US tax cuts will fail as Trump’s demographic deficit replaces Reagan’s demographic dividend

No country in the world now has a top quality pension system.  That’s the conclusion from the latest Report by pensions consultants Melbourne Mercer.  As the chart above shows:

  • Denmark and The Netherlands have fallen out of the top category
  • In the G7 wealthy nations: Canada is in category B; Germany and UK in C+; France, US and Italy in C; Japan in D
  • In the BRICS emerging economies: Brazil is in category C; India, China and S Africa are D; and Russia’s system is so poor it is unclassified

Unsurprisingly, the cause of the problems is today’s ‘demographic deficit’, as the authors highlight:

“The provision of financial security in retirement is critical for both individuals and societies as most countries are now grappling with the social, economic and financial effects of ageing populations. The major causes of this demographic shift are declining birth rates and increasing longevity. Inevitably these developments are placing financial pressure on current retirement income systems. Indeed, the sustainability of some current systems is under threat.”

These problems have been building for years, as politicians have not wanted to have difficult conversations with voters over raising the retirement age.  Instead, they have preferred to ignore the issue, hoping that it will go away.

But, of course, problems that are ignored tend to get worse over time, rather than go away.  In the US, public pension funds saw their deficits jump $343bn last year to $3.85tn – making it almost certain that, eventually, pension benefits will have to be cut and taxes raised.

The issue has been that politicians preferred to believe central bank stimulus programmes could solve the deficit by cutting interest rates and printing large amounts of virtually free cash.  And unfortunately, when it became clear this policy was failing to work, the banks “doubled down” and pursued negative interest rates rather than admitting defeat:

  • Currently, 17% of all bonds (worth $8tn), trade at negative rates
  • Swiss bond yields are negative out to 2027, as the Pensions Partners chart shows
  • Most major European countries, and Japan, suffer from negative rates

2 years ago, Swiss pension experts suggested that its pension system would be bankrupt within 10 years, due to the requirement to pay retirees an annuity of 6.8% of their total savings each year.  This rate is clearly unaffordable with negative interest rates, unless the funds take massive risks with their capital.

The US faces similar problems with Social Security, which is the major source of income for most retirees.  The Trustees forecast its reserves will be depleted by 2034, when benefits will need to be cut by around a quarter.  Medicare funds for hospital and nursing will be depleted by 2029.  And as the Social Security Administration reports:

173 million workers are covered under Social Security.  46% of the workforce in private industry has no private pension coverage.  39% of workers report that they and/or their spouse have not personally saved any money for retirement.”

Rising life expectancy is a key part of the problem, as the World Economic Forum (WEF) reported in May.  Back in 1889, life expectancy was under 50 when Bismarck introduced the world’s first state pension in Germany.  Today, the average baby born in the G7 countries can expect to live to be 100.  As WEF conclude:

“One obvious implication of living longer is that we are going to have to spend longer working. The expectation that retirement will start early- to mid-60s is likely to be a thing of the past, or a privilege of the very wealthy.” 

Sadly, politicians are still in denial, as President Trump’s proposed tax cuts confirm.

Today is not 1986, when President Reagan cut taxes in his October 1986 Tax Reform Act and was rewarded with higher tax revenues.  30 years ago, more and more BabyBoomers were entering the wealth creating 25 – 54 age group, as the chart from the Atlanta Fed confirms:

The issue is the ageing of the Boomers combined with the collapse of fertility rates:

  • The oldest Boomers left the Wealth Creator cohort in 2001, and the average Boomer (born in 1955) left in 2010
  • The relative number of Wealth Creators is also in decline, as US fertility rates have been below replacement level (2.1 babies/woman) for 45 years since 1970

Inevitably, therefore, Reagan’s demographic dividend has become Trump’s demographic deficit.

