HALF WAY INN, STOCKHOLM – Almost December, huh? This year has flown by faster for me than any other I can remember.
Perhaps it’s a good thing that 2020 is “getting itself over with” so we can crack on with a better 2021… but I suspect the barbs of 2020 will continue to cut long after Hogmanay.
The government’s response to WuFlu has caused significant collateral damage, the sheer scale of which will only be fully appreciated in the fullness of time. All manner of previously unimagined knock-on effects will arise the further we travel from the event; the sudden and dramatic increases in debt, the sudden and dramatic drop in interest rates, and the lockdowns crushing small businesses – all will sow the seeds of further turmoil in the years to come.
Some of these future consequences are very visible already. A bit like an iceberg on the horizon, becoming slowly larger as we sail towards it. And like an iceberg in the distance, it is possible to ignore it, and to pay attention instead to objects and events in closer proximity.
One of these icebergs is The Pension Problem. Already underfunded from a decade of uber-low interest rates and economic growth not meeting the optimistic expectations of decades past, it was obvious from the very get-go that the government’s response to the WuFlu outbreak was going to make an already significant problem of pension underfunding significantly worse.
Shutting down the economy, pushing interest rates even lower, and going on a debt-funded spending spree was only going to push the industry that’s supposed to be keeping current retirees afloat and allowing future retirees to retire at all.
But short termism reigns supreme in politics, and The Pension Problem – for the moment at least – mostly faces the private sector. Civil service, NHS, and MP pensions aren’t backed by a portfolio of investments – they’re only at risk when the government either runs out of money or decides they’re too generous (which doesn’t seem likely in the current environment).
But for pensions which rely on a healthy economy rather than a printing press, the outlook is bleak. From the Financial Times:
“Pension funds are really worried. Covid-19 has ravaged funding ratios for pension systems across the world,” said Amin Rajan, chief executive of Create Research, the consultancy which questioned 158 retirement plans across 17 countries that together manage assets of €2tn.
Nine out of 10 of the pension funds warned that they expected investment returns to be lower in the current decade than the last and three-quarters expected inflation to increase.
“The only way to shrink the global debt mountain is to inflate it away,” said one US pension fund executive, who declined to be named…
Cuts in dividend payments and reductions in interest rates during this year have further weakened the funding position of defined benefit pension plans, which pay a guaranteed income in retirement.
A third of the DB schemes surveyed expect to have to reduce retirement benefit payments because of their weak funding position. Just under half said they would need their plan sponsor to make additional financial contributions even though cash flows have shrunk for many companies and organisations during the pandemic.
“The harsh truth is that DB promise was easy to make but hard to keep in an era of low interest rates. Plan sponsors can only chip away slowly at retirement benefits to contain their ballooning obligations,” said Mr Rajan.
It’s only a matter of time before we see a series of these pensions require a government bailout. And those bailouts will have serious political consequences. Defined benefit schemes aren’t offered to youngsters in the private sector any more due to the huge problems facing them – they get enrolled into defined contribution schemes instead which don’t guarantee an income in retirement.
The bailout of more generous schemes, paid for through taxation or further borrowing, will increase the generational divide between boomers and millennials, which will in turn make the political environment more hostile. Calls for wealth redistribution in the other direction – from old to young – seem inevitable from my perspective. Something wicked this way comes…
But that’s enough doom and gloom for the moment. After all, we’re nearing Christmas time – we should be getting into the festive spirit, and leaving the problems of tomorrow to one side.
In tomorrow’s note, we’ll take a look at the much nearer future – to the approaching “Santa Rally” in the stockmarket, where we’ll explore if St Nick’s sleigh has been grounded this year, like so many airliners.
Don’t go away!
Boaz Shoshan
Editor, Capital & Conflict
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Category: Economics