Is global economic growth really controlled by monetary policy and interest rates? Can you create constant growth simply by adjusting government tax and spending policy? Do we know enough about how the economy operates to be able to do this? Or has something more fundamental been at work in recent decades, to create the extraordinary growth that we have seen until recently?
- As the chart shows for US GDP, regular downturns used to occur every 4 or 5 years
- Then something changed in the early 1980s, and recessions seemed to become a thing of the past
- Inflation, which had been rampant, also began to slow with interest rates dropping from peaks of 15%+
- For around 25 years, with just the exception of the 1st Gulf War, growth became almost constant
Why was this? Was it because we became much cleverer and suddenly able to “do away with boom and bust” as one UK Finance Minister claimed? Was it luck, that nothing much happened to upset the global economy? Was it because the Chairman of the US Federal Reserve from 1986 – 2006, Alan Greenspan, was a towering genius? Perhaps.
THE AVERAGE BABYBOOMER IS NOW 60 YEARS OLD
Or was it because of the massive demographic change that took place in the Western world after World War 2, shown in the second chart?
- 1921 – 1945. Births in the G7 countries (US, Japan, Germany, France, UK, Italy, Canada) averaged 8.8m/year
- 1946 – 1970. Births averaged 10.1m/year, a 15% increase over 25 years
- 1970 – 2016. Births averaged only 8.5m/year, a 16% fall, with 2016 seeing just 8.13m born
Babies, as we all know, are important for many reasons.
Economically, these babies were born in the wealthy developed countries, responsible for 60% of global GDP. So right from their birth, they were set to have an outsize impact on the economy:
- Their first impact came as they moved into adulthood in the 1970s, causing Western inflation to soar
- The economy simply couldn’t provide enough “stuff”, quickly enough, to satisfy their growing demand
- US interest rates jumped by 75% in the 1970s to 7.3%, and doubled to average 10.6% in the 1980s
- But then they began a sustained fall to today’s record low levels as supply/demand rebalanced
BOOMERS TURBOCHARGED GROWTH, BUT ARE NOW JOINING THE LOWER-SPENDING 55-PLUS COHORT
The key development was the arrival of the Boomers in the Wealth Creator 25-54 age group that drives economic growth. Consumer spending is 60% – 70% of GDP in most developed economies. And so both supply and demand began to increase exponentially. In fact, the Boomers actually turbocharged supply and demand.
Breaking with all historical patterns, women stopped having large numbers of children and instead often returned to the workforce after having 1 or 2 children. US fertility rates, for example, fell from 3.3 babies/woman in 1950 to just 2.0/babies/women in 1970 – below replacement level. On average, US women have just 1.9 babies today.
It is hard to imagine today the extraordinary change that this created:
- Until the 1970s, most women would routinely lose their jobs on getting married
- As Wikipedia notes, this was “normal” in Western countries from the 19th century till the 1970s
- But since 1950, life expectancy has increased by around 10 years to average over 75 years today
- In turn, this meant that women no longer needed to stay at home having babies.
- Instead, they fought for, and began to gain Equal Pay and Equal Opportunity at work
This turbocharged the economy by creating the phenomenon of the two-income family for the first time in history.
But today, the average G7 Boomer (born between 1946 – 1970) is now 60 years old, as the 3rd chart shows. Since 2001, the oldest Boomers have been leaving the Wealth Creator generation:
- In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, who spent an average of $62k ($2017). There were only 36m households headed by someone in the lower-spending 55-plus cohort, who spent an average of $45k
- In 2017, low fertility rates meant there were only 66m Wealth Creator households spending $64k each. But increasing life expectancy meant the number in the 55-plus cohort had risen by 55%. However, their average spend had only risen to $51k – even though many had only just left the Wealth Creators
CONCLUSION – THE CHOICE BETWEEN ‘DEBT JUBILEES’ AND DISORDERLY DEFAULT IS COMING CLOSE
Policymakers ignored the growing “demographic deficit” as growth slowed after 2000. But their stimulus policies were instead essentially trying to achieve the impossible, by “printing babies”. The result has been today’s record levels of global debt, as each new round of stimulus and tax cuts failed to recreate the Boomer-led economic SuperCycle.
As I warned back in January 2016 using the words of the OECD’s William White:
“It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something. The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”
That recession is now coming close. There is very little time left to recognise the impact of demographic changes, and to adopt policies that will minimise the risk of disorderly global defaults.
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More people left poverty in the past 70 years than in the whole of history, thanks to the BabyBoomer-led economic SuperCycle. World Bank and OECD data show that less than 10% of the world’s population now live below the extreme poverty line of $1.90/day, compared to 55% in 1950.
