Taxes, Deficits, Inflation – Oh My!

Read this.  Please.  It’s the annual report from the Social Security and Medicare trustees, and it has bad news for anyone who doesn’t already have one foot in the grave.

If you pay taxes, you will be paying more – a lot more – sometime soon.  The annual report contains all the numbers in black and white, and all that money has to come from somewhere. 

Medicare will pay out more than it brings in starting this year.  For 2008, Medicare is only projected to be $8 billion in the red, but that translates to a $16 billion increase in the deficit.  Why?  I’m glad you asked!

For years the government has been taking the “excess” revenues from Social Security and Medicare and “investing” them “in special non-marketable securities of the U.S. Government on which a market rate of interest is credited.” 

In other words, the government takes the money, writes an IOU (promising to pay it back with interest) to Social Security and Medicare, and spends it as part of general revenue.

That’s your trust fund.  There’s no money in a bank account drawing interest, there’s no gold in a vault, there’s no stock certificates.  There’s just a huge pile of government bonds (IOU’s) in the administration building.

Maybe that doesn’t make it clear so let me try explaining it this way….  You deposit $500 into an account (let’s call it a trust fund just for the hell of it) then – promising to pay yourself back – you transfer it to another account and spend it. 

You could even print out your IOU to yourself and stick it in a pretty box.  You do the same thing the next month.  And the next.  And the next….

After a year, how much money is in your trust fund?  Exactly nadda, nothing, zip, zilch, squat. 

You can’t take money out of one pocket, put it into the other pocket, and spend it.  Well, technically you can, but you haven’t saved anything.  And there’s no money left (you spent it on other things) to put back into the first pocket.

I hope that clears up the mystery of the Social Security and Medicare trust funds.  To put it bluntly, there’s no money in them.  Zip.

But the government stills owes that money to itself – or more accurately, they owe it to the designated recipients who have paid into the “trust fund.”  That’s you and me.

So where do they have to go to get the money they’ve promised to pay?  There are only three ways for the government to get money; taxes, borrowing, or printing more money – or a combination of these. 

Which one should they use?  Let’s take a quick look at the choices:

1) Taxes.  The government can raise taxes to cover their expenses.  Since we’ve run a deficit for years, I don’t think they’ll do this – which is actually the option which would cause the least pain for all. 

2) Borrow: This simply means they sell more bonds to foreigners.  We get to use their money and simply make payments on our national interest only loan.  Hey, it’s working out great for homeowners!  Right?

3)  Print more money:  Sounds, good – after all, the government makes a profit on each dollar they print.  It costs less than a cent to print a dollar bill, and it’s worth $1 – before inflation anyway.

See, there’s this little thing called supply and demand that refuses to go away.   When you make more of something without a corresponding rise in demand, each one of them is worth less.  Make too many, and each one is worthless.

That’s why we have inflation – we print dollars with nothing standing behind them.  The money supply (the supply part) rises faster than the economy grows – the demand side.   Rising prices for “real” stuff like oil, gold, wheat, and milk don’t cause inflation – they’re caused by inflation.

Read that paragraph again, it’s important.  Most people (even bankers and some of the fed board) don’t “get” this basic fact of life.

Anyway, the government will need to get the money to pay Social Security and Medicare benefits from somewhere, so my bet is that taxes, deficits, and inflation will all be a big part of the years to come. 

And if you think the deficit is big now, you ain’t seen nothing yet.  You can ignore those “pull the numbers out my ass” deficit projections from the government – because they actually assume that the money from the Social Security and Medicare trust funds are there!

I don’t know what “real” stuff will be worth in a week or a month, but gold, oil and silver will be a lot higher 10 years from now.  That’s where my money is.

gk

Tags: deficit, Federal Reserve, Gold, Medicare, oil, silver, Social Security, Trust Fund