The tide of global debt has peaked: 8 charts suggest what may happen next, as the tide retreats

The results of the central bankers’ great experiment with money printing are now in, and they are fairly depressing, as the charts above confirm:

  • On the left are the IMF’s annual forecasts from 2010 – 2018 (dotted lines) and the actual result (black)
  • Until recently, the Fund was convinced the world would soon see 5% GDP growth, or at least 4% growth
  • The actual outcome has been a steady decline until 2017 and this month’s forecast sees slowing growth by 2020

As the IMF headlined last week,current favorable growth rates will not last”.

  • On the right, is the amount of money the bankers have spent on money printing to achieve this result
  • China, the US, Japan, the Eurozone and the Bank of England printed over $30tn between 2009-2017
  • So far, only China – which did 2/3rds of the printing, has admitted its mistake, and changed the policy

The chart above shows what happens if you spend a lot of money without getting much return in terms of growth.  Again from the IMF, it shows that total global debt has risen to $164tn.  This is more than twice the size of global GDP – 225%, to be exact, based on latest 2016 data.  The IMF analysis also highlights the result of the money printing:

“Debt-to-GDP ratios in advanced economies are at levels not seen since World War II….In the last ten years, emerging market economies have been responsible for most of the increase. China alone contributed 43% to the increase in global debt since 2007. In contrast, the contribution from low income developing countries is barely noticeable.”

It doesn’t take a rocket scientist to work out the result of this failed policy, which is shown in the above IMF charts:

  • Global debt to GDP levels are higher than in 2008 and in the financial crisis; only World War 2 was higher
  • Debt ratios in the advanced economies are at their highest since the 1980s debt crisis
  • Emerging market ratios are lower (apart from China), but this is because of debt forgiveness at the Millennium

CAN ALL THIS DEBT EVER BE PAID PACK?  AND IF NOT, WHAT HAPPENS?
As everyone knows, borrowing is easy.  Almost all governments and commentators have lined up since 2009 to support the money-printing policy.  But the hard bit happens now as it starts to become obvious that the policy has failed.

We now have all the debt, but we don’t have the growth that would enable it to be paid off.

It would be easy to simply end here, and point out that John Richardson and I set out the reasons why money-printing could never work in 2011, when we published Boom, Gloom and the New Normal: How the Ageing of the BabyBoomers is Changing Demand Patterns, Again.  Our conclusion then was essentially based on common sense:

Central bankers simply confused cause and effect: demographics drive the economy, not monetary policy. 

Common sense tells us that young populations create a demographic dividend as their spending grows with their incomes.  But today’s ageing Western populations have a demographic deficit: older people already own most of what they need,and their incomes decline as they enter retirement.

But having been right in the past doesn’t help to solve today’s problem of excess debt and leverage:

  • Common sense also tells us that leverage equals risk – if it works out, everything is fine; if not…..
  • If you have a lot of debt and the world moves into recession, it becomes very hard to repay the debt

Financial markets are doing their best to warn us that the problems are growing.  Longer-term interest rates, which are not controlled by the central banks, have been rising for some time. They are telling us that some investors are no longer simply chasing yield.  They are instead worrying about risk – and whether their loan will actually be repaid.

Essentially, we are now in the and-game for stimulus policies.  Major debt restructuring is now inevitable – either on an organised basis, as set out by Bill White, the only central banker to warn of the 2008 Crisis – or more chaotically.

This restructuring is going to be painful, as the chart above on the impact of leverage confirms.  I originally highlighted it in August 2007, as the Crisis began to unfold – unfortunately, it now seems to have become relevant again..

PLEASE DON’T FIND YOURSELF SWIMMING NAKED WHEN THE TIDE OF DEBT GOES OUT 
Leverage makes people appear to be geniuses on the way up.  But on the way down, Warren Buffett’s famous warning is worth remembering: “Only when the tide goes out do you discover who’s been swimming naked”.

 

*Return on Equity is the fundamental measure of a company’s profitability, and is defined as the amount of profit or net income a company earns per investment dollar. 

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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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The Great Reckoning for policymakers’ failures has begun

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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Today’s New Normal world – the challenge of the 100-year life

MORI Nov162016 saw the start of the Great Reckoning for the failure of stimulus policies.

Political and social issues are now beginning to dominate the landscape.  As we saw in the UK’s Brexit vote to leave the European Union, voters no longer see economics as the sole issue in elections.  This paradigm shift was then followed by Donald Trump winning the US Presidency and Italy voting against premier Renzi’s constitutional reforms.

