Another cost of the budget surpluses

The previous conservative Australian government ran budget surpluses for 10 out 11 years between 1997 and 2007 and lauded them as the exemplar of fiscal prudence. Of-course, from a modern monetary theory (MMT) perspective it was clear that the fiscal drag embodied in this strategy undermined the capacity of the domestic private sector to save (given the current account deficits) and forced growth to be dependent on the increased indebtedness of the household sector. It was an unsustainable strategy. It also coincided with the government destroying significant components of private wealth as they paid out government bonds and slowed the issue of new debt to a trickle. The previous treasurer talked relentlessly about getting the public debt monkey of our backs. Well apart from it never being on our backs in the first place, we are now seeing some hidden manifestations of this squeeze on private wealth.

In its 2007-08 Annual Report, the Australian Office of Financial Management boasted that:

Overall, it appears that financial market participants adjusted without undue difficulty to the decline in the relative size of the Treasury Bond market for much of this period. Adjustments occurred in various ways. Some domestic investors reduced their holdings of Treasury Bonds by switching to other assets. Traders made greater use of derivatives (including Treasury Bond futures contracts) in adjusting their positions and managing interest rate risk. The market generally became more efficient in its use of the available stock of bonds … Another factor that may have facilitated the adjustment to a smaller relative supply of Treasury Bonds was a shift in investor preferences away from lower risk investments in order to achieve higher returns.

So no recognition that superannuation funds were squeezed by the lack of bonds available even if they desired lower risk positions. The thirst for higher risk was spawned by the growing neo-liberal push to liberalise superannuation funds in Australia. Many people little detailed knowledge or understanding were persuaded by glossy advertising that was provided for by both the industry and the government to move their superannuation assets into riskier positions.

The rise of the accumulation funds and the dramatic demise in defined benefit funds plus the shift away from low risk investment options accompanied the “get rich quick” rush that followed the deregulation of the superannuation industry. You can see detailed data for these trends in the Australian Prudential Regulation Authority publication – Superannuation Trends September 2004.

But now with the release of new OECD data we can clearly see that the two trends – the move to riskier portfolio positions and the lack of government bonds being issued has had negative impacts on the retirement wealth of many Australians.

In its October 2009 edition of Pension Markets in Focus, the OECD compare the impacts of the financial crisis on private pension (superannuation) funds across the OECD economies and beyond. It demonstrates that the budget surplus strategy imposed further costs on Australian families in that it exposed them to greater losses in the financial crisis.

I doubt whether anyone else is making this point but then I am used to being in that space.

You also might like to read Peter Martin’s coverage of this in the Melbourne Age today.

The headline of the OECD Report is:

In the first half of 2009 funded pension systems in the OECD have recovered more than $1.5 trillion of the $5.4 trillion in market value that they lost in 2008 (from USD 27.8 trillion in December 2007 to USD 22.4 trillion in December 2008). Pension funds alone experienced on average a positive return of 3.5% in nominal terms up to the end of June this year.

The following graph is a reproduction of the OECD’s Figure 1 Pension funds’ nominal investment rate of return in selected OECD countries and provides a comparison between the returns achieved between January and December 2008 (light blue) and January to June 2009 (dark blue). Australian superannuation funds experienced the third worst losses in 2008 and among the funds that have posted positive growth since January this year, we have the lowest recovery.


What reasons are given for the pattern of losses and returns shown in Figure 1?

The OECD suggest that the:

The impact of the crisis on investment returns has been greatest among pension funds in the countries where equities represent over a third of total assets invested. These countries have also experienced the sharpest drops in equity allocations. In 2008, Australian pension funds were the most exposed to equities, at 59% of total assets, followed by Ireland (52%), the United States (46%) and the United Kingdom (46%). By comparison, equity exposure in 2007 was highest in Ireland at 66% followed by Australia (61%) and the United States (57%). In other countries, pension funds have benefited from having a large proportion of their assets invested in bonds, whose rates of return tend to be lower but more stable than those of equities. In December 2008, in 13 OECD countries, over 50% of assets were invested in bonds.

