Central banks’ reliance on defunct economic theory makes people worry their children will be worse off than themselves

“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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China and NEA’s ‘demographic dividend’ turns to deficit

China births Nov13

October’s post ‘Women now have half the number of children compared to 1950‘ attracted great interest amongst blog readers from around the world.  It highlighted how global life expectancy has risen 50% since 1950 to average 70 years.  Over the same period, the average number of children being born has halved to just 2.5 per woman.

It thus suggested today’s ‘population explosion’ is in reality a ‘health explosion’.  The great benefit of increased life expectancy means women don’t have to have children every year, in order to ensure the family will earn enough to survive.  So they are free to do other things with their lives, such as go back to work after childbirth.

During December, the blog will therefore look in more detail at the position in the world’s 5 largest economies – USA, China, Japan, Germany and France.  Combined, these are half of the global economy ($36tn).

It starts today with China, which has the world’s largest population with 1.4bn people.  China has become the manufacturing capital of the world over the last 15 years.  But the future looks very different, as 450m people (41% of the adult population) will be in the New Old 55+ generation by 2030.  The chart above shows the background to this startling change:

  • Since the 1950s and the post-civil war chaos, life expectancy (red) has increased rapidly to 75 years today
  • At the same time, fertility rates (green) have collapsed from 6.1 to just 1.1 child per woman

Thus China’s ‘demographic dividend’ is rapidly turning into a ‘demographic deficit’ as the labour force now falls.

Clearly China’s ‘One Child Policy’ has been part of the reason for this collapse.  But the same phenomenon has also been seen across North East Asia (NEA):

  • Women in S Korea, Taiwan and Japan also now average just 1.1 child
  • Women in Hong Kong and Macau, again with no formal population controls, now have only 0.9 children each

Thus although China’s policy is now being slowly repealed, it may not lead to many new babies being born.

This, of course, matters enormously for future growth.  Simply maintaining the population level requires women to have an average of at least 2.1 children.  So NEA populations are therefore certain to decline at today’s fertility levels.  Equally, their ageing populations will inevitably spend much less than when they were younger:

  • Older people are essentially a replacement economy as they already own much of what they need
  • They also have less money to spend, as they move into retirement

China, however, has an even more serious problem looming, as the latest OECD Pension Handbook shows, due to its lack of Western-style pension and social security provision.

Its basic pension pays just 1% of average individual/province earnings for each year of coverage, subject to a minimum 15 years of contributions.  So 30 years’ employment provides a pension of just 30% of this average wage.  Some employees also pay 8% of their wages into a retirement fund and receive top-up annuities based on individual savings – but this only covers 210m urban employees.

The numbers tell the story of this dramatic turnaround:

  • Until 2000, 80% of the adult population were in the Wealth Creating 25-54 age group, or about to join it
  • Only around 20% of the adult population was in the New Old 55+ generation
  • So most adults could expect their wages and spending to rise in future years
  • But already today, one in four adults are now in the New Old
  • And the New Old’s numbers are rising rapidly: they will be one in three by around 2020, and 41% by 2030

Just imagine the challenge this poses for the new government.  It aims to refocus growth on domestic consumption, and away from exports and infrastructure spend.  Yet as the OECD reminds us, China’s average earnings are just $7500 (versus $42500 across the OECD).  So 30 years employment gives a pension of just $2250, plus annuity.

So how will all these New Old  – 250m people today, 450m by 2030 – afford to buy lots of consumer goods and services?  Almost certainly, China’s population is going to get old before it gets rich.

At least the new government understands the issue.  As premier Li noted in October, its priorities include increasing investment “in areas such as pension and health services, as people can currently wait 30 or even 40 years for a place in a state nursing home.”

But many Western and Asian companies have failed to recognise the criticality of this issue.  They imagine China is about to become a thriving middle class paradise – a mix of Manhattan, Knightsbridge and the Ginza rolled into one.

Reality is rather different.  Those companies who provide affordable basic products and services will do very well.  Others will find business very difficult, as yesterday’s demographic dividend turns to tomorrow’s demographic deficit.

Women now have half the number of children compared to 1950

Fertility Oct13

Demographics drive demand.  Developments since 1950 are thus creating massive and unprecedented change in global demand patterns, as the chart above highlights:

  • Fertility rates (green) have halved on a global basis, with the average woman having just 2.5 children today
  • Life expectancy (red) has increased by 50% over the same period, to average around 70 years

Virtually every country has seen the same trends.  Thus when people talk about a ‘population explosion’, they really mean a ‘health explosion’.

