Social Security’s real problem is not the trust fund

May 17, 2011, 1:00 PM UTC

FORTUNE — When it comes to fantasy finance, it’s hard to top the way most of Washington looks at Social Security’s finances.

How secure is your social security?

Take the reaction to the 2011 Social Security trustees report, issued Friday. The report’s “big news” was the fact that Social Security would exhaust its trust fund in 2036, a year earlier than last year’s report projected. Republicans viewed it with predictable alarm, while Democrats predictably said it’s no big deal because 2036 is a long time from now.

But the trust fund balance isn’t the right way to figure out Social Security’s financial status. Rather, you need to look at the program’s cash flow: the difference between the cash it collects and the benefits that it pays out.

Friday’s report said that Social Security now projects cash flow deficits as far as the eye can see. It’s the first time that’s happened since Social Security taxes were raised and growth in benefits was trimmed back in the early 1980s. That’s the real numbers news, as opposed to the trust fund stuff.

Why do I pooh-pooh the trust fund, the metric almost everyone uses, and care about cash flow, which is widely ignored? Because the “trust fund” is an abstraction whose shortfalls can be “solved” by diverting general revenues into the system or by simply giving Social Security more Treasury securities. But the cash flow deficit can’t be covered over with fancy financial footwork.

Take this year as an example. Social Security projects that it will collect about $46 billion less in cash than it will pay out in retirement and disability benefits. However, Social Security’s revenues include about $105 billion it will get from the Treasury to cover the cost of this year’s “tax holiday” for employees, who pay only 4.2% Social Security tax on their wages of up to $106,800 rather than the normal 6.2%. The Treasury has to borrow that $105 billion, in addition to borrowing the $46 billion to redeem the Treasury securities that Social Security will cash in to cover its cash shortfall. Total Social Security-related borrowing: about $150 billion.

Even in a world in which the Treasury has to borrow about $1.5 trillion a year, $150 billion is serious scratch.

Last year’s trustees report projected only a $7 billion cash shortfall this year, then three years of cash flow surpluses, followed by deficits. The 2009 report predicted a $28 billion cash surplus this year, surpluses through 2015, and then deficits. In other words, Social Security’s 2011 cash flow is almost $75 billion worse than projected just two years ago — a $46 billion cash deficit rather than a $28 billion cash surplus. Bad stuff. The shortfall, Social Security says, comes from the economy and wage levels are growing more slowly than it projected two years ago.

No, I’m not saying that Social Security is in crisis. And I think it would be only fair for the government to make good on its trust fund obligations, because they represent money that wage earners thought was being set aside for their future benefits, but was spent on general government purposes.

We can make the trust fund as big as we want by putting in general revenues, as we’re doing this year, or by simply stuffing new Treasury securities into it. But the cash flow shortages tell us is that Social Security’s problems are now in the present, not in the future.

A $2.6 trillion trust fund stuffed with Treasury securities makes a lot of people feel good. But no matter how big the trust fund is, the cash flow deficit means taxpayers are going to have to borrow — heavily — to cover beneficiaries’ checks. The trust fund is now irrelevant in financial terms, although it retains moral and some legal force.

Cash is king. As always.