Is the Great Pyramid Game about to Collapse?

Dear PGM CAPITAL Blog readers,

In March 2009, Madoff pleaded guilty to 11 federal felonies and admitted to turning his wealth management business into a massive Ponzi scheme, which he started in early 1990, which defrauded thousands of investors of billions of dollars.

On June 29, 2009, he was sentenced to 150 years in prison, the maximum allowed.

The main reason why Madoff managed to keep this scheme going for so long was, that he worked on the greed in people by showing them high and stable returns that always beat the stock market.

What his clients and prospect clients didn’t realize, until it was too late, that these high returns were an illusion and were realized by using (some) of his customers’ money to pay out these bogus profits.

In the industrialized world, hundreds of millions of working people today contribute every month a large proportion of their income to a Defined Benefit pension fund, in exchange for a promise to retire at a certain age and then live comfortably and warmly with decent medical care, just as they’ve seen their parents doing.

Similar to Madoff’s investors, they don’t realize until it’s too late that the Defined Benefit pension fund, initially worked fine, but isn’t sustainable in the longer run.

When Otto von Bismarck in 1889 introduced the world’s first Defined Benefit pension system in Germany the retirement age was stipulated at 65 and it was based on the fact that the life expectancy of a German man at that time was 66 years.

Today, due to improving living circumstances, better (preventive) care and medication, the average life expectancy in Europe and most Industrial countries is much higher and in many countries it is over 80 years.

That’s the good news. The bad news is that the equation on which the pension fund and premium are calculated is getting out of equilibrium, because the comfortable retirement of those retirees will be paid by a portion of the premium of those who are currently contributing to the fund. This has turned the Defined Benefit pension fund into a pyramid game for which the year 2011 may be the turning point.

Statistics show that in 2011, for the first time, the number of people in Europe who are between 15 and 64 will fall, while we’ll see an increasing the number of people of 65 and above.

This means that the income that accrues by the pension funds will not be sufficient to fulfill the promises of pensions and health care to retirees.

The Economist Jagadeesh Gokhale PhD, an internationally recognized expert on entitlement reform, labor productivity and compensation estimated in a report two years ago that this difference between promises and reality implies the adoption of a sum equivalent to over four times the gross domestic product for the average country in Europe. Or the roughly 48,000 billion Euros for the entire EU.

For the United States he estimated that the hole in the social security amounts 66,000 billion Dollars.

To even come close to balancing the necessary changes is such a radical enterprise, that it is not surprising that politicians are reluctant to roll up our sleeves.

Goldman Sachs estimated in a recent report that the retirement age in Europe must be increased by an average of ten years to close this gap.

An alternative solution might be to start importing young workers at a rate of between three and five percent of the population annually.

In the USA as a part of the Employee Retirement Income Security Act of 1974 (ERISA), The Pension Benefit Guaranty Corporation (PBGC) was created as an independent federal company, to encourage the continuation and maintenance of voluntary private defined benefit pension plans, provided timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at the lowest level necessary to carry out its operation.

The PBGC currently guarantees basic pension benefits for about 44 million U.S. workers and retirees taking part in nearly 30,000 defined benefit pension plans. In fiscal 2010 its deficit rose to an all time high of $23 billion.

During fiscal 2010, the PBGC took over 147 plans from financially ailing or failed employers, up from 144 the prior year. Since 1974, the PBGC has taken over 4,150 plans. In fiscal 2010, the agency paid $5.67 billion to participants in failed single-employer plans, up from $4.48 billion in 2009.

The above give a clear picture in which direction the Defined Benefit Pension plans are going. We believe that current Flat-World and Knowledge Age, Employees must create their own self sustainable retirement arc and that relying on a government or corporation Define Benefit plan might be an obsolete way of thinking.

Last be but not least, before following any investing advice, always take your investment horizon and risk tolerance into consideration and keep in mind that in accordance with former FED Chairman Mr. Alan Greenspan PhD, we are currently living in the age of turbulence and due to this markets can behave un-realistic in the short term and that sharp corrections might happen in the short term.

Yours sincerely

Eric Panneflek

One thought on “Is the Great Pyramid Game about to Collapse?

  • Alas, as I have said so often; it’s the politicians that ruin the economy. What a bunch of short-sighted, egocentric and incompetent fools. As long as they can get re-elected next time around or as long as their name will not be connected with the consequences of a policy that in the short term will cause a lot of suffering, but can save the country/world from total disaster, they will opt for doing nothing. Apres nour le deluge!
    Great. Shall we vote agin next time?

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