Polls confirm this, as the Ipsos MORI chart above shows.  Most people feel the current economic/political/social system is no longer working for them.  Worryingly, given the votes due in 2017, the survey also highlights that French voters (89%), Italians (82%) and Germans (69%) are even more upset than American (63%) and British voters (60%).

Voters are increasingly giving up on the “consensus wisdom” that ignores demographics, and which believes the world can somehow go back to the constant growth seen during the BabyBoomer-led SuperCycle.  As I wrote in August:

“The critical issue is that central banks have been in denial about the changes taking place in demand patterns as a result of ageing populations and falling fertility rates. Their Federal Reserve/US-type forecasting models still assume that raising interest rates will reduce demand, and lowering them will release this pent-up demand. But today’s increasing life expectancy and falling fertility rates are completely changing historical demand patterns. We are no longer in a world where the vast majority of the adult population belongs to the Wealth Creator cohort of those aged 25–54, which dominates consumer spending:

□  Increasing life expectancy means people no longer routinely die around pension age. Instead, a whole New Old generation of people in the low spending, low earning 55+ generation is emerging for the first time in history. The average western BabyBoomer can now expect to live for another 20 years on reaching the age of 65
□  Fertility rates in the developed world have fallen by 40% since 1950. They have also been below replacement levels (2.1 babies per woman) for the past 45 years. Inevitably, therefore, this has reduced the relative numbers of those in today’s Wealth Creator cohort, just as the New Old generation is expanding exponentially

“You cannot print babies” should be the motto hanging on every central bankers’ wall. Unfortunately, it is too late to quickly reverse their demographic myopia. Instead, the Great Unwinding is now set to evolve into the Great Reckoning. Investors, companies and individuals must prepare for heightened levels of volatility, as markets continue their return to being based on the fundamentals of supply and demand, rather than central bank liquidity.”

2017 is therefore likely to be a difficult year, contrary to the optimism of Western stock markets, as the landscape becomes ever more uncertain.  But the world has been through difficult years in the past.  And in time, no doubt, the need to adapt to the positive impact of  today’s demographic changes will become more obvious.  The issue is simple:

Today, Western life expectancy is around 80, and is around 20 years at age 65.  Due to the collapse of fertility rates, a G7 economy such as Italy has nearly as many people in the New Old 55+ cohort as in the Wealth Creator 25 – 54 cohort.  Another new stage therefore needs to be added to our life cycle – whereby we are born, are educated, work, and then retrain in our 50s/60s, before working again until we retire and then die.  

We need new leaders, with the vision and common sense required to help explain and manage this New Normal world, so that the benefits of the 100-year life are understood and welcomed.

 

Economic policy needs to focus on impact of the 100-year life

Right direction Nov16Nearly two-thirds of people in the world’s top 25 countries feel their country is heading in the wrong direction, according to a new poll from Ipsos MORI.  As their chart shows:

  China, Saudi Arabia, India, Argentina, Peru, Canada and Russia are the only countries to record a positive feeling
  The other 18 are increasingly desperate for change

The poll confirms that the UK’s Brexit vote, and Donald Trump’s election, were just early signs of the fact that most people feel the current economic/political/social system is not working for them.  Worryingly, given the votes due over the next 6 months, the poll shows that French adults (89%), Italians (82%) and Germans (69%) are even more upset than American (63%) and British voters (60%).

This highlights the fact that none of our political leaders are prepared to tackle the really critical issue of our time – how does the world cope with the combination of vastly increased life expectancy and the collapse of fertility rates?

  In 1850, average Western life expectancy was around 40 years
  Increasing life expectancy meant that by 1950, this had become the start of middle age
  Today, anyone aged 40 is only half-way through their expected life
  By 2050, on current trends, average life expectancy will be around 100 years

This change would be dramatic enough on its own.  But it is being accompanied by a collapse in fertility rates.  These have been below replacement levels of 2.1 babies/woman since 1970, meaning that there is a growing shortage of people in the economically critical Wealth Creator 25 – 54 age group.

It is therefore no surprise that GDP growth is unimpressive.  The New Old 55+ generation already own most of what their need, and their incomes decline as they enter retirement.  Essentially, therefore, the ageing of the BabyBoom generation means that we have traded 10 years of extra life expectancy for growth.

