Monday, 10 February 2014

Generational betrayal

This article was piublished in The Malta Independent on Sunday 09 02 2014

Every time I deposit my pension into my bank account, I get mixed feelings.

Graduates celebrate during commencement at Yale University in New Haven, Conn., Monday, May 23, 2011.  (AP Photo/Jessica Hill)
US graduates celebrate before
being crushed by loan repayments.
Malta education system is social
and sensible avoiding the worst forms
 of generaltional betrayal.
On the one hand, I have worked for nearly 45 years and have contributed substantially to the national coffers through direct taxation, national insurance contributions and indirect consumption taxes. So part of me feels a certain degree of entitlement to the pension.

On the other hand, I feel that I form part of a generational betrayal, which the democratic force in numbers of the baby boomers generation is imposing on its successors. Let me explain.

As those born between 1945 and 1965 – the decades following the end of World War II – reach pensionable age, the unfunded pension systems of most European states, including Malta, will feel the stress of a larger number of claimants and a reduction in the number of contributors. The ratio of pensioners to economically active contributors will fall, thereby making it difficult for subsequent generations to keep the system sustainable.

The baby boomer generation has been extremely lucky. We have lived through a period of peace and unprecedented economic development, during which the standard of living has increased beyond anyhting previous generations could only have hoped to aspire. Now, the baby boomer generation feels entitled to retire and draw on social security and public health service benefits for a period much longer than any actuary could have imagined when the contributory systems to such entitlement schemes were initially designed.

This is leaving a legacy of huge public debts and enormous future obligations to subsequent generations. It is the result of short-term economic management, where development was based on consumption rather than investment and on credit rather than on savings, leading the baby boomer generation to benefit from higher entitlements and lower taxes; even during their economically active life.

Furthermore, baby boomers benefited from rising asset prices. The homes they bought with pennies are now worth tens of thousands. Their savings in financial assets have also grown, provided they were carefully managed.

The younger generations must now contend with our legacy: a rising deficit that cannot even be reduced through privatisation revenues, as whatever could be has already been privatised. So the younger generation face the prospect of higher taxes to keep the deficit from exploding beyond the point of no return (somewhere between 90 and 100 per cent of GDP for most economies) and has to suffer austerity measures, including reduced entitlement benefits coupled with the need to show more flexibility in their work practices to bolster productivity.

I therefore feel somewhat ashamed that my baby boomer generation – unlike our predecessors who made great sacrifices, having experienced two world wars in the first half of the 20th century – is not leaving a better world for our successors.

Faced with a dire situation caused by the betrayal of the baby boomer generation, maybe it is worth considering that part of the re-balancing ought to be made through the toleration of higher inflation. A few years of inflation at four per cent would be very effective in transferring wealth from the retiring baby boomer generation (who normally have interest-bearing financial assets and no debts) to the economically active younger generation (who normally have real assets bought at high prices and financial debts). Maybe it is the only way by which to lighten the debt-burden being imposed on future generations and to avoid a general depression where everyone would be a loser.

Yet, at least in the EU, we seem to be heading in the opposite direction, as inflation falls dangerously below the two per cent target and approaches zero, where disinflation will turn into deflation, where the general level of prices not only rises more slowly but does not rise at all with the risk that if prices start falling, the economy will be trapped in a negative spiral as consumption is deferred once people perceive they can buy cheaper tomorrow.

Some eurozone countries are dangerously close to such a situation and the assurance given by the ECB this week that it does not see a risk of deflation seems optimistic. Without the wheels of credit creation working efficiently, there can be no sustainable economic growth and monetary policy will remain sterile as the channels for transmission of the interest rate policy will remain blocked. Without banks operating smoothly to deliver credit to SMEs who create jobs, economic growth will remain anaemic. Even if deflation is avoided, real recovery will take unduly long and unemployment will remain a chronic problem.

Banks must be recapitalised so that they stop acting like zombies and start acting as real banks, seeking to lend money profitably rather than being obsessed with how to reduce their balance sheets. In many EU countries, investors are not prepared to put new money in bank capital. They have been burnt these last few years with harrowing equity losses and do not see a clear indication of how any new investment in bank capital will be sufficiently profitable. Countries are indebted up to their ears and can hardly be expected to borrow more to fund bank recapitalisation. The ESM mechanisms to recapitalise banks are subject to strict conditions, making it practically impossible to access.

Yet the ECB is proceeding with an Asset Quality Review (AQR) of the main European banks which, if done rigorously (as otherwise there is no purpose of doing it in the first place) could expose gaping holes in banks’ capital requirements without having a ready source to address such capital deficit. All the pieces are in place to create a dangerous destabilisation of the EU banking markets.

One hopes that, as we get nearer to the results of the AQR, politicians will become more sensitive to these risks and will simplify the procedure whereby the ESM can use its resources to recapitalise banks that are under-capitalised but not insolvent.

And if this process has to involve some European version of quantitative easing or monetisation whereby the ECB, through its monetary policy can do what the EU as a group and many countries as separate countries are unable to do through fiscal policy, then so be it.

The typical German argument against such monetisation is that it could let the inflation genie out of the bottle. But the current problem is the opposite. It is disinflation not inflation. Even if such looser monetary accommodation were to reverse the current dangerous trend and deliver inflation somewhat above two per cent, it would not be the end of the world. As former governor of the Bank of England Mervyn King said, traditional monetary policy alone cannot right all that is wrong in the economy and circumstances may arise where monetary policy will, for the common good, have to tolerate somewhat higher levels of inflation. It is simply the choice of the lesser evil if the alternative is an endless recession.

Somewhat higher levels of inflation could also put right the generational betrayal where, for the first time, many EU countries see the prospects of the upcoming generation being less well off than their parents.

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