Many pension and sovereign wealth funds rely on capital gains to meet future obligations, but these gains can be illusory. Capital gains on assets such as real estate or equities do not always reflect underlying economic productivity or the ability of those assets to generate real value or cash flow in the future. This creates a mirage where asset values are inflated, often disconnected from the broader economy’s ability to support those values sustainably.
That's right. I remember in the financial crisis the value of all asset in our superannuation accounts fell nearly 20% in total. So what we thought was there to fund our retirement really wasn't.
Working in Emerging Markets gave me a front-row seat to many instances of egregious abuse of the idea of "funded" pension systems. You can see an excellent example of one of this systems heading toward implosion right now in El Salvador.
These systems are less hhonest than a pure pension bond, but work similarly. Workers "contribute" to "savings", but the managers of the "savings" accounts put nearly all the contributions into government bonds.
Problem number one is that this loosens the budget constraint. The "contributions" will be used to buy bonds even when investors who monitor the credit would have long ago cut the country off. Of course, had the country kept a pure PAYGO system, the debt would still be there, hidden, but it is easier to enact parametric reform of a pension system than to default on a bond. And the fact that "pension fund managers" continue to buy debt, robotically, creates the illusion of a functional bond market and defangs the bond market that would nnormally impose some degree of fiscal discipline.
Problem number two is that these "funds" *always* get looted. Look at how Chile did three or four rounds of "early withdrawal." Argentina looted its funds early in the Kirchner administration. So now you have all these bonds dumped into the market, and account holders spent today the pv they received for the bonds. End result is that you have all the downsides of a crystallized pension debt (as opposed to implicit debt), but it is now owed to the market instead of future pensioners, and the fisc will surely have to take some care of these pensioners anyhow.
I recall many years ago meeting with one of the designers of IceIands pension system. The pension fund managers were barred from investing more than a fraction of contributions in any Icelandic domestic asset. The regulator knew that for a small country the only real savings consisted of foreign assets. The existence of a huge positive in the International Investment Position was key in Icelands efforts to unwind the giant imbalances the private banks ran up before 2008.
Your point about reforming pensions compared to defaulting on a bond makes me think about how even though they are equivalent economically, politically this is far from the case. Would I consider that when the Rudd government increased the Australian age pension age from 65 to 67 a "default" on (part of) my right to the age pension?
Nope.
I went right on through. But it really was a default on future obligations by the government. But politically we all saw it as something very different.
Why create yet another financial product? Why not give people a share in the assets they pay to use? Later when they don't need them or they cannot use the ones they purchased sell them to someone who has more years to live and they in turn can sell them to someone .....
The secret is to stop creating new money through loans. Instead give the money to communities of users who will use the newly created money to build and own assets they use everyday - like roads, electricity, water, food, education, etc.
You don’t HAVE to create the pension bond. The fact that you can simply demonstrated what all Treasury officials and Central bankers know, which is that the age pensions is as “financed” as any other source of retirement income
If I understand correctly, the initial retirees in US-style social security get the “pension bonds” at a discount (because they either don’t pay anything or at least less than those who enter the workforce just after the program is introduced) and exchange them with workers for cash. The equivalent of this in a privatized setting would be if the initial retirees get regular financial securities at a discount, which is probably won’t happen. Also, one could make the former like the latter by not giving out the “pension bonds” to the initial retirees at a discount as well. Did I get that right?
In my the ought experiential, reiterees don’t exchange the pension bond with others for cash. The Treasury, which holds the bond for you, simply does an accounting operation to debit the bond and credit the cash that it gives you.
I’m not sure this gets to your confusion, or helps my explanation.
If I understand correctly, the payouts in the American social security system are a function of your wage earnings history. If you calculate the NPV for Alice, who retired just when the system is introduced, I think it'd be more than that of Bob, who had an identical wage earnings history but entered the workforce just when the system is introduced because the latter has negative cashflows in the form of the payroll tax they pay but the former doesn't.
Maybe I'm mistaken about this, in which case I wasted your time with my comment but if I'm not, one can think of it this way: Alice got a pension bond for free while Bob had to pay payroll tax to buy the pension bond. I understand that the government simply does an accounting operation in your thought experiment but I like to think of it this way because I think it makes comparisons with other systems easier.
If we had to replicate this system, in which Alice has a higher NPV, in a privatized social security system, the government would have to give regular financial securities (stocks, bonds, etc) to Alice for free. This probably won't happen but my objective of writing the original reply was to point out that we're okay with giving one type of a financial security (the hypothetical pension bonds you describe) at a discount to Alice but not others (stocks, bonds, etc), and how this makes privatizing American social security, in the way it probably will happen (if at all), costlier given that the Bobs of that world will have to both purchase now-worthless (for them) pension bonds from the retirees and also regular financial securities that will fund their retirement. I think I overcomplicated this, so sorry about that, but let me know if I'm wrong about anything.
Thanks for patient reading and doing god's work by writing this newsletter :)
Many pension and sovereign wealth funds rely on capital gains to meet future obligations, but these gains can be illusory. Capital gains on assets such as real estate or equities do not always reflect underlying economic productivity or the ability of those assets to generate real value or cash flow in the future. This creates a mirage where asset values are inflated, often disconnected from the broader economy’s ability to support those values sustainably.
