Retirement plans in European countries are slowly changing in recent years. Countries are moving away from Defined Benefit (DB) plans to Defined Contribution(DC) plans.

In DB plans an employer basically defines a benefit that the employee will receive at a certain date in the future usually after retirement. This is usually a set amount based on the employees wages, tenure, etc. Once the employee retirees the employer pays the defined amount(called as pension) periodically to the employee. Here the employer is responsible for the risk associated with managing the funds of employees in order to make sure enough funds are available to pay to the retirees.

In DC plans, an employee contributes a certain percentage of his/her income to the plan.Sometimes the employer may also contribute a small percentage to that plan usually based on the employee’s salary and tenure.The funds of the plan are then invested in the market mostly in mutual funds already pre-selected by the employer. In this type of plan, the employee is responsible for the investment risk.

In the U.S. most companies got rid of the DB plans in favor of DC plans in the past few decades since it makes the employee responsible for their retirement and reduces the liability for companies.

Unlike the U.S., most of Europe still have DB plans. But that is changing with the increasing adoption of DC plans.In Europe, strict regulations and resistance from workers have prevented employers from quickly dumping DB plans and implementing DC plans. However since DC plans not only reduces employers’ liability but also affords employees the opportunity to earn more with their investments,  they will be embraced by more employers.

The graph below the current retirement landscape in Europe:

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Source:  Cross-Border Defined Contribution Plans in Europe, Alliance Global Investors

The graph shows that the adoption of DC plans is not even among the countries.For example, DB plans are more prevalent in Greece and it is not changing towards DC plans. However countries such as Denmark, Ireland, UK, Sweden and Switzerland have large portion of DC plans compared to other countries.

The U.S. dollar will stay the reserve currency in 2014 and beyond according to a research report by Barclays. This is because there is no serious competitor despite the U.S running persistent current account deficits. poor fiscal position, loss of AAA credit rating and the ongoing QE program run by the Federal Reserve.

In addition to the above factors, three other factors that matter for the reserve currency status are: liquidity, depth of local capital markets and investor faith. In each of these categories the U.S. beats other major developed economies.

a) Liquidity

The US dollar is the most liquid currency by a wide margin. The nearest competitor Euro has a daily turnover of only about one-third  in the forex market relative to the dollar.

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b) Depth of local capital markets

The U.S. sovereign bond market is the largest in the world. Hence it is highly liquid for investors and prices are not easily distorted when someone winds up even a smaller position.

c) Investor faith

The dollar and its underlying assets still retain investors’ faith even during times of great stress. For example, during the global financial crisis the dollar and treasuries benefited greatly as investors piled into them seeking safe heavens.It is ironic that investors put their faith in the same country that started the financial crisis causing the loss of billions of dollars.

Serious competition to the domination of the US dollar as the top reserve currency is non-existent. Norway has strong fiscal balances, runs a strong current account surplus and enjoys the AAA rating. However the Norwegian Kroner(NOK) cannot compete vigorously against the dollar since the local capital market is shallow, the currency is illliquid and underperforms during times of stress.

The Japanese Yen and Euro are two of the other possible substitutes for the dollar. But Japan’s fiscal position and Europe’s internal fights among member countries make it unappealing to investors.

The next contender for the reserve currency status is China’s Renminbi. However it is unlikely to attain that position anytime soon since China’s capital markets are immature and its currency is illliquid. China’s capital controls and managed nature of the currency also does not help.

In summary, the US dollar will remain the top reserve currency for the foreseeable future.

Source: Compass, December 2013/January 2014, Barclays

Debt levels remain high across the world especially in the developed countries.However debt levels vary by type and country as shown in the following chart:

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Source:Vanguard’s economic and investment outlook, Jan 2014,  Vanguard

Debt held by the Federal government, households, non-financial and financial firms in the U.S. and Germany is moderate(between 50% and 100%)  as a percentage of GDP. The UK is similar shape except the financial institutions there are still in a mess. While the U.S. took swift action after the financial crisis and financial firms especially the banks cleaned up their books and raised capital, British banks failed to take proper actions. The painfully slow British political and regulatory system did not help to speed things up either.In Japan households are in much better shape than corporations and the federal government in terms of debt levels. Similarly Chinese households have low debt levels.

Vanguard predicts the global economic recovery to be modest over the next compared to the previous two decades.The chart below shows the potential growth rates for the world’s major economies:

The long-run economic growth potential of BRIC countries is higher than that of the developed countries including the U.S. However it should be noted that high economic growth does not necessarily mean higher equity market returns.

Related ETFs:

• iShares MSCI Brazil ETF(EWZ)
• Market Vectors Russia ETF (RSX)
• iShares FTSE/Xinhua China 25 Index Fund (FXI)
• iShares MSCI Emerging Markets ETF (EEM)
• Vanguard Emerging Markets ETF (VWO)
• SPDR S&P 500 ETF (SPY)
• SPDR STOXX Europe 50 ETF (FEU)

Disclosure: No Positions