Several unlikely countries (many so-called emerging) including Ukraine, Egypt, Namibia, Albania, Colombia, Macedonia, Nigeria, Israel, Pakistan, Chile, Liechtenstein, Lithuania, Bulgaria, Peru, Hong Kong have outperformed Australia in the recovery.

By way of explanation, the OECD says that:

Many non-OECD countries, such as Egypt and Ukraine, also suffered little from the 2008 crisis because of their high exposure to government bonds.

The following graph is a reproduction of the OECD’s Figure 2 Pension fund asset allocation for selected investment categories in selected OECD countries, 2008 which shows the distribution of pension fund investments (in percent) across different asset classes. You can see how reliant Australian superannuation funds are on shares.


So while you have to consider long-term trends when assessing returns on retirement assets and in that regard Australian superannuation funds have still generated positive returns averaged over the last decade, it still remains that a person who was to retire last year or in the next few years will realise significant losses relative to where they were prior to the crash.

We are still not able to model whether this has altered participation rates because we do not have enough data yet. But there is anecdotal evidence to suggest that it has, with older males particularly postponing retirement plans to try to recoup the losses.

The previous discussion is expressed within the logic of the deficit-debt terrorists. It is clear that running surpluses does destroy private wealth and has unintended consequences as shown in the OECD Report. The terrorists are silent on those matters.

With that said, from a MMT perspective, I have to admit ambivalence. This issue of superannuation funds and the thinning federal bond market was a topic of discussion during the Review of the Commonwealth Government Securities Market, which was conducted in 2002.

You can read the Treasury Discussion Paper along with all the public submissions, including that produced by The Centre of Full Employment and Equity (written by myself and Warren Mosler) if you are interested.

In our Submission, we addressed the claims made in the Treasury Discussion Paper that if superannuation and life companies “could not invest in CGS, then they may face more difficulties matching their relatively long-dated liabilities with their financial asset holdings” (Treasury, 2002: page 50).

We also addressed the Sydney Futures Exchange (2002: 5) claims that eliminating the CGS market would “deny superannuants an A$ denominated (default) risk free investment for their retirement planning at a time of an ageing population and in a mandatory superannuation environment.”

We noted that what is not often understood is that Commonwealth Government Securities (CGS) are in fact government annuities. That is, guaranteed income streams.

We wondered whether the “free market” lobby that were making these points (about superannuation losing out) really wanted the private sector to have access to government annuities rather than be directing real investment via privately-issued corporate debt, as an example?

The point is also applicable to claims that CGS facilitate portfolio diversification. Why would Australians want to provide government annuities to private profit-seeking investors? This clearly interferes with the investment function of private markets.

We argued that direct government payments be limited to the support of private sector agents when failures in private markets jeopardise real sector output (employment) and price stability. Later in the Report we detailed that this support should be largely confined to providing employment guarantees and that government endeavour be focused on the provision of first-class education, health, aged care and other activities which unambiguously advance public purpose.

In this context, we also demanded a comparison of this method of retirement subsidy against more direct methods involving more generous public health and welfare provision and pension support. No such comparison was ever forthcoming from the Government or its private sector puppeteers who were both rushing to increase the surpluses and had actively promoted the reduction of welfare benefits that were being received by the disadvantaged Australians and wide scale deregulation and privatisation.

They also had promoted the “public debt-monkey” arguments but once it started to threaten their own “corporate welfare” part of the world they sought reassurances from Government that a minimum volume of government debt would be issued each year even though (in their own words) it was not required to “fund” net spending (which was negative throughout this period – that is, budget surpluses).

This whole Review and the subsequent decisions highlighted the hypocrisy of the “debt-monkey lobby”. It was clear that it should be publicly identified with the position of getting rid of all government support (welfare) unless it impinges on their ability to live the high-life.

So what should a retirement income scheme look like? That is the topic of another blog one day given its breadth. But the government doesn’t have to issue debt to ensure that superannuation funds enjoy low risk options.

First, you can view an interesting Chronology of Australian Superannuation provided by the Australian Parliamentary Library.

