The Case for Marking More to Market

Plus! Petrodollar Recycling; Importing Talent; Self-Regulation; Apple/Google; Exits

In this issue:

03 18 2024 09 23 24

The Case for Marking More to Market

Some political debates convert a lot of energy into waste by leading people to fixate on the framing rather than the economic reality. Take social security: in one sense, it's a classic pension; there's a set of trust funds that invest the proceeds from payroll taxes, and that are used to pay beneficiaries. That trust fund is invested more conservatively than a typical pension, which would take advantage of the predictable nature of its inflows and outflows to earn an extra premium from duration risk, liquidity risk, etc.[1]

But wait! That trust fund is an accounting fiction! Social Security is a promise from the government to pay a certain amount in the future, and it's backed by a trust fund that consists of—promises from the government! It's circular, like having your retirement savings exclusively take the form of IOUs from yourself back to yourself.

But that, too, is off. The trust fund is indeed an accounting fiction, but it's not the only one. Really, it's equally fictional to say that a government-issued promise to pay $x on some date (i.e. a treasury bond) is in the same category as a promise from AT&T or Ford to pay a dollar amount on some date. Ford prints dollars by investing in capital equipment, buying materials, hiring workers, and mixing those together to create a car it can hopefully sell for a bit more. The US government manufactures dollars through the more straightforward process of taking a mix of linen and cotton, and stamping it with assorted decorations, one of which is a denomination that makes this scrap worth more than the ~6 cents it costs to manufacture. This tends to have a more predictable margin than the private sector approach.

But that only describes one set of interactions in a system. The Federal government can merrily convert cheap materials into expensive dollar bills, but that only matters if the dollar bills are actually worth something. It's similar to the fact that companies can, within limits, issue as much common stock as they care to. That privilege is only worth something if the common stock is worth something, and the stock is only worth something if 1) it's a claim on a valuable business, and 2) the median market participant doesn't believe that this claim will be endlessly diluted unless it's for a good reason.

If the trust fund is an accounting gimmick backed by a different accounting gimmick, is Social Security unbacked? No: it owns what amounts to preferred stock in every American worker: 12.4% of their income up to a cap of $168.6k.[2] That's a valuable asset, and it makes sense to think of it as a stream of future cash flows, not just a series of one-off payments—if it's pay-as-you-go, then so is a retirement portfolio of stocks and bonds, each of which is valued primarily based on its long-term cash flows. (If you own $1m of Netflix, the pay-as-you-go component is, depending on the finer details of how you model things, either the $20k or so in profits that a $1m equity position represents or the $0 in dividend they currently earn.)

But that just raises another problem: we can debate exactly what a share of any given company ought to be worth—this is, in fact, a fun and absorbing hobby for many people! But that debate is implicitly settled in real time throughout the trading day, when buyers and sellers find a price they're both satisfied with. There is not a market price on the total size of payroll taxes in the year 2044. But maybe there should be: Social Security could auction off, say, 1% of each year's future payroll tax payments for every year in which currently-living taxpayers would be working, and then run a new auction each year. The point of this wouldn't be to raise funds, and in fact to keep this from being slightly deflationary we'd want to spend slightly more to compensate—instead, the goal would be to put a market value on what's a combination of an actuarial, macroeconomic, and political bet: how much will future workers be paying into social security, and what does that say about the sustainability of the current system?
If we did this, we could also auction off small slices of other streams of government income. Government contractors in California could hedge their risks by shorting tranches of future California income tax collections (as could banks that depend on tech IPOs); bets on future tax receipts for gas, cigarettes, and gambling could be proxies for expectations about various kinds of externalities. You could look at the term structure of different kinds of taxes on the same stream of income—payroll taxes and income taxes, for example—to get a market-based read on when the smart money expects the tax code to change, and where.

And, finally, we'd be able to mark Social Security's actual assets to market, and figure out how solvent we should expect it to be.[3] Since Social Security is, economically, a pension fund with one big asset, which achieves diversification by covering the incomes of so many different workers, all you'd need to do is add up assets, compare them to the present value of liabilities, and see whether the system could last or not.

Of course, another feature of the entire debate is that if Social Security were to become insolvent, such that checks were drawn on an account with insufficient funds, this particular fact would be unimportant. A world where that happens is a world with some serious problems, but the object-level issue of one government department being unable to make good on its promises really indicates two more fundamental issues:

  1. Some kind of institutional dysfunction wherein the promised benefits can be economically paid to beneficiaries, or
  2. An inability to provide the promised benefits without raising either taxes or inflation to politically untenable levels.

In a sense, the US government can't default, but America can, by failing to produce enough taxable output to make good on the promises America has collectively made to itself and the rest of the world.[4] In that sense, a default isn't like forgetting to pay a bill or even declaring bankruptcy; it's like sleeping in and then thinking "Okay, tomorrow is when I start being an early riser." And that's a problem regardless of what accounting formalisms describe it. An actual Social Security default is another way of saying that the aggregate standard of living the US promises to workers and retirees exceeds the US economy's ability to provide it. That is a problem that can be solved, through some combination of higher productivity growth and lower consumption. It's a problem I used to worry about more—in high school, I tried to list my future Social Security benefits on eBay (sadly, they took the auction down; that $5 missed out on two decades of compounding!). Today, it seems that the US has a record of doing quite well on economic growth and muddling through on policy, and it's a reasonable starting point to extrapolate both of those trends forward. But to the extent that entitlements are a looming problem, the first step to measuring it is to privatize enough of them that we know what the consensus view is, which has the added benefit that all sides of the debate can put their money where their mouths are.