Globalisation has been a key element in enabling this progress, as countries and regions began to trade with each other. But now global trade is starting to decline, as the chart from the authoritative Dutch World Trade Monitor shows:
- After a good start to 2018, February saw trade fall 0.7% in February and 1.2% in March
- The major slowdown was in Asia, particularly China, as its lending began to slow
And then on Friday, President Trump confirmed the opening of his long-planned trade wars:
- He imposed 25% import tariffs on steel and 10% on aluminium from Canada, Mexico and the European Union
- Similar tariffs were already in place on imports from China, Russia and other countries
- America’s longest standing allies have since imposed their own sanctions in retaliation
- The stage is now set for a developing global trade war as more countries join in
PRESIDENT TRUMP IS IMPLEMENTING THE POLICIES ON WHICH HE WAS ELECTED
None of this should have been a surprise, as it simply follows the agenda that President Trump set out in his Gettysburg speech just before the election. His policy proposals then, which I featured here in depth in January 2017, were crystal clear about his objectives, as the slide shows:
- Those policies marked in red are now being introduced
- Only 2 of them – around China being a currency manipulator, and infrastructure – are still to be delivered
- Yet companies, commentators and analysts have preferred to ignore the obvious
It was clear then, and is even clearer today, that Trump intends to abandon the policies followed by all post-War Republican and Democratic presidents including Eisenhower, Reagan and Clinton, and summarised in President Kennedy’s 1961 Inauguration Speech:
“To those old allies whose cultural and spiritual origins we share, we pledge the loyalty of faithful friends. United there is little we cannot do in a host of cooperative ventures. Divided there is little we can do–for we dare not meet a powerful challenge at odds and split asunder.”
As I noted after Trump’s own Inauguration Speech in January last year, he broke very explicitly with these policies:
“We assembled here today are issuing a new decree to be heard in every city in every foreign capital and in every hall of power. From this day forward, a new vision will govern our land. From this day forward, it’s going to be only America first, America first. Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families.”
BAD NEWS HAS ALWAYS LED TO MORE STIMULUS IN THE PAST
Unsurprisingly, financial markets have chosen to ignore this rise in protectionism. For them, bad news is always good news, as they expect the central banks to provide more stimulus via their money-printing policies. As the left-hand chart shows of Prof Robert Shiller’s CAPE Index (Cyclically Adjusted Price/Earnings ratio) since 1881:
- When Trump took office, the ratio was already at 28.5 – above the 1901 and 1966 peaks
- Since then it has peaked at 33.3, above the 1929 peak
- Only 2000 was higher at 44, when the end of the SuperCycle coincided with the Fed’s first liquidity programme to prevent any problems with the Y2K issue
The right-hand chart confirms the bubble nature of the rally:
- It compares S&P 500 developments with the level of margin debt in the New York Stock Exchange
- Until 1985, the Fed operated on the principle of “taking away the punchbowl as the party gets going“
- Since then, it has increasingly believed, as then Fed Chairman Ben Bernanke said in November 2010
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
As a result, the S&P 500 has risen along with margin debt, which peaked at $659bn in January ($2018).
FINANCIAL MARKETS HAVE AN UNPLEASANT “SURPRISE” AHEAD AS CHINA SLOWS
It is therefore no great surprise that financial markets have continued to ignore developments in the real world.
Yet a decline in world trade, and the rise in protectionism, will inevitably produce Winners and Losers. This will be quite different from the SuperCycle, when the rise of globalisation created “win-win opportunities” for countries and regions:
- Essentially the deal was that consumers in richer countries got cheaper, well-made, products
- People in poorer countries gained paid employment for the first time in history by making these products
History also suggests President Trump will be proved wrong with his March suggestion that: “Trade wars are good and easy to win”. Like all wars, they are easy to start and increasingly difficult to end.
So far, financial markets have ignored these uncomfortable facts. They still believe that any bad news will lead to even more central bank stimulus, and a further rise in margin debt.
But as I noted last week, China – not the Fed – was in fact the major source of stimulus lending. Now its lending bubble is history, the party in financial markets is inevitably entering its end-game.
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“Average UK wages in 2022 could still be lower than in 2008”
UK Office for Budget Responsibility
While Western stock markets boom under the influence of central bank money-printing, wages for ordinary people are not doing so well. So it is no wonder that Populism is rising, as voters worry their children will be worse off than themselves at a similar age.
