001. To make this payment, the government must set aside $1.47 trillion.

This is close to Peterson's estimate of $1.5 trillion at 7%.

The government will not set this aside in fiscal 2001.

So, the principal owed in 2002 will be $24.2 trillion. And so on, year after year.

Even if the government invested $1.5 trillion a year in the private sector for the next 30 years, could it be sure of a constant 5% return on the total investment? At some point, these assets will have to be sold off to pay off the retirees. Then the market value of these assets will fall. The rate of return will fall.

Peterson in 1994 was a member of a government commission on tax reform. It was named for the Democrat and Republican Senators who chaired it: the Kerrey-Danforth Commission on Entitlement and Tax Reform. There were 20 Republican and Democrat members of Congress, and 11 private citizens. By a vote of 30 to 1, the Commission's members agreed to the findings. The Commission looked at the evidence and concluded that in the year 2030, the cost of paying off five programs -- Social Security, Medicare, Medicaid, Federal civilian pensions, and Federal military pensions -- will require more than the entire budget of the U.S. government (p. 8).

Obviously, this will not happen. Someone is going to get stiffed by the government. The promises will be broken.

My point is simple: the existing political promises are gigantic. Without capital investment in the private sector, there is insufficient productivity to pay for all of the retirees and their medical expenses. The IOU's that the Treasury issues to the two Trust Funds will not be able to be redeemed without taxing the workers. That will reduce their productivity and also their incentive to work.

There are other estimates of the unfunded liabilities of the two programs. I have seen estimates as low as $13 trillion (as of fiscal 1998). But Peterson has devoted almost two decades to the study of this problem. He has served on a major government commission that studied it. I use his estimates as the benchmark.

We are facing a political crisis, as are all other Western, industrial nations. The magnitude of the political promises will exceed the ability of governments to pay off.

What if governments don't amortize their retirement systems by means of purchasing productivity-increasing private capital assets? All of the systems will go bankrupt over the next 20 years. According to Peterson's estimate, Japan's fiscal system faces a crisis beginning in 2003. Italy's crisis will begin in 2005.

Younger families will be hit by rising payroll taxes.

They will also be burdened with the support of aged parents -- something that neither the old nor the young have planned for.

Are you prepared to move in with one of your children? Are any of them ready to have you move in? THE RESPONSIBILITY OF GRAY-HAIRED WORKERS For those gray heads who are still in the labor force, the handwriting is on the wall: you and I are going to be stiffed by the government before we die. The government may decide to raise the retirement age before Social Security kicks in, but politically this would be tough.

So, governments will defer a major decision until the system cannot be funded by rising payroll taxes. Then they will probably inflate, or maybe default outright. But inflation will conceal the default. High prices can always be blamed on " merciless speculators. "

Older workers will have to remain in the labor market longer than expected. I see no other way for older workers to maintain their lifestyles. It takes about $250, 000 of invested capital at 5% to generate $1, 000 of income per month (before taxes), and this fixed income will be at risk when inflation kicks in.

Having millions of older workers stay in the job market is a good thing. It increases the division of labor. The whole economy benefits. But it will force major plan revisions on older people. The vast majority of older workers are not prepared for this. They will be furious. They will seek political revenge. This will divide the electorates between tax-absorbers and taxpayers.

The alternative to staying in the work force is to create new capital. This capital must produce high income: above 5%. That is, it involves greater risk. For those of you who have read THE MILLIONAIRE NEXT DOOR or RICH DAD, POOR DAD, you know how this is done best: by building a small business. A successful small business allows you to create a personally controlled stream of income.

A person who can create a stream of income as an entrepreneur, and who then lets it go on auto-pilot, has the best shot at retiring successfully. If the source of income grows with the market, this can offset the losses in purchasing power generated by rising inflation. A fixed- income investment, such as a bond, declines in value in a time of price inflation.

There will be no budget surplus. The deficit will reappear during any recession. But even if times stay good, election-year politics will spread around layers of pork. Congress will spend whatever comes in. It always does.

The Trust Funds are not going to be funded with anything but IOU's from the Treasury, which require either taxes or inflation to pay off. The magnitude of the required funding -- at least $1.3 trillion per year -- is sufficient to keep any serious discussion of the problem from taking place in public.

This means that you must find long-term employment or else investment income sufficient to maintain your lifestyle. There is only one way for most people: to stay in the labor force, either as salaried workers or as small business owners.

Being a salaried employee is easier than becoming a small business owner, but the rewards are minimal. Also, an employee remains at the mercy of his employer. When it's time to fire people, managers will look for a reason to fire older workers, even though this is illegal.

Managers will find a legal excuse.

You need to protect yourself. You also need to protect your children from the risk of having to take you in at some point.

NEVER SAY RETIRE! It is time for every worker to face the grim but inescapable reality of the numbers. There will not be a comfortable retirement for most people at age 65. They will have to stay in the work force for an extra decade.

But they will not be welcome in businesses that prefer younger workers.

This is why you should have a small business on the side, just in case. You need something to " retire into. "

Find out what would be best for you.

Not many of your peers are thinking about the " new economy " that is heading toward us like a freight train, an economy in which older people must stay in the work force.

Your peers are comfortable today. They are also naive.

They are going to be hammered by economic conditions that almost no one dares to forecast today.

You know better. What difference will this make? What will you differently from your peers? How soon will you begin to make plans? The surplus is a thing of the past. The attack on September 11 has given the President carte blanche to run any size deficit he wants. The demise of the Social Security Trust Fund is now assured. It was anyway, but the myth of the surplus is now doomed.

It is time to re-think your future.