Vaccination, inflation, retirement provision, shares

At first glance, these four terms have nothing to do with each other. Nevertheless, they are linked through the influence of politics. The topic of "vaccination" has now become a hot topic. Nevertheless, we will shed light on it in order to describe the fundamental approach of politics in Germany, which we hope has become clear to everyone during the coronavirus crisis.

This topic is particularly relevant because the state is exercising its considerably increased influence on the economy and society with a certain zest for action, but currently without the necessary expertise, which we will demonstrate, and will unfortunately place an increasing burden on the economy as a result. It is also interesting to take a comparative look at other countries. We will place a certain focus on the analysis of funded pension provision, as this is an area in which the lower and middle income groups in particular are negatively affected if political influence is exerted incorrectly, just as with the corona issue.

A. Vaccination

The most important and unfortunately unpleasant insight from the German state's handling of the organization of the vaccination of citizens is that our long-held and loudly voiced suspicion that our government is a completely strategy-free event has been fully confirmed. The UK under Boris Johnson and the US under Trump pursued strategies with Brexit and the trade war that have certainly done their countries more harm than good, including their initial ignorance of the pandemic. Immediately after the discovery of a vaccine, however, there were people somewhere in the government apparatus of these countries who understood the importance of quickly purchasing and deploying the quantities of vaccine needed to contain the pandemic and acted accordingly, with the result that 41% of the population in the UK and 35% in the US have already been vaccinated (Germany, France, Italy, Spain approx. 11-12%). One reason for this success, apart from the right strategy, is certainly the fact that people with a business and military background were involved in the implementation. They are no strangers to strategic action. Accordingly, they understood that ending the pandemic quickly was far more important than the question of whether to pay $4, $12 or $47 per dose of vaccine (this is how much the Israelis are said to have paid, having now vaccinated well over 50% of their citizens). These governments were also indifferent to the liability of vaccine manufacturers in the event of vaccine damage; they were prepared to assume this liability themselves. So they acted strategically in these countries by comparing the cost of vaccination with the economic damage caused by a prolonged lockdown and came to the conclusion that the vaccine was cheap at the prices per dose mentioned, especially if delivered quickly. In the EU (and certainly in Germany), on the other hand, the supposed desire of voters to avoid wasting money and hedge against any risk has been prioritized; we see the result today. In continental Europe, the next lockdown is just beginning.

In addition to this lack of strategy (or rather: refusal to adopt a strategy), there are also intellectually fascinating weaknesses in the details. Just one example: After the vaccinations started in Germany, my digitally experienced and talented sister tried to get an appointment for our 90-year-old mother. After a few days of futile efforts and waiting on the hotline, she delegated this task to her even more digitally gifted son, who then somehow managed it. My mother would never have managed it on her own; she doesn't have a computer or a smartphone - she wouldn't even know what they are. Apparently no one in this government had the idea of simply giving the over-80s a fixed appointment by letter - my mother knows her way around letters - and providing a hotline number just in case someone is not available at that time. In January 2021, the coronavirus risk groups were neither on Malle nor shopping or with family (adult children were allowed to visit their parents, but not parents their adult children), they were all at home. Customer-oriented entrepreneurs would have thought of this.

B. Rent cap, Berlin Airport BER

There are too few affordable rental apartments in Berlin. In the eastern part of this beautiful city, people asked in GDR times what would happen if socialism came to the Sahara. The answer was: nothing for 10 years, and then the sand would run out. On Berlin's rental housing market, it only took a few months after the introduction of the rent cap for only double-earning senior doctor couples (preferably childless) to have a chance of finding one of the rarely available rental apartments. A housing shortage can only be eliminated through housing construction, but it is precisely this strategically correct path that Berlin's politicians do not want to take, because a rent cap can appeal to many voters emotionally in the short term and, in view of the now exacerbated housing shortage, they can continue to insult the "rich" landlords. So this is not just a case of incompetence and soft populism, but a problem is being willfully left unsolved. According to the wishes of several parties, the rent cap is now to be introduced nationwide. This even surpasses the much-lamented inability of the German government to learn from the successful examples of other countries when it comes to vaccination and testing, in that the whole of Germany is to learn from Berlin. Deliberately damaging the profitability of investments reduces the supply (here: of rental apartments) and thus increases the long-term inflation risks. It is precisely this approach throughout the economy, initially to the delight of voters, that has brought hyperinflation to Venezuela. The successful and sharp-tongued French statesman Charles Maurice de Talleyrand (1754-1838) would have said: "This is more than a crime, it is a mistake".

