Economist Veronique de Rugy cautions Social Security’s looming shortfall could trigger immediate market upheaval

The Congressional Budget Office projects that the Social Security trust fund will exhaust its reserves by fiscal year 2032, a date that now falls within the upcoming term for senators elected this November. This rapidly approaching deadline presents a significant challenge for lawmakers, who must navigate the political complexities of either reducing benefits, increasing taxes, or finding alternative funding mechanisms. The temptation to defer difficult decisions and instead finance the program’s deficit through additional borrowing looms large, a path that economist Veronique de Rugy warns could have swift and severe economic repercussions.

De Rugy, a senior research fellow at George Mason University’s Mercatus Center, has articulated concerns that financial markets would not patiently await the accumulation of new debt. Instead, she suggests markets would react almost immediately to any commitment by Congress to a debt-financed solution. Her perspective diverges from some conventional outlooks that anticipate a more gradual impact from increased national debt. This time, she argues, the consequences could manifest as inflation, arriving the moment such a borrowing strategy is adopted, rather than after the debt has fully materialized.

For decades, the Social Security system operated with a surplus, building a trust fund designed to cover benefit payments when payroll tax revenues alone became insufficient. That pivotal moment arrived in 2010, and since then, the trust fund has been steadily drawn down. Should Congress fail to act before the projected insolvency, benefits would then be paid solely from incoming revenue. The Committee for a Responsible Federal Budget estimates that a typical couple, currently aged 60 and retiring at the point of insolvency, could face a substantial reduction in their annual benefits, potentially as much as $18,400.

The baseline forecasts from the CBO typically assume that Social Security payments will continue on their present course even after the trust fund is depleted. These projections also generally anticipate a period of relative stability in interest rates and inflation over the next decade. However, de Rugy contends this outlook might be misleading. She emphasizes that the perceived value of government debt is fundamentally tied to investor confidence in the government’s ability to generate primary surpluses sufficient to meet its obligations. When this confidence wavers, markets tend to adjust instantaneously, and in the United States, such adjustments frequently appear as inflationary pressures.

She points to the roughly $5 trillion in pandemic-era stimulus, largely financed through debt without subsequent austerity measures, as a recent example. This period was followed by a surge in inflation, peaking at 9%, which devalued the dollar and forced a repricing of government debt to reflect altered expectations for future primary surpluses. De Rugy cautions that a similar borrowing spree to shore up Social Security could trigger an even more immediate and pronounced market reaction. She suggests investors might not grant Congress a grace period to develop a sustainable long-term solution. If U.S. debt is repriced suddenly, inflation could accelerate far beyond official predictions, not merely due to the sheer volume of existing debt, but because faith in the underlying plan for future debt has eroded.

This scenario would place the Federal Reserve in a difficult position. The central bank would face the dilemma of raising interest rates to combat inflation, thereby increasing the cost of servicing the national debt, or tolerating higher inflation to avoid exacerbating the debt issue. Bernard Yaros, lead U.S. economist at Oxford Economics, previously speculated that Congress might initially opt for the politically easier route of allowing Social Security and Medicare to draw from the general federal revenue. However, he noted that such a move could provoke a negative response in the U.S. bond market, interpreting it as a capitulation on a key opportunity for reform. A sharp increase in the term premium for longer-dated bonds, he argued, might compel lawmakers to reconsider and adopt a reform-oriented mindset.

Ultimately, this pressure from bond markets, often referred to as “bond vigilantes,” could force Congress to make difficult choices. Yaros suggests that these corrective actions would likely involve cuts to non-discretionary programs like Social Security, given that discretionary spending constitutes a smaller portion of total government outlays. While these actions would undoubtedly be painful for many households, he believes they are necessary to avert a fiscal crisis, characterized by an abrupt and significant decline in demand for Treasury bonds relative to supply, leading to a sharp and sustained increase in interest rates.

Ruth Forbes

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