Superannuation Has Failed

Congratulations, as of today you are working for yourself. Thanks to research by our man behind the scenes, Terence Duffy, we can declare today Tax Freedom Day in Australia today. Average Australian taxpayers have earned enough to pay for this year’s government taxes.

Of course you pay the tax burden slowly over the course of the year. But looking at the burden as though you had to pay it up front each year helps illustrate how expensive government is over time.

It now costs just over a third of the year to pay off the government’s dues. According to the same research, over the past 54 years, Labor governments tend to take 4 days longer to pay off. But the Howard and Rudd/Gillard regimes seem to have changed that paradigm.

The big flaw here is government borrowing, because it allows lower taxes without lowering spending. So tax is only one side of the coin. But government debt featured in yesterday’s Daily Reckoning. There’s something much more interesting going on.

Paul Keating came right out and said it. The former Australian Prime Minister, and master of the modern insult, reckons his own landmark economic policy is a failure:

You can’t save under super for 30 years or 35 years and then live another 30 years off from it… In other words, the pool can never be big enough to sustain you till your 90s.

That’s about as insightful as calling John Howard a ‘desiccated coconut’ — our first experience of Mr Keating’s political skills, during the 2007 election. But why Keating couldn’t see the shortage coming until now is a mystery.

Anyway, the politicians have figured out that Australia’s plans for retirement won’t make ends meet. Now they’re likely to do something about it. As President Ronald Reagan said, ‘The nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’’

But what will they do? The Superannuation contribution is already on the up. It will slowly rise to 12% by 2020. That’s 3% higher than the 9% it was in 2012.

This is in keeping with the government mantra, ‘If something doesn’t work, do more of it.’

Increasing the contribution might improve the future retirement balances of those currently working. But it’s too late for those retiring or approaching retirement. They’re likely to be saving much more than the 12% anyway. An increase in the compulsory contribution might not increase their total savings at all — just make them slightly more tax efficient by taking savings from outside the super system and moving them into it.

You’ll never guess what Keating’s solution to his failed policy is. A ‘Longevity Levy’ of 3% of income. They’re fashionable these days, levies are.

Why 3%? Well that’s how much the super contribution will rise. You know how it is, good things come in threes. A recent study showed that if you give a person three reasons to agree to something, they are more likely to agree than if you give four. Maybe that’s where current PM Tony Abbott went wrong with his 1% debt tax.

Now there’s something inherently problematic in taxing the working people to provide for the old. What will you do in 30 years’ time?  The retirees of the future will be missing the same 3% you took from them.

The good thing about demographics is that they’re predictable. Surely this is a matter of maths? We just need to know how many retirees there will be, how much retirees will need and then find a way to provide it. The debate should be about the last part.

Unfortunately the math doesn’t work out. There just aren’t enough young people relative to old to make it work. And right now the dependency ratio is set to surge dramatically.

KPMG Partner Bernard Salt explained in yesterday’s Australian Financial Review just how sudden the baby boomer bulge is going to change things. ‘In the past 60 years the number of Australian in their 70s has never increased by more than 20,000 in a single year. However, this year alone those entering that age bracket will reach 60,000 people. And within three years Mr. Salt expects to see 80,000 Australians enter the age bracket.’

Yikes. The amount of people entering retirement age brackets will triple from one year to the next.

The problem with this is that you buy the most financial assets just before you retire. Then you suddenly sell them. So if you have a demographic bulge like the baby boomers a surge in demand for investment assets happens just before a surge in supply.

Imagine if the bulk of customers at farmers’ markets suddenly decided to take up growing their own food and selling it. The price of goods would crash. Or the market would close.

I think the same thing will happen to Australia. Actually, it has already begun. Wind back Mr Salt’s frightening demographic statistics a few years to the financial crisis. The tripling of people entering the 65 year age bracket — which is important under pension and superannuation law — happens to coincide with the beginning underperformance of our stock market during the financial crisis. In other words, financial markets in Australia have been struggling since the amount of baby boomers hitting 65 suddenly tripled. The point at which 40,000 more people than usual turned from buyers of financial assets into sellers.

Of course, the math isn’t that precise. People don’t all retire at 65. But the market force is still there in broader terms.

What’s also clear is that anyone wanting to retire comfortably in this environment needs a plan. That plan is being finalised as you read this and is scheduled to hit your inbox tomorrow.

Those who have seen the advanced copy are equally impressed and worried. Despite the powerful solutions you can make use of, it’s not enticing to think what will happen to those who don’t make the right changes in time.

One key point is that Australia’s current retirement system is facing something similar to the beginning of the end of a Ponzi scheme.

‘Ponzi scheme’ is an emotionally charged term that gets thrown around like a ragdoll these days. But the concept is relevant to demographics in a very specific way…

A Ponzi scheme operates by paying existing investors with new investors’ funds.

In that sense, the stock market and property market are Ponzi schemes. Or, as we prefer to put it, they need ‘greater fools’ to come along and buy assets at higher prices…so that other investors can get their cash out at a profit.

Ponzi schemes fail when the inflow of cash from new investors can’t meet payments out to existing ones. There is a race for the exit and those left holding the assets are the greater fool.

The worry is, there aren’t enough greater fools amongst Australia’s younger generations to buy all the assets retirees will want to sell.

In the US, younger people no longer believe houses inherently go up in price, thanks to the scars of the financial crisis. This has created an entire generation of renters — about 20 million according to Market Watch — many of whom can comfortably afford to buy a house but simply aren’t interested. They see a house as a cost and paperwork nightmare they can pay a landlord to handle.

In Japan, where demographics and the stock market both peaked in 1990, young people don’t believe shares go up in price. So they’re not interested in buying them.

What if this happens in Australia? Who will you sell your houses to? Who will buy your shares? At what fraction of their current price?

The silver lining is this: a small amount of people escape Ponzi schemes with their wealth intact…some with even greater wealth than when they entered. They are called the First Movers. It is upon this principle that the plan of action is based on. It’s called The First Mover Manifesto.

More on that tomorrow under the subject line: ‘How to Prepare for The Big Flip’.

Watch out for it in a separate email!


Nick Hubble+
for The Markets and Money Australia

Join Markets and Money on Google+

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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