The state of Tata Steel UK’s pension fund, as the company tries to unload its British operations, highlights the extraordinary uncertainty surrounding the valuation of pension fund liabilities in a world of low or negative nominal bond yields. The former British Steel pension scheme reportedly has £15bn of assets and a deficit of £485m. That deficit is a gigantic poison pill for any buyer of the businesses. If a way can be found to square EU rules on state aid, there would be a case for government underpinning via the Pension Protection Fund. But how onerous would that be for the British taxpayer?
It is impossible to know. In the short and medium term, the deflationary forces in the world are such that the actuarial discount factor used to value the liabilities will remain at historically depressed levels, keeping the liabilities high. Where the trajectory of interest rates is concerned, the current market mantra is lower for longer. Yet the British Steel fund saga provides an opportunity to explore potential flaws in the conventional wisdom and the circumstances in which interest rates might rise sooner than investors or central banks expect.
The starting point is the global savings glut, which is an important cause of the long decline in bond yields since the mid-2000s. China and Japan explain much of the glut and it is not difficult to put a case that their behaviour will change.
In China, official reserves have been running down. Having peaked at close to $ 4tn in 2014 they fell to $ 3.2tn this February.
The economy is shifting from excessive reliance on investment and exports towards consumption. Because Beijing fears the social instability that could come from a bumpy transition, this will not be rapid. Yet the current course, involving continuing investment in industries with surplus capacity — the prime cause of Tata’s woes — and ever-increasing debt is not sustainable. Change is inevitable.
Japan is trickier. It suffers from underconsumption and excessive corporate saving. Devaluation of the yen is the only part of Abenomics that has had much impact. Yet that has perversely benefited the corporate sector at the expense of households. A deflationary mentality is entrenched and too little of the structural reform that is needed to raise the growth rate is happening. There is nonetheless a point at which even the Japanese, when in a hole, will stop digging and address the real problem.
Dissaving in these two countries could contribute to more robust global economic growth. It is possible, too, that as central banks’ unconventional measures show a diminishing capacity to stimulate growth, developed-world governments will finally seize the opportunity presented by rock-bottom interest rates to invest in badly needed new infrastructure. A higher-growth world would, incidentally, resort less to competitive devaluation and the currency wars that have been a big driver of the move to negative interest rates.
The final point is that demographics are about to reverse the disinflationary trend that has been in place since the 1980s. The ratio of the old to people of working age is set to deteriorate, so there will be friction between workers, who have labour market power, and pensioners, who have political clout. If pensioner power inflicts higher taxes on workers to support today’s relatively generous levels of pensions and healthcare, workers will demand higher wages.
Among the forces pushing interest rates higher will be employers’ desire to invest to restrain labour costs and a decline in savings as a larger retired population spends more of its income. That will all bring us back to a world of less marked inequalities of income and wealth, as higher interest rates restrain asset prices and the share of labour in national income rises at the expense of profits.
There is enough here to indicate how interest rates might revert to something closer to the historical average and make pension liabilities, including those of the former British Steel scheme, more manageable. Yet asset prices may take a hit. And the timing of such a move is impossible to predict.
A further worry is that the transition could be painful, notably in China, where rebalancing presents a huge challenge, and Japan, where the retreat from extreme monetary policy could be very messy. But do not discount the possibility that rates could be lower for less long than the markets now assume.
John Plender is a columnist at the FT
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