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TheStreet Open House

Social Insecurity: Inside the 'Trust Fund' Illusion

In other words, Social Security's nonmarketable bonds are merely markers for actual Treasury bonds, which must be sold, and for which interest must be paid. Thus, Social Security is entirely dependent on the Treasury's sale of new bonds for its future solvency. If interest rates spike or global buyers become wary of buying trillions of dollars in U.S. T-bills, costs for that borrowing will skyrocket, crowding out all other federal spending.

As a result, U.S. taxpayers are now paying twice for their Social Security benefits: Once through payroll taxes, and again when the Treasury uses their taxes to pay interest on the bonds it sold to fund Social Security.

This is not some far-in-the-future issue: The Treasury reported in October that it had to sell new bonds to fund Social Security shortfalls in 15 of the previous 25 months.

A Budgetary Illusion

Another way of understanding the hollowness of Social Security's nonmarketable securities is to ask: What difference would it make if we erased the Trust Fund from the ledger?

The answer: none whatsoever. In the "Trust Fund" we now have, when Social Security's outlays exceed its payroll-tax income, then the Treasury sells freshly minted bonds and transfers the cash to Social Security. If we eliminated the so-called Trust Fund, the exact same thing would occur: When Social Security's outlays exceed its payroll-tax income, the Treasury would sell bonds and transfer the cash to Social Security.

This thought experiment reveals that the Trust Fund is illusory, but the reality is that the U.S. Treasury will have to borrow $2.6 trillion on the global bond market to redeem Social Security's nonmarketable securities. That means the Social Security system is totally dependent on the Treasury's ability to sell trillions of dollars of bonds at interest rates that won't cripple the federal government.

The Treasury borrowed $1.3 trillion in 2010 just to fund the federal deficit. As baby boomers retire and payroll taxes remain stagnant, the Treasury will have to borrow substantially more to fund shortfalls in Social Security. If the global bond market hesitates to buy more Treasury debt at low interest rates, then all federal programs will feel the impact -- including Social Security.

-- Charles Hugh Smith writes for AOL's DailyFinance.

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