The chart above is the key to the story. It shows births in the G7 countries (Canada, France, Germany, Italy, Japan, UK, USA) since 1921. They are important as until recently, they represented around 50% of the global economy. Equally important is the fact that consumer spending represents 60% – 70% of total GDP in each country.
As the chart shows, the absolute number of consumers saw a massive boost during what became known as the BabyBoom after the end of World War 2:
- The US Boom lasted from 1946 – 1964, and saw a 52% increase in births versus the previous 18 years
- The Boom lasted longer in the other G7 countries, from 1946 – 1970, but was less intense
- In total, there were 33 million more G7 births in 1946 – 1970 versus the previous 25 years
- This was the equivalent of adding a new G7 country the size of Canada to the global economy
Today’s dominant economic theories were also developed during the BabyBoom period, as academics tried to understand the major changes that were taking place in the economy:
- Milton Friedman’s classic ‘A Monetary History of the United States’ was published in 1963, and led him to argue that “inflation is always and everywhere a monetary phenomenon”
- Franco Modigliani’s ‘The Life Cycle Hypothesis of Saving‘ was published in 1966, and argued that consumers deliberately balanced out their spending through their lives
Today’s problem is that although both theories appeared to fit the facts when written, they were wrong.
We cannot blame them, as nobody during the 1960s realised the extraordinary nature of the BabyBoom. The word “BabyBoom” was only invented after it had finished, in 1970, according to the Oxford English Dictionary.
Friedman had no way of knowing that the number of US babies had risen by such an extraordinary amount. As these babies grew up, they created major inflation as demand massively outgrew supply. But once they entered the Wealth Creator 25 – 54 age cohort in large numbers and began working, supply began to catch up – and inflation to fall.
Similarly, Modigliani had no way of knowing that people’s spending began to decline dramatically after the age 55, as average US life expectancy during the BabyBoom was only around 68 years.
But today, average US life expectancy is over 10 years higher. And as the second chart shows, the number of households in the 55+ age group is rocketing, up by 55% since 2000. At 56m, it is fast approaching the 66m households in the critical 25 – 54 Wealth Creator cohort, who dominate consumer spending:
- Each Wealth Creator household spent an average of $64k in 2017, versus just $51k for those aged 55+
- Even this $51k figure is flattered by the large number of Boomers moving out of the Wealth Creator cohort
- Someone aged 56 spends almost the same as when they were 55. But at 75+, they are spending 47% less
- Older people already own most of what they need, and their incomes decline as they approach retirement
Unfortunately, today’s central bankers still base policy on these theories, just as Keynes’ warned:
“Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”.
The result is seen in the third chart from the Brookings Institute. It highlights how labour’s share of income has collapsed from 64% in 2000 to 57% today. The date is particularly significant, given that the oldest Boomers (born in 1946), reached 55 in 2001 and the average US Boomer became 55 in 2010.
- Fed Chairman Alan Greenspan tried to compensate for this paradigm shift from 2003 by boosting house prices – but this only led to the 2008 subprime crisis which nearly collapsed the global economy
- Since then, Fed Chairs Ben Bernanke and Janet Yellen have focused on boosting the stock market, as Bernanke noted in November 2010:
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
But fewer Americans own stocks than houses – only 54% versus 64% for homes. So “printing babies” cannot work.
The real issue is that the dramatic increase in life expectancy has created a paradigm change in our life cycle:
- It is no longer based on our being born, educated, working, retiring and then dying
- Instead, we have a new stage, where we are born, educated, work, and then retrain in our 50s/60s, before working again until we retire and then die
This transition would have been a difficult challenge to manage at the best of times. And having now gone in the wrong direction for the past 15 years, we are, as I warned last year, much closer to the point when it becomes:
“Obvious that the Fed could not possibly control the economic fortunes of 321m Americans. Common sense tells us that demographics, not monetary policy, drive demand. Unfortunately, vast amounts of time and money have been wasted as a result. The path back to fiscal sanity will be very hard indeed.”
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Unsurprisingly, Friday’s US GDP report showed Q1 growth was just 0.7%, as the New York Times reported:
“The U.S. economy turned in the weakest performance in three years in the January-March quarter as consumers sharply slowed their spending. The result fell far short of President Donald Trump’s ambitious growth targets and underscores the challenges of accelerating economic expansion.”
And as the Wall Street Journal (WSJ) added:
“The worrisome thing about the GDP report is where the weakness was. Consumer spending grew at just a 0.3% annual rate—its slowest showing since the fourth quarter of 2009… As confirmed by soft monthly retail sales and the drop off in car sales, the first-quarter spending slowdown was real“.
