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.
Never let reality get in the way of a good theory. That’s been the policy of western central banks since the end of the BabyBoomer-led SuperCycle in 2000, when the oldest Boomer moved out of the Wealth Creator 25-54 age group and into the Perennial 55+ cohort.
Inevitably this led to a slowdown in growth, as the Perennials already own most of what they need, and their incomes decline as they enter retirement. 40% of Americans aged 65+ would have incomes below the poverty line, if Social Security didn’t exist.
The well-meaning folk at the US Federal Reserve chose to ignore this development, and instead launched their subprime experiment But demographics are destiny, and their first attempt to effectively “print babies” ended in 2008’s near-disaster for the global economy.
Their problem, as John Maynard Keynes noted in his conclusion to his 1936 General Theory, was that:
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”
And in the case of today’s central bankers, they are enslaved to the theories of 2 defunct economists:
- One is Franco Modigliani, who won the 1955 Nobel Prize with his “life-cycle hypothesis”, which suggested individuals plan out their lifetime income and spending in advance, so as to even out their consumption over their entire lifetime
- The other is Milton Friedman, who won the 1975 Prize for his argument that “inflation is always and everywhere a monetary phenomenon”, ignoring the importance of supply and demand balances
Modigliani and Friedman were working before anyone realised a BabyBoom had taken place. When John Richardson and I were researching our book ‘Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’ in 2010, the authoritative Oxford English Dictionary gave the earliest use of the word as being in 1979.
So they might have some excuse for not being aware of the demand pressures caused by the fact that the number of US babies rose by 52% in 1946-64, compared to the previous 18 years. But today’s central bankers have no such excuse. Common sense, or a quick glance at the charts above would immediately confirm:
- Increasing life expectancy and falling fertility rates mean that an entirely new generation, the Perennials 55+, is alive today for the first time in history
- And the data shows very clearly that their spending falls off away once they turn 55, and is down 43% by the time they reach the age of 75
Similarly, common sense suggests that inflation is not a monetary phenomenon, but a function of supply and demand balances. The post-War BabyBoom was inevitably going to create a lot of demand and hence inflation, particularly as factories had first to be converted back from military production.
Similarly, when all these babies moved into the workforce, it was almost inevitable that:
- We would see more or less constant demand, as the Boomers reached their Wealth Creator years
- This demand would be turbo-charged as women went back into the workforce after starting a family, creating the two-income family for the first time in history
Fertility rates fell below replacement levels of 2.1 babies/woman as long ago as 1970. Inevitably, therefore, the number of Wealth Creators has plateaued – just as increasing life expectancy means that the number of Perennials is growing rapidly.
Since 2008, the Fed has completely failed to recognise this critical development for supply/demand balances.
Instead it has “doubled down” on the subprime policy, via record levels of stimulus. If you ask them why, they will tell you their core economic model – the Dynamic Stochastic General Equilibrium model – doesn’t need to include demographic detail, as it is based on Modigliani and Friedman’s theories.
We are therefore now almost certainly approaching a new crisis. As the chart on the left from Charlie Bilello confirms :
- The total of government bonds with negative interest rates has now reached $13tn
- The stock market is ignoring this evidence of slowing demand, and is still powering ahead
One or the other is soon going to be proved wrong.
THE END-GAME FOR THE STIMULUS POLICIES WILL LIKELY BE MAJOR DEFLATION
The central banks have spent the past 10 years following Friedman’s theory, believing they could create inflation via stimulus policies. Instead, their low interest rates encouraged companies to boost supply, at a time when the rise of the Perennials meant demand growth was already slowing.
Unsurprisingly, therefore, interest rates are going negative, as the Fed’s policies have effectively proved deflationary. Very worryingly, around 14% of US companies are already unable to service their debt, because their earnings are not enough to pay their interest bills.
