Understanding The Savings Wash-up

The Age

Saturday November 11, 2006

VICTORIA THIEBERGER

AUSTRALIANS are spending more than they save every year, and have been for years. That's what conventional measures show. The official household savings rate has been negative since 2002.

Now, Treasurer Peter Costello argues, that doesn't matter, because if you use a broader definition of savings - say, include superannuation, shares, and capital gains on investments - then household finances are in fine shape.

Costello made that argument at a recent Committee for Economic Development of Australia seminar, and it is also a view espoused by the Reserve Bank.

The trouble with that interpretation, however, is it ignores the huge increase in risk households have taken on alongside that shift in behaviour. Australians hold only 25 per cent of their financial assets in bank deposits and bonds now, down from 40 per cent 20 years ago, according to the RBA.

"The key point is that conventional measures of saving do not take into account capital gains," says RBA deputy governor (financial markets) Ric Battellino. Australians are abandoning traditional "active" saving in favour of "passive" saving by counting on capital gains, as the RBA puts it.

Alongside the search for higher yield has come increased risk of lower returns or even capital losses, which could spell trouble as the first baby boomers turn 60 this year.

As more and more of the burden of funding retirement is shifted onto retirees from government and companies, increasingly complex financial decisions are being left up to individuals. The International Monetary Fund described this phenomenon as the household sector becoming the "shock absorber of last resort" in the financial system.

Households are more dependent on volatile sharemarket returns to fund retirement, especially with the shift from defined-benefit schemes, where employers face the risk that investments will be sufficient to meet pension needs, to defined-contribution superannuation, where retirees are responsible for that risk. And as life expectancy stretches out, the money has to last longer.

Households used to rely on banks to provide fixed returns on simple savings accounts, minimising their exposure to economic shocks unless the bank itself collapsed. Without the banks acting as intermediaries, households are now more directly exposed to meltdowns in financial markets if asset prices fall. Some studies suggest that as baby boomers approaching retirement look to liquidate financial assets en masse, there could be sharp declines in asset prices.

"It's quite correct that if you add back in capital gains, then savings in Australia look magically better," says Access Economics director Chris Richardson.

"But the immediate and obvious flaw in that line of thinking is, you have to ask if recent capital gains have been sustainable. And they haven't. To assume the luck continues that provides this never-ending supply of capital gains is silly."

Ironically, the RBA warned in a separate study that investors are increasingly taking on higher-yielding, but riskier, products, such as those offered by hedge funds or buying stocks on margin. In its half-yearly Financial Stability Review, the RBA said house and share prices assume good times ahead and "remain susceptible to disappointing news. At some point, conditions are likely to be less favourable than is currently the case." That's central bank speak for "past performance is no guarantee of future results".

"In such an environment, the basic assumptions that underpin current asset values and investment strategies would need to be reassessed, prompting large and potentially disruptive balance-sheet adjustments," the RBA says.

Those "adjustments" could come as a nasty shock to anyone counting on double-digit investment returns and capital gains to fund their retirement, as millions of Americans found when their pension portfolios evaporated with the bursting of the sharemarket bubble in 2000. And the proportion of Australians who own shares is much greater now (55 per cent) than at the time of the last market crash in 1987.

The RBA, and the Treasurer, can't have it both ways.

© 2006 The Age

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