If a country doesn’t have any babies, then in time it won’t have an economy. But that’s not how the central banks see it.
For the past 20 years, through subprime and now their stimulus policies, they have believed they could effectively “print babies”. Even today, they are still lining up to take global interest rates even further into negative territory.
But common sense tells us their policy cannot work:
- New data shows 2018 births in the G7 richest Western countries were just 7.8m
- This was the lowest level seen since records began in 1921
- It was even lower than at the height of the Depression in 1933 when births dropped to 7.99m/year
- By comparison during the 1946-70 BabyBoom, they averaged 10.1m/year and peaked at 10.6m
The chart above confirms the unique nature of the Western BabyBoom. Births jumped by 15% versus the previous 25 years, and since then they have fallen by an average 17%. Every single country is now having fewer births than at the peak of the Boom:
- US births were 3.79m last year, versus a peak of 4.29m in 1959
- Japan had 0.92m versus 2.7m in 1949; Germany had 0.79m versus 1.36m in 1963
The BabyBoom mattered because the Boomers were part of the richest society the world has ever seen. In 1950, the G7 were half of the global economy, and they were still 45% in 2000. The “extra babies” born during the Boom, effectively created a new G7 economy the size of Canada.
But since 1970, the West has not been replacing its population, as fertility rates have been below 2.1/babies per woman. This matters, as the second chart shows for the USA, the world’s largest economy.
Consumer spending is 70% of GDP, and it peaks in the 25-54 Wealth Creator generation – when people are building their careers and often settle down and have children. Spend then drops by over 40% by the age of 75.
This didn’t matter very much for the economy in the past, when most people died around pension age:
- In 1950, for example, there were just 130m Westerners in the Perennials 55+ age group. By comparison, there were 320m Wealth Creators and 360m under 25
- But today, there are 390m Perennials compared to 515m Wealth Creators and just 350m under-25s
This means it is impossible to recreate the growth of the Boomer-led SuperCycle.
Does this matter? Not really.
Most of us would prefer to have the extra 15-20 years of life that we have gained since 1950. But because policymakers have pretended they could print babies via their stimulus programmes, they were able to avoid difficult discussions with the electorate about the impact of the life expectancy bonus.
Now, this failure is catching up with them. Perennials are, after all, effectively a replacement economy. They already own most of what they need, and their incomes decline as they move into retirement. So we need to adjust to this major change:
- In 1950, it was normal for people to be born and educated, before working to 65 and then dying around pension age
- Today, we need to add a new stage to this paradigm – where we retrain around the age of 55, probably into less physically demanding roles where we can utilise the experience we have gained
- This would have tremendous benefits for individuals in terms of their physical and mental health and, of course, it would reduce the burden on today’s relatively fewer Wealth Creators
- It is completely unfair, after all, for the Boomers to demand their children should have a lower standard of living, and instead support their parents in the Perennials cohort
There is, of course, one other fantasy peddled by the central banks as part of their argument that monetary policy can always create growth.
This is that the emerging economies have all now become middle class by Western standards, and so global growth is still going to power ahead. But as the third chart shows, this simply isn’t true:
- It shows the world’s 10 largest economies (the circle size) ranked by fertility rate and median age
- Only India still has a demographic dividend, with its fertility rate just above replacement levels
- But India’s GDP/capita is only $2036: Brazil’s is just $8968 and China’s $9608
- By comparison, the US is at $62606, Germany is at $48264 and France/UK are at $42600
Companies and voters have been completely fooled by these claims of a “rising middle class” in the emerging economies. In reality, most people have to live on far less than the official US “poverty level” of $20780 for a 3-person household.
In China, average disposable income in the major cities was just $5932 last year, and only $2209 in the poorer rural half of the country. Its great success has actually been to move 800m people out of extreme poverty (income below $1.90/day) since 1990.
Demographics don’t lie, and they clearly challenge the rose-tinted view of the central banks that further interest rate cuts will somehow return us to SuperCycle days.