  1. Social Security could do this, but it instantly raises political questions. Does it invest solely in public equities? Which ones? Does that amount to a subsidy for big business, or at least for businesses that the market perceives as potentially bigger in the future? What about private companies? Does anyone want to defend a case where a PE fund delivers below-average returns, and half of its gross proceeds pay managers' fees rather than retirees' incomes? Also, how do you manage the timing: as George W. Bush discovered, proposing that social security funds be invested in livelier asset classes is politically feasible when the stock market has been doing well for a while, but having proposed this becomes a liability when the market drops. ↩︎

  2. The cap creates odd discontinuities where a taxpayer's marginal tax rate can drop at higher income. From the perspective of income redistribution, having taxes phase out at higher incomes would be crazy; you'd want higher earners to pay more, not less. But from the perspective of social security as a minimalist pension, it makes sense to require it up to a certain point and to tell people that if they want a better retirement than what Social Security provides, they'd better have some savings of their own, too. It's a bit like hybrid healthcare systems where care at some baseline is either cheap or free at point of use, but fancier treatments are handled by the private sector. ↩︎

  3. Among other things, you could trade income tax futures against payroll tax futures as a way to speculate on future income inequality. A world where a tiny minority of AI researchers and roboticists have automated most of the economy is a world where high earners do quite well, but where payroll taxes to fund Social Security are a minor contributor to the overall budget. ↩︎

  4. Owners of treasury bonds look like senior creditors, and in nominal terms they are. But in real terms, they're junior creditors: if the only way to keep the electorate happy happens to involve more spending, the goods-and-services-denominated obligation to voters supersedes the dollar-denominated obligation to lenders. ↩︎

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Petrodollar Recycling

Saturday's post included a quick review of a book about the collapse of Penn Square Bank; one contribution to this was petrodollar exporters recycling their dollar-denominated savings back into the US financial system, where they created demand for more loan volume. Petrodollar recycling still exists, and is intermittently an important feature of the economy, but its form has changed. The Economist highlights the rise of oil exporters' investments in Africa ($). Some of this is the natural result of a marginal spender and a low denominator: total investment in Africa is small enough that a new spender will quickly have a big impact. But there's also a strategic argument: countries tend to consume more energy per capita as they get richer, so an energy exporter worried about conservation and renewables in the rich world can hedge through investments that make poorer parts of the world rich enough to use more oil but not so rich that there's political pressure to create alternatives.

Importing Talent

Japan has a new visa program offering five year residency to angel investors ($, Nikkei). Venture ecosystems are hard to spin up, but also hard to disrupt once they exist: exit liquidity through M&A and IPOs continuously adds to the number of angel investors with budgets and relevant experience. But getting that first set of angel investors is a challenge. Japan has many of the ingredients of a successful startup ecosystem, including opportunities for very early IPOs. Making it easier for companies to bridge the period where they're growing but not profitable solves for an important missing piece.


Before the SEC, finance was more of a free-for-all. It wasn't anarchy, though, or, if it was, it's the liveliest testament to the school of anarchism holding that people will come up with prosocial institutions and reasonable rules as a community in the absence of some all-powerful ruler. So market manipulation was legal, but egregious instances of it could lead to someone getting expelled from the New York Stock Exchange (one successful corner in 1920 led to its organizer being expelled from the NYSE). An exchange run for the benefit of its members didn't want them exploiting one another too aggressively.

Today, crypto exchange Binance is tightening up its own rules for new offerings, requiring longer lockups and a security deposit. The Binance pitch is, basically, that they're willing to thumb their nose at US and Chinese regulators, making them an ideal venue for people with large sums of money who aren't anxious to address detailed questions about where it came from. (And, of course, people who just want to speculate, and the liquidity providers who are happy to make them a market.) Binance doesn't need loyalty from the creators of new tokens, both because most of them flame out fast and because it's an indispensable venue for them. But it does need to keep liquidity providers happy, and it's easier to run the entire business if retail punters, who largely realize that they're gambling, at least know that they're gambling at a fair casino.


When Apple launched the iPhone, it didn't have a complete ecosystem of apps. Parts of that ecosystem did exist, but as default-desktop services provided by other companies. So they launched with a maps app powered by Google, a video app powered by YouTube, etc. Some of these they've been able to partly replace, some they've worked to fragment, and some, like search, they just haven't managed to get rid of. Apple is now considering incorporating Google's Gemini AI into the iPhone. (There was clearly immense demand for positive news about Google's AI efforts; Google shares are currently trading up ~7%.)

One way to look at tech partnerships is that it's optimal for a market leader to bundle together a collection of market laggards to fill out its offering. If Bing were more competitive with Google, that's presumably what Apple would do in search. Their first priority is to make sure whatever product they're bundling is good enough, but once they've satisfied that criterion, the thing to maximize is their leverage to capture the upside.


US venture and PE firms are worrying that it will be hard to get money out of China ($, FT). This is an old, old problem; a running theme in Mr. China, covering the 90s, is that in countries with strict currency controls and iffy property rights, there's a big difference between buying into a profitable company and realizing any of those profits. Part of the country risk cycle is that early on, it's a risk premium—you get a bit of extra return as compensation for the possibility that your profits will be seized, or won't be easy to repatriate. But over time, that risk premium becomes part of the backtest, more capital flows in, and the abundance of capital makes governments less likely to exercise strict control. But if something disrupts either the flow of capital or underlying returns, the extra macro risk comes right back.