The two developments are, of course, closely connected.  Increased life expectancy means women don’t have to have children every year, in order to ensure the family will earn enough to survive.  So they are free to do other things with their lives, such as go back to work after childbirth.

This led to the arrival of dual-income households for the first time in history in the 1980s, and was great news for the economy.  It opened up important new markets, as working women not only needed labour-saving appliances for the home, but also had the income to buy them.

The world thus saw a growth SuperCycle between 1983-2007, where the US suffered only 16 months of recession in 25 years:

  • The arrival of the Western BabyBoomers, the largest and wealthiest generation is history, meant growth became virtually constant
  • As they entered the Wealth Creator 25 – 54 age range, they settled down, had kids, and saw their incomes rise
  • Increasing numbers of women entered the workforce, and their incomes relative to men also increased to record levels

But that was then, and this is today.

Most of us, not just the lucky few, can hope to live beyond retirement age.  So we now have record numbers of people in the New Old 55+ generation, also for the first time in history.

This, in turn, means the economy has gone ex-growth.  Older people represent a replacement economy, who already own most of what they need.  Equally, they have much less money to spend.  A couple retiring at age 65 would need a pension fund of $1m just to equal median US income of $40k/year.  Most people have nothing like this amount of savings.

Equally, and contrary to popular belief, the emerging economies are totally unable to replace this lost demand.  Their incomes rose during the SuperCycle but are typically only a tenth of those in the West.  In China, for example, only 4% of the population earn more than $20/day.  And even this $7300/year would leave them a long way short of joining the Western middle class.

Demographics, as we describe in ‘Boom, Gloom and the New Normal’ are now driving major and fundamental change in the global economy.  Those who instead believe in a return to the SuperCycle are going to be very disappointed.

G7 births hit new record low in 2012

G7 in 2013The G7 group of countries are almost half (47%) of global GDP*.  They also have the highest incomes, and are therefore still the major driver for the global economy.  If we understand what is happening to their populations, we have a great insight in the key driver for demand, as we showed in ‘Boom, Gloom and the New Normal’.

The chart above is therefore the blog’s annual update of this key data, showing 2012 births.  It shows this data by age profile, so older people are to the right.

This highlights some important messages:

  • Across the G7, there was an enormous increase between 1946-70 in the number of babies born
  • This BabyBoomer generation was 15% larger than the previous cohort born between 1921-45
  • Crucially, the Boomers are also 16% larger than the generation born between 1971-2000
  • Even more importantly, the average Boomer joins the New Old 55+ generation this year

55 is a key age in terms of demand patterns.  It marks the moment when people’s spending begins to reduce, as they already own most of what they need, whilst their incomes reduces as they move into retirement.

In the past, of course, this cohort was not of great importance to the wider economy.  Even in the G7, life expectancy was only 66 years as late as 1950.  In the emerging economies it was only 44 years.   And generally speaking, people’s needs were very limited in their last few years of life.

The good news is therefore that life expectancy in the G7 has now risen dramatically to around 80, and to around 70 in the emerging economies.  This is a truly dramatic achievement.  But it also means a large number of people are now in the New Old generation for the first time in history.  And whilst their needs are larger than in 1950, they still represent a replacement economy and have to depend on pensions when they retire.

The chart also highlights how the number of G7 births hit a new record low in 2012 at 8.17m.  This was 200k lower than in 2011:

  • The US was unchanged at 3.95m, Japan declined to 1.03m, the UK was unchanged at 810k
  • France was unchanged at 790k, Germany declined to 670k and Italy to 530k, Canada was unchanged at 380k
  • By comparison, there were 10.1m G7 babies in 1958, when today’s 55-year-olds were born
  • 4.3m were born in the US; 1.7m in Japan; 1.2m in Germany; 870k in Italy and the UK; 810k in France; 470k in Canada

Increased life expectancy is a fabulous benefit.  But it has been accompanied by a similarly major fall in the number of babies being born to the average woman.  So today’s ‘population explosion’ is in fact a ‘health explosion’.

Demographics drive demand.  Today, around 40% of the G7′s adult population is thus in the New Old generation, and in their low-spending years.  This means economic growth will remain slow for decades to come.  Smart companies will instead focus on the new demand drivers of age and income, if they want to maintain growth for the future.

* G7 = USA, Japan, Germany, France, UK, Italy, Canada