As I warned back in May, debt and demographics are set to destroy Trump’s growth dream.  And without immigration, the US working age population will fall by 18m by 2035, making a bad situation even worse.  Instead of tax cuts, Trump should instead be focused on 3 key priorities to:

  • Design measures to support older Boomers to stay in the workforce
  • Reverse the decline that has taken place in corporate funding for pensions
  • Tackle looming deficits in Social Security and Medicare”

Future retirees will not thank him for creating yet further debt headwinds by proposing unfunded tax cuts.  These might boost GDP in the short-term.  But they will certainly make it even more difficult to solve tomorrow’s pension deficits.

The end of the Economic SuperCycle

Landing page Infographic

A paradigm shift is underway in global petrochemical and polymer markets, as I discuss in a new article for ICIS Chemical Business.

Previously successful business models, based on the supply-driven principle, no longer work. As our new study, “Demand – the New Direction for Profit”, explains, companies now need to adopt demand-led strategies if they want to maintain revenue and profit growth.

The infographic above highlights the key issues:

  • During the 1980s/1990s, the BabyBoomers – the largest and wealthiest generation that the world has ever seen – entered the Wealth Creator generation (those aged 25 – 54), when income and spending peak
  • They powered an Economic SuperCycle
  • The world’s largest economy, the USA, suffered just 18 months of recession in 25 years between 1983 – 2007
  • The demand surge created the phenomenon of globalisation, integrating Eastern Europe, then China and India, into the global economy
  • It peaked between 1995 – 2000, when all the BabyBoomers (born 1946-70) were in the Wealth Creator generation

But then the oldest Boomers began to join the New Old generation of those aged 55+.  In the past, they would have died very quickly – life expectancy, even just a century ago, was only 46 years in the West, and 26 years in emerging economies.  But major advances in healthcare, food/water safety, and personal lifestyles meant that the average 65-year old could instead hope to live another 15 – 20 years.

Demand growth began to decline.  The New Old already own most of what they need, and their incomes decline as they enter retirement.

Policymakers refused to accept this obvious fact.  Instead, they claimed to be able to produce constant growth by boosting financial markets.  First they created the subprime bubble in the USA, and then today’s stimulus bubble.  This had created $57tn of debt by 2014, nearly the size of the global economy.  Clearly, this could not continue:

  • China was the first to change economic course, when President Xi Jinping took office in 2013
  • The Great Unwinding of policymaker stimulus began in August 2014

China had been responsible for more than half of the stimulus spending under the previous leadership.  So its New Normal policies had a major impact on the global credit bubble.

Since then, oil and commodity prices have collapsed, and economies dependent on exports to China have gone into recession.  Global GDP fell by a record $3.8tn in 2015 in current dollars.  Inflation is turning into deflation.

But still, policymakers in the developed world refuse to accept that demographic changes are driving the global economy.  Instead, they are creating even more debt – which can probably never be repaid.

What are companies and investors to do?  As the infographic below describes, they have a clear choice ahead:

  • They can either hope that somehow these new stimulus policies will succeed despite past failure
  • Or, they can join the Winners who are now starting to develop new revenue and profit growth by adopting demand-led strategies

Please click here if you would like to download a copy of the feature article, and click here to download a copy of the Study brochure.

New Normal infographic

Pension funds suffer as retirement ages have fallen whilst life expectancy has risen

US pensions Sept15

10k Americans have been retiring every day since 2011, and 18k Europeans, as the BabyBoomer generation reaches the age of 65.  But pension schemes have not adapted to the fact that average life expectancy is now 20 years at age 65.   This is causing major problems for the economy as pensioners leave the workforce – and placing a increasingly large burden on the younger generation who have to fund their pensions for the next 20 years.

The problem is that these changes have happened within just a few generations.  It is not all that long ago, relatively speaking, that life for people even in the developed world was “nasty, brutish and short”, as author Thomas Hobbes had written in 1651.

