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Monday, July 30, 2007

KiwiSaver - Good For New Zealand? Good for a Kiwi?

KiwiSaver has the potential to be the most significant positive development for our economy and for our well being that has ever being instituted in New Zealand. Unfortunately it is a highly flawed system. KiwiSaver could:::

* Increase business development in New Zealand as this newly available money is used for investment.

* Create worthwhile jobs (as opposed to the present low paid, menial jobs) for Kiwi's from both the construction and running of these businesses.

*Reduce inflation since there would be  less money chasing consumer goods. If you are saving you have less to spend.

* Facilitate a better exchange rate due to lower inflation leading to increased exports. Ideally, one wants a lower inflation rate than one's trading partners to take advantage of the lag factor. (economic hysteresis)

* Reduce prices at the store for the average Kiwi due to competition**. With less money chasing goods, competition between retailers increases. This results in lower prices for the consumer. This helps to make up for the fact that we will have less money to spend when more of our income goes into savings.

     ** this effect was clearly demonstrated worldwide following the 2008 economic downturn as consumers opted to pay down debt rather than to buy-buy-buy.  Despite huge "Quantitative Easing" prices did not increase.

* Reduce the need for the reserve bank to hike interest rates to keep inflation under control since saving lowers inflation automatically. In fact, when increased saving has lowered inflation, the reserve bank should be able to reduce the base lending rate. Since interest is a business expense, lower interest rates increases profits. Lower interest rates will also discourage the "carry trade" in which "mom and pop" from overseas, largely from Japan,  speculate in our currency. Our own savings will replace money from the Carry Trade. The Carry Trade bubble also contributes to inflation as it forces the reserve bank to raise the base interest rate. Instead of the interest on investment going overseas, it will stay in New Zealand.

* Stimulate rather than choke business. The hiking of the base interest rate by the Reserve Bank chokes business by increasing this business expense whereas saving/investment powers business by providing less expensive credit.
Credit is less expensive due to this fund of KiwiSaving money being available for loaning. Simple supply and demand kicks in when lending institutions have an excess of liquidity. Money held in their vaults does them no good. They must reduce interest rates to get this money moving and working for them so all borrowers benefit.

* Make businesses more profitable, especially export businesses, since, with lower interest rates, it costs them less to service their loans. More profit leads to higher wages and/or more investment back into their business, further strengthening our economy.

We shouldn't be too hard on over-seas people who are investing in our economy. We aren't saving enough for the banks to have enough cash to lend us for our mortgages and business loans. Without this investment from overseas we would be in a difficult situation. For some reason it is worthwhile for them to invest in our economy but not worthwhile for us to do so???  This is probably due to the way the two groups (domestic and overseas investors) are taxed but I still find it a mystery. The result, though, is that the profit (interest) from our loans is flowing overseas rather than staying in New Zealand to power other enterprises. Hopefully, with some further improvements for the investor in KiwiSaver, it will become worthwhile for us to invest in our own economy and stop this financial hemorrhage. If we hypothesize a 10% leak from our economy, this means that every profit dollar that stays in New Zealand is exchanged 10 times, lubricating our business engine. Profits that go overseas are oil taken out of the motor.

* Provide a more stable and hence more attractive environment for business, possibly tipping the balance toward New Zealand for some businesses which are contemplating relocating overseas. Also the possibility of encouraging outside businesses to relocate to New Zealand. More businesses means lower unemployment figures and more competition between businesses for employees which translates into higher wages.  This, of course, flies in the face of what certain governments try to do.  Namely to keep wages down for the benefit of their business friends and their share portfolio.  It also results in more taxes into the government coffers and hence less overseas borrowing.  Less overseas borrowing raises our credit rating and makes those loans we still have to take, less expensive.

House affordability 

More money going into kiwisaver would ease the purchase of a house for Kiwis:

 *  (1) because of mortgages with lower-interest rates  This is caused by lending institutions having more money (supply and demand again) and because of the competition between the lending institutions to lend this money. This will allow more people to purchase their own homes.

*  (2) due to lower house prices  With a safe, worthwhile alternative investment through KiwiSaver, less people will be speculating on housing**. High house prices are a bubble, just as the currency speculation is a bubble and is powered by perception rather than intrinsic worth. All bubbles contribute to general inflation. Without the housing bubble, not only would houses be more affordable but so would bread and milk at the corner dairy.  Many house investors would probably be willing to take a somewhat lower return in KiwiSaver than they expect in housing speculation.  If you have ever owned a rental property, you know what a hassle it can be.

     **Some years ago when we looked for a house in Christchurch, nine out of ten houses we were shown were empty.  When you are selling the family home you generally have to sell it before you move out.  These were speculation houses.  Imagine the effect on house prices$$  of all of these spec-houses flooding back on to the market when there is a viable alternative investment.

$$This may explain why it is not being done.  How many MP's own speculation/rental houses and don't want to see the price of housing come down. For that matter, how many MP's don't want their family house to loose value.

