Farewell Welfare in Retirement — Part Two

Farewell Welfare in Retirement — Part Two

I believe we’re in a secular bear market. Phil thinks we’re heading into the biggest boom of all time over the next decade. So our views clearly differ. But Markets and Money is not about reaching a consensus. It’s about thinking differently and provocatively, with the various editors, including me, arguing passionately about their ideas.

Yesterday I argued that Australia’s welfare system was becoming increasingly fragile.

In case you missed it, here’s a quick recap of Farewell Welfare Part One: Welfare is not an entitlement. It’s an expense to current and future taxpayers. In a compassionate society, the majority are prepared to pay this tax cost — within reason.

There are two ways to fund welfare programs. The first is via a national social security fund, where income generating assets produce the revenue needed to fund welfare payments. The second is via taxes. But for this to work over time the taxpayer base must significantly outnumber the amount of welfare recipients. That is, like a pyramid, the base of taxpayers must be significantly larger than the ‘tip’ of the recipients.

This pyramid principle has worked for the past century. My parents, grandparents and great-grandparents were all age pension recipients.

The growing population base in the Western world (climaxing with the baby boomers) ensured a large enough tax base to support the welfare system.

But as Bob Dylan sang, ‘The times they are a changin’.

You need to understand the numbers behind this change. You need to be prepared for the incremental squeeze today and tomorrow’s governments are going impose on your age pension.

Germany and Japan have a negative birth/death ratio. That is, in both countries more people are dying than being born. In Australia, Netherlands, UK, France and the United States, the birth/death ratio is only marginally positive. The highest birth/death ratios are in countries like Ghana, Honduras and Algeria, where families — not the state — care for their elderly.

In the West, you have a situation where generous static promises are careening headlong into the reality of a dynamic world.

Western society would do well to remember the wisdom of Ayn Rand:‘You can avoid reality, but you cannot avoid the consequences of avoiding reality.

You can pretend that the Social Security Ponzi scheme will continue. But that won’t change the outcome that befalls an inverted pyramid.

The following charts shows you the financial and demographic reality facing the Western world.

The first chart is a compilation of private and public debt levels (as a percentage of GDP) in various countries.

Private and fovernment debt in % of GDP

click to enlarge

Source: Ineichen Research & Management


The left hand side of the chart is dominated by the West. Japan is the clear ‘winner’. Australia ranks 10th, with slightly more than 200% debt to GDP.

What these numbers DO NOT show you is the level of unfunded liabilities — future welfare and health costs — for each country. For example, the guesstimates on US unfunded liabilities range from $50 trillion to $200 trillion.

Using the lesser figure of $50 trillion would add approximately 300% of GDP to the ‘official’ debt levels in the chart. An honest politician (now there’s an oxymoron) would say this is not repayable. He’d look into how best to manage the expectations of taxpayers and those who receive taxpayer funded benefits.

The ‘poorer’ countries — the ones with higher birth/death ratios — have the lowest debt levels. These are the countries that have had to live within their means and not indenture future generations into tax paying servitude.

The chart is a clear indication that the West is living beyond its means. On the public level, it’s running welfare and health schemes we cannot fund. On a personal level, it’s about living lifestyles (and buying homes) above our pay grades.

Debt repayment is a function of variables — time, income and interest rates.

The following chart on the median age in various countries shows that the West is running out of time.

Median age of different countries

click to enlarge


The most indebted countries have the highest median ages. The combination of our elderly living longer, the boomer demographic bulge and smaller families has skewed the Western median age higher.

The traditional pyramid structure of society is starting to look more like a rocket ship.

Time is working against Western governments’ tax collection model. The employed (on average) have less time to retirement and retirees are spending more time in retirement.

To change the time variable is (in theory) simple. If you’re currently working you’ll need to extend your working life well beyond 70. More time employed and less time retired. But good luck to the political party trying to sell this ‘ask not what your country can do for you’ message.

Governments’ welfare illusion makes you believe you can have money for nothing. But in the real world taxes must rise to cover the increasing shortfall between revenue and expenditure. And higher taxes means you’ll have less money to repay your own debts.

A combination of having to work longer to pay off your own debts and governments (oh so) gradually increasing the age for pension eligibility, means political parties will be spared the need to ask ‘what you can do for your country’.

This sort of change is subtle. It creeps up on you over time. Society then gradually realises and begrudgingly accepts the need to work a little (or a lot) longer.

But this ‘glide path’ scenario may or may not be the case. What if the interest rate variable changes?

We are in the midst of the lowest interest rates in the history of money. Japan is currently only paying 0.6% per year on a 10-year bond. The only change to the interest rate variable is UP. And Janet Yellen has already let on that US rates may rise in 2015.

Governments, businesses and individuals paying more in debt servicing costs will upset everyone’s budget applecart.

To date, the West has not paid the full price for thirty years of wanton spending. The GFC started the process of correcting the imbalances. But policymakers used nearly every weapon in their armoury to keep the dream alive. You may have even benefited from their propping up share and property markets with ultra low interest rates plus underwriting massive budget deficits with QE.

Up until now, central bankers have put enough ‘fingers in the dam wall’, to plug the holes. But the debt and demographic pressure behind the wall is building.

When reality eventually trumps illusion the dam will break. And most people will be unprepared for a world where they are forced to live within their means.

Whether it is the ‘glide path’ or ‘bursting dam’ scenario that awaits you, you would do well to prepare for the worst and hope for the best.

Anyone recently retired or planning for retirement in the next 10 to 20 years should have a financial plan that errs on the side of caution.

Your plan should factor in a worst case scenario of reduced tax payer funded pension payments. This far-sighted (and what today may seem pessimistic) strategy can only provide you with a pleasant surprise if you’re wrong.

Change is coming and it definitely won’t be in the form of more generous welfare payments. After a century of escalating vote-buying welfare commitments, we have reached the stage where it’s time to say farewell welfare.


Vern Gowdie
for Markets and Money

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Vern Gowdie

Vern Gowdie

Editor at Markets & Money

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

He is a feature editor to Markets and Money and is Founder and Chairman of the Gowdie Family Wealth and the Gowdie Letter advisory services.

Vern Gowdie

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2 Comments on "Farewell Welfare in Retirement — Part Two"

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Earl Mardle
On the money Vern, and along with the secular bear market goes the deflation that accompanies it. As a 63 yr old who is working up a 10 acre block to feed and heat us and cook our food and whose wife has a sufficient income to enable that, for the moment, I am already well into a plan on those lines. But there are two things more that you have overlooked. Those who have planned and worked and saved hard so that their pension funds look in good shape, are in for a nasty shock when they discover that,… Read more »
David Barnes

Thanks for another reality check. I’m 68 and know about all this. My son and daughter are in their twenties and both have full time jobs earning circa 75k. I sometimes wonder what is the best advice to give them other than save your money, be wary of Super Funds that have an eighty percent weighting in shares, get a deposit for a house,see the bank manager, and the best of British.

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