Had the Fed focused on demographics, it would have been obvious that the best way to create demand was to increase the spending power of the Perennials, who typically rely on savings for extra income. But instead of allowing markets to set higher interest rates, the Fed chose to lower them, making deflation almost inevitable.
History suggests their next round of stimulus policy, if/when the S&P 500 weakens again, will be to introduce Friedman’s idea of “helicopter money” – and electronically transfer perhaps $500 to every American’s bank account. This will be the ultimate test for Friedman’s theory, as if it doesn’t magically create inflation, the Fed will have nothing more to do.
Maybe, this final burst of stimulus will work. But probably most Perennials, and many Wealth Creators, will instead save the money – alarmed by the Fed’s sense of desperation. In turn, this will turbocharge the deflationary cycle – forcing interest rates even lower and risking major economic turmoil.
Last year it was Bitcoin, in 2016 it was the near-doubling in US 10-year interest rates, and in 2015 was the oil price fall. This year, once again, there is really only one candidate for ‘Chart of the Year’ – it has to be the collapse of China’s shadow banking bubble:
- It averaged around $20bn/month in 2008, a minor addition to official lending
- But then it took off as China’s leaders panicked after the 2008 Crisis
- By 2010, it had shot up to average $80bn/month, and nearly doubled to $140bn in 2013
- President Xi then took office and the bubble stopped expanding
- But with Premier Li still running a Populist economic policy, it was at $80bn again in 2017
At that point, Xi took charge of economic policy, and slammed on the brakes. November’s data shows it averaging just $20bn again.
The impact on the global economy has already been immense, and will likely be even greater in 2019 due to cumulative effects. As we noted in this month’s pH Report:
“Xi no longer wants China to be the manufacturing Capital of the world. Instead his China Dream is based on the country becoming a more service-led economy based on the mobile internet. He clearly has his sights on the longer-term and therefore needs to take the pain of restructuring today.
“Financial deleveraging has been a key policy, with shadow bank lending seeing a $609bn reduction YTD November, and Total Social Financing down by $257bn. The size of these reductions has reverberated around Emerging Markets and more recently the West:
- The housing sector has nose-dived, with China Daily reporting that more than 60% of transactions in Tier 1 and 2 cities saw price drops in the normally peak buying month of October, with Beijing prices for existing homes down 20% in 2018
- It also reported last week under the heading ’Property firms face funding crunch’ that “housing developers are under great capital pressure at the moment”
- China’s auto sales, the key to global market growth since 2009, fell 14% in November and are on course for their first annual fall since 1990
- The deleveraging not only reduced import demand for commodities, but also Chinese citizens’ ability to move money offshore into previous property hotspots
- Real estate agents in prime London, New York and other areas have seen a collapse in offshore buying from Hong Kong and China, with one telling the South China Morning Post that “basically all Chinese investors have disappeared “
GLOBAL STOCK MARKETS ARE NOW FEELING THE PAIN
As I warned here in June (Financial markets party as global trade wars begin), the global stock market bubble is also now deflating – as the chart shows of the US S&P 500. It has been powered by central bank’s stimulus policies, as they came to believe their role was no longer just to manage inflation.
Instead, they have followed the path set out by then Federal Reserve Chairman, Ben Bernanke, in November 2010, believing that:
“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.”
Now, however, we are coming close to the to the point when it becomes obvious that the Fed cannot possibly control the economic fortunes of 325m Americans. Common sense tells us that demographics, not monetary policy, drive demand. Unfortunately, vast amounts of time and money have been wasted by central banks in this failed experiment.
The path back to fiscal sanity will be very hard, due to the debt that has been built up by the stimulus policies. The impartial Congressional Budget Office expects US government debt to rise to $1tn.
