Pensions – Not So Boring Anymore…

In my deep past I wrote a paper for a college economics class.  I recall it was on a solid but boring topic for the time (mid – 70’s), related to pensions and the effect on budgets of mis-forecasting rates of return.  Now this was in an era when interest rates were boring, but soon they would not be so.  In the Seventies the big issue became inflation, or stagflation, which after the ’73 oil shock, started heading towards double digits.  At a time when inflation revolved around 10%, the question was can a pension then earning 9% keep up?

The yield problem, particularly for public sector pensions, has come home to roost in the current era of minimal inflation.  With nominal interest rates near zero, it is hard to achieve a return above 7%.  This is causing political problems for many municipal entities, a problem foreseen several years ago.

Responses have varied, but have come from both the right and left.  With the Tea Party behind him, Wisconsin Governor Scott Walker attacked the unions on collective bargaining rights, going after pay and pensions.  The left has taken up the call, as noted by Democratic advisor David Crane of California in 2010, “I have a special word for my fellow Democrats,” Crane told a public hearing. “One cannot both be a progressive and be opposed to pension reform.”  All this rancor over a bucket of money which has been promised to our public servants (teachers, fire, police, etc.).  But as Crane implied, in the current environment, keeping up with these fixed return obligations is threatening basic services like public schools and social services for the needy, not to mention fire, police, and garbage collection.

All this is being revisited across the country now, as an example New York City faces the prospect of an additional $1.9 billion in annual pension contributions due to a reduction in the assumed rate of return from 8% to 7%.  Its pension contributions currently make up 10% of the total operating budget.

With the majority of American workers now facing retirement with a combination of maybe a 401K yielding 2% and Social Security looking dicey, the public sphere is living in the past.  It is time for them to share the risks of the markets that we all do.  A promise to pay is one thing, a promised return is another.  It is time to put to bed traditional pensions for municipal employees, and the arcane activity of forecasting reasonable returns.

Rob Cannon is a frequent guest contributor at SMBmatters and is a principal at Cannonomics.  He is a virtual CFO for hire.

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Finer Things In Life – FTIL #8: Pleasure Metrics

breguet tourbillon perpetual calendar watch

Please get your mind out of the gutter – this is a family friendly blog… 🙂  No, not that kind of pleasure metrics, rather the pleasure one gets from owning watches like the Breguet Tourbillon Perpetual Calendar Model 3755pr, pictured above for cool 250K each.  I know – some are lucky enough to wear what’s equivalent to a down payment on a house on his or her wrist…

Learjet

ForbesLife recently published a quick snapshot of the 2-year inflation rate, from 2010 to 2012, in the ultra-luxury goods segment – from handbags to Learjet to watches.  While most of us certainly don’t think about dropping almost 10MM for a 2000HP speedboat, it was an interesting read.  If nothing else, it makes you think about our government’s assertion that 2% – 3% annual inflationary rates or increase of money supply in circulation represents a healthy growth.

A few indicators:

  • Slightly more affordable version of the aforementioned Breguet – Messidor Tourbillon in rose gold, from 139.9K in 2010 to 146.9K in 2012
  • Petrossian Special Reserve Ossetra (1 kilo ultra-exclusive caviar, one of the few items that dropped in price) – from 18.4K in 2010 to 12K in 2012
  • Magnum Marine 80 (2.4K HP speedboat) – 8.95MM, no change in price between 2010 and 2012, same with Rolls-Royce Phantom (380K) and Bombardier Learjet 40XR (10.61MM)
  • Hermes Kelly bag in calfskin – from 7.3K in 2010 to 7.5K in 2012
  • Courtside-seat ticket at LA Lakers game – from 2.5K in 2010 to 2.7K in 2012
  • One night stay at overwater 1  bedroom villa at St Regis Bora Bora during high season – from 1.33K in 2010 to 1.56K in 2012

krug clos du mesnil champagne

While I will not be purchasing a bottle of Krug Clos Du Mesnil for 1K anytime soon, my wife and I had the pleasure of sharing a bottle of ’96 Henriot ‘Cuvee des Enchanteleurs for our recent 10 year anniversary thanks to a dear friend and a business partner.  Delicious…   Now if only I could afford the Omega Skeletonized Tourbillon Co-Axial Platinum Limited Edition watch…   Here’s to enjoying our slice of finer things in life!

 

 

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Death of the Penny (Part 2 of 3 Part Series)

Sheena Moore, an analyst for our sister site Spend Matters’ popular Friday Latte segment, reported that Canada will no longer produce its pennies citing increasing costs of production and decreasing relevance.  “Pennies take up too much space on our dressers at home.  They take up far too much time for small businesses trying to grow and create jobs,” stated Canada’s finance minister during his budget speech in front of the lawmakers in the House of Commons.

Growing up in Korea, I vaguely recall when the South Korean government ceased production of 1 won coins (~tenth of penny at today’s exchange rate) during the 70’s (yes, I am giving away my age).  Transactions were rounded up to 5 won denomination which caused much ire at the time before 5 won coins faced similar fate.  Now 10 won denomination is the lowest.  Many economists agree that getting rid of pennies won’t pose adverse impact on inflation and that sound policy dictates dismissal of the lowest denomination when raw material used in creation is worth more than the denomination itself.

Indeed, there are many precedents in addition to Canada.  Singapore, Mexico, Sweden, and Israel all eliminated their lowest denomination in the past two decades in a smooth transition.  But just three years ago, businesses in the East Coast were begging for households to break their penny jars when shortage occurred in the marketplace.  Question is, if the US follow Canada’s lead in abolishing our pennies, will it go away quietly like Hungarian forint or will it cause a stir as it did in 1999 shortage or an upheaval as it did during the Reagan Administration shortage?

Editor’s Note – This story really has two major angles that are subject to analysis and debate, and perhaps we’ll spark some further discussion on such topics:

(1)   The production costs of coins have shifted significantly in some countries, largely as the result of price fluctuations in the raw metal commodities that are used in the minting process.  Some nations take the prudent route of changing the metal content of their coins, but the market value of the materials used in coins has spawned cottage industries among coin hoarders, who hope to capitalize on extracting the metals from coins which are (sometimes) worth more than the face value of the coins themselves.  Sovereign control over currency production and laws preventing the destruction of coins serve as a practical limitation on melting down coins, but that doesn’t mean some people aren’t intent upon doing it.  http://abcnews.go.com/Business/laws-change-penny-hoarders-cash-thousands-dollars/story?id=15076522

http://tech.fortune.cnn.com/2012/04/11/penny/

(2)   The second issue is when some countries legislate a unit of currency out of existence, not just stopping the production of coins, but by getting rid of units that are deemed too small to remain practical.  While economists have largely supported the historical efforts of countries to “retire” coins and currencies of negligible value, there is some anecdotal evidence that consumers perceive or experience inflation when coins or currencies are dropped.  How much penny candy can you buy when there are no more pennies?  Some research and analysis of the Euro transition’s effect on pricing and consumer perception shows that there are some potential risks when currencies are transitioned out of circulation.

http://www.princeton.edu/ceps/workingpapers/101mastrobuoni.pdf

http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp588.pdf

Editor’s Note 2 – If economists are quick to dismiss the inflationary effects (real or perceived) of coin abolition on consumers of penny candy, you have to wonder if they’d be as dismissive of the interests of investors in the enormous penny stock industry?  I’m just sayin’…

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