A Pensions Mega Crash?


I’m not a doom and gloom kind of guy. In fact I am quite the opposite. I own and run my own business, which isn’t something many pessimists tend to do. My accountant called me and explained about the government’s legislation regarding compulsory employee pensions contributions (workplace pensions) increasing in April 2018. Obviously I knew about it; everyone needs a decent pension and the current levels would clearly not help people financially survive their retirement. Why write up an article about that? I’m not. I’m writing an article about something much more important.

“Why is the government legislating a compulsory increase in contributions?”

Subheading: “Why are the government making pensions compulsory in the first place?”

The obvious answer is to help people cope with their retirement. However, seeing as so many pensioners are having to sell their homes and downsize or move in with their children, this altruistic view did not fit the current government’s behaviour…or any government’s behaviour. They (the government) were not helping those in present-day retirement and we’ve never known a government to start long-term projects because any success may be outside of their term in office and they would be giving all the glory of achievement to the other party (this is why there is no tidal power generation), so why was it REALLY changing the rules?

Clearly the love of the people was not the reason. So it was time to look at the numbers and take a “Freakonomics” style rogue-view of the situation. We need to look at the angle that the majority are not considering.

First up, who are the pensioners that would benefit from the increased investment? Clearly it was the generation that would be retiring where the increase of contributions would be helpful. Which means anyone retiring in the next 5-10 years is unlikely to see any real gains from the change. That generation has already had their pension funds ‘enhanced’ by the change of retirement age, which has provided them an additional 3 or 4 more years to save for retirement.

The increase of the retirement age would also be of benefit to the generations just starting work now. But if everything was peachy, why was the retirement age put back? It has changed from 60 to 65 to 67 and no doubt will be increased further, as people are living longer. Increasing the retirement age means people get to save for longer. It also means people will be paying more taxes because they are working for longer and the government will not need to pay out state pensions quite as soon as they would have. It’s almost as if a buffer zone was put in place where the government can save up and get ready for a big hit in retirement spending.

Currently the largest generation in history is the baby-boom generation (those born in the 22 years after WW2, i.e. between 1946 and 1964). The baby-boomers are retiring now and over the next few years. They are, on average, the richest generation on earth and have huge investments in the stock market as well as in their pensions. So propping them up with an extra 8% over 1 to 2 years of employment will do little to nothing for their employment/private pension pots. Moreover they have the state pension ready to go.

Speaking of state pensions, rumour has it Gordon Brown sold off the UK gold reserves to be able to pay the state pensions. But that’s another conversation all together. However, we could use the “Ability to pay” as a start point for a line of enquiry.

Adding the largest generation in history to the government’s ability to pay state pensions could be an interesting situation for an already cash-strapped government to face. The financial system has already been propped up by a few rounds of Quantitative Easing (QE), which went to the banks…or so we were told. Well, they did, in a way. If you do a little research you will find that the QE was implemented by buying up gilts. HOWEVER, and it is a capitalised however for a very good reason, these gilts were held by insurance and pension funds. This increased their liquidity to buy more stocks and shares as well as reinstate their position for gilts. So the insurance companies’ holdings and pension funds’ holdings have had an injection of cash that can be used to buy appreciating assets for their balance sheet. More money means buying back more gilts and shares. Which then fits with supply and demand. The demand increases, so the price increases.

It looks to me as if the stock market is being artificially propped up by each successive round of QE. I say ‘it looks’ but in my opinion this is exactly what is happening. The more interesting thing is that once the gilts have been purchased from these investment organisations, they would no longer be balanced. DANGER!!! Or is there something else going on?