Japan – the world’s 3rd largest economy – is the Case Study for the problems likely ahead:
- Consumer spending is 55% of Japan’s GDP. It falls by around a third at age 70+ versus peak spend at 55, as older people already own most of what they need, and are living on a pension
- Its gross government debt is now 2.5x the size of its economy, and with its ageing population (median age will be 48 in 2020), there is no possibility that this debt can ever be repaid
- As the Nikkei Asian Review reported in July, the Bank of Japan’s stimulus programme means it is now a Top 10 shareholder in 40% of Nikkei companies: it is currently spending ¥4.2tn/year ($37bn) buying more shares
- Warning signs are already appearing, with the Nikkei 225 down 12% since its October peak. If global stock markets do now head into a bear market, the Bank’s losses will mount very quickly
CHINA MOVE INTO DEFLATION WILL MAKE DEBT IMPOSSIBLE TO REPAY
Since publishing ‘Boom, Gloom and the New Normal: how the Ageing Boomers are Changing Demand Patterns, Again“, in 2011 with John Richardson, I have argued that the stimulus policies cannot work, as they are effectively trying to print babies. 2019 seems likely to put this view to the test:
- China’s removal of stimulus is being matched by other central banks, who have finally reached the limits of what is possible
- As the chart shows, the end of stimulus has caused China’s Producer Price Inflation to collapse from 7.8% in February 2017
- Analysts Haitong Securities forecast that it will “drop to zero in December and fall further into negative territory in 2019“
China’s stimulus programme was the key driver for the global economy after 2008. Its decision to withdraw stimulus – confirmed by the collapse now underway in housing and auto sales – is already putting pressure on global asset and financial markets:
- China’s lending bubble helped destroy market’s role of price discovery based on supply/demand
- Now the bubble has ended, price discovery – and hence deflation – may now be about to return
- Yet combating deflation was supposed to be the prime purpose of Western central bank stimulus
This is why the collapse in China’s shadow lending is my Chart of the Year.
The US 10-year Treasury bond is the benchmark for global interest rates and stock markets. And for the past 30 years it has been heading steadily downwards as the chart shows:
- US inflation rates finally peaked at 13.6% in 1980 (having been just 1.3% in 1960) as the BabyBoomers began to move en masse into the Wealth Creator 25 – 54 age group
- Instead of simply boosting demand, as during the 1960s-1970s, they began to work and create new supply
- This meant supply/demand began to rebalance and interest rates then peaked at 16% in 1981
By 1983, the average Western Boomer (born between 1946-1970) had arrived in the Wealth Creator cohort, which dominates consumer spending, and the economy really began to hum. There was a final inflation scare in 1984, when US inflation suddenly jumped from 3% to 5%, but after that the trend was downwards all the way.
The Boomers were the largest and wealthiest generation that the world had ever seen. Their move to become Wealth Creators completely transformed the inflation outlook, as more and more Boomers joined the workforce. And they transformed the economy by moving it into the NICE era of Non-Inflationary Constant Expansion.
Central bankers took credit for this move, claiming it was due to monetary policy. But in reality, people are the key element in an economy, not monetary policy. You can’t have an economy without people. And sadly, the idea that the US Fed Chairman Alan Greenspan had somehow become a Maestro, blinded everyone to 2 key issues for the future:
- Life expectancy was rising rapidly, meaning that the Boomers would not normally die just after retirement. Instead, they would likely live for another 15 – 20 years after reaching age 65
- From 1970, fertility rates had fallen below replacement level (2.1 babies/woman) across the Western world
This combination of a rise in life expectancy and a collapse in fertility rates was creating a timebomb for the economy.
THE RISE IN LIFE EXPECTANCY AND COLLAPSE OF FERTILITY RATES CREATED AN ECONOMIC TIMEBOMB
Western economies are based on consumer spending. And spending declines once people reach the age of 55 – they already own most of what they need, and their incomes decline as they approach retirement, as the second chart shows:
- There were 65m US Wealth Creator households in 2000, who spent an average of $62k ($2017)
- There were only 36m in the 55+ cohort, who spent just $45k each
- In 2017, there were 66m Wealth Creators (almost the same as in 2000) who spent $64k each
- But there were now 56m in the 55+ cohort, who spent just $51k each
The rise in 55+ spending was also only temporary, as large numbers of Boomers have just reached 55+ and have not yet retired. Spending by those aged 74+ was down by nearly 50% versus the peak spending 45-54 age group.