Their real legacy has been to create record levels of debt, which can probably never be repaid.
The blog has now been running for 12 years since the first post was written from Thailand at the end of June 2007. A lot has happened since then:
Sadly, although central banks and commentators have since begun to reference the impact of demographics on the economy, they refused to accept the fundamental issue – namely that economic growth is primarily driven by the needs of the Wealth Creator 25-54 age group:
- Their numbers are reducing because Western fertility rates have been below replacement level (2.1 babies/woman) for nearly 50 years
- Central bank attempts to effectively “print babies” via stimulus policies have therefore only increased debt to record levels
As a result, the world has become a much more complex and dangerous place. None of us can be sure what will happen over the next 12 months, as I noted last week. But clearly, the risks are rising, as UK Justice minister, David Gauke, has highlighted:
“A willingness by politicians to say what they think the public want to hear, and a willingness by large parts of the public to believe what they are told by populist politicians, has led to a deterioration in our public discourse. This has contributed to a growing distrust of our institutions – whether that be parliament, the civil service, the mainstream media or the judiciary.
“A dangerous gulf is emerging, between the people and the institutions that serve them. Such institutions – including the legal system and the judiciary – provide the kind of confidence and predictability that underpins our success as a society.
“Rather than recognising the challenges of a fast-changing society require sometimes complex responses, that we live in a world of trade-offs, that easy answers are usually false answers, we have seen the rise of the simplifiers.
“Those grappling with complex problems are not viewed as public servants but as engaged in a conspiracy to seek to frustrate the will of the public. They are ‘enemies of the people’.”
THANK YOU FOR YOUR SUPPORT OVER THE PAST 12 YEARS
It is a great privilege to write the blog, and to be able to meet many readers in workshops and conferences around the world. Thank you for all your support.
Residential construction work in Qingdao, China. Government stimulus is unlikely to deliver the economic boost of previous years © Bloomberg
China’s falling producer price index suggests it could soon be exporting deflation, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
On the surface, this year’s jump in China’s total social financing (TSF) seems to support the bullish argument. TSF was Rmb5.3tn ($800bn) in January-February, a 26 per cent rise on 2018’s level.By comparison, it rose 61 per cent in 2009 as the government panicked over the impact of the 2008 financial crisis, and 23 per cent in 2016, when the government wanted to consolidate public support ahead of 2017’s five-yearly Party Congress session, which reappointed the top leadership for their second five-year term.
The markets were certainly right to view both these increases positively, as we discussed here two years ago. But we also added a cautionary note, suggesting that 2017’s Congress might well be followed by a “new clampdown”, as Xi’s leadership style was likely to “move away from consensus-building towards autocracy”. This analysis seems to have proved prescient, and it makes us cautious about assuming that Xi has decided to reverse course in 2019.
Consumer markets are also indicating a cautious response. Passenger car sales, for example, were down 18 per cent in January-February compared with the same period last year, after having fallen in 2018 for the first time since 1990. Smartphone sales were also down 14 per cent over the same period. In the important housing market, state-owned China Daily reported that sales by industry leader Evergrande fell by 43 per cent.
There is little evidence on the ground to suggest that Xi has decided to return to stimulus to revive economic growth. Last month’s government Work Report to the National People’s Congress said it would “refrain from using a deluge of stimulus policies”.
Instead, it seems likely that this year’s record level of lending was used to bail out local government financing vehicles (LGFVs) and other casualties of China’s post-2008 debt bubble. The second chart illustrates the potential problem, with TSF suddenly taking off into the stratosphere after 2008, when stimulus began, while GDP growth hardly changed its trajectory.
The stimulus programme thus dramatically inflated the amount of debt needed to create a unit of GDP. And given the doubts over the reliability of China’s GDP data, it may well be that the real debt-to-GDP ratio is even higher. These data therefore support the argument that debt servicing is now becoming a major issue for China after a decade of stimulus policies.
