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Wholesale Rip-off: Part 4: Blowing Up Pensions

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This is part 4 of our monthly series about how money really moves in America, and thus how the financial services industry rips off average investors.  Parts 1, 2, and 3 are here, here, and here.  This series is a direct result of more than a decade in this industry with a close-up view of the rip-off it truly is.

A Foundation of Quicksand

The fateful day was August 15th, 1971.  That was the day Richard Nixon took the United Sates off what remained of the gold standard.  From that day forward the dollar was a “fiat” currency; created out of thin air and backed by nothing.  The United States government was now able to inflate as much as they desired, and they desired a lot.  For purposes of this discussion the most relevant effect was the destruction of the corporate pension system in the United States.

It is important to understand the role of corporate pensions.  It was considered critical by many elements in society that workers have pensions.  This was addressed in the public sphere by Social Security. (The effects of inflation, demographics and political largesse have destroyed Social Security as well.  It only awaits a final declaration as to a time of death.)  In the private sector this was addressed by corporate and union pensions.  Many of these pensions were set up under pressure from the government.  However, many were set up to attract and retain a productive labor force.  Union pensions are not considered here but face many of the same issues.  It was, however, harder to dump these pensions than it was for non-union pensions.  Also ignored here is the moral hazard created by government pension bailouts via the Pension Benefit Guarantee Corporation.

In the end businesses do not care if compensation is a mix of wages and/or benefits.  Health care, parking, or pensions, it does not matter.  If a worker wants deferred compensation in the form of pension benefits that matters not to management.  What matters to management is that each worker is paid according to their contribution to company revenue.  If it helps attract and retain better workers to offer them pension benefits then companies would be happy to do so, so long as the risk to them was minimal.

For a long while the risk to corporations was minimal.  The dollar was relatively stable so businesses could plan accordingly.  All the planning necessary to fund such pensions is the purchase of an annuity.  This can be done in a stable monetary environment with a present value calculation that will tell a pension plan how much they need to invest now to produce the needed funds later.  This relatively stable monetary environment also worked reasonably well for workers.  They could be well assured that the money they drew upon in retirement would retain its purchasing power and therefore allow them to maintain their standard of living.

All of this was blown up after the United States unhinged its money from gold and began to systematically inflate.  It became increasingly difficult to adequately hedge against monetary fluctuations in the wake of the move off the gold standard.  Price inflation was rampant by the mid-1970s and by the middle of Jimmy Carter’s Presidency it had hit 18%.  Obviously neither the pension plan administrators, company officials or participants could be comfortable regarding the purchasing power of their money in retirement.

A Case Study in Instability

As a further indicator, as to how difficult it had become to navigate monetary fluctuations it is instructive to look at the case of the dollar vs. the Deutsch Mark.  In May of 1972, less than 9 months after the abandonment of the gold standard the D-mark, currency of West Germany one of the United States’ largest trading partners, was worth 3.2 D-marks per dollar.  As the money machine cranked up in the 1970s the value swung violently downward so that by 1980 the dollar was only worth 1.72 D-marks.  In reaction to spiraling inflation, then Federal Reserve Chairman, Paul Volcker slammed the brakes on U.S. monetary growth.  This reversed the downward spiral of the dollar so that by February 1985 it was worth 3.05 D-marks, up 90% since 1980.  Then by September of 1985, due to the Plaza Accord, the United States forced down the value of the dollar in an explicit desire to encourage exports.  This moved the value of the dollar down to 1.6 D-marks by the end of 1987.  This meant a 50% loss of value in less than 30 months.  All told the dollar had lost 50% of its value against the D-mark since 1972 but during this time the volatility amounted to the equivalent of 400 percentage points of gross change.  This violent volatility was unprecedented during the gold standard years.  This phenomenon was true across a variety of currencies during this time. (All this was documented by David Stockman in his book, The Great Deformation, pg. 292-293) This volatility made it difficult for corporations to hedge their normal business operations much less manage pension obligations.

The Final Destruction of Pensions

Add on top of this the fact that the S & P 500 was essentially flat from 1968-1980, due to the stagflation of the 1970s, and you can see why corporations jettisoned pension plans as quickly as they could.

Jettison them they did.  According to the Social Security Administration from 1980 until 2008 the percentage of private wage and salary workers participating in a defined benefit (pension) plan went from 31 percent to 20 percent.  Additionally, many employers have frozen and/or discontinued their pension plans.  Contrast that with the period from 1940-1960 when those covered by such plans went from 3.7 million to 19 million or 30 percent of the workforce.  By 2022 according to the government data only 15% of private sector workers had access to a defined benefit (pension) plan and only 12% had both a defined benefit and a defined contribution (401K) plan.  Even those companies that still have a pension plan, most are not open to new hires, and many are in distress. 

The Pieces Are All in Place

The foundation for the hosing of the American investor had been laid.  A high inflation, easy money policy from the Federal Reserve designed to benefit the upper echelons of the financial world had been fully brought online by 1971.  This resulted in massive instability and volatility in the financial markets causing most corporations to dump their pension plans.  Investors were now faced with managing the bulk of their own retirement funds with no income guarantees when they retired and precious little useful advice during their working years.

Enter “Professor” Harold Hill ready to sell the investor all that they would need to prepare for retirement.  Never mind that if the plan blew up Mr. Hill would be long gone with the investor’s fees safely in his pocket.  It is to the rise of this investment advisory industry that we will turn to next month.

Praise Be to God

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