Trust And The Spontaneous Order Of Money

In a series of posts on Left2Right, Elizabeth Anderson and Neil Buchanan argue against the notion that we shouldn't trust Social Security Trust Fund because it is just an imaginary accounting fiction. Anderson and Buchanan don't deny the plain truth of the matter: with or without the trust fund, the government would still have to collect revenue to cover its obligations to retirees. In either case, the money is still coming from and going to the same places. They do claim, however, that through the miracle of fiscal transubstantiation, the obligation to retirees becomes extra trustier when routed through Treasury Bonds.

Even if this magic trick works, the fact remains that, as Julian Sanchez puts it, "If you write me a check, that’s an additional asset I’ve got. If I write myself a check, it isn’t." Making the system marginally more trustworthy by shifting from general government obligations to Treasury Bonds may be a good idea, but it is only a difference in degree, not kind. The idea of a trust fund implies an independent, tamper-proof account, and not one-hand-washes-the-other shenanigans ala Harry and Lloyd. Certain branches of the government may be more trustworthy than other parts, so shifting obligations from one hand to the other may make those obligations more solid, but we musn't forget that in the end it all falls under one organizational umbrella. When corporations do this sort of thing, by shifting businesses losses to subsidiary corporations to hide the bad news from shareholders, or by shifting businesses gains to subsidiaries to hide the tax burden, the government accuses them of shady accounting practices. When the government itself does it, the same rules do not apply.

One analogy that both Anderson and Buchanan use is especially interesting, when viewed through the lens of the Austrian critique of fiat money. Anderson and Buchanan argue that U.S. Treasury Bonds are analogous to the U.S. Dollar. Both are imaginary, unbacked by anything more than words and promises, yet both are fairly secure. Therefore, the argument goes, if we trust the dollar, we should also trust the Treasury Bonds on which the Social Security Trust Fund is based.

What's being accumulated in the Social Security trust fund is trillions of dollars worth of U.S. Treasury Bonds, universally considered the safest investment in the world. Bush is contrasting the trust to be placed in these bonds with the trust one should place in cold, hard cash -- which is to say, trillions of dollars of U.S. Federal Reserve Notes. Since both of these are obligations of the U.S. Government, backed by nothing but trust in the U.S. Government, the contrast is slight.

But this contrast is not slight at all. It is the difference between trusting a monopoly and trusting a market price set by the competitive interactions of millions of different actors. As B.K. Marcus explains in his now famous Gilligan's Island-style intro to Austrian monetary theory, money evolves over time, through a trusted network of stability, where no single entity has the power to violate this trust by default or inflation.

Over centuries, governments have taken over money from the market, and in the 20th century, most currencies became unbacked by anything other than the force of the State. But, as we see in the case of post-war Iraq, the fiat history of a currency can serve as the starting point for its post-fiat valuations. The Saddam Dinar doubled its value (measured against the Dollar) in only two weeks, but it couldn't have gotten started without its previous, albeit inflationary and unstable, exchange value. At that point, astonishing as it may seem, no government was necessary to maintain the value of the money. The market can reclaim money from government.

Why did the unbacked paper do better than the US Dollar? Because the quantity of dinars was relatively fixed, while the supply of dollars grew. The law of supply and demand tells us that, all else being equal, a rise in the supply of a thing will lower the price of that thing. The thing, in this case, is the Dollar itself; its "price" is its buying power, which the Iraqis watched erode drastically within days.

This is why the castaways value Thurston Howell's paper dollars: because whatever absurd amount he may have brought with him for "a three-hour tour," that amount is now fixed. Dollars are the most stable currency available on Gilligan's Island, and the government has nothing to do with it. Or rather: the absence of government has everything to do with it. If people are allowed to pick their own preferred money, they will pick whatever holds its value most reliably.

So, contra Anderson and Buchanan, there is an important distinction between trusting a decentralized socio-market network and trusting a single monopoly. If the U.S. Treasury and all government agencies related to the production, distribution, and use of money disappeared tomorrow, chances are people would still use U.S. dollars for the forseable future, and the value of the dollar might even increase, as we saw in Iraq. If, on the other hand, the U.S. Federal Reserve disappeared tomorrow, its bonds would be worthless because there would be no one around to pay.

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It's true that the

It's true that the government can't make your dollars worthless by defaulting on its debt, but if it's holding your dollars for you it doesn't have to, it can just withhold them. I think the point was that it's (almost?) unprecedented for the US government to say to bondholders "Just to let you know, we might not actually be giving you this money back", and that if they deny the obligation to repay bonds, there's no reason to believe they would repay cash. In that sense, the distinction is indeed slight.

To talk about how

To talk about how trustworthy the bonds are is to miss the point entirely. Let us suppose, for the sake of argument, that we can be 100% certain that the bonds will be repaid, and that they will be repaid at a positive real interest rate. The real problem remains: US treasury bonds are backed by no assets other than the US government's ability to extort funds from US taxpayers. For the bonds to be paid back, you and I and everyone else under the age of fifty must suffer in the form of dramatically higher taxes. That the US government will force me to honor its obligations is not a thought I find comforting.

But, in this instance, isn't

But, in this instance, isn't this a case where the governemnt is the bondholder.

Yes, in this case the

Yes, in this case the government is looking after the bonds on behalf of future retirees. That's what makes them insecure from the perspective of someone relying on the social security fund, not the fact that the bonds' value depends on a single entity instead of a decentralised market. The distinction Micha makes between dollar bills and bond certificates applies when you keep them in a private safe or under your mattress. When your assets are entrusted to someone who denies you access to them, their market- or monopoly-determined value is irrelevant.

The value of currency is,

The value of currency is, and will always be, subjective and subject to market fluctuations. If the US continues to make promises based upon a future generation’s “ability to pay”, it may well be courting economic disaster. Eventually, all ponzi schemes implode.

The bonds in the "trust

The bonds in the "trust fund" are not traditional treasury bonds as we know them. They are non-tradable "special public debt obligations", bear no market risk and are always redeemable at par. A more complete definition can be found in appendix A of section IV of the current trustees report at

Despite the difference, changing to traditional bonds will not solve the problem either. In addition, the government would then have the moral obligation to hedge the portfolio against value fluctuations in changing interest rate scenarios. Any guesses on how successful that venture would be? Guess who would bail out their mistakes? One only need look at the impropriety at FNMA and FHLMC to see the potential problems (different securities, yes, but same problems).

If the Federal Reserve were

If the Federal Reserve were to disappear tomorrow, it wouldn't have any impact on U.S. government bonds. They are obligations of the U.S. Treasury, not the Federal Reserve.

Note that their implicit

Note that their implicit premise that we should trust the dollar to hold its value even if federal fiscal policy continues on its current course is, um, suspect.