One example comes from the FT’s analyses of the debt problems affecting China Rail and China’s vast network of city subways. The FT reported that China has 25,000km of high-speed rail tracks, two-thirds of the world’s total, and that China Rail’s debt burden had reached Rmb5tn — of which around 80 per cent related to high-speed rail construction. Its interest payments have also exceeded its operating profits since at least 2015.
Unsurprisingly, given China’s relative poverty (average disposable income was just $4,266 in 2018), income from ticket sales has been too low even to cover interest payments since 2015. And yet the company is planning to expand capacity to 30,000km of track by 2030, with budgets increased by 10 per cent in 2018 as a result of the decision to boost infrastructure.
The same problem can be seen in city subway construction, where China accounted for 30 per cent of global city rail at the end of last year by track length, but only 25 per cent of ridership, which suggests that some lines may be massively underused and economically unviable.
The issue is not whether this level of investment is justifiable over the longer term in creating the infrastructure required to support growth. Nor is it whether the debt incurred can be repaid over time. Instead, the real question is whether the need to support economic expansion has led to a financially-risky acceleration of the infrastructure programme and whether, in turn, Beijing is now being forced to cover potential losses in order to avoid a series of credit-damaging defaults.
So where does this alternative narrative lead us? It suggests that far from supporting consumer spending, the TSF increase is flagging a growing risk in Asian debt markets — where western investors have rushed to invest in recent years, attracted by the relatively high interest rates compared with those enforced by central banks in their home markets. In 2017, for example, Chinese borrowers raised $211bn in dollar-denominated issuance, at a time when corporate debt levels had already reached 190 per cent of GDP.
This risk is emphasised if we revisit our suggestion here at the end of last year, that data for chemicals output — the best leading indicator for the global economy — was suggesting “that we may now be headed into recession”. More recent data give us no reason to change this conclusion, and therefore highlight the risk that some Chinese debts may prove more equal than others in terms of the degree of state support that they can command. Missed interest and capital repayments are now becoming common among the weaker borrowers.
The performance of China’s producer price index provides additional support for our analysis. As the third chart shows, this is now flirting with a negative reading, suggesting that a decade of over-investment means that China now has a major problem of surplus capacity. This problem will, of course, be exacerbated if demand continues to slow in key areas. In turn, this suggests that the implications of our analysis go beyond Asian markets.
China still remains, after all, the manufacturing capital of the world, and its falling PPI implies that 2019 could see it exporting deflation. This would be exactly the opposite conclusion to that assumed by today’s rallying equity markets, although it would chime with the increasingly downbeat messages coming from global bond markets. Investors may therefore want to revisit their recent euphoria over the level of lending in China, and their new confidence that the so-called “Powell put” can really protect them from today’s global market risks.
Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.
Back in 2015, veteran Saudi Oil Minister Ali Naimi was very clear about Saudi’s need to adopt a market share-based pricing policy:
“Saudi Arabia cut output in 1980s to support prices. I was responsible for production at Aramco at that time, and I saw how prices fell, so we lost on output and on prices at the same time. We learned from that mistake.”
As Naimi recognised, high oil prices created a short-term win for Saudi’s budget between 2011-4. But they also allowed US frackers to enter the market – posing a major threat to Saudi’s control – whilst also reducing overall demand. And his “boss”, Crown Prince Mohammed bin Salman (MbS) agreed with him, saying:
“Within 20 years, we will be an economy that doesn’t depend mainly on oil. We don’t care about oil prices—$30 or $70, they are all the same to us. This battle is not my battle.”
Today, however, Saudi oil policy has reversed course, with MbS now trying to push prices towards the $80/bbl level assumed in this year’s Budget.
Saudi’s dilemma is that its growing population, and its need to diversify the economy away from oil, requires increases in public spending. As a result, it has conflicting objectives:
- Its long-term need is to defend its market share, to guarantee its ability to monetise its vast oil reserves
- But its short-term need is to support prices by cutting production, in order to fund its spending priorities
The result, as the chart above confirms, is that prices are now at levels which have almost always led to recession in the past. It compares the total cost of oil* as a percentage of global GDP with IMF data for the economy, with the shaded areas showing US recessions. The tipping point is when the total cost reaches 3% of global GDP. And this is where we are today.