Berlin's politicians have caused the disaster of the new BER airport just as willfully. Originally, the construction was to be carried out by professionals, namely the listed company Fraport. Then they had the disastrous idea of scoring points with voters by not leaving the expected profit from this business to greedy entrepreneurs. The result is well known, as are the financial losses, which of course ultimately have to be borne by the voters. Incidentally, I own neither rental apartments in Berlin nor shares in housing companies investing in Berlin.

C. Funded pension provision

Now we come to an equally obvious and, in the long term, equally relevant problem area: funded pension provision in Germany.

More than other comparable countries, the German state has a duty to help citizens with low or medium incomes to accumulate assets in order to compensate for the gradually diminishing capacity of the pay-as-you-go pension system in the future. In no comparable country does the marginalcountries does the marginal burden of taxes and social security contributions exceed 55% for low incomes and an incredible 60% for middle incomes. With the exception of Sweden, even high earners in countries such as Switzerland, the UK, the USA and Spain, as well as in Germany, are subject to a significantly lower tax burden than German low earners as their income rises (source: Manager Magazin, August 2020, p. 104). Private wealth accumulation is therefore not possible for many Germans without state assistance.

Almost 20 years ago, the Riester pension was introduced in Germany as a component of a funded pension scheme due to the demographic trend that was already known at the time. However, the number of current Riester savings contracts has stagnated since the middle of the last decade. The main reason for this is that the interest rate on long-term government bonds in Germany fell below 1% for the first time in 2014 and has continued to fall to this day. It is no coincidence that in 2015, three state politicians in Hesse proposed the introduction of a Deutschland-Rente, a predominantly equity-based funded supplement to the statutory pension scheme (GRV) managed by the state at low cost, based on the Swedish model. However, the financial industry lobby quickly managed to banish the topic from the minds of politicians and the media. The money saved with Riester contracts is predominantly invested at high cost (in favor of the financial industry) in ("safe") government bonds and other extremely low-yielding bonds. As a result, since the fall in interest rates, the state allowances are no longer sufficient to generate significant returns after deducting the high sales and administration costs. There has therefore been an urgent need for several years to increase the profitability of funded pension provision in Germany. And - like vaccination and testing - this is so easy that other governments have managed to do it, for example Sweden, whose politicians have taken a strategic approach to the issue. They have researched the suitability of investment vehicles and come to the right conclusions.

The following chart shows that government bonds only generated a significant real total return (interest income + price gains after deduction of the inflation rate: + 6.7% p.a.) on a global average in the years from 1984 to 2020. They were therefore suitable for retirement provision during this period. In the 84 years from 1900 to 1984, however, the annual real total return only reached an extremely meagre 0.18% p.a.

As will be shown, this was not an unfortunate and irrelevant coincidence for the future. However, during this difficult period, which was characterized by two world wars, various hyperinflations and the Great Depression from 1929 to 1932, equities were still able to generate a real total return (dividend payments + price gains minus inflation) of 4.5% per annum. With returns of this kind, the purchasing power of a globally diversified equity portfolio would increase by 280%, i.e. almost four times the amount paid in, over a period of 30 years relevant to retirement provision, while government bonds would have achieved a barely noticeable increase in purchasing power of 5.5% (in total after 30 years, not per year!).