BELIEF IN MONETARISM LED TO THE DOTCOM AND SUBPRIME DISASTERS
The dot-com crash in 2000 should have been a wake-up call for the failure of monetarism. It also, after all, marked the moment when the oldest Boomers began to join the 55+ cohort. But instead, policymakers thought monetarism could solve “the problem” and cut interest rates to boost the housing market – causing the subprime crash in 2008.
One might have thought – as we wrote in Boom, Gloom and the New Normal in 2011 – that this disaster would have destroyed the monetarism myth. But no. Abandoning monetarism would have led to a difficult conversation with voters about the need for everyone to retrain in their 50s, and prepare to take on new, and less physically demanding, roles.
Instead, policymakers tried to replace lost BabyBoomer demand by printing vast amounts of free money via the Quantitative Easing and Zero Interest Rate Policies. Their aim was to avoid deflation, as inflation had fallen to just 0.6% in 2010 – although why this was a “bad thing” was never explained. But in reality, they were running uphill, and the pace of the climb was becoming more vertical, as the average Western Boomer joined the 55+ cohort in 2013.
Of course, flooding the market with cheap money boosted asset prices, as they intended. Stock markets and house prices soared for a second time. But it also created a major new risk. More and more investors began to panic as they hunted through the markets, trying to obtain a decent “return on capital”. They assumed central banks would never let markets fall, and so gave up worrying about the risk of making a dud investment.
INTEREST RATES ARE NOW HEADED HIGHER AS PEOPLE WORRY ABOUT RETURN OF CAPITAL
The end of the Bitcoin bubble has highlighted the fact that that risk and reward are normally related. Most investments that offer potentially high rewards are also high risk – a lot has to go right, for them to make the possible return. This process of price discovery – the balance of risk and reward – is the key role of markets.
Left to themselves, markets will price risk properly. But they have been swamped for the past decade by central bank liquidity and their crucial role has been temporarily destroyed. Now, the fact that the US 10-year bond has broken out of its 30-year downtrend tells us that markets they are finally starting to regain their role.
How high will interest rates now go? We cannot yet know, and we can also be sure they will not move in a straight line as central banks will continue to intervene. But as more and more investments, like Bitcoin, prove to be duds, so more and more investors will start to worry about return of capital when they invest.
4% therefore looks like the next level for rates, as we are now trading within the blue bars on the chart. It may not take very long for this level to be reached, given the fact that the world now has a record $233tn of debt – 3x the size of the global economy. After that, we shall have to wait and see.
I strongly believe that forecasts should be monitored, which is why I always review the previous Annual Budget forecast before issuing the next Outlook, and always publish the complete list of Annual Budget Outlooks.
I now plan to begin monitoring my blog forecasts, using the percentage mechanism highlighted in Philip Tetlock’s masterly “Superforecasting” book. The first forecasts relate to last week’s post on US polyethylene exports and today’s forecast for the US 10-year Treasury bond. I will change confidence levels as and when circumstances change.
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“There isn’t anybody who knows what is going to happen in the next 12 months. We’ve never been here before. Things are out of control. I have never seen a situation like it.“
This comment from former UK Finance Minister, Ken Clarke, aptly summarises the uncertainty facing companies, investors and individuals as we look ahead to the 2018 – 2020 Budget period. None of us have ever seen a situation like today’s. Even worse, is the fact that risks are not just focused on the economy, or politics, or social issues. They are a varying mix of all of these. And because of today’s globalised world, they potentially affect every country, no matter how stable it might appear from inside its own borders.