The reason is that high oil prices reduce discretionary spending. Consumers have to drive to work and keep their homes warm (and cool in the summer). So if oil prices are high, they have to cut back in other areas, slowing the economy.
CENTRAL BANK STIMULUS MADE OIL PRICES “AFFORDABLE” IN 2011-2014
There has only been one occasion in the past 50 years when this level failed to trigger a recession. That was in 2011-14, when all the major central bank stimulus programmes were in full flow, as the left-hand chart shows.
They were creating tens of $tns of free cash to support consumer spending. But at the same time, of course, they were creating record levels of consumer debt, as the right-hand chart shows from the latest New York Federal Reserve’s Household Debt Report. It shows US household debt is now at a record $13.54tn. And it confirms that consumers have reached the end of the road in terms of borrowing:
“The number of credit inquiries within the past six months – an indicator of consumer credit demand – declined to the lowest level seen in the history of the data.”
SAUDI ARABIA IS NO LONGER THE SWING SUPPLIER IN OIL MARKETS
Oil prices are therefore now on a roller-coaster ride:
- Saudi tried to push them up last year, but this meant demand growth slowed and Russian/US output rose
- The rally ran out of steam in September and Brent collapsed from $85/bbl to $50/bbl in December
Now Saudi is trying again. It agreed with OPEC and Russia in December to cut production by 1.2mbd – with reductions to be shared between OPEC (0.8 million bpd) and its Russia-led allies (0.4 million bpd). But as always, its “allies” have let it down. So Saudi has been forced to make up the difference. Its production has fallen from over 11mbd to a forecast 9.8mbd in March.
Critically however, as the WSJ chart shows, it has lost its role as the world’s swing supplier:
Of course, geo-politics around Iran or Venezuela or N Korea could always intervene to support prices. But for the moment, the main support for rising prices is coming from the hedge funds. As Reuters reports, their ratio of long to short positions in Brent has more than doubled since mid-December in line with rising stock markets.
But the hedge funds did very badly in Q4 last year when prices collapsed. And so it seems unlikely they will be too bold with their buying, whilst the pain of lost bonuses is so recent.
Companies and investors therefore need to be very cautious. Saudi’s current success in boosting oil prices is very fragile, as markets are relying on more central bank stimulus to offset the recession risk. If market sentiment turns negative, today’s roller-coaster could become a very bumpy ride.
Given that Saudi has decided to ignore al-Naimi’s warning, the 2014-15 experience shows there is a real possibility of oil prices returning to $30/bbl later this year.
*Total cost is number of barrels used multiplied by their cost
A petrochemical plant on the outskirts of Shanghai. Chinese chemical industry production has been negative on a year-to-date basis since February
Falling output in China and slowing growth globally suggest difficult years ahead, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
Chemicals are the best leading indicator for the global economy. Data for both Chinese and global chemical production, shown in the first chart, are warning that we may now be headed into recession.
China’s stimulus programme has been the key driver for the world’s post-2008 recovery, as we discussed here in May (“China’s lending bubble is history”).
It accounted for about half of the global $33tn in stimulus programmes and its decline is currently having a dual impact, as it reduces both demand for EM commodities and the availability of global credit.
In turn, this reversal is impacting the global economy — already battling headwinds from trade tariffs and higher oil prices.
Initially the impact was most noticeable in emerging markets but the scale of the downturn is now starting to hit the wider economy:
- China’s demand has been the growth engine for the global economy since 2008, and its scale has been such that this lost demand cannot be compensated elsewhere
- China’s shadow banking bubble has been a major source of speculative lending, helping to finance property bubbles in China and many global cities
- It also financed a domestic construction boom in China on a scale never seen before, creating excess demand for a wide range of commodities
But now the lending bubble is bursting. The second chart shows the extent of the downturn this year. Shadow banking is down 84% ($557bn) in the year to September, according to official People’s Bank of China data. Total Social Financing is down 12% ($188bn), despite an increase in official bank lending to support strategic companies.