These excess returns on equities were even achieved without increased risk (see table).

The three worst investment periods for equities and bonds

The chart also shows the enormous long-term risks of government bonds for investors who have concentrated their pension provision on the bonds of a single country or currency. German government bondholders have suffered a total loss in purchasing power of 78% since 1900, Italian investors 70% and Japanese investors 58%. In the meantime, losses in Germany and Japan have reached almost 100%. The objection that this is due to two world wars and therefore cannot be taken into account for future calculations does not apply for two reasons. Firstly, in a world in which new "cold wars" have emerged, for example between the USA and China or the EU and Russia, sharp increases in military spending cannot be ruled out in principle. Secondly, even Germany, which is supposedly so solidly financed, is in a far worse financial position than is generally assumed. Even if you add the German state's unfunded pension obligations of around €2,000 billion for its civil servants to its officially reported debt, the national debt rises to over 100% of national income. Every company in Germany is legally obliged to do this, but not the state. If the mandatory future state contributions to the statutory pension scheme (already €100 billion in 2020, and rising) and to the demographic-related increase in healthcare costs were also included, this would significantly exceed 200%. This was already shown by the generational balance sheet of the Market Economy Foundation in July 2019. Therefore, the enormous losses shown above, which investors have already suffered twice with German government bonds, are by no means likely in the future, but can no longer be completely ruled out.

Compared with government bonds, the figures for the three worst stock markets over the last 120 years look much better. In real terms, wealth has increased 11-fold in the Italian stock market, 40-fold in Spain and 44-fold in France; on average, investments in the stock markets of the 16 countries considered have increased 754-fold.

Capital market theory says that investment forms with higher returns also have higher risks. This applies to short-term 1-year considerations: the large blue dot (government bonds) in the following charts shows a low real return (2.1% p.a.) and a low risk (12.5%); equities have a higher real return of 5.7% p.a., but also a higher risk (horizontal axis).

However, this is not the case with regard to long-term risks, as already shown above using the phases of maximum declines in value.

That is why you can see below once again the returns and risks of shares and government bonds over the last 120 years in - and this is the crucial point for retirement provision - 10-year periods, because the short-term risks are completely irrelevant for retirement provision.

Now the red dot is slipping much more to the left than the blue one. Equities still have the high real return of 5.7% p.a., but their risk is now even lower than that of government bonds. In addition, the two charts on the right show that international diversification also makes a lot of sense for equities. In both charts, the average return (large red dot) is in the upper area of the small red dots and also far to the left (low risk).

This shows the absurdities of state-regulated funded pension provision in Germany. Providers of life insurance policies and also capital-guaranteed Riester contracts have to pay attention to short-term fluctuations because of the guarantee to repay at least the amounts paid in at the end of the contract. This made some sense when interest rates were in the mid-single-digit range and pension assets invested primarily in (government) bonds could actually ensure both a guarantee of the contributions paid in and a moderate return on capital. However, as the charts above show, even in the interest-bearing past, equities were far superior and also less risky.

Governments such as the Swedish government, which have thoroughly addressed the issue of sensible pension provision, have of course been able to recognize this fact. Their extremely successful, almost cost-free equity-based pension product AP7, which has been the largest and for years the most profitable equity fund in Europe since August 2020, is fully invested in equities without any guarantee. Sweden has therefore acted strategically. A problem has been recognized (in Germany at the latest since 2014) and, after analyzing the facts (high returns and low long-term risks only with globally distributed equity investments), the clear and simple conclusions have been drawn. Cost burden plays a major role here (more on this later, because our government has already failed on this really simple point; as so often, it listened to the advice of the financial lobby instead of thinking for itself). In Sweden, only particularly low-cost funds may be used, and an investor who is unable to make a decision due to a lack of knowledge automatically invests in the above-mentioned extremely low-cost equity fund managed by the state. The practical details for successful implementation have therefore also been thought through (see "Vaccination", last paragraph).

