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Post details: Tooth Fairy Pension Funds

Tooth Fairy Pension Funds

The growing wealth inequality has many causes, some natural and obvious, some less so. One of the more esoteric ones occurred to me the other day when I was reading an article about the precarious position some of our pension funds got themselves into. I will start with a small scale model which better demonstrates the idea.

Imagine a small town somewhere on the surface of this Earth. Most people in this town work in a shoe factory which is owned by a respectable capitalist whom I will call Mr Smith. These folks are a prudent kind who live within their means and save enough for their well deserved retirement. The business is going reasonably well but one day Mr Smith figures out that people would be buying many more shoes if they were not putting so much money into their pension funds. Being a well connected entrepreneur, he decides to do something about it and creates the Magical Tooth Fairy Retirement Fund which offers great returns for basically a third of the traditional costs. People blithely embrace the new opportunity and pour all their savings into the new fund. With extra cash suddenly available for spending, they then buy those fashionable shoes they always wanted and live happily ever after. Or more precisely - until the moment the retirement fund has to make good on its prospectus.

Before that happens, however, let's pause for a little bit and see what effect Mr Smith's operation has on the fortunes of the denizens of our town. Its good people won't see much change at first since their retirement needs seem to be taken care of and so they will just go about their lives as usual, perhaps with an extra pair of shoes in their closets. The factory workers won't see much change either as they are paid the same hourly wage regardless of the extra shoes being sold. Only Mr Smith will see a real improvement, as his sales and profits - and by extension his bank account balance - register a healthy increase. At this point you may wonder though: where do these new revenues really come from? Well, most of their value comes from the poorly funded retirement assets. It's kind of like when you buy a cheap insurance - it seems fine until you have your first accident - and then you discover that the value is not there. Likewise, at some point in the future the townsfolk will have realized that their pension assets have not been as valuable as they once believed. Yet this extra value which they counted on has not simply disappeared, it has merely moved into Mr Smith's private accounts.

Now that is an oversimplified view of reality, of course. But I think its main point stands. Much of the record profits that flowed into a decreasing number of global corporations, and thus into a decreasing number of pockets, was made possible (at least in part) by a false sense of security on the part of consuming public. The promises of future income streams - well funded or not - allowed people to spend head over heals, wrongly assuming that their golden years had been secure. We have a large variety of pension funds, ranging from private to public, and satisfying just about every imaginable life style; yet the soundness of their balance sheets is something we have not been paying much attention to. Many have based their spectacular projections on Dow Jones hitting some ridiculously overvalued levels, others on the assumption that interest rates will stay high for indefinite periods of time. Last but not least - as people in Greece and Spain are realizing these days - some have put too much trust in the value of government bonds.

I would not be surprised if some of the wealth we think is awaiting us over the retirement rainbow turned out to be a phantom accounting entry whose intrinsic value had been quietly siphoned off into private coffers by the aforementioned mechanism. As the baby boomers are entering the 65+ demographics in hordes, we'll soon see how good all those pledges are. I am afraid not all of them will be golden. Perhaps people in the future will rely less on expectations of the well compensated fund managers, and more on the good old fashioned savings. It may curtail our consumptive vigor, but it will make us stronger in the long run.

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