Wednesday, 7 May 2008

When I'm 65 or will that be 67 or 70?

“The trouble with retirement is that you never get a day off.”

Abe Lemons (American basketball college Coach. 1922-2002)

At the turn of the 20th Century Lloyd George, then Chancellor of the Exchequer, introduced the first state pension. Before this people had to either work in old age or rely on their children to support them. This was during a time when the Liberal party were in government and many social changes were introduced to try and provide more equality in society. The state pension has remained since, with a few changes along the way. However the system that was introduced around 100 years ago has become a ticking time bomb in most Western Economies. With people living longer due to advances in medicine, and declining birth rates this is probably the most understated issue that we will all face over the next 15-20 years.

For an economy it is vital to have sufficient numbers of working people. After all these are the people who produce the goods and the trade that provides wealth within the economy. These people pay the taxes that provide money to hospitals, schools and other important services that we all take for granted. Economies can cope with reasonable numbers of people not in productive work, but if some population demographic was to radically change over the next couple of decades, say there was a lower ratio of working people compared with the total population, then what would happen? Obviously less goods would be produced, thus less trade thus less wealth in society. Also the wealth created within society would be used more as a proportion for less productive aspects to support this new aging population. More health costs, as ever increasing medical treatments are developed, more money to support the older members of society. So how is the above going to happen?

Well for one, we are all living longer - that is common knowledge. To die before 65 these days is considered a young death. This means people claim their pension longer, thus are a burden on society longer. The baby boomer generation - people born through the late 40's up till the 60's. All these people are due to retire over the next couple of decades and they make up a significant number of the population. They also represent a large number of currently employed experienced positions within industry. The next demographic band is simply not large enough to replace them all which will further drive up wage demands for certain jobs and lead to lower production for the money paid. We have a declining birth rate, with younger people choosing to have children later in life, also having fewer due to the associated costs (a perception of our society - we have plenty of money for food and clothing - its modern ipod and mobile phone youth culture - materialistic goods that are not required in raising a child) or "career" choices. Younger people are also choosing to stay in eduction longer thus many are not starting work until well into their twenties rather than their teens (although we do need as a society a band of educated people - maybe not as many as we currently produce). In recent years we have witnessed many families where both parents now work. This has supported GDP growth in recent years but its a short term one time boost. Our working population can't increase over night. This is why the government has been so welcoming to immigrants. Without them over the coming decades our economy would probably fall apart.

With all the above its no wonder the government has decided the retirement age needs to rise over the coming decades. What does the above mean then. Quite simply we are going to have to work longer with the age eligible for the benefit raising all the time. If you think the state pension is going to improve, forget about it. It's low for a reason and it will only go lower in relative terms. The alternative to the above is that we raise taxes to prop up the existing system. This will put even more burden on the working population and take out more money that could be used to drive the economy (either in savings or consumption). In the future there will be more taxes, as more people retire the taxation pool will shrink. My advice is if you haven't got a private pension then start one up. The sooner the better (read about the power of compounding to see why - Einstein even marvelled at it's power). And when I say pension I mean a liquid diversified pension, not the latest fad which is buy to let portfolios in property. It's simply too illiquid and not diversified. Investors don't lock up all their money in a single sector, in illiquid investments, they move money around quickly and grasp opportunities.

Why not property? Well for one we have just witnessed the biggest boom in property over the past ten years and the only way is down - for a long time. All the above I have mentioned will put our economy under considerable strain. We have had a decade of pretty sluggish growth, 3-4% tops. Many western economies over the past decade have been struggling to keep their economies growing even though we have created huge amounts of debt. We have reached a point I feel where this can only get worse. The UK may well have seen the peak in property for a long time. George Soros even states the end of the Leveraged boom by stating the western economies have reached saturation point. Credit isn't going to get cheaper in the long term. We have just had the biggest credit binges in history along with historically low interest rates. Therefore for house prices to continue to rise GDP would have to rise, but as I have mentioned this is looking very doubtful. How can an economy become more productive when there are less workers? Unless we invent an army of robots to drive productivity however this is very unlikely in the medium term future. You need to think of GDP growth as exponential growth. Its not linear as people commonly think it is. If the economy grows 3% per year it grows from a start of 100% to 103%, then to 106.09% to 109.2727% - it compounds year to year, ever increasing. Once you understand this then you realise it becomes very difficult to keep growing exponentially forever. In fact unsustainable and impossible as there are only finite resources on our planet especially as more of the worlds wealth increases.

What is also going to be a future problem that will put further pressure on our economy in the future is the growth of Asia. What happens when their economies grow using up more and more natural resources? We only have one planet with finite resources, yet we grow our economies exponentially. Recently the price of food, oil etc have been on the rise. In the future we will have to pay more and more for these commodities, eroding more of our disposable income, while our economy struggles to grow. The days of cheap food prices have gone. We have had science alter our agriculture technique (GM crops etc) but there is only so far technology can take you. With the above it is no wonder I am pessimistic over the price of housing. The UK property market has probably reached a peak for at least the next 10 years, however it could be a couple of decades. Your income will be diverted more to commodity goods rather than mortgage or rental payments. Just as recently when food and clothes have been cheap relative to the historic trend, this meant people had more disposable income to service debt. This will go into reverse over the coming decades.

Sure the commodity bull market may downturn in the short term and China and fellow Asian countries will have a bad recession maybe a depression sometime over the next couple of years but for the long term all the above will hold. China is set up for the long term to grow more and more, and at the current rate will be the largest economy in the world within a couple of decades. Its the sheer manpower that is powering the growth and strain on the worlds resources. This will put further strain on the worlds resources. There has been massive investment in the infrastructure in China, which is far superior to ours, making it a more appealing economy to invest in.

Its not just working power you need to grow an economy. It also requires capital (money) for investments in the economy. However as the population ages, older people become more conservative in their investments as they have a more short term view. Young people are prepared to take risks as they can afford to place savings and pension funds into higher risk, higher return investments. But what will happen when more of our population ages and choose to shun these risky investments. Quite simply more innovative but risky business can not start up as the capital is not there. This could be a real problem for the economy creating further drag. Especially if people carry on living as we are now - with record low savings. Although the de-leveraging process has recently begun so cash is again king.

I think the most interesting comment I heard recently was from the Governor of the bank of England. People say he is too much of an academic but he generally talks sense. He is saying too many of our nations talented youngsters over the past number of years have been looking at the financial sector for a job rather than productive sectors of of the economy. This trend has to be reversed and we need to reduce our reliance in finance. If we are to keep supporting the ever aging population we need to be more productive and invest in technologies that improve production. If not, then our economy will stagnate for decades. The quote at the start of the article may become true for my generation - maybe we will never be able to afford to retire, unless we all save more.

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