Can the Age Pension Promise Be Kept?

In the spring of 1899, a Brooklyn bookkeeper, William Miller, persuaded three members of his local prayer group to invest money into his fledgling ‘Franklin Syndicate’.

The investment opportunity would pay a dividend of 10% per week plus a commission for each new investor they recruited.

How could he deliver such returns?

Miller claimed to have inside knowledge on how profitable businesses operated. Due to promised returns from the Franklin Syndicate, Miller was referred to as ‘520%’.

Word spread and investors were clamouring for some of the Franklin Syndicate action. According to folklore, the crush of prospective investors caused the staircase to Miller’s office to collapse.

In due course, the Franklin Syndicate suffered the same fate as the staircase…it too collapsed.

Miller’s scheme defrauded investors of US$1 million (and that was 1899 dollars). Miller was convicted of grand larceny and sentenced to 10 years in jail.

Miller’s infamy was short lived and long forgotten.

Whereas the 1920s ‘investment opportunity’ operated by Charles Ponzi, made his name synonymous with pyramid schemes.

A pyramid scheme is a business model that recruits members via a promise of payments or services for enrolling others into the scheme, rather than supplying investments or sale of products. As recruiting multiplies, recruiting becomes quickly impossible, and most members are unable to profit; as such, pyramid schemes are unsustainable and often illegal.

Pyramid schemes have existed for at least a century in different guises. 


Pyramid schemes are doomed to fail

The reason pyramid schemes are doomed to fail — sooner or later — is it comes down to simple mathematics.

The apex needs to be supported by a compounding base.

Eventually (even if the promoter snares every single person in the world into their trap), the scheme runs out of people. When the base can no longer be expanded…it collapses.

Port Phillip Publishing

Source: Wikipedia

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While it seems like an ‘open-and-shut’ case on how simple maths dooms pyramid schemes to failure, there is one complexity the graphic does not capture. More on that shortly.

In 1889 — a decade before William Miller launched the ‘Franklin Syndicate’ — German Chancellor Otto von Bismarck introduced the world’s first nationwide system of social insurance.

The system was legislated into existence after Germany’s Emperor William the First wrote to Parliament, stating…

…those who are disabled from work by age and invalidity have a well-grounded claim to care from the state.

The eligibility age for the original scheme was 70.

The good intent of the German parliament — to look after its nation’s elderly — was the very thin edge of the entitlement wedge.

Governments in the developed world gradually followed Germany’s welfare model.

The cynically minded suggest the intent was not always pure. Perhaps politicians were less interested in the well-being of society and more interested in buying votes. Surely not.

In Australia, Age Pension schemes were first introduced in 1900 by NSW and Victorian state governments prior to Federation.

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After Federation, the various state schemes were amalgamated and administered by the Commonwealth.

According to the Australian Bureau of Statistics (ABS) (emphasis is mine):

The Commonwealth of Australia was formed on I January 1901 by federation of the six States under a written constitution which, among other things, authorised the new Commonwealth Parliament to legislate in respect of age and invalid pensions. In the event, the Commonwealth did not exercise this power until June 1908 when legislation providing for the introduction of means-tested ‘flat-rate’ age and invalid pensions was passed. The new pensions, which were financed from general revenue, came into operation in July 1909 and December 1910 respectively…

The new pension was paid to men from age 65. It was paid to women at age 60, but not until December 1910.

Nations all adopted different funding models.

In Australia’s case, pensions were originally paid from general (tax) revenue.

In other nations, the welfare model required payment into a designated ‘pension’ account.

Australia (briefly) introduced this model in 1945, but then abandoned it five years later in 1950.

Whichever way you slice and dice it, the majority of welfare payments — whether there’s a designated ‘National Welfare Fund’ or not — are made from annual tax receipts.

The French system is indicative of this (emphasis is mine):

The mandatory state pension is an unfunded contributory pension based on redistribution of contributions from those working to those in retirement. The scheme aims to provide up to a maximum of 50% of the retiree’s income during their highest earning years up to a limit of €35,000 annually (in 2010).

The state scheme is financed by a payroll tax known as “social security contributions”…


The greater the level of promises, the greater the taxes

While the tax may have a specific name — like, social security contributions — it actually gets paid into a pot for ‘redistribution of contributions from those working to those in retirement.

In essence, social security is a giant Ponzi (or if you prefer, Miller) scheme…a business model that recruits members via a promise of payments or services for enrolling others into the scheme.

The meeting of promised payments is conditional upon an ever-increasing base of ‘enrolled’ taxpayers.

The greater the level of promises, the greater the taxes (and/or government borrowings) that are needed to honour the social contract.

And the cost of meeting those promises has risen dramatically since Otto von Bismarck’s days:

Port Phillip Publishing

Source: Our World in Data

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How has this global Ponzi scheme survived (prospered and expanded) where Miller, Ponzi and Madoff failed?

This is where the simple maths of your typical pyramid scheme becomes a little more complex.

The Pyramid graphic is an illustration of a snapshot in time. It’s based on the number of people living in the world at that moment.

But what if there was a constant source of new recruits? The base numbers are now dynamic rather than static.

The welfare system promises, that in return for paying taxes in your youth, there’ll be a payment awaiting you in your latter years.

The timeframe for making good on this promise is measured in decades.

Pension promises will be pared back

Which means the ‘enrolment’ of new contributors is not limited to only those living at the time the promise is made.

Future enrolees to the model are not yet conceived. Tomorrow’s base has no idea what they’ve been forcibly committed to.

In theory, the longevity of the model is assured while there’s a new generation waiting to be born…in sufficient numbers.

The traditional Ponzi scheme exhausts itself within a few years due to the static nature of potential new recruits.

Social security’s pyramid operates on an evolving and dynamic model — one that adds future generations to its base.

But that base is in decline. Birth rates in China and the developed world are now under two and falling.

Port Phillip Publishing

Source: Our World in Data

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In the years ahead, the steady decline in the birth rate is going to play havoc with the welfare pyramid scheme.

The Mercer Global Pension Index 2020 report gives us a glimpse into what the future holds for retirees (emphasis added):

The economic recession caused by the global health crisis has led to lower pension contributions, reduced investment returns and higher government debt in most countries. Inevitably this will reduce future pensions in retirement. This will mean some individuals will need to work longer whereas others may adopt a higher level of investment risk for their savings or have to settle for a lower standard of living in retirement.

If something cannot continue, then it won’t. Little by little, pension promises will be pared back.

If you plan to spend 20, 30 or possibly even 40 years in retirement, then be sure you have capital reserves available to draw on in your later years.

Otherwise, be prepared to settle for a lower standard of living in retirement. Possibly, much lower than you envisaged when you retired.


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

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