Second, this Report provides an interesting assessment of the inequalities inherent in the Australian superannuation system. This recent speech from the Australian Human Rights Commission Sex Discrimination Director is also interesting. Further, gays and lesbians are discriminated against by our superannuation laws.

Third, between 1973 and 1976 the National Superannuation Committee of Inquiry conducted a major analysis into the feasibility of a national superannuation scheme in Australia. The Inquiry culminated in the 1976 release of the Final report of the National Superannuation Committee of Inquiry (link to Part 1 only – Part 2 was released in 1977).

The Australian Parliamentary Library Chronology (noted above) says that:

The … Inquiry recommended a partially contributory, universal pension system with an earnings-related supplement. A minority recommendation suggested a non-contributory flat rate universal pension, a means tested supplement, and encouragement of voluntary savings through expanding occupational superannuation.

At any rate, it was started under the Whitlam Labor Government which was subject to a conservative coup in 1975. By the time the final Report was released the conservatives were in power and the neo-liberal era in Australia began (November 1975). They subsequently rejected all notions of a national superannuation scheme.

While I do not support all the elements proposed by the National Superannuation Committee of Inquiry the idea of a public superannuation scheme is very attractive. The national government has the fiscal capacity to implement a scheme that would eliminate poverty among pensioners, dramatically reduce income inequality, and offer risk-free retirement plans for those who wished to avail of them.

It could easily offer guaranteed returns on saving (tantamount to a debt-based annuity) to a regulated public scheme leaving private schemes to take whatever risks they liked.

Further, to improve the future retirement prospects of all Australians, the best thing the government can be doing on a continuous basis is to maintain full employment and ensure that real wages grow in line with labour productivity. It should also use its fiscal capacity to promote excellent educational opportunities, particularly in disadvantaged areas.

The conduct of government in the neo-liberal period has, however, been the antithesis of what is required to provide for our future welfare. That is one of the ironies that always amazes me.

We accept all this nonsense about the intergenerational challenges facing our ageing population but then in the same breath support government policy which would worsen any of the likely consequences arising from our changing demography. That is one of the greatest neo-liberal deceptions of the many they get away with.


My lost travel bag with all my working papers from last week’s meetings turned up in Sydney this morning and is, allegedly, heading up my way as I type.

This Post Has 3 Comments

  1. Bill the bonds the OECD report refers to are treasury bonds and corporate bonds.

    Chartwest (an independent super ratings agency) released a report recently that showed that bonds (corporate and government combined, not government issued bonds alone) have outperformed equities over the last 15 years. This is combined with the benefit of less volatility than equities- so you are not going to get the situation where you reach retirement age, and a GFC comes along and wipes out 20%ish off your accumulated benefit.

    Both corporate and government issued bonds have been rare beasts in recent times in Australia.

    Christopher Joye has an interesting idea, maybe similar to your national super scheme, he is calling kangasuper that may be of interest to you.

  2. Hi Bill,

    A couple of points to reinforce.

    The ‘lack’ of tsy securities is ‘matched’ by a reduction in balances available to buy tsy secs. as the funds to buy them come from the deficit spending itself. So at the macro level there is no shortage of tsy secs.

    What does happen is spreads change between tsy secs and other secs when the supply of tsy secs falls. This is because the funds allocated to buy securities in general often come from the deposits created by private sector debt who proceeds finds it’s wan into pension funds and other investors of long term securities. In other words, some of the funds generated by the increase in household debt find their way into securities investments via contributions to pension funds and individual savings vehicles.

    That ‘technical supply situation’ results in a widening of spreads between tsy secs, the risk free rate, and other secs as markets do their usual grope towards indifference levels of prices and yields.

    The Australian report, above, seems to miss this point.

  3. I don’t understand the thinking behind the increase of the age of the pension. After reading your link to the Chronology of Australian Superannuation, it states that the age of the pension will continue to rise until 67 (from memory). Do you think this will place greater pressure on younger people entering the job market and perhaps the health and financial security for older people leaving the job market?

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