  • No government thought to offer pensions even 200 years ago, as most had no regular sources of tax revenue
  • Average life expectancy in the West then was just 36 years, and only 24 years everywhere else
  • People relied on their children to look after them, if they were lucky enough to live longer than average
  • So parents typically had large numbers of children, to ensure some would still be alive to look after them

This situation only began to change when Germany introduced the world’s first state pension in 1889.  The UK, then the world’s wealthiest country, followed 20 years later (delaying because it was worried about the cost):

  • UK life expectancy was only 50, but pension age was set at 70 to ensure it was affordable
  • Only 600k of the UK’s 40m population received the pension, which was worth just £17 ($25) in today’s money)
  • But today, only 100 years later, it has become a universal benefit, received by 17% of the entire UK population

When we first began to write ‘Boom, Gloom and the New Normal’, we assumed policymakers fully understood the economic impact of today’s ageing populations.  It seemed just common sense – more older people, all spending less, and fewer young people inevitably meant slower growth and probably deflation.

How wrong we were!  Even today, most policymakers simply ignore this critical topic.  Instead, they continue to believe that creating ‘wealth effects’ in financial and property markets will somehow maintain growth:

  • Yet older people already own most of what they need, and their spending drops quite sharply as they move into their 70s and 80s
  • Plus, of course, there are relatively few young people in the main wealth-generating 25 – 54  age group, as fertility rates have been below replacement level for the past 45 years

Increasing life expectancy is, of course, great news for us as individuals.  But for the economy, it means that yesterday’s ‘demographic dividend’ has turned into a ‘demographic deficit’.  Now many pension funds are having to face the fact that they risk not being able to pay out the promised benefits.

As the chart shows from the Wall Street Journal, most US state pension funds are now being forced to reduce their expected annual returns on investment.  This means that local and state governments will have to increase their payments – either by raising taxes, or cutting spending.  And many analysts worry the assumed returns are still too high – which could mean more funds having to cut actual pension payments as in Detroit.

Private and personal retirement saving faces the same pressures as life expectancy keeps increasing.  As a result, the typical US corporate pension fund now has only 78% of what it needs to meet its pension promises.  And this, of course, is a vicious circle:

  • If companies pay more money into their funds, their earnings will fall, leading to pressure on their stock price
  • If they don’t pay more and default on their promises. pensioners will have less money to spend in retirement

Nor is the US alone in this problem.  In the UK, 4500 corporate pension schemes are in deficit, compared to only 1750 in surplus.  Major telecoms utility BT is in even worse shape, with its £47bn ($72bn) pension fund now 150% of its entire market capitalisation. In Switzerland, pension experts expect the national fund to be bankrupt within 10 years.

There is no easy solution to this problem.  But the longer it is ignored, the worse it is going to get.

10 forecasts for the New Normal world in 2020

New Normal Jun15We seem to be approaching Stage 2 of the Great Unwinding of policymaker stimulus, as the economic implications of demographic change become ever stronger.

The combination of today’s ageing populations with the collapse in fertility rates means it is totally unrealistic to expect growth rates to continue at the SuperCycle levels of the past.  They were turbo-charged by the BabyBoomers being in their prime period of income and spending growth – especially as female Boomers entered the workforce in unparalleled numbers.

Yesterday’s New York Times confirmed this common sense fact for the US economy:

“Over the last 40 years, the American economy has grown at an average of 2.8%/year. That’s slower than the 3.7% average from 1948 to 1975, but the future looks even gloomier because that 2.8 figure relied on two favorable trends that are now over: women entering the work force, and baby boomers reaching their prime earning years.

“After 2020, with the percentage of the American population that is of prime working age shrinking, the Congressional Budget Office expects growth to stabilize at 2.2%….(given the) demographic headwinds caused by baby-boom retirements.”

