10 December 2007

It's made to be dull for a reason

Yet again there are things going on in finance of much import to the (wo)man on the street. The consideration it might deserve is however is not exactly guaranteed. One problem (or advantage, depends on your perspective) being it competes poorly with certain reincarnated canoeists or X-factor nonsense, especially in the Advent social calendar. The other being of course that anything to do with finance feels a) inextricably dull and b) a bit tricky to understand.

Duller than all, but maybe more important for most: pensions. Oh god, even the word sounds so dull. But again, depending on your interests, maybe it's supposed to. But over the weekend and continuing today is some UK government scolding (particularly aimed at Brown and Darling) for not guaranteeing pension rights to 125 000 workers who lost their entitlement due to financial failure of their employers. Not to tar the whole administration with the same brush; apparently the cabinet is deeply divided on the issue and internal critism is extraordinarily strong. One is left wondering why Brown and Darling are blocking the support and what their motives are. It doesn't look like the hallmark of a liberal-left government in any case.

If this is reminiscent to you of a potential bailout then that would not be incorrect. And then of course the Northern Rock bell might well ring again in your head. But for the common characteristic of potential financial life raft, it is the contrasts in the two cases that are far more illuminating. Northern Rock's rescue involves a sum so large that it would feature prominantly in the UK PLC's annual accounts (if such a dream of transparency were ever to materialise), the last time I checked it was not far behind the UK's annual 'defence' budget and approaching circa £30 billion. Naturally, the treasury expects (aka hopes) to get a sizeable proportion of this back. The other noteworthy difference in the two cases is the speed of response. The mortgage lender's failure was met, to the government's short-term credit (to be discussed further), with national emergency response times. As soon as uncomfortably long queues of savers developed in the City of London, swift action was required to calm ensuing panic and a stave off a self perpetuating, disasterous bank run. This is London 2007 and not late 90s Buenos Aires and we will not have the national savings stashed under beds thank you very much.

Back to the pensioners. The scheme to fund the payments of the short-changed 125 000 is undeniably paltry in comparison. And to be fair they should recieve up to 80% of their disappeared annuity. Note this is far from a new story and many have not yet recieved this. Why the delay? Why the neglect? Why the political risk to confidence in pensions?

Pensions are considered, in some qualified circles, something of a misnomer. The word originates from pendere (to pay, weigh) and describes a notion of payment for service rendered. Not sure how the 125k aforementioned bankruptcy victims would swallow that one. To some, including me, any confidence at all in the entire pension system is something of a total mystery. A complete conundrum. The deal is thus: you allocate a proportion of your wealth to an agent, that agent will invest that wealth on your behalf and then you can capitalise on it when you are in your 60s. The bonus: you can invest this money before tax and so benefit from that otherwise-taxed proportion contributing to compounding interest. In principle, this makes an enormous difference and is quite possibly one of the most important and least appreciated characteristics of (personal) finance. The catch: the money is locked away for a long time and during that time you have absolutely no control (beyond your limited democratic influence) on future government legislation dictating the fate or availability of your money. Put like that, the whole prospect starts to look a lot less attractive. But that invest-and-accrue-your-tax carrot is a big one. The purpose: a massive proportion of national wealth is locked in long term to either government funds or capital markets. For supporting economic stability in this way you should be, in theory, rewarded in your retirement.

And so on to the agents. This is either the government (i.e. state pensions) or private fund managers. It looks to me like UK state pensions are all but disappeared so what of the private sector? As far as I know (and I would love to be corrected here) no pension (or US mutual -) fund manager has ever consistently beaten the market over the mid - long term. This means, effectively, that the future pensioner is paying an agent a non-insignificant fee to invest in a market but that investment actually yields less that the market made itself over the same interval. The stockpickers are maybe not so hot at picking stocks or their fees are too high, maybe both.

In any case, despite the huge tax incentive, this all makes pensions rather unattractive to me. And I'm not alone. So I wonder why, in a story like the one above, the UK government may risk a system's already debatable credibilty.


So, from pensions to another dreary, but more immediately-experienced matter of finance: inflation. And the oft-regurgiated (in the press, by the government) case of restricting wage rise to control inflation. It would be fair enough, if the implied relationship were known to be true. Any public sector pay dispute is invariably accompanied with a technocratically-sounding anti-inflation justification to limit increases below any decent level. The argument goes, as often sold by the paymaster or the analysis-starved subservient sector of the press and TV, that to overly support 'excessive' pay rises is to drive up inflation and so in the end batter the economy and increase unemployment. But the factors driving inflation are diverse and complex and to allude to this simple non-existent wage rise = inflation = unemployment relationship is nonsense. What of the evidence that wage growth fuels consumer demand and so is of economic benefit? What a surprise!

So the relationship between earnings, inflation and employment is not exactly thoroughly understood. For people to argue against a deserved, modest pay rise on the basis of inflation, as in the case of the current UK civil service pay dispute, is utterly disingenuous as they have no evidence that the legend is true. If the government cannot afford, for example, to pay the civil service more, then say so, with real justification, but please stop blaming the ghost of inflation in the cupboard. And will the media sector that joins in stop churning out the same groundless nonsense and maybe engage a more involved debate?

Strong inflation erodes the value of money, akin to accelerating your own death; making you less and less effective every day in the future. It is a vicious poison that has to be abated - and central banks have not been doing a terrible job of it recently. But to use a bogus threat of inflation on those who are owed a correct price for the services they provide to the state is simply wrong.

How often have you heard the same government or the same media accuse city bonus recipients of being such inflation supporting scourges? And it's not unlikely that when it comes to price rises in certain markets, those concerned are not at all uninvolved. In economically favorable times, firms are naturally keen to increase their prices as much as is possible to build profit. I wonder what this does to inflation? And, oh yes, energy prices. Which would you be more scared of: the price of oil or the Job Centre staff getting 2.5%?

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