California and Greece have some interesting similarities. Both have beautiful coastlines dotted with rocky islands. Both enjoy a famously Mediterranean climate, where it rains more in the winter than in the summer (a very rare phenomenon found in only a few places in the world). Both produce excellent grapes and olives and wine and olive oil and cheeses.
More importantly to investors, both illustrate a grave problem which fuels the degradation of the purchasing power of their money over long periods of time.
The problem both share involves their extremely generous pension promises to large numbers of citizens, which many fear will be unsustainably expensive going forward.
For instance, in Greece, civil servants can retire with 80% of their "pensionable salary" for the rest of their lives, and the average retirement age is 58 (the 80% number generally applies to pensioners who began service prior to 1993; after that, pensions were reduced to 2% per year of service prior to retirement -- which still works out to 74% of their salary for the rest of their life for someone who works from age 21 to age 58).
In California, government employees such as teachers and prison guards can retire at ages as young as 52 or 55 and receive a pension of 60% or more of what they earned for the rest of their life, along with medical benefits and a cost-of-living-adjustment causing the pension to rise each year to keep pace with inflation. Recent articles have appeared highlighting California state pensioners who make over $100,000 per year from their state pensions, and even some whose pensions give them over $200,000 per year for life. Department of Education data reveal that the median retirement age for public school teachers is 58 (another fascinating similarity with Greece).
While it may seem like a nice thing to provide large number of citizens with the ability to retire in their 50s and draw a substantial pension for life (with medical benefits), it is massively expensive. The same system is responsible for the collapse of two of the three US automakers, leading to the assumption of those companies' expensive benefit packages by the US taxpayer.
Bondholders -- those who loan to these entities -- have been getting nervous lately, particularly in Greece. Lenders get worried when they hear their credit card customers say, "I won't be able to make payments on this credit card anymore: my budget is just too crazy."
The usual solution when this happens to an individual is bankruptcy -- lenders and the borrower work out some amount that will be paid on each dollar (pennies on the dollar). The borrower's budget must be downsized as well -- extravagant expenses have to be slashed or eliminated.
However, such as solution is very painful, and politicians typically don't like to face the kind of pain it entails. Cutting expenses in the case of Greece or California means cutting pension benefits, and renegotiating pennies on borrowed dollars means angering bondholders, who will of course howl loudly.
Therefore, the other solution governments historically turn to in these kinds of situations is to print money. Since neither California nor Greece is allowed to print money themselves, this means begging either the U.S. Government or, in Greece's case, the European Union of which Greece is a member, to do it for them in order to keep their bondholders and pensioners from experiencing pain.
Inflating the currency spreads the pain to everyone who uses that currency, and spreads it out over long periods of time, so it is less noticeable. We have written about the almost unnoticeable manner that inflation slowly corrodes purchasing power in numerous previous articles, especially in last year's "Stand still, little lambs, to be shorn!"
What does all this mean for investors? It is a complicated question, and one that bears careful consideration and deliberation now and going forward. Certainly, inflation hurts everyone, especially those now living on a fixed income, and those who own long-term bonds.
Many think the answer is to rush into commodities such as gold. Gold's price certainly has risen sharply over the past year.
However, we have written before that we believe the best answer is to own well-run companies providing a valued service that are growing and have strong growth prospects for the future. Such companies are able to take a variety of actions to deal with inflation and continue to add value to their customers and their shareholders. We strongly believe, as did the late Dick Taylor who managed money in previous decades, that the ownership of great companies remains the best foundation for the preservation of purchasing power against the corrosion of inflation.
All investors should understand this important issue, and why it is not likely to go away anytime soon.
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For later posts on this same topic, see also:
- "European debt issues and the primacy of growth" 11/08/2010.
- "Another wake-up call" 11/29/2010.
- "Lawlessness in California" 12/16/2010.
- "The question of our time, continued" 03/14/2011.
- "In defense of the politicians" 04/07/2011.
- "The silver lining to the S&P change in outlook" 04/19/2011.
