When established in 1935, Social Security made its first payments to Americans at the age of 65. These first recipients never contributed and were paid from contributions made by younger Americans. Those Americans and successive generations believed their contributions were investments, and that they would be paid at retirement by the earnings on those investments.
In fact, those younger Americans were paid by the contributions of successive generations of "investors," as the federal government spent their money to help finance operating deficits. With the ratio of retirees to contributors rising, the Trust Fund will run out of money by 2036, if not sooner.
Such a scheme could only continue if the working age population grew more rapidly than the number of retirees, but it hasn't because Americans live longer and the birth rate has declined.
President Obama's claims notwithstanding, Social Security is now a growing burden on federal finances, as the difference between the Trust Fund's income and what it pays out grows each year. As we approach 2036, either payments will have to be dramatically curtailed, or the government will have to shutdown, on a massive basis, other activities.
Either Social Security fails, or the United States fails.
In a Ponzi scheme, first investors, through a mechanism like a chain letter, are paid immediate returns by monies collected from subsequent investors, who are in turn paid by other investors who follow them in time.
Social Security did not even ask the first recipients to put up a dollar, and by any reasonable reading of the definition of a Ponzi scheme, Social Security qualifies for that appellation.
Social Security can work as long as it finds more and more workers to support the growing number of retirees, but it can't -- because the system encourages folks, who once relied on their children and savings to help them through old age, to have fewer children. And by its nature, reduces incentives for savings and investment, thereby slowing economic growth and making it more difficult for each successive generation to support the elderly.
Governor Perry is right to call Social Security for what it is, but he is wrong to think going to a privately funded system -- Americans' contributions would be invested in stocks and bonds -- is the answer.
Not enough money could be invested on behalf of young contributors, because the government would still have the burden of paying off the present and next generation of retirees, and so not enough of young folks' money could be invested for their old age. The government would still have to provide a subsidy.
Second, in the end, there is no getting around the fact that folks above a certain age can't work, and that some of what is made by the economy -- think of it as a slice of a big pie -- must be transferred from working age folks to support them. Whether done by the government or through investments, a public vs. a private system only defines how the claim of old folks is defined.
Third, individual investors are not particularly good at managing money, and guaranteeing investors a minimum return, as Congressman Paul Ryan proposed, is just a backdoor to the present poorly run system. Moreover, the U.S. stock market has not returned a dime to investors for more than a decade, and interest on bonds and savings accounts are too low to make the system work.
Fourth, most ordinary Americans are already too heavily taxed by falling real incomes, and ever more acquisitive federal and state governments, to invest enough additional dollars that a truly private system, not guaranteed by the government, would require.
In the end, the only way to make the system work is to ask Americans to work longer.
If Governors Perry and Romney want to fix the system, instead of arguing over terminology, they must address the retirement age. It simply must be raised to something close to 70 -- no exceptions but for the truly disabled.
Americans won't like that but it beats what President Obama is offering. Characteristic to his thinking on economics, he prefers to believe what his liberal ideology, not the facts, require -- and incorrectly insist the system is solvent.
Social Security, by the findings of Mr. Obama's own Social Security Administration, is insolvent and hence a Ponzi scheme. Americans would be better served by hearing the truth if they are to have some dignity in retirement.
Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.
Peter Morici served as Chief Economist at the U.S. International Trade Commission from 1993 to 1995. He is an economist and professor at the Smith School of Business, University of Maryland, and a widely published columnist. He is the five time winner of the MarketWatch best forecaster award. Follow him on Twitter @PMorici1.