SOMETIMES the financial system can appear like one of those Escher drawings in which water flows simultaneously uphill and downhill. Governments rescued banks from the threat of failure in 2008, but banks are also big buyers of government bonds—so much so that a sovereign default in Europe might cause a banking crisis. Who is supporting whom?

The same question can be asked of pension funds. European countries would struggle to fund themselves without demand from the pensions industry. A survey by Mercer, an actuarial consultancy, suggests that around half the assets of continental European funds are invested in government bonds. Yet governments also stand behind their domestic pension funds.

The commitment is explicit in the case of public-sector schemes. But in America and Britain there is surely implicit backing for the insurance funds (respectively the Pension Benefit Guaranty Corporation and the Pension Protection Fund) that backstop the private sector's schemes. It is hard to imagine politicians standing idly by if pensioners were at risk of losing their benefits.

An example of this tangled relationship can be seen in the efforts of individual American states to deal with budget shortfalls. Some states are launching special bond issues to get the funds needed to finance their pension contributions. And who are likely to be significant buyers of those bonds? State pension funds.

The relationship between governments and pension funds seems to grow ever closer. In the 1980s and 1990s the cult of equity lured many funds into a heavy stockmarket weighting. That left them horribly exposed to the two bear markets of the current millennium.

Meanwhile, accounting standards have forced company pension schemes to discount their liabilities using a corporate-bond yield. Not everyone is a fan of this accounting approach, though it has a sound theoretical basis. A pension promise is a bond-like liability in that it obliges the scheme to pay out a steady stream of cash well into the future. Companies can “offload” their pension schemes by asking insurance companies to assume the burden on their behalf; the cost of doing so varies with government-bond yields. The requirement to value pension liabilities in this way has made corporate balance-sheets more volatile, and encouraged finance directors to try to reduce their risk.

The result has been that many companies have adopted a “liability-driven” approach, in which they buy government bonds (or use related derivatives) so that the funding level closely matches the cost of paying the benefits. But the problem with this is that it looks expensive in the short term. Pension schemes that invest in equities can assume higher returns from their portfolio over the long run, which allows the corporate sponsor to make lower contributions. Buying bonds means that the returns are likely to be lower, and thus the contributions must be higher.

In the face of this increased cost many companies have decided to pull the plug, closing their schemes to new members and, in some cases, to existing employees. Final-salary pensions are now largely a perk for government workers, perhaps because public-sector schemes are not usually subject to the same accounting regime as their private-sector counterparts.

By itself, the closure of schemes to new members makes a pension fund more “mature”, in the sense that the focus switches to paying benefits to retirees rather than investing contributions for the long-term. This reinforces the tendency to invest in bonds rather than equities.

The process has some rather bizarre implications. What happens if governments default on their bonds, or inflate away the debts, rather than put their voters through the years of austerity required to pay them down? The result would be huge shortfalls in domestic pension funds. It won't only be champagne-swilling fund managers that lose out should a country default, but the nation's retirees, a key group of voters.

The rationale behind private-sector pensions is to reduce the burden on governments of an ageing population. Yet if private funds are invested mainly in government bonds, then pension promises end up being a claim on future taxpayers all the same. This may merely reflect reality. Pension benefits, whether funded or unfunded, are a postdated cheque on the income of future workers. When the number of workers falls relative to the number of retirees, it creates a problem that accounting conventions and clever asset allocations cannot disguise.