Wednesday, September 19, 2012

Quantitative Easing policy offers younger generations prospect of being worse off than parents

In trying to decide on who Quantitative Easing hits hardest, your humble blogger determine that the real economy was the number one victim.  It was a close race with the younger generations entering or already in the work force.

A Der Spiegel article describes how as a result of Quantitative Easing for the first time in memory we, in the EU, Japan, UK and US are offering a younger generation the prospect of being decidedly worse off than their parents.

What truly appalls your humble blogger about offering a younger generation the prospect of being decidedly worse off than their parents is that this prospect is the direct result of a choice by policymakers and financial regulators to pursue the Japanese model for handling a bank solvency crisis.

Under the Japanese model, preserving bank book capital levels and banker bonuses is more important than saving the real economy and the prospect that future generations will have a better life than their parents.

We absolutely do not have to hand future generations a worse deal than the greatest generation enjoys.

Iceland has shown that by adopting the Swedish model and forcing the banks to absorb the losses on the excess debt in the financial system, not only can the real economy be spared, but the social network can be expanded.

Of course, banker cash bonuses were a casualty of Iceland's adopting the Swedish model.  However, this seems reasonable given that nobody forced the bankers to originate and expose themselves to all that debt that couldn't be repaid in the first place.

In case any reader is wondering, I would argue that the EU, Japan, UK and US adopt the Swedish model as quickly as possible to save the real economy and restore the promise that future generations will have a better life than their parents.