We at FINVIA create the data analyses for this in a few hours. Why don't the thousands of academically educated civil servants at the Ministry of Finance or Economics or the Bundesbank do it? Instead, at the beginning of last year, our finance minister, now designated SPD candidate for chancellor, who wanted to become SPD chairman at the time, stood in front of his party members and announced that he would not buy shares but would put his money in a savings account. Either he is incompetent or populist; he probably believes that decent Social Democrats reject shares as gambling securities for rich speculators. This is no way to contribute to the wealth creation of the "little people", just as the rent cap does not harm the wealthy Berliners, but especially the low-income earners who are looking for an apartment. The months of haggling over the price of vaccines and liability risks in order to flatter the German saver's soul instead of buying quickly and in bulk is on the same intellectual level. Here, too, the low-income earners are particularly damaged because, unlike the "higher earners", they are often unable to work from home.

The question now arises as to whether results from the past can be transferred to the future.

In his ground-breaking book "Inquiry into the Nature and Causes of the Wealth of Nations", published in 1776, the founder of economics Adam Smith explained why capital invested in companies yields a higher return than bonds or loans. According to this, the entrepreneur only invests his capital in his company if the achievable price for the goods or services he offers not only reaches the production costs, but also includes an appropriate reward for the risk. Otherwise, he prefers to lend his capital at fixed interest rates. But then there is less supply for these goods, the price rises and the entrepreneurial activity is worthwhile again. That says it all. The expected return on entrepreneurially invested capital must be higher than that of fixed-interest securities, otherwise there would be neither entrepreneurs nor stock corporations, as the deterrent examples of the Soviet Union and Venezuela have shown. The fact that the long-term risk of fixed-interest securities is even higher than that of shares is due to the global introduction of paper money a good 100 years ago, the circulation of which is greatly expanded by governments in times of financial stress, first during the First World War and most recently during the coronavirus crisis, which resulted in inflation risks unknown before the First World War and will continue to do so in the future.

We now show how the superior profitability of equities in the past would have affected a funded pension plan over the last 45 years at different cost rates, and then analyze what results should be expected in the future. Looking to the future - which is always uncertain - is an essential part of any strategy. The British ordered vaccines before they knew whether they would be approved. Let's start with a calculation by financial analyst Volker Looman from the FAZ newspaper on May 19, 2020. For an employee whose income has exceeded the contribution assessment ceiling of the statutory pension insurance (GRV) since 1975, i.e. who receives the maximum possible pension, he notionally invested their contributions (employer and employee share) in the DAX for 45 years. The proceeds were then divided equally over the remaining life expectancy (24 years) and the result was that this pension is more than twice as high as the maximum GRV pension (€ 35,124 p.a.). In addition to the assumption that the SPS pension will grow by 2% p.a., we have added the unavoidable cost factor of 0.11%, which is the cost of the Swedish AP7 fund, plus 1% and the 2% given by many Riester contracts. We have also carried out the calculation using the REXP (index of price changes and interest yields on German public bonds):

It can now be clearly seen that even under the conditions of the last 45 years, in which the REXP has increased by 5.9% annually, only an almost cost-free state fund with a cost rate of 0.11% with German government bonds with a cost rate of 0.11% would have provided the same pension as the GRV (102% in the table above). Privately priced funds (expense ratio 1% or 2%) could only generate 81% or 63% of the statutory pension. Pure DAX funds, with a DAX performance (compared to the REXP) of 7.4%, which is only 1.5 percentage points higher p.a., still managed to generate 18% more pension than the GRV, even with a 2% cost burden. Even with this small difference in returns compared to equities, government bonds were therefore unsuitable for expensive Riester contracts. Incidentally, roughly half the amounts in the tables above apply to average earners. This means that an average earner would not have paid more than €900,000 in fees (€2,267,652 minus €1,332,015) like a "high earner" with a top pension at 2% costs in the DAX portfolio, but would still have paid almost half a million € less wealth in old age than with a low-cost government solution. Ignoring the cost side was a serious political mistake.