The problem is simple. Economic policy since 2000 under both Democrat and Republican Presidents has been dominated by wishful thinking, as I discussed in my Financial Times letter last week.
The good news is that there are now signs this wishful thinking is finally starting to be questioned. As the WSJ reported Friday, BlackRock CEO Larry Fink, who runs the world’s largest asset manager, told investors:
“Part of the challenge the U.S. faces, Mr. Fink said, is demographics. Baby boomers, the largest living generation in the country are aging, reaching retirement age. “With our demographics it seems pretty improbable to see sustainable 3% growth.””
And earlier this year, the chief economist at the Bank of England, Andy Haldane, suggested that the importance of:
“Demographics in mainstream economics has been under-emphasized for too long.”
Policymakers should have focused on demographics after 2001, as the oldest Boomers (born in 1946) began to join the low-spending, low-earning New Old 55+ generation. The budget surplus created during the SuperCycle should have been saved to fund future needs such as Social Security costs.
But instead, President George W Bush and the Federal Reserve wasted the surplus on futile stimulus policies based on tax cuts and low interest rates. And when this wishful thinking led to the 2008 financial crisis, President Obama and the Fed doubled down with even lower interest rates and $4tn of money-printing via quantitative easing.
This wishful thinking has therefore created a debt burden on top of the demographic deficit, as the chart confirms:
Between 1966 – 1979, each $1 increase in US public debt created $4.49 of GDP growth, as supply and infrastructure investment grew to meet the needs of the Boomer generation
Debt still added to GDP in 1980 – 1999 during the SuperCycle: each $1 of debt created $1.15 of GDP growth
But since 2000, debt has risen by $13.9tn, whilst GDP has risen by just $4.6tn
Each $1 of new debt has therefore only created $0.33c of GDP growth – value destruction on a massive scale
It is therefore vital that President Trump learns from the mistakes of Presidents Bush and Obama. Further stimulus policies such as tax cuts will only make today’s position worse in terms of debt and growth. Instead, he needs to develop new policies that focus on the challenges created by today’s ageing population. as I suggested last August:
“3 key issues will therefore confront the next President. He or she:
□ Will have to design measures to support older Boomers to stay in the workforce
□ Must reverse the decline that has taken place in corporate funding for pensions
□ Must also tackle looming deficits in Social Security and Medicare, as benefits will otherwise be cut by 29% in 2030
It has always been obvious that the Fed could not possibly control the economic fortunes of 321m Americans. Common sense tells us that demographics, not monetary policy, drive demand. Unfortunately, vast amounts of time and money have been wasted as a result. The path back to fiscal sanity will be very hard indeed.”
TIME magazine covers often capture the mood of a moment. And that was certainly true in February 1999, with their now famous cover picturing then US Federal Reserve Chairman, Alan Greenspan, under the heading “The Committee to SAVE the World“.
In a further sign of the times, Greenspan was flanked by the US Treasury Secretary and his Deputy, Robert Rubin and Lawrence Summers. The message was clear – the central bank led, and the government followed. And their remit was indeed global, as Time commented:
“As volatility has upset foreign markets and economic models, the three men have forged a unique partnership to prevent the turmoil from engulfing the globe”.
The cover set the pattern for the next 15 years:
“Dotcom crisis in 2000″ – call for Greenspan; “Subprime crisis in 2008″ – call for his successor, Bernanke
Regional crises were the same. “Eurozone debt crisis in 2012” – call for ECB President, Draghi; Japanese deflation in 2013 – call for Bank of Japan Governor, Kuroda; “Brexit crisis in 2016″ – call for Bank of England governor, Carney
But now, it seems that its not just the UK markets that are losing faith in their former super-heroes:
US 10 year rates have risen by a third from their July low to 1.8%
German rates have gone from a negative 0.2% to a positive 0.06%
Even Japanese rates have risen from a negative 0.3% to a negative 0.05%
These are major moves in such a short space of time, especially when one remembers these bonds are supposed to be “risk-free”. Clearly markets are starting to worry that they may not be “risk-free” after all.
In the past, the central banks had made the task of managing the global economy seem very easy. These incredibly powerful men (and today, one woman), seemed able to resolve any financial crisis with a nod and a wink to their friends in the markets, backed up by an interest rate cut and a round of money-printing.
And, of course, markets wanted to believe what they were being told. After all, hadn’t Greenspan invented the “Greenspan put”? This was a phrase derived from the Options market, which meant traders knew he would ride to the rescue if ever markets looked like falling out of bed.