I haven’t met anyone who is unhappy – from a personal viewpoint – with this trade.  The problem is that policymakers chose to ignore the social, political and economic consequences.  Instead they tried to compensate for this slower growth by printing money.  But all this has done is to create vast levels of debt, which can never be repaid.

100 year life

The second chart highlights the longer-term background to today’s position.  It shows Western life expectancy versus GDP/capita, and highlights the dramatic nature of the changes now underway.  These began in 1796 when Edward Jenner’s discovery of smallpox vaccination suddenly changed life expectancy:

  200 years ago, life expectancy was 35 years in the developed world.  Smallpox infected 60% of the population – and 20% died of it. But after 1796, life expectancy began to rise quite rapidly. As a result, the life cycle began to change.  No longer were people born, then usually worked from an early age, and then died – instead an education stage was added, and GDP rose as parents could pass on learning to their children
  100 years ago, life expectancy had reached 50 years, and the Western economy was growing fast in terms of GDP/capita – leading Germany and then the UK to introduce the concept of the pension.  This added another new stage to the life cycle as people were born, educated, worked, retired and then died. But the number of pensioners was still small, 600k in the UK out of a 43 million population
  Today, Western life expectancy is around 80, and is around 20 years at age 65.  And due to the collapse of fertility rates, a G7 economy such as Italy will soon have nearly as many people in the New Old 55+ cohort as in the Wealth Creator 25 – 54 cohort.  Another new stage needs to be added to the life cycle – where we are born, are educated, work, and then retrain in our 50s/60s, before working again until we retire and then die

This is the key economic, political and social issue of our time. And until policymakers wake up to its implications, the Populists will continue to triumph.  Ordinary people are not stupid.  They can see that stimulus programmes don’t produce the promised results.  As the poll shows, they understand that we are going in the wrong direction.

Today, we therefore need leaders with vision and common sense to set out a plan for living in a world where the 100-year life is becoming normal.

Common sense continues to elude central banks as they battle demographic cliff

Index Jan16aCentral banks are in a losing battle, as they try to reverse the inevitable slowdown created by the arrival of the demographic cliff.  Last year’s 5% fall in global GDP in current dollars tells its own story.

Common sense would tell them they can’t possibly win.  After all, how do you persuade New Olders in the 55+ age group to spend more money – when they already own most of what they need, and their incomes are declining as they enter retirement?

  • The New Olders will soon be 1 in 5 of the global population thanks to vastly increased life expectancy
  • And there are relatively fewer of the high-spending Wealth Creators aged 25-54 due to collapsing fertility rates

But as I feared in my Budget Outlook for 2016-18, this won’t stop central bankers from trying. Last Friday, the Bank of Japan joined the European Central Bank in moving to negative interest rates – where you pay the bank to look after your money. This is likely to create further problems in high-yield and emerging market debt, to add to those already appearing, as investors rush into stupid high-risk investments in a desperate search for yield.

As Time magazine has reported, even the strongest and best-managed companies are now being impacted:

“As Moody’s recently warned, some of the world’s biggest firms, like Royal Dutch Shell, Total, and Chesapeake Energy, are among the 175 firms that are at risk of ratings downgrades thanks to plunges in commodity prices.”

Of course, the Japanese move produced the usual knee-jerk rally in financial markets, confirming once again that the biggest rallies always occur in bear markets.  This time last year, the ‘SuperBowl Rally‘ saw oil prices rally from $45/bbl to $70/bbl, before they resumed their fall to today’s levels around $30/bbl.

But this only highlights the growing vulnerability of Western stock markets.  The chart of the IeC Boom/Gloom Index shows sentiment is weakening and market volatility is increasing.  This usually indicates a market is changing direction.  And the Index itself is now firmly back in negative territory, confirming the downturn signalled last month.

As with subprime, the banks are blind to these developments.  They are sure their economic models are just about to produce a sustained recovery, and so they see no need to consider other viewpoints.  It could be a very bumpy ride.

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 68%
Naphtha Europe, down 63%. “Naphtha crack slips into negative territory – US gasoline inventories rise once again”
Benzene Europe, down 60%. “Prices in Europe have seem some roller coaster action over the past week.”
PTA China, down 47%. “Restocking of cargoes were just about finished, with most companies expected to stop business activities from next week due to the Lunar New Year holidays”
HDPE US export, down 42%. “Export prices remained steady”
¥:$, down 18%
S&P 500 stock market index, down 1%