Pensions World

We are all in it together. Every one of us is dependent on the performance of the global economy, says Lindsay Tomlinson, NAPF chairman

You cannot eat a share certificate, so even those who are counting on pension promises backed by invested assets are living at the mercy of economic performance.

In the UK, we always over-complicate things. This undue complexity is a natural consequence of a desire for fairness and for the protection of every citizen. Such over-complexity is nowhere more evident than in UK pension provision. As Lord McFall recently commented, even Einstein would have struggled.

At least we are now seeing our government make some effort to simplify the state system. But we have a long way to go.

Because of complexity, we are rarely able to see the wood for the trees. We debate the technical details ad nauseam, but we never get to the key underlying principles. But if you step back and think about it, there are a small number of axioms on which the whole pensions edifice is built.

As an example, our solvency and accounting regimes are based on the Efficient Market Hypothesis, which has driven the marking-to-market of long term assets. I believe the principle is flawed and has devastating economic consequences. Likewise, any pensions system must demonstrate intergenerational equity. Ours does not and is therefore heading for the rocks.

There is a third fundamental principle, which has been consistently wished away – that society as a whole can, over time, live only off the wealth it itself produces. If the economy fails to deliver, society as a whole will suffer. Arguments about pension entitlements are then arguments about how the economic cake is shared.

Society is starting to realise and to come to terms with the fact that we are collectively not as wealthy as we once thought. Quite simply, our economy is smaller than we thought it was prior to the financial crisis which means that we cannot all continue to enjoy the same standards of living. And we are all going to suffer the consequences, some more than others.

Those of us involved in pensions wish to preserve the real value of pension promises that have been made. But remember that the assets backing these promises are merely paper claims on future economic performance. There are many ways of attacking the real value of these claims.

Inflation tax

At the moment, savers are paying an inflation tax. Government is keeping real interest rates negative. Real wealth is being transferred from savers to the over-borrowed. Why has the financial crisis spawned so few bankruptcies? Because interest rates have been manipulated to derisory levels. This is an intergenerational transfer from the old to the young.

Right from the start, I have predicted that the UK authorities would take the usual way out. As with every crisis, they will trash the currency and inflate away the debt burden. That avenue of escape is open because the UK did not join the Eurozone. And it is now becoming increasingly clear that this is the strategy being pursued. If this analysis is correct, you need to buy real assets such as equities and property. Take care about index linked gilts because the inflation numbers will probably be pretty dodgy.

But I may be wrong. The forces of deflation may be so strong that they overwhelm all inflationary stimuli. In those circumstances, those buying conventional UK gilts poised on their bed of nitro-glycerine will have been proved wise indeed, or just plain lucky.

What does the prudent person do? The only rational choice is to diversify across the asset classes.
The fundamental point is that we can only collectively reward ourselves from the wealth the economy produces. We cannot insulate one section of society, those with pension entitlements, from our overall economic performance.

We are indeed all in this together. The global economy looks pretty sick. Get ready to tighten your belts!