The following article by me was published in the Observer on 14 July 2002. Not that much has changed since, and my sentiment remains largely the same, which is why I have suggested dedicated government bonds to link savings to infrastructure this morning:
The problems of the pensions 'industry' have been highlighted recently as falling share prices left massive holes in the funding for thousands of pensioners. Yet all this was only to be expected.
The simple fact is that most of what people need in their old age can only be provided by people still at work. You can't store healthcare, food and leisure activities for use at a future time. So the reality of financing healthcare provision has to be based on one of two things.
Either people in work have to agree, implicitly or explicitly, to directly fund the pensions of those who are retired as part of a moral contract between the generations. Or those who are now working have to put aside part of the wealth they generate in such fashion that those who will be working when they are retired will want to buy it from them.
The first option seems to be out of fashion so the second is the one we must favour. And for reasons that have always baffled me the 'store of value' we choose to sell to the next generation is shares in quoted companies.
It is hard to think of anything more unsuited to the task. Shares are intrinsically worthless, second-hand, unenforceable property rights to a future income stream from companies run for the benefit of those who work for them now, and not for the sake of those who might be in retirement at some time in the future.
The only reason shares have gone up in price in the past has been that more people have been persuaded to buy them, either by choice or by coercion as pension funds have had little choice but to buy them.
But that game is over now. People realise the system isn't working. And when that is the case the funds stop flowing into the market. As we have seen in property crashes, like that of 1989, when the net inflow of funds into a speculative market stops the market falls apart.
But the solution is readily available. And it happens to be extremely expedient for any politician with the will to use it. The biggest potential problem we have in our society is the lack of public spending on infrastructure. It is what people continually demand of politicians.
To date those same politicians have denied the population access to the very funds that can provide the resources the population wants, not just now but after retirement, because they've insisted people's spare cash must go into shares.
If, however, politicians thought for a moment instead of following economic dogma, they'd let that cash be used for what the current generation wants. These are things of real worth, like schools, hospitals, sewers, transport systems and so on. Quite possibly, those who built them might benefit from them in their own retirement. It is equally possible that the next generation who use them might be willing to pay what is in effect a rent to do so, and so provide an economic return for the future.
It's always been the case that long-term saving needed to be matched by long-term investment. If the government could create venture capital trusts at short notice to meet the needs of the dotcom boom, there's no doubt that if it takes this problem seriously it could create a suitable investment vehicle for this purpose as well.
Nothing would restore confidence in pensions more than people seeing their cash paying for the new hospital they'll use in old age. And we could at the same time see the back of the appalling burden of the Private Finance Initiative.
Social capital investment can provide just as much opportunity for the financial markets as the less desirable, and decidedly more fickle capital markets. All it needs is will power.
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The mad and bad PFI scheme landed our local set up with huge bills. So we now have decent buildings but the real problem for my fellow aged is the support and related services necessary as time takes its toll. Why, I wonder, do our politicians promise this and that but not getting rid of the PFI burden. Or would that upset too many of their personal friends?
With regard to PFI schemes “Quantum Meruit” (as much as he deserved) should apply. Providers of capital are entitled to a fair return, but that is all. The rest gets torn up.
Another sane post in an insane world.
I could not agree with you more.
Shares for services – not shares for profit (rent).
The concept of using bonds to pay for infrastructure is an interesting one. A couple of questions do arise however, but I’m sure you have probably given this deeper thought in the intervening period, so you may already have answers to hand:
1) What rate of interest would you envisage the bonds paying if they were launched today ? I’m assuming there would be some sort of government guarantee backing the issues, so yields would presumably be similar to Gilts. But in order to attract investment, wouldn’t there need to be a yield premium ? And if this is the case, wouldn’t that mean the government having to pay a higher rate of interest than if Gilts were simply issued to pay for the spending ? Or are we talking about a new class of ‘special purpose undertaking’ debt with a higher rate of interest, despite there being the same government guarantee ?
2) The idea of asking future users to pay rent for the use of the assets created would obviously pay the interest return generated by the bonds. You have always expressed a dislike of rent-seeking behaviour from the ‘owners’ of assets, however I assume for these purposes, asking future users to pay the government for the use of the specific healthcare, roads, sewers and schools provided by each Bond would be acceptable ? (Would there need to be some sort of provable link between the infrastructure provided by the bond, and the charges paid by the users of those specific assets) ?
3) How would you envisage financing the interest payments resulting from the inevitable delay between the infrastructure being built, and the projects becoming income generating, to pay the interest for those years ?
These are all of course technicalities, and none of these issues are insurmountable, but I was wondering whether you had any innovative solutions.