It is true that sometimes (as with subprime) central banks appeared rather slow to realise that a crisis was brewing. But as soon as they did notice, they went straight into action to make sure prices went straight back up again, as Greenspan’s successors followed “The Master of the Universe’s” teaching.
His departure was followed by the “Bernanke put”, and then the “Yellen put”, when Janet Yellen took over at the Fed. Traders therefore learnt to borrow as much as possible after 2000, as Doug Short’s chart shows of margin debt on the New York Stock Exchange. Being bold was best, when you knew the central bank would always cover your back.
But today, many traders worry that their super-heroes can’t actually create the promised growth? They wonder how governments can pay back the vast sums of money they have borrowed for the monetary experiment? How would markets react if, one day, a major economy proved unable or unwilling to pay its debts?
And they are not alone in worrying. Even the IMF has woken up to the fact that borrowing has now doubled to $152tn since 2000, and is still rising. 15 years is, after all, a long time for an experiment to run, without producing the expected results. At some point, the funding tap must be turned off.
This is the Great Reckoning in action. Clearly some traders and investors now don’t believe that monetary policy can deliver the promised results. And as I noted on Friday, even one of the US Federal Reserve Banks has now come close to accepting our argument that demographics – not central banks – really drive the global economy.
Last week as the BBC reported, Bank of England Governor, Mark Carney, explained to an audience in Birmingham that the Bank had saved the UK economy after the Brexit vote in June:
“Between 400,000 and 500,000 jobs could have been at risk if the Bank had not taken action after the referendum, he said. ”We are willing to tolerate a bit of an overshoot [on inflation] to avoid unnecessary unemployment. We moved interest rates down to support the economy.””
Imagine that! How wonderful, that one man and his Monetary Policy Committee could save “between 400,000 and 500,000 jobs“, just with a speech, an interest rate cut, and more money-printing.
There was only one problem, as the chart above shows. Markets didn’t applaud by buying more UK government bonds and so reducing interest rates. They sold off again (red line)*, panicked by the idea that debt was rising whilst growth was slowing and the currency falling (blue line):
Interest rates had fallen after the June 23 vote, as traders bet that Carney would add more stimulus
They fell to 1.09% on June 24, and then to 0.65% after his August confirmation that this was underway
But then, in a departure from the Bank’s script, they bottomed at 0.53% a week later, and began to rise
Premier Theresa May caused further alarm at the Conservative Conference, suggesting Brexit might be for real
They closed on Friday after Carney’s speech at 1.1% – nearly twice the August level, and above the June 24 close
Over the weekend, traders were then able to read the previously unpublished comments of Foreign Secretary, Boris Johnson, on the implications of a Brexit vote:
“There are some big questions that the “out” side need to answer. Almost everyone expects there to be some sort of economic shock as a result of a Brexit. How big would it be? I am sure that the doomsters are exaggerating the fallout — but are they completely wrong? And how can we know?
“And then there is the worry about Scotland, and the possibility that an English-only “leave” vote could lead to the break-up of the union. There is the Putin factor: we don’t want to do anything to encourage more shirtless swaggering from the Russian leader, not in the Middle East, not anywhere.
“And then there is the whole geostrategic anxiety. Britain is a great nation, a global force for good. It is surely a boon for the world and for Europe that she should be intimately engaged in the EU. This is a market on our doorstep, ready for further exploitation by British firms: the membership fee seems rather small for all that access.
“Why are we so determined to turn our back on it?”
Its just a pity that it was left until now for Johnson’s “alternative view” on Brexit to emerge. It confirms my fear immediately after the Brexit vote, that Brexit will prove to be:
“The canary in the coalmine. It is the equivalent of the “Bear Stearns collapse” in March 2008, ahead of the financial crisis. And as I have argued for some time, the global economy is in far worse shape today than in 2008, due to the debt created by the world’s major central banks.”
The sad conclusion is that the world is now likely to suffer some very difficult years. Markets will have to relearn their true role of price discovery, based on supply and demand fundamentals, rather than central bank money-printing. On Wednesday, I will look at some of the wider implications for global interest rates.
* Bond prices move inversely to interest rates, so a higher rate means a lower price
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 50%
Naphtha Europe, down 48%.“Petrochemical demand high despite margin drop”
Benzene Europe, down 53%. “Prices have ebbed and flowed with the crude oil/energy market as well as market developments in the US”
PTA China, down 40%. “Bottle chip producers in China have been staying away from purchasing import cargoes, with traders describing demand for PET producers as ‘soft”
HDPE US export, down 31%. “The depreciation of Chinese Yuan dampened buying interest for import cargoes”
S&P 500 stock market index, up 9%