Presidential candidate George W. Bush, following a Republican playbook scripted in the mid-nineties as the party lurched from defeat to defeat, its ambitious agenda for the housebreaking of the Federal Leviathan stymied by Clinton's deft triangulations, said little about Social Security. As President, he proposed an audacious (within the narrow consensus of American politics) partial privatization of the gargantuan entitlement program, whose unfunded liabilities foretell all manner of political and economic upheavals, scheduled to begin once the pig-in-the-snake of the Baby Boom generation reaches retirement age.
For his admittedly desultory effort, he was rewarded with a political rebuke: failure, and falling poll results. Americans cherish all manner of illusions about the nature and stability of the program, and probably even believe in the unbelievable myth of the Social Security Trust Fund; when presented with the dire facts about the future of the program - which become still more sombre when Medicare is incorporated in the calculations - they make quick resort to magical thinking: it cannot happen; things will work out fine; all things will continue as they have since FDR brought salvation to America.
Curiously, financial markets also appear to indulge in magical thought.
A serviceable estimate of the unfunded liability places the figure in the vicinity of $40 trillion, though this figure does not account for the new Medicare drug benefit, and will probably be revised upwards before I finish typing. Jagadeesh Gokhale observes:
So it's a puzzle why the prospect of a negative economic impact from unavoidable fiscal policy changes in the not too distant future aren't already reflected in financial markets.
Certainly, this ought to be puzzling, given our societal faith in the market as an efficient - the most efficient - mechanism for the assimilation and analysis of information. What information could be more relevant than that pertaining to an entitlement crisis that will necessitate wrenching changes such as benefit cuts, punishing tax increases, and/or, in extremis, the devaluation of the currency? Gokhale considers several explanations for this apparent oversight, finding them wanting.
It cannot be that investors are simply wallowing in ignorance; these shortfalls have been widely bandied about, despite originally being buried in the abyssal depths of turgid government reports only three people read, and financial market actors are supposed to be, well, well-informed. Neither could the explanation lie in the temporal horizons of investors; the Baby Boomers will be retiring before my three-year-old hits high school. Investors might also believe that there exists some sort of magic bullet fix for the problems, a fix that shortly will be enacted, despite the sepulchral silence in Washington on the issue; however, there is no magic bullet than can fell hard, demographic and political realities: the population of retirees is about to burgeon, they will resist reforms, and any attempted reforms will either provoke widespread discontent and electoral wrath, or crater the economy. Or both. Then there is this:
A third possibility is that financial markets are flush with savings from foreign, especially East Asian, countries. The primary sources of these funds are trade surpluses that those countries have been running with developed countries such as the U.S. Although these funds are good for U.S. financial markets, the fact that they are largely controlled by a few foreign governments rather than a great many individual investors makes them riskier.
Those governments could more easily coordinate an exit from U.S. capital markets if fiscal imbalances started taking a toll, hitting the U.S. economy even harder. But this prospect means that investors -- mainly the foreign governments themselves -- may be severely mispricing the risks associated with investing in U.S. capital markets.
So, globalization adds an additional layer of political complexity to the problem, as well potentially adding a befogging haze of ignorance on the part of the largest investors. Lovely. In the end, Gokhale does not advance an explanation or hypothesis for the discounting of critically relevant information; the mystery is left to find some other resolution. Perhaps, however, it all comes down to that magical thinking, or, rather, the wellsprings thereof: acknowledging the looming crisis might threaten to deflate the market, and so happy, magical thoughts are invoked to stave off the thought of gloom. In the end, markets embody instrumental reason, the reason of the efficient allocation and application of means to the attainment of ends; this is to say that no market can be more rational than the ends chosen by market actors, that no market can be rational if its actors are less than optimally rational. And perhaps, in that less-than-optimal rationality, they deceive not only themselves, but us as well, concerning what lies in wait for us.