1) I would not be offering a premium: the demand for secure savings already exists in abundance at gilt rate. I have suggested an ISA wrapper in the past although even that seems unnecessary now
2) I am not sure where the rent is at negative current yields
3) Government guarantee as the user
Apologies for further questions, and I am sure you have considered this, but maybe the proposal is an over-complication. If the idea is to simply issue the new bonds at Gilt yields, (and with similar Govt. backing) then surely the government should simply issue the new special purpose undertaking debt as Gilts, but should ensure that the proceeds are dedicated to the required infrastructure ? (and financed in the manner you suggest, with user pays charges on the future use of the assets).
There is one further issue, which you rightly acknowledge. 10 year gilt yields are presently around 1.3%, whilst inflation is running at around 2.9% (And with the outlook for further inflationary pressure should the Pound decline further with all the BREXIT issues ahead). Would a negative real yield represent an attractive proposition for a pension scheme, because if inflation exceeds the (very low current) yield during the life of the issue, the scheme would be effectively locking in a real loss of capital over the bonds life ?
And one final question, as I am really learning from you on the job here, so might as well chuck this into the pot. A To B payments (User to Bond holders) would finance the interest costs of the bonds, but how would the capital repayment of the bond be met ? Would there be a ‘surplus’ user pays charge each year towards the capital sum to ultimately be repaid to the holders of the debt ?
Very much appreciate your time
The reason for the idea is simple
It’s called marketing
It makes people aware that government borrowing pays for thinGS they want. That’s it
And 1.3%? Many would like that on cash equivalent sums
Bond issues are six times over subscribed right now
And capital repayment would simply rolled over: I suggest very long term bonds redeemed by sale of the underlying asset to HMG who would issue gilts to replace them
I take it the GS was a slip, not a reference to a well known vampire squid !!
1.3% – Absolutely that is better than a cash return. But you take my point, even a yield of 1.3%, (and absolutely accepting your point on the huge demand for Gilt issuance at present), would still represent a loss in real terms for holders of the new bonds whilst the inflation rate remains above that yield ? I guess holders would have to hope for lower inflation in the future.
That’s a neat solution on the tater capital repayment. So the government would simply issue debt to repay old debt, whilst continuing to charge users. (I see a slight drawback in rising maintenance costs of an older wasting asset, but I figure inflation of the user charges could cover that ?)
Interesting
I put my pension pot into Fundsmith. The companies it invests in are, on average, over 100 years old. Since its launch, 7 years ago, it has tripled in price. Even if you had put money into a the FTSE when you wrote the article above you would have made 4% a year in dividends and around 50% in capital growth. Put it into the FTSE 250 and you could at least double that.
I fully agree the pensions industry is full of shysters. However, for long term returns, shares produce a far superior result to any other form of investment. You may not regard it as ‘investment’, you might decry the fact that they are “second hand”, they may not be as socially useful, but if you invest your pension pot in shares and are willing to hold for 20 or 30 years, it will massively outperform a 1.3% annual return. History proves that over any period you choose. So the real question is whether people should accept a much smaller pension pot in return for funding better facilities in the U.K. Which is an interesting argument, especially as we appear to be at a point where the future for the UK seems to be based upon devaluing the pound and so any share investment will naturally be biased towards foreign assets.
And you think when neoliberalism is failing investing in it for the long term makes sense?
But I’m not investing in neoliberalism. I am investing in companies that make lifts, or ketchup, or beer, or soap, or catheters, on the assumption that people will continue to need these things in the future. I don’t know what the future holds, but I am pretty certain that for as long as there are Chinese people they will eat soy sauce and there will be money to be made from making soy sauce. The average age of companies that Fundsmith invest in, for example, is over 100 years.
There is an argument about investing locally in socially productive facilities. But it is not an argument that can be won using facts and figures: financially, shares will outperform over any long term period, particularly shares in smaller companies and in developing regions. The argument has to rest on other benefits. And the difficulty, which I think you recognise, is that for many people the social contract is broken: whether poor or rich, people feel that the state will not look after them throughout their life. The response of the better off is to seek financial independence from the state through private education, healthcare and pension provision. This has been encouraged by the state over many decades. You can and do make the case that the state should be more central to people’s lives. That is fine, but it is wrong to attack the stock market as somehow failing to provide good long term returns. It does. The problems are that it is populated by shysters from whom the public need protection and that for the majority, financial independence from the state is not realistically achievable, and even if it was, is it really desirable?
No you’re not
You’re investing in their future income streams protected by property rights that are dubious and overvalued in many cases