Our current choice of the Japanese model is condemning future generations to a lower standard of living.
For decades, Germans have been able to live out their golden years in comfort. For today's younger generations, however, the retirement dream is turning into a nightmare. 
Increased life expectancies, an aging population, low birth rates and vanished investment returns have many worrying about a future of poverty. 
Jaime Aguilar loves his job. Every morning, when the 27-year-old German of Mexican origin wakes up the disabled youth who live in his group home in Stuttgart, he looks forward to yet another fulfilling day. "Whatever I give my boys, I get it back twofold," says the caregiver. 
What Aguilar doesn't appreciate is the sight of his pay slip. Even back when he was in training, his instructor warned him: "You won't be able to live on your pension." 
Now he has read it in black and white in the newspaper. In 2052, when he retires after 40 years of working, based on his gross monthly income of €1,800 ($2,300), he will receive less than €590 a month in benefits. 
When he reaches retirement age, he will probably rely on payments from the welfare office -- and that makes him furious. "I don't want to have to struggle to survive," he says.
To avoid a life of poverty in old age, a coworker recently advised him to open a special savings account with a fixed interest rate. But Aguilar hasn't made up his mind yet. He needs the money to pay the rent, phone bills and his monthly public-transport pass. How is he supposed to cut back on these expenses? And, with everything that he has heard about the financial crisis, how much savings would he end up with anyway? "I can't trust the banks," he says "and I don't want to live on €5 a day." 
The young caregiver is not the only worried worker in the country. Ever since German Minister of Labor and Social Affairs Ursula von der Leyen recently published alarming figures on the future level of German pensions, there has been widespread concern over the looming danger of old-age poverty. 
Von der Leyen, a member of Chancellor Angela Merkel's conservative Christian Democratic Union (CDU), released data showing that, in two decades, the statutory pension will only be enough to guarantee a life on the edge of poverty, even for average earners. 
To make matters worse, what Germans have managed to save during the course of their working lives is in danger of evaporating in the chaos of the global financial and debt crises....
This is a damning indictment of the policies pursued as a result of choosing to implement the Japanese model.
Germans are afraid that their dream of a golden retirement could turn into a nightmare. For decades, one of the certainties of life in Germany was that the next generation of retirees would be better off and live a more secure existence than the preceding one..... 
No other segment of the population currently has a lower risk of falling into poverty than pensioners. 
But now even well-paid skilled workers and employees are afraid that this could change in the future. They see that the nation's falling birth rate has resulted in a dwindling number of employees who pay into state retirement funds. And they have noticed that inflation and low interest rates are eating away at their assets. 
Indeed, Thomas Meyer, the former chief economist at Deutsche Bank, recently wrote in the Frankfurter Allgemeine Sonntagszeitung that the effects of the crisis threaten to reduce the purchasing power of private pension plans by one-half. 
Germans are growing increasingly anxious, and a growing number of politicians in Berlin are asking tough questions: How can Germans secure their later years as sources of retirement income decrease? What has to change in the retirement system? And, last but not least, how can the cost of covering the impending shortfall be fairly shared among contributors to state retirement funds and pensioners?
All this because policymakers and financial regulators refuse to force banks to absorb the losses on the excesses in the financial system and refuse to make bankers give up the cash bonuses.
A monumental challenge must be tackled. Now that Germans are living longer, pensions also have to cover a longer period of time. Back in the 1960s, pensioners received retirement benefits for an average of 10 years. Today, a typical retirement lasts twice as long -- and there is nothing to indicate that the trend will reverse itself.... 
Most people welcome this as a remarkable achievement, but it spells bad news for private and state pension plans. Costs in the insurance industry are being driven up by a so-called "rising longevity risk." By 2060, it is anticipated that insurance companies will have to pay pensions to men for up to 25 years and to women for up to 27 years. 
This increases the danger of rising poverty as the level of state pensions continues to drop. 
In a bid to cushion the impact of declining birth rates, various German governments have repeatedly amended the pension formula since the late 1990s and raised the legal retirement age to 67 years. As a result, the level of retirement payments will fall from 51 percent of the last net salary to 43 percent in 2030. 
For the time being, though, this development has forced relatively few senior citizens to eke out a subsistence-level existence. Only some 2 percent of the more than 20 million German pensioners currently rely on basic social security, which supplements low pensions. 
Better yet, anyone who goes into retirement these days can usually benefit from company pension plans or life insurance benefits, and anyone who has a traditional, regular employment situation, with a long-term and secure job, can still hope to receive an adequate pension in the future. 
But it's another story altogether for workers in the so-called low-wage sector, which includes poorly paid seasonal work, bogus "self-employment" schemes and "mini-jobs," which allow people to work part-time and earn a limited amount of money without paying tax or social security contributions....
Back in 2007, the government pension agency published a study called "Old-Age Pensions in Germany," which is the largest evaluation of pension data ever conducted for Germans born between 1942 and 1961. 
The results were alarming. They clearly showed that old-age poverty is increasing. 
The reason for this trend is clear: The number of Germans in irregular work situations has risen dramatically since 1996, from over 6 million to more than 10 million. ...
In addition, there is a rising number of low-wage earners. There are now some 8 million German employees who work for an hourly wage of less than €9.15...
Figures from the German government's new report on provisions for old age, to be published in November, show that of the roughly 25 million employees in the country between the ages of 25 and 65 who make social security contributions, more than 4.2 million earn a gross monthly salary of less than €1,500. This only entitles these individuals to the legally guaranteed basic social security.... 
Nobody is more familiar with the dismal odds faced by investors than Andreas Beck, a mathematician who has his office in an attic loft of an old building in Munich. This is home to the Institute for Asset Accumulation (IVA), an asset-management service provider he founded. 
"Money no longer multiplies on its own," says Beck, who provides consulting services to banks in addition to insurance and investment companies.
This is a direct result of QE.
According to his sobering calculations, anyone who is currently looking for a low-risk investment for their golden years -- in other words, primarily high-quality sovereign bonds and German Pfandbriefe, a class of covered bonds -- can at best expect a market return of some 3.1 percent. 
That sounds respectable -- but, in reality, it's disastrous. Indeed, the investor will have to use these yields to pay for fees associated with the portfolio and withholding taxes on investment gains. Furthermore, inflation eats away at the value of the savings. The bottom line is that the investment loses over 1 percent of its purchasing power -- every year. 
Consequently, making investments today often means that one can afford less tomorrow
If interest and inflation rates remain at today's level, the purchasing power of a €10,000 investment will melt away to just €6,730 within 30 years. By contrast, an individual who invested the same amount three decades ago will enjoy a purchasing power worth more than €18,000. 
In the future, even risk-prone savers will only be able to dream of a comparable return on investment. According to Beck, after deducting various costs, taxes and for inflation, such a portfolio would only generate annual gains of 0.01 percent. This does not allow for anything more than maintaining the money's purchasing power -- even when taking considerable risks. 
"The young generation is the big loser in this development," says Beck, "and they can count themselves lucky if they can purchase as much with their money later on as they can today." 
Indeed, these developments have deeply shaken Germans' belief that they can spend their golden years living a life of prosperity. It used to be that Germans could be fairly certain that they would be better off in old age than during any other phase of their lives. Today, they have to worry that Germany will also experience conditions such as those in the US, where over one-fifth of the country's senior citizens live in poverty. 
It's little wonder that the looming pension crisis has startled politicians in Berlin. German parties across the political spectrum are working on a new pension concept, but they haven't made much headway.... 
Today's wage-earning generation cannot shoulder this kind of a dual burden, and both politicians and citizens must face up to a bitter reality: The problem of old-age poverty cannot be solved with just additional pension reforms, which merely redistribute the money between individual groups of wage-earners and retirees. Likewise, given the currently low yields on investments, expanding the private pension system wouldn't achieve much either.
Experts believe that anyone who wants to effectively combat old-age poverty must strengthen the very economic foundation of the pension system: employment. 
Employment which QE suppresses because of its negative impact on demand.

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