Contract law has long relied on a legal concept known as force majeure, which is French for “superior force”, that is, beyond the ability of humans to foresee or control, such as acts of nature, or God. It is of particularly common use in the insurance industry.
This is understandable. Insuring against acts of God (or nature) is probably a loss-making proposition. Satan and his followers bet against God, and according to the Scriptures, that didn’t work out so well. There are numerous other examples.
But here we are, in the 21st century, long after Nietzsche let us know that God was dead, and yet the insurance industry is still relying on force majeure clauses to protect them against catastrophic loss. What gives?
Well, there is a very practical reason behind the venerable legal concept of force majeure. The fact is, insurance serves a vital social purpose: distributing risk from those less able to bear it, to those rather more so. And there are risks that are so random, so unknowable, so uncertain, that no one could be expected to be able to model, in any way, the risks thereof.
In other words, risk and uncertainty are not quite the same thing. That might surprise some of you.
Risk is differentiated from pure uncertainty because risk is distributed in a way modelling can estimate with some precision. The probability of a given distributional event, however unusual or unlikely, can be known, and provisioned against accordingly. The cost of that provision provides the basis for whatever insurance premiums are to be paid in exchange for the corresponding insurance policy.
Force majeure is thus reserved for those things that are beyond both human control and human’s ability to model the associated risks. Hence I was rather astonished when I came across an article in the US National Law Review which argued that the recent, sharp rises in inflation and interest rates could be considered as force majeure events.
The article, titled “Effects of High Inflation on Real Estate Developments and Leasing,” describes force majeure as follows:
Force majeure clauses excuse a party’s obligations under a contract if an extraordinary event directly prevents one or both parties from performing. Generally, force majeure events include natural events such as hurricanes and earthquakes …
But shortly thereafter follows this passage (emphasis added):
Landlords should negotiate force majeure clauses to expand the scope of protection to include delays or excuses from performing obligations due to rising costs from inflation or increased interest rates.
Inflation and interest rates are financial market phenomena. They are the effects of the supply and demand for money, goods and services in an economy. Legions of economists are employed to model and forecast both. It’s literally what they do for a living.
Moreover, neither God nor Mother Nature sets interest rates or controls the money supply. That is normally the role of the central bank and the broader, interbank money market.
To claim that the decisions taken by central banks or other participants in the money markets are somehow force majeure seems rather a long stretch to me. It is rather as if lawyers are trying to insert themselves into what many, including me, would argue is just the normal course of doing business. Not force majeure at all, rather force mineure.
But that’s it now, isn’t it? Lawyers ARE trying to push into new areas! Why shouldn’t they? Theirs is a business, after all, why shouldn’t they seize every available opportunity to expand?
Imagine the bumper demand for legal services if financial contracts generally had to be reviewed and re-written so as to recharacterise large fluctuations in inflation and interest rates not as financial market risks to be borne by the signing parties, but as force majeure phenomena. It would be lucrative for the profession for certain.
Every time there was a large swing in inflation or rates, the lawyers would find further need for their services, to argue whether or not it was a force majeure event. Many disputes might be settled out of court, but that would still generate handsome fees for the lawyers retained in the dispute.
The downside for the rest of us, however, is that legal “solutions” can introduce much friction to commerce. Like many regulations, which tend towards “one size fits all” specifications, so legal intermediation in commercial affairs can have the perverse effect of counterparties challenging contracts at every turn, rather than honouring them. And each and every time, the associated legal fees would need be paid.
No doubt these costs would be passed along. Eventually, they would arrive where all economic costs do: in consumer prices.
This helps to illustrate an important point. Markets in general, not only financial, are intended to allocate goods and services in a price-based manner, one that is not constantly being second-guessed and reviewed by lawyers or regulators. In a market, traders go about their business trading on price, with good, services and contracts standardised to some degree. Yes, disputes occasionally arise, and yes lawyers might end up getting involved. But that’s supposed to be the exception, not the rule.
Rules serve an important purpose. Any good game relies on them, and on a good referee. But the rules of the game should be clear and should reduce to some form of common sense. The referee should also apply them fairly and without bias.
When rules become too specific and are “hyper-applied” to basic, day-to-day commerce, they introduce completely unnecessary frictional costs that ultimately are borne by those consuming the fruits of such commerce. You and me in other words.
Economists call economic activities that impose indirect or unseen costs as negative “externalities”. So, an overly litigious economy would be replete in negative legal externalities. It would be less efficient. By the time economic input – raw materials, capital and labour – turned into useful economic output – consumer goods, the negative legal externalities would have piled up, making everyone worse off overall.
Economists call those who thrive on such negative externalities as “rent-seekers”. They don’t produce anything that society needs or wants at all. All they do is find ways to insinuate themselves into the activities of others in a way that adds to others’ costs, but at their self-benefit.
Britain’s “productivity puzzle”
Economists also have a term for the collective costs of misguided regulations or rent-seeking behaviours that are unproductive: dead-weight loss. There are few things on which most economists agree, but keeping dead-weight loss to a minimum is generally regarded as desirable.
In recent years, here in the UK, economists have been debating what they call the “productivity puzzle”: that productivity growth in the UK has been unusually low for years, both relative to the UK’s own history and to other similar economies.
Could it be that the Westminster cocktail of high taxes, onerous regulations and various negative externalities, including rent-seeking behaviours, provides part of the explanation?
Those who voted for Brexit probably did so because the Brussels cocktail wasn’t much to their liking. But is the Westminster variation any better? Has it in any way reduced the associated dead-weight loss?
So far, at least as far as the productivity puzzle is concerned, Brexit has been a bust. The government is not showing any inclination towards policies that might improve productivity growth.
That should be of great concern. Productivity growth is the key to higher incomes. By extension, it is also the key to a higher tax base to provide for better public services. This includes the NHS, state pensions and other benefits for the old and young alike.
However, the older one is, the less time that remains for the productivity puzzle to be solved to their benefit. This makes active retirement planning all the more urgent. The older you are, the more imperative it is that you get the most you can out of your retirement assets.
There are various retirement strategies that can work, but the classic British homeownership retirement plan may no longer be among them now that interest rates have risen so sharply. Relying on perpetual house price appreciation for fund one’s retirement may have worked to some extent during the past few decades, but those days may now be over.
With this in mind, we’re keen to hear about your own experiences regarding your own nest egg. Are you worried? Happy to ride it out? Keen to hear more from us about specific strategies designed to help boost your retirement pot?
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Until next time,
Investment Director, Fortune & Freedom