This is why my Budget Outlook for 2018 – 2020 is titled ‘Budgeting for the Great Unknown’. We cannot know what will happen next. But this doesn’t mean we can’t try to identify the key risks and decide how best to try and manage them. The alternative, of doing nothing, would leave us at the mercy of the unknown, which is never a good place to be.
RISING INTEREST RATES COULD SPARK A DEBT CRISIS
Central banks assumed after 2008 that stimulus policies would quickly return the economy to the BabyBoomer-led economic SuperCycle of the previous 25 years. And when the first round of stimulus failed to produce the expected results, as was inevitable, they simply did more…and more…and more. The man who bought the first $1.25tn of mortgage debt for the US Federal Reserve (Fed) later described this failure under the heading “I’m sorry, America“:
“You’d think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few months later—after a 14% drop in the U.S. stock market and renewed weakening in the banking sector—the Fed announced a new round of bond buying: QE2”
• And the Fed was not alone, as the chart shows. Today, the world is burdened by over $30tn of central bank debt
• The Fed, European Central Bank, Bank of Japan and the Bank of England now appear to “own a fifth of their governments’ total debt”
• There also seems little chance that this debt can ever be repaid. The demand deficit caused by today’s ageing populations means that growth and inflation remain weak, as I discussed in the Financial Times last month
China is, of course, most at risk – as it was responsible for more than half of the lending bubble. This means the health of its banking sector is now tied to the property sector, just as happened with US subprime. Around one in five of all Chinese apartments have been bought for speculation, not to be lived in, and are unoccupied.
China’s central bank chief, Zhou Xiaochuan, has warned that China risks a “Minsky Moment“, where lenders and investors suddenly realise they have overpaid for their assets, and all rush together for the exits – as in 2008. Similar risks face the main developed countries as they finally have to end their stimulus programmes:
• Who is now going to replace them as buyers of government debt?
• And who is going to buy these bonds at today’s prices, as the banks back away?
• $8tn of government and corporate bonds now have negative interest rates, which guarantee the buyer will lose money unless major deflation takes place – and major deflation would make it very difficult to repay the capital invested
There is only one strategy to manage this risk, and that is to avoid debt. Companies or individuals with too much debt will go bankrupt very quickly if and when a Minsky Moment takes place.
THE CHINA SLOWDOWN RISK IS LINKED TO THE PROPERTY LENDING BUBBLE
After 2008, it seemed everyone wanted to believe that China had suddenly become middle class by Western standards. And so they chose to ignore the mounting evidence of a housing bubble, as shown in the chart above.
Yet official data shows average incomes in China are still below Western poverty levels (US poverty level = $12060):
• In H1, disposable income for urban residents averaged just $5389/capita
• In the rural half of the country, disposable income averaged just $1930
• The difference between income and expenditure was based on the lending bubble
As a result, average house price/earnings ratios in cities such as Beijing and Shanghai are now more than 3x the ratios in cities such as New York – which are themselves wildly overpriced by historical standards.
Having now been reappointed for a further 5 years, it is clear that President Xi Jinping is focused on tackling this risk. The only way this can be done is to take the pain of an economic slowdown, whilst keeping a very close eye on default risks in the banking sector. As Xi said once again in his opening address to last week’s National Congress:
“Houses are built to be inhabited, not for speculation. China will accelerate establishing a system with supply from multiple parties, affordability from different channels, and make rental housing as important as home purchasing.”
China will therefore no longer be powering global growth, as it has done since 2008. Prudent companies and investors will therefore want to review their business models and portfolios to identify where these are dependent on China.
This may not be easy, as the link to end-user demand in China might well be further down the supply chain, or external via a second-order impact. For example, Company A may have no business with China and feel it is secure. But it may suddenly wake up one morning to find its own sales under attack, if company B loses business in China and crashes prices elsewhere to replace its lost volume.
PROTECTIONISM IS ON THE RISE AROUND THE WORLD
Trade policy is the third key risk, as the chart of harmful interventions from Global Trade Alert confirms.