It is also not difficult to look forward, and see where we will be in 5 years time, if we take off our rose-tinted glasses. John Richardson and I did this in chapter 4 of our eBook, Boom, Gloom and the New Normal.  We made 10 forecasts for the world in 2020:

  • A major shake-out will have occurred in Western consumer markets.
  • Consumers will look for value-for-money and sustainable solutions.
  • Young and old will focus on ‘needs’ rather than ‘wants’.
  • Housing will no longer be seen as an investment.
  • Investors will focus on ‘return of capital’ rather than ‘return on capital’.
  • The term ‘middle-class’ when used in emerging economies will be recognised as having no relevance to Western income levels.
  • Trade patterns and markets will have become more regional.
  • Western countries will have increased the retirement age beyond 65 to reduce unsustainable pension liabilities.
  • Taxation will have been increased to tackle the public debt issue.
  • Social unrest will have become a more regular part of the landscape.

The transition to the New Normal will be a difficult time. The world will be less comfortable and less assured for many millions of Westerners. The wider population will find itself following the model of the ageing boomers, consuming less and saving more. Rather than expecting their assets to grow magically in value every year, they may find themselves struggling to pay-down debt left over from the credit binge.

Companies therefore need to refocus their creativity and resources on real needs. This will require a renewed focus on basic research. Industry and public service, rather than finance, will need to become the destination of choice for talented people, if the challenges posed by the megatrends are to be solved. Politicians with real vision will need to explain to voters that they can no longer expect all their wants to be met via endless ‘fixes’ of increased debt.

We could instead decide to ignore all of this potential unpleasantness.

But doing nothing is not a solution. It will mean we miss the opportunity to create a new wave of global growth from the megatrends. And we will instead end up with even more uncomfortable outcomes.

Boom, Gloom and the New Normal is available for download in PDF or Kindle format

Fertility rates have collapsed in the world’s 10 largest economies

Top 10 fertilityOne of the great myths of our time is that the world’s population is inevitably growing.  Almost everyone has heard that the population is certain to reach 9bn by 2050, from today’s 7.3bn.

Yet births in 2013 in the G7 economies (almost half of the global economy) were at the lowest level since the Great Depression year of 1933.  And as I noted last year, global fertility rates have halved since 1950 to average just 2.5 babies/woman – and in many countries are already below replacement level of 2.1 babies.

As a result, there is great doubt about whether the population will continue to expand beyond 2030.  On current trends, the population will peak within a decade at 8.3bn, and then decline.

Essentially, we have all been fooled by the rise in life expectancy, which is 50% higher today than in 1950.  

If people are living longer, then the population must rise, even if fewer babies are being born per woman.  But within a decade, today’s ageing BabyBoomers will start dying in large numbers.  And then we will suddenly realise there are not enough young people to replace them.

The chart above highlights the issue, based on the UN Population Division’s low scenario for the world’s 10 largest economies (which are almost 2/3rds of the global economy):

  • US fertility rates have halved to 1.7 babies/woman since 1950 (black), whilst China has fallen from 6.1 to just 1.1 babies/woman (red)
  • Japan, the 3rd largest economy has seen rates fall from 3 babies to 1.1 babies (blue): Germany has fallen from 2.2 babies to 1.2 babies (dark blue)
  • France, the 5th largest, has seen them fall from 2.8 babies to 1.6 babies (orange); the UK has fallen from 2.2 babies to 1.5 babies (green)
  • Brazil, the 7th largest, has seen them fall from 6.2 babies to 1.3 babies (yellow); Russia has fallen from 2.9 babies to 1.2 babies (black)
  • Italy, the 9th largest, has halved from 2.4 babies to 1.2 babies (pink); India has fallen from 5.9 babies to 2 babies (brown)

Of course, if I talk to my friends in the central banks, they tell me that none of this matters.  They are confident they can create constant growth with the right mix of tax and stimulus policies.  They also believe inflation is due to monetary policy, not supply/demand balances.  So if they print more money via Quantitative Easing, they can create inflation.

But after years of this debate, I see no sign that they are right.  My argument is simple – only babies can create demand once they have grown up and start earning an income.  All central banks can do is create ‘wealth effects’ by boosting asset prices in housing and stock markets.