If you’re not into financial terms, let me explain this in a more simplistic manner:

Imagine a point-to-point race and you need to bet on the winner. If you are hoping to mitigate risk and guarantee that you put a successful bet on the winner, you would need to put a bet onto every horse in the race. We’ve all seen point-to-points where nobody saw the old stubborn nag make a name for itself. So you have to bet on every horse in the race. If the horses were lined up and numbered 1 to 10 and you were betting on the right side of the field, you’d be unbalanced, because there is a chance those horses on the left may win. The same with investment companies’ strategies. They tend to hedge their bets by investing in everything possible e.g. precious metals, property, gilts, stocks, crypto-currencies etc. Then they put slightly more towards the horses they believe are going to do the best. So that regardless of the outcome of the race, they will win. With gilts being bought up by the rounds of QE, the organisations were given more cash but were being unbalanced at the same time. Because they were only betting on 8 or 9 of the 10 horses in the race.

A little explanation on how QE works here in regards to the race analogy:

Betting on a horse costs £1.00 per bet. You have £1000 and there are 10 horses in the race. So you spend £100 per horse. This means that you hold 100 x £1.00 slips per horse. More specifically you hold 100 x £1.00 slips for the horse named Gilts. The bookie comes along and says “I’ll pay you £1.20 for each slip you have for Gilts.” This is what happened with QE, but explained in a really basic way. The fun thing is, the bookie didn’t change the price of the £1.00 slips. So of course you’d say yes, because you now have £120 in your pocket and can just go and buy your £100 worth of slips back i.e. 100 lots of £1.00. So you would be £20 richer. That extra £20 cash would buy you a nice cup of coffee to watch the point-to-point and a little extra spare for spending money. You’d rebuy your slips, have the whole field covered, and be guaranteed extra cash for everyday costs.

So, the natural response of the investment companies was exactly that, to re-buy the gilts. The government has basically injected cash into the insurance and pension funds as well as provide extra cash for them to cover their everyday costs such as paying out on pensions, without having to cash-in any of their stocks or shares.

Is the government actually bailing out the pension funds and not the banks as it claimed QE was for? I’m not saying yes or no to that. But you can make your own mind up on it.

Why all the focus on pension funds and their liquidity? Why should they not just cash in their assets to cover the cost of what they need to pay out?

The simple reason, in my opinion, is because when the largest generation in history is coming up for retirement, the supply and demand principle would come into effect and crash the market. Companies would have to sell huge volumes of pension assets. The most easily convertible to cash (most liquid) are cash itself and stocks/shares. The abundance of shares hitting the market means the supply would increase, but the demand would not be there, as people who are currently in employment do not have the cash in their pockets to buy them back up. So the price would drop. When the price starts dropping, everyone starts selling because nobody wants to make a loss, and the supply gets larger and the demand stays low, so the prices go down again, and inevitably even more people sell, more supply with the same low demand…market crash! Pension Funds betting on the horse named Shares finds out its horse has a broken leg. Everyone betting on Shares, including the pension funds, tries to sell their betting slips for pennies.

Because pension funds need a lot of cash to cover people drawing out their pensions, they would need to start selling other assets, which would go back to supply and demand principles. Markets would be flooded with assets, prices would drop, everyone starts selling, and prices keep going down. It’s a very dangerous position to be in. However…if you could FORCE a large demand into this equation, the prices should not start to fall as the demand is equal to the supply, and thus the market is being propped up, thereby also propping up the pension funds. Which brings us full circle to the start of what has become a small essay. To me it looks like, the current generation’s retirement (the baby boom generation) is being financed by the latest change in Work Place Pensions.

For many years and continuing into the next few years the pension system has been artificially inflated with regular injections of cash and legislation changes. This has clearly continued and will need to do so for quite some time. The government is stretched way too far, financially, and I think they will be cutting the State Pension or at least making some MAJOR cuts elsewhere to be able to afford to keep paying the state pension. Well, either that or taxes will have to rise an awful lot!

If this situation is not carefully monitored and controlled, it could well cause the largest crash in history. Especially with it having had £375billion…yes BILLION in quantitative easing between 2009 and 2012.

When the bubble bursts and pension funds crash, there will be a whole lot of people up a creek without a paddle. It could happen any year. If the latest changes are not enough, a major financial crash far beyond the 2007/2008 crash and even more devastating than the 1929 Great Depression in the US could well be on the cards. I severely hope I’m wrong.

The optimist in me says “Expect the Best” but the realist says “Prepare for the Worst.”