That's right. I remember in the financial crisis the value of all asset in our superannuation accounts fell nearly 20% in total. So what we thought was there to fund our retirement really wasn't.
Working in Emerging Markets gave me a front-row seat to many instances of egregious abuse of the idea of "funded" pension systems. You can see an excellent example of one of this systems heading toward implosion right now in El Salvador.
These systems are less hhonest than a pure pension bond, but work similarly. Workers "contribute" to "savings", but the managers of the "savings" accounts put nearly all the contributions into government bonds.
Problem number one is that this loosens the budget constraint. The "contributions" will be used to buy bonds even when investors who monitor the credit would have long ago cut the country off. Of course, had the country kept a pure PAYGO system, the debt would still be there, hidden, but it is easier to enact parametric reform of a pension system than to default on a bond. And the fact that "pension fund managers" continue to buy debt, robotically, creates the illusion of a functional bond market and defangs the bond market that would nnormally impose some degree of fiscal discipline.
Problem number two is that these "funds" *always* get looted. Look at how Chile did three or four rounds of "early withdrawal." Argentina looted its funds early in the Kirchner administration. So now you have all these bonds dumped into the market, and account holders spent today the pv they received for the bonds. End result is that you have all the downsides of a crystallized pension debt (as opposed to implicit debt), but it is now owed to the market instead of future pensioners, and the fisc will surely have to take some care of these pensioners anyhow.
I recall many years ago meeting with one of the designers of IceIands pension system. The pension fund managers were barred from investing more than a fraction of contributions in any Icelandic domestic asset. The regulator knew that for a small country the only real savings consisted of foreign assets. The existence of a huge positive in the International Investment Position was key in Icelands efforts to unwind the giant imbalances the private banks ran up before 2008.
Very interesting story Ben.
Your point about reforming pensions compared to defaulting on a bond makes me think about how even though they are equivalent economically, politically this is far from the case. Would I consider that when the Rudd government increased the Australian age pension age from 65 to 67 a "default" on (part of) my right to the age pension?
Nope.
I went right on through. But it really was a default on future obligations by the government. But politically we all saw it as something very different.
Why create yet another financial product? Why not give people a share in the assets they pay to use? Later when they don't need them or they cannot use the ones they purchased sell them to someone who has more years to live and they in turn can sell them to someone .....
It is simple to do and we can use the existing money system without bonds. https://kevin-34708.medium.com/a-better-way-to-introduce-money-into-an-economy-36cda1d01476
The secret is to stop creating new money through loans. Instead give the money to communities of users who will use the newly created money to build and own assets they use everyday - like roads, electricity, water, food, education, etc.
You don’t HAVE to create the pension bond. The fact that you can simply demonstrated what all Treasury officials and Central bankers know, which is that the age pensions is as “financed” as any other source of retirement income
If I understand correctly, the initial retirees in US-style social security get the “pension bonds” at a discount (because they either don’t pay anything or at least less than those who enter the workforce just after the program is introduced) and exchange them with workers for cash. The equivalent of this in a privatized setting would be if the initial retirees get regular financial securities at a discount, which is probably won’t happen. Also, one could make the former like the latter by not giving out the “pension bonds” to the initial retirees at a discount as well. Did I get that right?
I’m not sure 100% sure what you are saying.
Who are you referring to as “initial retirees”?
In my the ought experiential, reiterees don’t exchange the pension bond with others for cash. The Treasury, which holds the bond for you, simply does an accounting operation to debit the bond and credit the cash that it gives you.
I’m not sure this gets to your confusion, or helps my explanation.
If I understand correctly, the payouts in the American social security system are a function of your wage earnings history. If you calculate the NPV for Alice, who retired just when the system is introduced, I think it'd be more than that of Bob, who had an identical wage earnings history but entered the workforce just when the system is introduced because the latter has negative cashflows in the form of the payroll tax they pay but the former doesn't.
Maybe I'm mistaken about this, in which case I wasted your time with my comment but if I'm not, one can think of it this way: Alice got a pension bond for free while Bob had to pay payroll tax to buy the pension bond. I understand that the government simply does an accounting operation in your thought experiment but I like to think of it this way because I think it makes comparisons with other systems easier.
If we had to replicate this system, in which Alice has a higher NPV, in a privatized social security system, the government would have to give regular financial securities (stocks, bonds, etc) to Alice for free. This probably won't happen but my objective of writing the original reply was to point out that we're okay with giving one type of a financial security (the hypothetical pension bonds you describe) at a discount to Alice but not others (stocks, bonds, etc), and how this makes privatizing American social security, in the way it probably will happen (if at all), costlier given that the Bobs of that world will have to both purchase now-worthless (for them) pension bonds from the retirees and also regular financial securities that will fund their retirement. I think I overcomplicated this, so sorry about that, but let me know if I'm wrong about anything.
Thanks for patient reading and doing god's work by writing this newsletter :)