The argument about monetary policy is thus a fallacy.  The vast increase in births during the post-War BabyBoomer period meant demand soared, inevitably creating inflation.  Supply simply couldn’t keep up, especially as the economy was transitioning from a war-time basis.  You can’t eat tanks, or wash clothes in fighter planes.

The collapse in fertility rates means this pattern is now reversing.  Today, we have all the supply built for the Boomer-led SuperCycle.  But the lack of babies, combined with the ageing population, means demand is inevitably weakening.  Older people already own most of what they need, and their incomes are declining as they enter retirement.

My view is therefore that the central banks are guilty of wishful thinking at our expense.  And by creating such high levels of debt, they have actually created even more headwinds for growth.  Today’s young people now have to repay all this debt at a time when the arrival of deflation means the cost of debt is actually increasing.

 

 

 

“Investors retreat as deflation fears rise”

Deflation Dec13The blog’s important eBook, ’Boom, Gloom and the New Normal: How Ageing Western BabyBoomers are Changing Demand Patterns, Again’, was published 3 years ago this month.  Co-authored with John Richardson, it identified the major changes taking place in global and national demand patterns:

Growth accelerated from the 1980s, as the population became concentrated in the wealth creating 25 – 54 age group, and the number of dependent children reduced.

Growth then moved into SuperCycle mode as low fertility rates freed large numbers of women to re-enter the workforce after childbirth.

The past 30 years were thus an entirely exceptional period of growth in the global economy.

But the next 30 years will be quite different:

  • For the first time in history, the world has an entire generation of people aged over 55
  • And low fertility rates have created a shortage of those in their peak demand years

Growth will inevitably slow, as the relative size of the wealth creator generation will continue to reduce, due to more and more men and women joining the New Old 55+ group

This slowdown will be accentuated, as the New Old represent a replacement economy.  They already own most of what they need, and their incomes are reducing as they enter retirement

For the past 3 years, the blog has had the privilege of working with the Boards of many major companies, describing the challenges and opportunities created by these immense changes in demand patterns.  It has also spoken at a wide range of conferences around the world, as clearly these changes are having widespread impact.

But now, the time for talking and discussing is over.  Companies must instead start to turn words in action, or risk suffering a major downturn in their business over the next 5 – 10 years.

Last week, China’s President Xi Jinping highlighted that China is now moving into the New Normal:

We must boost our confidence, adapt to the New Normal condition based on the characteristics of China’s economic growth in the current phase” 

At the same time, the world’s leading financial media were reporting how developments in the global economy are following the forecasts set out in Boom, Gloom, and the New Normal:

  • The front page headline in Friday’s Financial Times was ”Investors retreat as deflation fears rise
  • Reuters’ headline on the same day was “The world needs to get ready for a New Normal with Chinese characteristics
  • Whilst the Wall Street Journal wrote under the headlineGlobal Growth Worries Climb

“Five years after the financial crisis ended, soft growth in Europe, a stop-and-start U.S. recovery and waning momentum in China have policy makers groping for what to do next.”

We are now at the parting of the ways.  Global growth cannot, and will not, go back to the world of the Boomer-led SuperCycle.  The next 30 years will see a whole range of major new opportunities develop, for those companies who are willing and able to grasp them.

Our 5-step APPLY Workshops are individually tailored to meet the needs of your business.  Please click here if you would like further details of their Value Proposition.  And please click here to download your copy of ‘Boom, Gloom and the New Normal.

 

The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
PTA China, down 14%. “Slower demand seen in the polyester markets towards the week’s close has kept the majority of end-users adopting a rather pessimistic market outlook”
US$: yen, down 3%
Benzene, Europe, down 2%. “Spot price levels dropped this week to their lowest since the start of the year”
Brent crude oil, down 1%
Naphtha Europe, up 2%. “A potential rise in imports from Russia, coupled with the end of the US refinery maintenance season, could ease supply pressures”
S&P 500 stock market index, up 3%
HDPE US export, up 7%. “Latin American buyers were purchasing significant volumes of lower-priced material from Korea”