In future, the yield gap between equities and bonds will be much greater. The two charts below show that 78% of the performance of German government bonds over the next 10 years can be explained by the current interest rate level alone, namely currently around 1.5% (right chart) before costs and inflation.

For equities, a similarly good forecast quality (77%) is obtained for the performance estimate of equity investments (example: Europe) for the next 10 years, whereby the valuation of equities relative to cash flow (gross profit without depreciation or provisions), i.e. the price/cash flow ratio, is used here. On the basis of current cash flows, which are depressed due to the coronavirus, the expected return is 4% p.a.. However, as it is highly likely that the decline in earnings will be made up for in the next few quarters, the performance expectation for Europe is 6% p.a. for the next 10 years. The figure is even slightly higher for Japan and the average of the emerging markets and slightly lower for the USA, meaning that a global return expectation of around 6% p.a. (green arrow in the right-hand chart) is realistic for the next 10 years.

If these expected returns are incorporated into the above calculation (with the bold assumption that the performance of the SPS will be just as good in the future 45 contribution years as in the past 45 years), it can be seen that a low-cost sovereign wealth fund with a portfolio invested entirely or predominantly in equities will generate significantly better pension payments than the SPS, especially as the benefit level of the SPS is - as already mentioned - significantly overestimated here. Government bonds may only make up a small proportion at most of a funded pension scheme; otherwise, such a supplement to the SPS does not make sense regardless of the cost rate.

These purely statistically determined return expectations should be supplemented by a few historical aspects. The performance of government bonds was extremely low worldwide during the period of high strain on the public finances of many countries (see right-hand chart on p. 2), while equities proved to be much more stable in the face of wars, inflation and currency crises (left-hand chart on p. 2). This experience is transferable to the future, at least with regard to the financial burdens of the state. In the coming decades, government debt will continue to rise due to demographic trends - hopefully not as a result of serious international political crises. The sharp rise in the number of older people over the next few decades will gradually erode the pay-as-you-go statutory pension scheme and also cause healthcare costs to rise massively. The real yields on government bonds will therefore have to be kept extremely low by the central banks in the long term in order to mitigate state financial problems. The government debt problem can only be stabilized in the long term through inflation rates that are significantly higher than government bond interest rates. This means that there is great pressure to fundamentally reform the funded pension system. Here too, as with vaccination and the rent cap, it is the low earners who will suffer if funded pension provision is poorly managed or not offered at all.

Conclusion

The following overview shows that the important political measures of at least the last few years have not been implemented appropriately, but rather in supposed execution of the will of the voters. One could easily apply this analysis to the euro crisis of 2011 and 2012 or the energy transition in 2011, as well as the maternity and skilled workers' pensions, and come to the same conclusion, namely extremely high costs, social injustice and serious errors in detail, because the supposed will of the voters was simply implemented without further thought and the strategies of other countries were ignored.

The direct implementation of the current will of the electorate is only very successful for politicians in one respect, namely the short-term increase in poll ratings. Previously, the damage only occurred after several years and was therefore forgotten. In the corona pandemic, however, the costs and other negative consequences - and the better results of other countries - are becoming clear after just a few months, and there is therefore a - tiny - hope that politicians will once again base their decision-making on several pillars, including perhaps even strategy and rapid, thorough detailed planning, as in some other countries.

If this does not happen, the rising debt burden caused by the continued waste of money will keep interest rates at rock bottom for even longer and increase the long-term inflation risks. This is not a problem for investors with tangible assets (shares, private equity, real estate and gold), but the vast majority of German savers will suffer considerably. Politicians must finally take on their most important task, namely to make life more comfortable and secure for the "little people". The others are doing quite well as it is. To achieve this, a fundamental change of direction is absolutely necessary, currently in the case of funded pension provision.