Here’s a question: who is the largest holder of US Government Debt?
By looking at this chart you might think its China—which holds $1.2 trillion worth of US Treasuries. But if you thought that you would be wrong. If you read the title of the chart carefully you’ll notice that it reads: “Foreign Holders of U.S. Government Debt”. The largest worldwide holder of US Government debt is not China, but in fact the United States itself.
The reason is simple: The Social Security Trust Fund. Beginning in 1983 (the year the Trust Fund took effect) Social Security starting taking in slightly more revenue than it paid out in benefit expenditures. To protect this savings against inflation, the leftover funds were used to buy what is generally considered the safest of all investments: United States Government-backed bonds. They aren’t normal US Treasuries, but rather so-called “special issues”, bonds that are created by the Treasury for explicit use by the Trust Fund.
It’s important to understand that this is both sensible and ridiculous. Sensible because, ignoring for a moment the wisdom of our current Social Security policy, if you have a large bucket of money that you plan on saving for many years to come, it would be a bit silly to let it sit in a bank account without earning interest, eroding year after year as inflation creeps forward. And what safer way to earn interest than buying US bonds. Ridiculous because when you get down to it we are lending money to ourselves. It would be like taking your vacation fund and using it to pay your mortgage, only instead of canceling your upcoming travel plans out of concern that your travel fund is now empty, you grab your wife and galavant blithely toward the airport.
So how much do we owe to ourselves? I took this off of the socialsecurity.gov website today:
As of December 2010 the Treasury owed the Social Security Trust Fund $2.6 trillion dollars (if you read the note at the top of the chart you’ll notice the dollar figures are in thousands), or more than twice as much as we owe China. Many of the same worries that afflict those critics of debt to China apply.
As the Social Security website notes, “Tax income is deposited on a daily basis and is invested in “special-issue” securities. The cash exchanged for the securities goes into the general fund of the Treasury and is indistinguishable from other cash in the general fund.” In other words, past revenue from FICA has subsidized lower income taxes and more government spending in the years since 1983.
I should note that there is debate about whether the Trust Fund being filled with IOUs from the US Treasury is a problem. On one hand the US Government, for all practical purposes, has unlimited credit so there is little fear that it won’t be able to pay these outflows as they continue to grow (there are enough IOUS to cover seniors at the current level until somewhere between 2042 and 2052 depending on the estimate).
On the other hand the money will have to be paid back at some point and that means either raising future taxes, reducing Social Security benefits in some manner, cutting government spending, further credit financing, or, if you agree with Niall Ferguson’s recent article in Newsweek, a fire sale of US Government assets. Each one of these options has real world repercussions for those citizens caught in the crossfire. And unlike in the case of China, because social security benefits are inflation adjusted, there is no hope of an eroding dollar value cushioning these debt payments.