Deflating Social Security

Deflation is a concept many Americans have a tough time understanding. They do understand the concept of Social Security. As Federal budget deficits soaring, the public is being barraged by late night advertisements to buy gold as an inflationary hedge. Unfortunately, the deflationary environment we are facing today is the biggest threat to the Social Security check Joe the Plumber is counting on for retirement.

The definition of deflation as a decrease in the general prices of goods and services may be simple, but a Google search for articles on deflation generates 3.5 million “hits”, versus a whopping 354 million “hits” for inflation. This demonstrates that Americans are 100 to 1 more knowledgeable of inflation!

There have only been three bouts of deflation in the United States since its founding over 200 years ago. The first was the recession of 1836, when the currency in the United States contracted by about 30%. The second was after 1865, when the Nation returned to a gold standard by retiring paper money printed during the Civil War. The third period was the Great Depression, when prices and output fell by 25% from 1928 to 1933. Very few Americans are familiar with the specifics of what happened during these periods, but they know it was a bad time for the “common man.”

Social Security was established during the Great Depression and continues to be the most important income stream for America’s seniors. A large majority of the 16 million people over age 65 rely on Social Security for at least half of their income. One-third of this group relies on Social Security for over 90% of their income. Most retirees have come to rely on the annual cost-of-living increases in their check to make their life better. In a deflationary environment we are facing today, few recipients are prepared for their check to actually shrink.

Social Security tax collections provide a very reliable gauge of strength or weakness of employment conditions for 160 million U.S. workers. Ominously, for the first six months of 2010, Social Security Trust Fund collections are down 5% and benefit payments are up 4%. This is the first cash flow deficit in the history of Social Security.

The 2009 Social Security’s annual report predicted Social Security would exceed payouts through at least 2016 and would continue to be solvent through at least 2037. However, these erroneous assumptions were based on an average unemployment rate of 8.2 percent in 2009 and 8.8 percent this year. With nearly 1 in 10 Americans still unemployed, Social Security is accelerating its race towards insolvency – we have finally reached the tipping point.

Ben Bernanke the Federal Reserve Chairman and 2009 “Time Man of the Year”, made his reputation as an expert on the Great Depression. In a 2002 speech titled “Deflation: Making Sure ‘It’ Doesn’t Happen Here”, The Chairman was asked if deflation was a threat to the economic health of the United States in the near future. His response:

“So, is deflation a threat to the economic health of the United States? Not to leave you in suspense, I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small, for two principal reasons. The first is the resilience and structural stability of the U.S. economy itself. Over the years, the U.S. economy has shown a remarkable ability to absorb shocks of all kinds, to recover, and to continue to grow. Flexible and efficient markets for labor and capital, an entrepreneurial tradition, and a general willingness to tolerate and even embrace technological and economic change all contribute to this resiliency. A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape.”

By the time Congress is asked to battle deflation there will be limited weapons in their arsenal. With Social Security up side down, $3 trillion in squandered stimulus, credit rating agencies threatening to downgrade the U.S. and 10% unemployment what can Washington do to stave off deflation? Only two antidotes remain (1) raising taxes and (2) cutting benefits. If the deflationary disease does not kill the patient, the treatment very well might.