These are now running at 3x the level of liberalising interventions since 2008, as Populist politicians convince their voters that the country is losing jobs due to “unfair” trade policies.
China has been hit most times, as its economy became “the manufacturing capital of the world” after it joined the World Trade Organisation in 2001. At the time, this was seen as being good news for consumers, as its low labour costs led to lower prices.
But today, the benefits of global trade are being forgotten – even though jobless levels are relatively low. What will happen if the global economy now moves into recession?
The UK’s Brexit decision highlights the danger of rising protectionism. Leading Brexiteer and former cabinet minister John Redwood writes an online diary which even campaigns against buying food from the rest of the European Union:
“There are many great English cheese (sic), so you don’t need to buy French.”
No family tries to grow all its own food, or to manufacture all the other items that it needs. And it used to be well understood that countries also benefited from specialising in areas where they were strong, and trading with those who were strong in other areas. But Populism ignores these obvious truths.
• President Trump has left the Trans-Pacific Partnership, which would have linked major Pacific Ocean economies
• He has also said he will probably pull out of the Paris Climate Change Agreement
• Now he has turned his attention to NAFTA, causing the head of the US Chamber of Commerce to warn:
“There are several poison pill proposals still on the table that could doom the entire deal,” Donohue said at an event hosted by the American Chamber of Commerce of Mexico, where he said the “existential threat” to NAFTA threatened regional security.
At the moment, most companies and investors seem to be ignoring these developments, assuming that in the end, sense will prevail. But what if they are wrong? It seems highly likely, for example, that the UK will end up with a “hard Brexit” in March 2019 with no EU trade deal and no transition period to enable businesses to adjust.
Today’s Populist politicians don’t seem to care about these risks. For them, the allure of arguing for “no deal”, if they can’t get exactly what they want, is very powerful. So it would seem sensible for executives to spend time understanding exactly how their business might be impacted if today’s global supply chains came to an end.
POLITICAL CHAOS IS GROWING AS PEOPLE LOSE FAITH IN THE ELITES
The key issue underlying these risks is that voters no longer believe that the political elites are operating with their best interests at heart. The elites have failed to deliver on their promises, and many families now worry that their children’s lives will be more difficult than their own. This breaks a century of constant progress in Western countries, where each generation had better living standards and incomes. As the chart from ipsos mori confirms:
• Most people in the major economies feel their country is going in the wrong direction
• Adults in only 3 of the 10 major economies – China, India and Canada – feel things are going in the right direction
• Adults in the other 7 major economies feel they are going in the wrong direction, sometimes by large margins
• 59% of Americans, 62% of Japanese, 63% of Germans, 71% of French, 72% of British, 84% of Brazilians and 85% of Italians are unhappy
This suggests there is major potential for social unrest and political chaos if the elites don’t change direction. Fear of immigrants is rising in many countries, and causing a rise in Populism even in countries such as Germany.
“Business as usual” is always the most popular strategy, as it means companies and investors don’t have to face the need to make major changes. But we all know that change is inevitable over time. And at a certain moment, time can seem to literally “stand still” whilst sudden and sometimes traumatic change erupts.
At such moments, as in 2008, commentators rush to argue that “nobody could have seen this coming“. But, of course, this is nonsense. What they actually mean is that “nobody wanted to see this coming“. The threat from subprime was perfectly obvious from 2006 onwards, as I warned in the Financial Times and in ICIS Chemical Business, as was 2014’s oil price collapse. Today’s risks are similarly obvious, as the “Ring of Fire” map describes.
You may well have your own concerns about other potential major business risks. Nobel Prizewinner Richard Thaler, for example, worries that:
“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping.”
We can all hope that none of these scenarios will actually create major problems over the 2018 – 2020 period. But hope is not a strategy, and it is time to develop contingency plans. Time spent on these today could well be the best investment you will make. As always, please do contact me at firstname.lastname@example.org if I can help in any way.
