The Equity Premium

In thinking about Social Security privatization Brad DeLong writes:

Will [Social Security privatization] be a good deal? It could be, if:

  1. The large premium return on equities really is a market failure that private accounts can profit from, rather than merely compensation for risk.
  2. Private accounts are set up so that they are not eaten away by high administrative costs.
  3. Private accounts are set up so that they are not decimated by improperly balanced and diversified portfolios.
  4. Private accounts are set up so that they cannot be pledged or emptied by imprudent and impatient beneficiaries.

I can imagine private account plans that I would think are worth risking. I’m impressed enough by the large size of the equity premium to think that there are some $1,000 bills left on the table here that the Social Security system might as well try to sweep up. Propose a private accounts plan by which Social Security beneficiaries’ private accounts are managed by the Treasury employee’s Thrift Savings Plan, and according to which accounts cannot be tapped or pledged before retirement, and you could get me to sign on.

I think that we need to add a fifth condition to Brad’s list: that the act of SS privatization doesn’t reduce or eliminate the risk premium, assuming that a usefully exploitable one exists today.

Since the Bush administration’s vision for SS privatization would have diverted roughly $75 billion in 2004 alone from US treasuries into equities, isn’t it possible that this could have an effect on the prices of both type of asset? Within about 10 years the net demand for equities would be nearly $1 trillion higher with SS privatization than it would be currently, and the total demand for bonds would be about $1 trillion lower. That number strikes me as plausibly large enough to raise treasury yields and increase equity prices so much that the equity premium could be significantly diminished. Doesn’t it?