What would pensions and investments look like with sound money?
It is fascinating watching in real time as the existing fiat money system cracks and lurches from side to side, with sticking plasters frequently applied to keep it going for a bit longer. It could still take many years or decades, but it got me thinking about what our pensions system could look like when we eventually revert to sound money. Whilst it had weaknesses, a formal or de facto gold standard operated in Britain for over 200 years up to 1931, during which much actuarial progress was made in life assurance and pensions. This article speculates on some key future principles.
Choice of asset classes
Living with a sound money tends to reduce long term interest rates. That’s because there is little to no inflation in the money supply and therefore prices of goods and services generally reduce for everyone across the economy as technology improves productivity. A real interest rate above price deflation could therefore be a near zero nominal interest rate.
Also, as wealth increases, there is more certainty about the future, which leads people to increasingly seek longer term future satisfaction instead of short-term gratification. Or, in other words, they use a lower interest rate to put present values on future outcomes.
For most people, most of the time, holding sound money could be sufficient particularly as it tends to be simpler to understand and do. No need to pick the best companies, fund managers or stock indices. No need to understand interest rate duration, bond convexity or forward curves. More time to spend on the day job, family and friends.
Bonds could be financially unattractive to most people, particularly compared to just holding sound money. They add complexity, uncertainty, and counter-party risk. Long term debt which is secured on a real asset or convertible to equity may still be attractive at the right yield.
Some people have a higher risk appetite and will want exposure to certain companies, industries, or economies. Equity should be much more attractive than bonds as it gives unlimited upside potential.
Residential property could stop being an investment. Houses that we buy to live in and enjoy rather than to use as a leveraged savings account to protect us against inflation. Commercial property could still be an investment, but companies may prefer to own it themselves as part of their long-term corporate planning.
Insurance and pensions
Personal uncertainties will remain and therefore the need for insurance to pool those uncertainties. Insuring our lives, health, and property gives peace of mind for us and our loved ones. There will continue to be an important role for actuaries in assessing risks and uncertainties.
There could be a rise in self-insurance and self-reliance. To protect against future uncertainties, we hold cash balances. When that cash loses value every year it hurts our efforts to support ourselves in bad times. When money increases in value each year, we are not only able to better support ourselves but also our family, friends and the communities around us.
Defined benefit schemes could be much less attractive than they were in the 1970s/80s/90s. A combination of mismatched assets and liabilities with a heavy reliance on the employer to fix any shortfalls are probably unattractive for anyone with a long-term outlook.
Defined contribution schemes with investment strategies that most employees don’t understand or aren’t engaged with won’t be attractive to either employers or employees.
A sustainable solution could combine holding sound money with some risk pooling for life expectancy and ill health. This could be very popular as employers avoid the uncertain balance sheet liability risk, whilst employees benefit from risk pooling and avoid reliance on the solvency of former or current employers. This solution should also be cheaper for employers than defined benefit and easier for employees to understand than defined contribution.
State pensions could still exist in some form, but governments would have to learn to live within their means. Taxes could be high or low but the money supply can no longer be abused to hide an overpromise. It depends what the population vote for, but state retirement benefits for the poor and the sick seem likely as a minimum.
We could see the re-emergence of friendly societies. They provided financial support for the old and/or sick, but also valuable local community bonding for all members.
Conclusion: pensions and investments could look very different with sound money, but they should be easier for everyone to understand and be more sustainable. I doubt that the transition will be easy though.
Sam Roberts, Director of Investment Consulting at Cartwright
