Greenspan's Real Concern Is the Baby-Boomer Bulge
HEN Alan Greenspan presents testimony to the United States congress, investors invariably focus on the implications for short-term interest rates. They tend to overlook the Federal Reserve chairman's insights into the evolution of capital markets. This is a pity, though it is understandable. Substantial trading positions in the markets depend on in- vestors anticipating correctly the next move in the Fed's interest-rate policy.
Last month, when Greenspan made congressional appearances, US investors were convinced that he was conveying a message that the federal funds target rate would be cut by 25 basis points at the US central bank's policy meeting on 21 August. This was what they believed would happen in any case.
Probably, Greenspan's real intention was to keep his options open and give nothing away. He was more precise in the warning he issued on the longer-term problems facing US policymakers. He foresaw a build-up of claims on resources, as the "baby boomers" retire, that could have serious consequences for the valuation of financial assets.
In the US, the old-age dependency ratio - the elderly population (over 65) as a percentage of the working-age population (20-64) - has been stable in recent years at around 22%. It is expected to rise to 37% by 2030, however, with an especially steep rate of increase between 2010 and 2025. The question is how the living standards of these extra pensioners are to be financed when there will be fewer workers to support them.
There is a debate in the US over whether existing pension arrangements are sustainable. These comprise modest federal provision through the social security trust fund, augmented by substantial private-pension schemes and per- sonal savings facilities. The argument has centred on whether government provision should switch from its present basis - pay as you go - with the US Treasury making good any losses and claiming surpluses. The idea is that better pensions might be provided more cheaply if contributions to the trust fund were invested in financial assets pending their disbursement as pensions. Meanwhile, the fund would benefit from the returns from those assets.
This might work in practice by diverting individuals' social security contributions to accounts dedicated to investment in equities. If this reform were enacted, there would be an initial boost to equity prices since an extra source of demand for equity assets would open up.
Greenspan's point was that it did not really matter how future pension liabilities were financed. Whether or not pension liabilities were funded, they would represent a claim on national income as and when they arose. If the present system were maintained, the federal government would be obliged to meet existing pension promises either by raising contribution rates or by increasing the tax burden.
Should social security trust funds be invested in equities, the income from those holdings would not be available for reinvestment in productive activity but would be earmarked to meet pension payments. …