It seems highly likely that the property bubble has begun to burst, with China Daily reporting that new home loans in Shanghai were down 77% in the first half. In turn, auto sales fell in each month during the third quarter, as buyers can no longer count on windfall gains from property speculation to finance their purchases.
The absence of speculative Chinese buyers, anxious to move their cash offshore, is also having a significant impact on demand outside China in former property hotspots in New York, London and elsewhere.
The chemical industry has been flagging this decline with increasing urgency since February, when Chinese production went negative on a year-to-date basis. The initial decline was certainly linked to the government’s campaign to reduce pollution by shutting down many older and more polluting factories.
But there has been no recovery over the summer, with both August and September showing 3.1% declines according to American Chemistry Council data. Inevitably, Asian production has also now started to decline, due to its dependence on exports to China. In turn, like a stone thrown into a pond, the wider ripples are starting to reach western economies.
President Trump’s trade wars aren’t helping, of course, as they have already begun to increase prices for US consumers. Ford, for example, has reported that its costs have increased by $1bn as a result of steel and aluminium tariffs. Trump’s withdrawal from the Iran nuclear deal has also caused oil prices as a percentage of GDP to rise to levels typically associated with recession in the past.
The rationale is simply that consumers only have so much cash to spend, and money they spend on rising gasoline and heating costs can’t be spent on the discretionary items that drive GDP growth.
It seems unlikely, however, that Trump’s trade war with China will lead to his expected “quick win”. China has faced far more severe hardships in recent decades, and there are few signs that it is preparing to change core policies. The trade war will inevitably have at least a short-term negative economic impact but, paradoxically, it also supports the government’s strategy to escape the “middle income trap” by ending China’s role as the “low-skilled factory of the world”, and moving up the ladder to more value-added operations and services.
The trade war therefore offers an opportunity to accelerate the Belt and Road Initiative (BRI), initially by moving unsophisticated and often polluting factories offshore. It also emphasises the priority given to the services sector:
- Already companies, both private and state-owned, are focusing their international acquisitions in BRI countries. According to EY, 12 per cent of overall Chinese (non-financial) outbound investment was in BRI countries in 2017, versus 9 per cent in 2016, and 2018 is likely to be considerably higher. Apart from south-east Asia, we expect eastern and central Europe to be beneficiaries, given the new BRI infrastructure links, as the map highlights
- Data from the Caixin/Markit services purchasing managers’ index for September suggests the sector remains in growth mode. And government statistics suggest the services sector was slightly over half of the economy in the first half, with its official growth reported at 7.6 per cent versus overall GDP growth of 6.8 per cent
We expect China to come through the pain caused by the unwinding of the stimulus bubbles, and ultimately be strengthened by the need to refocus on sustainable rather than speculative growth. But it will not be an easy few years for China and the global economy.
The rising tide of stimulus has led many investors and chief executives to look like geniuses. Now the downturn will probably lead to the appearance of winners and losers, with the latter likely to be in the majority.
Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.
“The 1950-2000 period is like no other in human or financial history in terms of population growth, economic growth, inflation or asset prices.”
This quote isn’t from ‘Boom, Gloom and the New Normal: How Western BabyBoomers are Changing Demand Patterns, Again‘, the very popular ebook that John Richardson and I published in 2011. Nor is the chart from one of the hundreds of presentations that we have since been privileged to give at industry and company events around the world.
