Wednesday, September 19, 2012

Pension Fund Death Spiral undoes any benefit from Quantitative Easing

In his Telegraph column, Damian Reece confirms that the Pension Fund Death Spiral undoes any benefit for Quantitative Easing.

Regular readers know that under the Pension Fund Death Spiral, first discussed by your humble blogger, companies have to use money that could be reinvested for growth to fund the loss in earnings on the pension fund assets.  Diversion of this capital from the real economy slows its rate of growth.
As fast as the Bank is printing money, it’s disappearing down a pension black hole. 
The scale of the problem was highlighted on Wednesday by Smiths Group. It paid at least £122m last year to fund a pension deficit that has artificially ballooned as an unforeseen consequence of the Bank of England’s quantitative easing programme to print money and keep borrowing costs low. 
Rules on pension deficits were not designed with QE in mind and are no longer fit for purpose. They are damaging the economy.
I would disagree with Mr. Reece in that I think the rules are fit for purpose and that it is QE which is damaging the economy as the Pension Fund Death Spiral is an unintended consequence of QE.
As fast as the Bank creates more cash through QE, chunks of it are being recycled straight into accounting black holes, which means billions are not being invested to create jobs or pay dividends. 
And it’s not at all clear whether pension trustees actually want the cash. 
Their regulator restricts them from reinvesting it usefully in the stockmarket, buying yet more gilts is a one-way guaranteed bet to lose capital, and cash in the bank doesn’t earn anything and is hardly being put to work by lenders. 
I won’t bore you with the inner workings of the problem, but basically the rules state deficits have to be measured at a single point in time using the current return on gilts to calculate the future liabilities as if they all fell due today.
QE is forcing the return on gilts down to microscopic levels, meaning that companies have to make up the difference with ever-larger amounts of hard-earned cash that would otherwise be spent growing the business or boosting returns.... 
As we know, the funds will pay pensions out over the next 40 to 50 years as people retire and should be funded accordingly.
Hence the reason that I think that pension accounting rules are fit for purpose.  We know that Japan has been pursuing QE for 2+ decades, so there is no reason not to think that the UK will be pursuing QE for at least that long.

All that changing pension accounting rules would do is to put younger workers pensions at risk as the pension funds would not have the assets they need.

As reported by the Telegraph, the CEO of Smiths Group discussed the Pension Fund Death Spiral as follows,

In the first warning of its kind from a major British company, chief executive Philip Bowman said the £375bn bond-buying scheme was keeping gilt yields artificially low and partly explained a jump in the company’s pension deficit to £620m in the last financial year from £199m a year earlier. 
Smiths, which makes airport scanners, medical devices and seals for oil and gas pumps, has injected £378m into its pension scheme over the past five years to service the mounting deficit, and £122m in the past year alone. 
“The problem is investment performance as [the Bank of England] has continued to print money, driving gilt yields down and making a substantial difference. 
“This is money which we could otherwise use to invest in the business or on increasing dividends,” Mr Bowman said.
Please re-read the highlighted text as it describes the Pension Fund Death Spiral.
Were bond yields to rise again, the deficit would lower, but Mr Bowman said this might also pose a problem. “The scheme could be over-funded and you would never be able to get the money out again, so there is a potential double jeopardy.”

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