*  (3). because of more money in peoples hands When people go to buy a house they will have a larger down payment in their hands from KiwiSaver, still further easing the purchase of a home. (The government has suggested that it will be possible to access KiwiSaver funds to purchase the first house and hence, a larger down payment resulting in a lower monthly mortgage payment to Australian banks).

*  (4)  due to increased wages  Investment in one's country increases per-capita productivity as money goes into the means of production (machinery, infra structure). As long as wage increases do not exceed increases in per-capita productivity, they are not inflationary. With a higher real wage (as opposed to a higher nominal wage that inflation quickly neutralizes), it is easier to buy a house.

back to general benefits

* Put more money in peoples hands at retirement with all the benefits this brings. Although this is the major reason given for KiwiSaver, it is actually a relatively minor benefit compared to all the other benefits which will come from all of us investing in our own economy.  With money in their hands, retired people become a positive asset to an economy rather than a drain as they seem to be considered at present. Retired couples tend to spend the money they have.  There is not much incentive for them to continue saving.

* Reduce the need for investment from overseas since we have our own increased source of investment. Overseas investment results in profit being sent overseas where it is lost to the New Zealand economy. Profit earned in New Zealand supports our home grown businesses at many levels as we spend our money locally.

* Reduce the debt owed by Kiwi's. Instead of buying something on credit, incurring interest and paying it back over time, people will save, get interest and then buy. High debt is going to land a lot of us in trouble. This depends on easier access to our KiwiSaver funds*, something that the government is against at this juncture and so we may not see this benefit. It also depends on KiwiSaver being a worthwhile system of investment so people will invest in it. Certain purchases such as an electric car, house insulation, solar panels etc are, in effect, a pension which starts at the date of purchase, not at age 65. Serious consideration should be given to allowing KiwiSaver funds to be used for these as well as the purchase of a first house.

* Help avoid the 'crunch'%%  which is coming due to us regularly spending 10% more than we earn. If this continues, it will eventually lead to a precipitous fall in our exchange rate as outside investors loose faith in the worth of our currency. Such economic earthquakes are as bad for everyone as is our present over-inflated currency. The longer this excess spending goes on, the greater will be the size of the inevitable correction. Our objective should be to induce overseas investors to gradually get out of our currency as we fill the gap rather than to have them suddenly pull the plug.

%% Note (Oct 2011) We have just been downgraded from AAA to AA.  Is this the beginning of "the crunch"

Up to this point the tacit assumption has been that all the money collected under the umbrella of KiwiSaver will be invested in New Zealand businesses. This is of course unrealistic. However, investing overseas is not all bad. True, we are investing in the businesses of our competitors but on the other hand, we are bringing their profits into New Zealand where they can help with our balance of payments.

So those are the potential benefits. Now,,, what is wrong with KiwiSaver as it stands.

The Employer Contribution
The employer contribution is the most cynical part of the kiwisaver con trick and like all con tricks it depends on the 'mark' thinking he is getting something for nothing. The employee looks at the system and believes he will be getting an increase in salary of 4%. Sure, he doesn't get to spend it but it will be waiting for him when he retires. Nonsense!

It is true that for the first year or two of the scheme, the employee will be getting a real benefit. He is on a negotiated salary and the employer will be adding money for KiwiSaver. Also, someone on the minimum wage will be getting a benefit since he must still get this minimum wage in hand.* Incidentally, most of this money is coming out of the employee's pocket anyway through taxes since the government is subsidizing the employer so that he can pay this extra. Even worse, it is coming out of the pockets of all tax payers and is going into the pockets of people who join KiwiSaver. However, leaving that aside, these first couple of years are irrelevant. What do you think will happen as inflation continues on its 3% per year course. What will happen when he changes jobs.

*just watch employers try to deduct money from the minimum wage to put into KiwSaver.  

In both these instances, the employer will calculate what he can afford for the great privilege of having you work for him. He will then deduct what he has to, to pay for KiwiSaver and offer what is left as a salary. If the employee stays in his present job, his salary will not increase as much as he would otherwise have expected and if he changes jobs, he won't be offered as much as he would have expected.

The employee, on the other hand will unwittingly be complicit in this fiction. He will look at his salary and say, OK it isn't what I was expecting but on the other hand, my employer is putting in X amount into KiwiSaver which will benefit me when I retire. Wake up. He is not putting in anything. He has simply offered a reduced salary so that he can afford to put his contribution into KiwiSaver.  You are in a forced saving plan that you can't access until you retire.

The Government Contribution 
The government contribution is also a fiction.  It is your tax money being given back to you after administration costs.  To do this, the government must take more money from you, from, for instance, increased GST*, or reduce services or  putt your children deeper into debt.  The present government is doing all three.

