If one were to ask if GDP, that is Gross Domestic Product, was growing and at what rate the data would be confusing at best. The worst part of relying on GDP as a measure of economic expansion or retraction is that expenditures by the local, state, and federal governments is added into the equation. GDP is equal to C, the sum of consumption plus I, investment or savings (which is a form of investment) plus G, government spending, and X-M, which is net exports or exports minus imports. The variable, G, is the real joker for it does not matter if government spending reflects solely the expenditure of taxes collected or includes debt borrowed for the purposes of spending. But then the variable C does not distinguish between wages spent and any corporate and consumer debt spent. Indeed, that is one of the problems with trying to calculate GDP, one never knows how much borrowed money or debt (what one might call future GDP spent today) affects the measure of an economy. We simply assume that an increase in GDP must be a good thing even if it is the result of government borrowing and the spending of that debt. If the governments spend enough borrowed money then they may report that the health of the economy is good.
But should the government find itself unable to borrow more money than how would that reflect the state of GDP? What if the government could only spend tax revenues minus service on current debt (I do believe that the current debt may have reached to large a sum that could be repaid on any easy credit payment plan). Then we might see GDP take a severe plunge due to that reduced spending and the servicing of the current debt. We cold even see a reduction in economic activity, a deflation in general prices and a deflation in assets. Why would this cause trouble for Pensions? After all, aren’t the contributions invested in financial instruments that increase in value and thus deliver a high rate of return? That is the current wisdom, high rates of return mean that what might have been underfunded pension plans will deliver those returns that make sure the payments to retirees will always be funded or made.
Let us for argument consider that our pension plan contributions are being made on a regular basis and our yield from a bond fund gives us that expansion to fund all pension payments. Sounds good, why should we worry about our future pension payments? What do we know about our various local, state, and federal governments? The number of government jobs or general employment has increased in the past twenty years. True, we had some government layoffs (not federal, for people are seldom laid off from federal positions), usually in school, fire, police, and agencies in the late 70s and into the 80s. But all that is in the past. Since 1985 the fastest growing sector of employment has been the various government agencies. In police forces alone our various government agencies had created their own police forces. The Federal Reserve has their own, so does the Justice department (separate from the Federal Marshals and FBI), congress and various other agencies have them, it is amazing just how many federal police we truly need to keep our government and its employees safe from whatever outside harm that may come. But police aren’t the only ones. The NSA, the CIA, and HLS (Home Land Security, think air travel) have added a great many employees. Right now, total local, county, state, and federal government workers slightly outnumber the private sector employment. One might call these salaries transfer payments since the work tends to be non productive. That is, no one buys the output of such employment.
But back to pensions. Oh yes, when one increase the number of employees then one increases the number of payments for future pensions and defined benefits. But there is another problem. And that is public service unions. The wage or remunerations keep increasing, better known as wage increases and this inflates future pension payments. The question is whether the employer contributions increase as well? Well, that is a sticky wicket. After all, few employers actually pay in the true cost of pensions in the future. That is why all pension plans have lobbied for less strict rules for both contributions and investment options. We know that for many decades that corporations often supplied shares of their stock in lieu of actual monetary compensation. One of the more restrictive rules involved what forms of investment were available. If one chose to buy bonds to fund the pension fund then those bonds were limited to a minimum class A rating (class AAA being the highest rating in safety). Any other investment was considered too risky. And normally a to AAA bond usually paid about 3, maybe 4 percent per annum. It was a very conservative investment for these monies must be available in the future, all things being equal.
Ah, but was just the point, all things were never going to be equal. As long as defined benefits kept increasing in a relative monetary way and as long as pension payment were linked to the last five highest years of yearly wage or salary and that wage or salary kept increasing as well as being augmented by overtime and other payments, then an employer would never contribute enough money to the pension funds. Well, we could always relax our investment standards and let the pension funds chase high yield investments and returns, but high yield is also high risk and sooner or later one is caught holding the bag of bad investment and losses. A c rated corporate bond at 10% coupon rate and selling at a discount so that the yield became 15% had little probability of being repaid let alone continuing the service payments on the coupons.
The fact is, so many of the current pension funds in both the private sector and the public sector minus the federal pension funds which are funded by the tax revenues collected, are on firm foundations. With the corporate and consumer debt overhang, to say nothing of the various government debt overhangs, the pension funds are literally depending on a no default future. But as the debt bubble comes to a bursting point we see that such an expectation is unreal. High interest rates on debt instruments indicate the higher risk of nonpayment. Doubling and tripling the P/Es of stock issues means that corporate profits must not only grow by expansion of the business but must grow as a percentage of the increasing revenue minus costs. How many electric utilities which serve the public at large and are governed by State Public Utility Commission and thus have their profits limited to usually no more that 10%, that is revenue minus costs. are selling at P/Es in excess of 20? What kind of idiocy is this? Clearly the stock market is vastly oversold and any profits to be made will be, for the most part, on price speculation. The Calpers pensions are underfunded by 40 to 50 percent. Many other state pension funds are in the same boat. I doubt that there is any state pension fund that is funded at more than 85% and most are considerably below that. But they invest in state and municipal bonds. We are seeing more and more cities start to declare bankruptcy and thus default on their bonds. These are not isolated occurrences but will become increasingly more common. Do you really think the taxpayers are going to do the “right thing” by these government employees and not only keep the high pension payments and defined benefits but support ever increasing wage contracts? Why should I empty out my pockets and eat dog food just so some public employee or retiree can eat steak and lobster every day? With my own pension in jeopardy why should I secure some civil servants high on the hog living? Its coming friends and whether one supports democrats or republicans, any of those politicians that want me to be their bonded slave to their lifestyle is going to lose votes. Don’t believe those stupid polyannas who say that pensions are not in trouble. Do the math and watch the economy. The give aways can’t last long.