It’s from the highly-respected Jim Reid and his team at Deutsche Bank in their latest in-depth Long-Term Asset Return Study, ‘The History (and future) of inflation’. As MoneyWeek editor, John Stepek, reports in an excellent summary:
“The only economic environment that almost all of us alive today have ever known, is a whopping great historical outlier….inflation has positively exploded during all of our lifetimes. And not just general price inflation – asset prices have surged too. What is this down to? Reid and his team conclude that at its root, this is down to rampant population growth.” (my emphasis)
As Stepek reports, the world’s population growth since 1950’s has been far more than phenomenal:
“From 5000BC, it took the global population 2,000 years to double; it took another 2,000 years for it to double again. There weren’t that many of us, and lots of us died very young, so it took a long time for the population to expand. Fast forward another few centuries, though, and it’s a different story.
“As a result of the Industrial Revolution, lifespans and survival rates improved – the population doubled again in the period between 1760-1900, for example. That’s just 140 years. Yet that pales compared to the growth we’ve seen in the 20th century. Between 1950-2000, a mere 50 years, the population more than doubled from 2.5bn to 6.1bn.”
Actually, it was almost certainly Jenner’s discovery of smallpox vaccination that led to the Industrial Revolution, as discussed here in detail in February 2015, Rising life expectancy enabled Industrial Revolution to occur’:
“Vaccination against smallpox was almost certainly the critical factor in enabling the Industrial Revolution to take place. It created a virtuous circle, which is still with us today:
- Increased life expectancy meant adults could learn from experience instead of dying at an early age
- Even more importantly, they could pass on this experience to their children via education
- Thus children stopped being seen as ’little adults’ whose role was to work as soon as they could walk
- By 1900, the concept of ‘childhood’ was becoming widely accepted for the first time in history*
The last point is especially striking, as US sociologist Viviana Zelizer has shown in Pricing the Priceless Child: The Changing Social Value of Children. We take the concept of childhood for granted today, but even a century ago, New York insurance firms refused to pay death awards to the parents of non-working children, and argued that non-working children had no value.
Deutsche’s topic is inflation, and as Stepek notes, they also take issue with the narrative that says central banks have been responsible for taming this in recent years:
“The Deutsche team notes that inflation became less fierce from the 1980s. We all think of this as being the point at which Paul Volcker – the heroic Federal Reserve chairman – jacked up interest rates to kill off inflation. But you know what else happened in the 1980s?
“China rejoined the global economy, and added a huge quantity of people to the working age population. A bigger labour supply means cheaper workers. And this factor is now reversing. “The consequence of this is that labour will likely regain some pricing power in the years ahead as the supply of it now plateaus and then starts to slowly fall”.”
THE CENTRAL BANK DEBT BUBBLE IS THE MAIN RISK
The chart above from the New York Times confirms that that the good times are ending. Debt brings forward demand from the future. And since 2000 central banks have been bringing forward $tns of demand via their debt-based stimulus programmes. But they couldn’t “print babies” who would grow up to boost the economy.
Today, we just have the legacy of the debt left by the central banks’ failed experiment. In the US, this means that the Federal government is almost at the point where it will be spending more on interest payments than any other part of the budget – defence, education, Medicaid etc.
Relatively soon, as the Congressional Budget Office has warned, the US will face decisions on whether to default on the Highway Trust Fund (2020), the Social Security Disability Insurance Trust Fund (2025), Medicare Hospital Insurance Trust Fund (2026) and then Social Security itself (2031). If it decides to bail them out, then it will either have to make cuts elsewhere, or raise taxes, or default on the debt itself.
THE ENDGAME FOR THE DEBT BUBBLE IS NEARING – AND IT INVOLVES DEFAULT
Global interest rates are already rising as investors refocus on “return of capital”. Investors are becoming aware of the risk that many countries, including the USA, could decide to default – as I noted back in 2016 when quoting William White of the OECD, “World faces wave of epic debt defaults” – central bank veteran:
“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.”
The next recession is just round the corner, as President Reagan’s former adviser, Prof Martin Feldstein, warned last week. This will increase the temptation for Congress to effectively default by refusing to raise the debt ceiling. Ernest Hemingway’s The Sun also Rises probably therefore describes the end-game we have entered:
“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said. “Gradually and then suddenly.”
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