*(oct 2011) Since writing this blog, GST has gone from 12.5% to 15%.  Any bets when it will be increased again.

                             Fixing KiwiSaver
KiwiSaver as it stands is a very poor investment. One indication of this is that the government has had to bribe people with the various incentives to get them to enter the system. Whenever someone is giving you something for nothing, suspect a con trick. KiwiSaver is a case in point. So what is wrong with KiwiSaver for the investor.

There are two problems with KiwiSaver**. First, if you are a middle income earner on a marginal income tax bracket of 33%#, you have to earn $150 in order to invest $100. Secondly, when you earn a dividend or interest of $100 through KiwiSaver, you only get to keep $66. If you work through a calculation assuming you can get a 6% investment through KiwiSaver and that inflation over your life time is 3%, you will find that it takes just over 40 years before the first money you invested at, say, age 20 is back to the buying power of what you originally earned.**

 You are already close to retirement. Money invested later in life never does get back up to its original buying power. Its not as if no other country has got it right. Australia, the UK and the USA all have systems that allow the investor to invest before taxes (in the case of Australia you are taxed 15% on investment and dividends regardless of your tax bracket) and to keep what he earns through his pension plan investment.

 The whole problem with KiwiSaver is the tax regime imposed on it by the government and the bribes they provide, are a sure indication that they realize what a poor investment it is. When people wake up to what a poor investment KiwiSaver is, they will be opting-out and the huge benefits to New Zealand listed at the beginning of this blog will not occur.##

# Earning more than $70,000 as of 2014

##This is a quote from Wikipedia describing the Australian system
These taxes contribute over $6 billion in annual government revenue.[8] Superannuation is a tax-advantaged method of saving as the 15% tax rate on contributions is lower than the rate an employee would have paid if they received the money as income. The Federal government announced in its 2006/07 budget that from 1 July 2007, Australians over the age of 60 will face no taxes on withdrawing monies out of their superannuation fund if it is from a taxed source.

**The calculation
You earn $150. You are taxed before investment so you can only invest $100 for every $150 you earn. You put this money into a fixed interest investment in the bank (who would trust stocks and shares or a Kiwi investment company after the recent econo-quake). You earn 6%. At the end of the year, the tax man looks at your investment as sees that you have earned $6. You are in the 33% tax bracket so he takes $2. Remember that this money is on top of your other earnings so you are taxed on it at your marginal rate. Since inflation is 3%, you need $103 just to break even and you have $104 after taxes.  You have earned $1 in real profit. Taking this $1 back to when you invested it, your true earning is actually 97 cents but let's not quibble. If you plug this in to the compound interest formula (log 1.5/log 1.0097) you find that it will take 42 years to get back to your original buying power.  Let Kiwis invest before taxes and you are investing the whole $150 and are 42 years ahead of the game even without stopping taxes on your dividends.

Make KiwiSaver into a worthwhile investment and all the benefits will accrue to the economy as listed above.  Better still, us Kiwis will be the owners of our own economy.  We continue to sell off our assets** to keep our heads above water.  It is like a trucking company selling off its trucks to pay its debts.  Not sustainable.

** (Oct 2011)  Now the National government is talking about selling off 49% of our SOEs to us who already own them.  We will sell them off to overseas investors when the price is right or when we need the money and the dividends will go overseas.  Taxes will rise to make up for the loss of income.  Who is benefiting from all this.  Rich Kiwis, while they retain the shares, will have some dividends to make up for higher taxes.  Poor Kiwis not.  Once again money coming out of the pockets of poor Kiwis into the pockets of the rich***. 

*** The government has another cute little wrinkle in this story.  Even rich Kiwis have to pay taxes (well sometimes anyway).  The dividends they receive are taxes at their marginal rate.  Even though the government no longer owns the shares, they get about a third of the dividend anyway as long as these shares are in the hands of kiwis.  Very neat!!!!

ps(Oct 2011) A new wrinkle just came to my attention.  We have just had our economic rating reduced from AAA to AA.  The reason stated was that our national debt is too large.  This despite the fact that following the mini economic quake in 2008, Kiwis started to save in KiwiSaver.  The reason:  The government subsidies to KiwiSaver put the government further into debt so our total national debt which is made up of government debt and personal debt is not decreasing.  Solution:  Stop subsidizing KiwiSaver and simply make it  a worthwhile investment as outlined above.

How to structure Kiwi Saver
1)  Allow investment before taxes
2)  Don't tax the interest or dividends you earn.  KiwiSaver is not like other investments such as housing or shares where you have the option to go in and out of the investment when you want for profit taking.  You are asked to make an investment for your entire working life.  Therefore KiwiSaver investments should not have the same rules that apply to other investments.

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