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Next week, I will publish my annual Budget Outlook, covering the 2018-2020 period. The aim, as always, will be to challenge conventional wisdom when this seems to be heading in the wrong direction. Before publishing the new Outlook each year, I always like to review my previous forecast. Past performance may not be a perfect guide to the future, but it is the best we have:
The 2007 Outlook ‘Budgeting for a Downturn‘, and 2008′s ‘Budgeting for Survival’ meant I was one of the few to forecast the 2008 Crisis
2009′s ‘Budgeting for a New Normal’ was then more positive than the consensus, suggesting “2010 should be a better year, as demand grows in line with a recovery in global GDP“
The 2010 Outlook was ‘Budgeting for Uncertainty’. This introduced the concept of Scenario planning, to help deal with “today’s increasingly uncertain New Normal environment.”
2011 was ‘Budgeting for Austerity’. It anticipated weak growth across Europe as a result of the austerity measures being introduced, and disappointing global growth, whilst arguing that major new opportunities were opening up as a result of changing demographic trends
2012 was ‘Budgeting for an L-shaped recovery’, arguing that recovery was unlikely to meet expectations
2013 was ‘Budgeting for a VUCA world‘ where Volatility, Uncertainty, Complexity and Ambiguity would dominate
2014 was ‘Budgeting for the Cycle of Deflation‘, 2015 was ’Budgeting for the Great Unwinding of policymaker stimulus’, 2016 was ‘Budgeting for the Great Reckoning’
Please click here if you would like to download a free copy of all the Budget Outlooks.
My argument last year was that companies and investors would begin to run up against the reality of the impact of today’s “demographic deficit”. They would find demand had fallen far short of policymakers’ promises. As the chart shows, the IMF had forecast in 2011 that 2016 growth would be 4.7%, but in reality it was a third lower at just 3.2%. I therefore argued:
“This false optimism has now created some very negative consequences:
Companies committed to major capacity expansions during the 2011 – 2013 period, assuming demand growth would return to “normal” levels
Policymakers committed to vast stimulus programmes, assuming that the debt would be paid off by a mixture of “normal” growth and rising inflation
Today, this means that companies are losing pricing power as this new capacity comes online, whilst governments have found their debt is still rising in real terms
“This is the Great Reckoning that now faces investors and companies as they plan their Budgets for 2017 – 2019.”
Oil markets are just one example of what has happened. A year ago, OPEC had forecast its new quotas would “rebalance the oil market” in H1 this year. When this proved over-optimistic, they had to be extended for a further 9 months into March 2018. Now, it expects to have to extend them through the whole of 2018. And even today’s fragile supply/demand balance is only due to China’s massive purchases to fill its Strategic Reserve.
Policymakers’ unrealistic view of the world has also had political and social consequences, as I noted in the Outlook:
“The problem, of course, is that it will take years to undo the damage that has been done. Stimulus policies have created highly dangerous bubbles in many financial markets, which may well burst before too long. They have also meant it is most unlikely that governments will be able to keep their pension promises, as I warned a year ago.
Of course, it is still possible to hope that “something may turn up” to support “business as usual” Budgets. But hope is not a strategy. Today’s economic problems are already creating political and social unrest. And unfortunately, the outlook for 2017 – 2019 is that the economic, political and social landscape will become ever more uncertain.”
As the second chart confirms from Ipsos MORI, most people in the world’s major countries feel things are going in the wrong direction. Voters have lost confidence in the political elite’s ability to deliver on its promises. Almost everywhere one looks today, one now sees potential “accidents waiting to happen”.
Understandably, Populism gains support in such circumstances as people feel they and their children are losing out.
The last 10 years have proved that stimulus programmes cannot substitute for a lack of babies. They generate debt mountains instead of sustainable demand, and so make the problems worse, not better.
Next week, I will look at what may happen in the 2018 – 2020 period, and the key risks that have developed as a result of the policy failures of the past decade.
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