Boomer SuperCycle unique in human history – Deutsche Bank

“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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Why everyone ignored my warnings ahead of the financial crisis

It’s 10 years since my forecast of a global financial crisis came true, as Lehman Brothers collapsed.  I had warned of this consistently here in the blog, and in the Letters column of the Financial Times. But, of course, nobody wanted to listen whilst the party was going strong.  As the FT’s world trade editor wrote at the time, commenting on the Queen’s question “Why did nobody see this coming”:

“Why didn’t people see it coming? Some did, Ma’am. Some did. But it doesn’t mean they were listened to. And there is a long history of people in authority running up vast debts without public accountability and eventually losing their heads. Let’s just try and get through this one without a civil war, shall we?”

That rationale, I understood.  I was the “party pooper” warning of crisis for nearly 2 years.  But people didn’t want warnings.  And, of course, until we got to March 2008 and Bear Stearns collapsed, I couldn’t answer their all-important question, “When is this going to happen?”.

If you take the 4 great questions of life – Why, What, How and When – the ‘When’ question is really the least important:

  • If you know ‘Why’ something is going to happen, ‘What’ it involves and ‘How’ it will impact, then ‘When’ is simply the detail that confirms the analysis was right
  • But if you don’t want to know about a problem, its the easiest thing in the world to dismiss it by arguing “your comment is no use to me, unless you can tell me when its going to happen”

But I admit that what did surprise me, after John Richardson and I had written Boom, Gloom and the New Normal: how the Western BabyBoomers are Changing Demand Patterns, Again, was that people really liked our analysis of the impact of demographic change on the economy – but still ignored its implications for their business and the economy.

The above chart is a good example, showing the latest data from the US Consumer Expenditure Survey.  It confirms what common sense tells us:

  • Household spending is closely linked to age
  • Housing expenditure is the biggest single expense for most people, and peaks between the ages of 35-54
  • Transport and food & drink are the next largest spend, and peak at the same ages
  • Health expenditure, on the other hand, peaks as one gets older

This is critical information for central bankers, companies and investors, given that consumer spending is 60%-70% of GDP in most developed countries.

Yet the only central banker who took it seriously, Masaaki Shirikawa, Governor of the Bank of Japan, was promptly sacked after premier Abe came to power.   Printing money seemed so much easier than having difficult but essential discussions with voters about the impact of an ageing population, but as Shirikawa noted:

“The main problem in the Japanese economy is not deflation, it’s demographics. The issue is whether monetary policy is effective in restoring economic recovery. My observation is, it is quite limited.”

Equally, the second chart confirms that the US is also a rapidly ageing society, with 20m households having moved into the 55+ age range since 2000.  And whilst the 55+ group’s spending has increased over the period, this is only because many of the younger BabyBooomers are still in their 50s or early 60s.  So whilst their spend is declining, it hasn’t yet suffered the 43% fall that occurs after the age of 75 (by comparison with the peak spending 45-54 period).

Yet policymakers still insist that the 2008 crisis was all about liquidity, and had nothing to do with the impact of today’s ageing populations on spending and economic growth.  And most companies also still plan for “business as usual”.

SO WHAT HAPPENS NEXT, AS THE DEBT BURDEN GROWS?
For obvious reasons, I disagree with these views.  Of course, it would be lovely to find that today’s record levels of debt – created in the vain attempt to stimulate growth – could be made to simply disappear.  I have read analyses by learned commentators arguing that central banks can simply “write off” their debt, and it will magically disappear.

But I have never yet found a bank or credit card company prepared to “write off” any debt that I owe them in this way.  (If you know of one, please let me know, and I will pass on the details).  And most of us know from personal experience that interest costs soon mount up, if you can’t pay the debt at once and have to finance it for a while.

So its quite clear that today’s record levels of debt create massive headwinds for future growth. At $247tn, it now amounts to 318% of global GDP.  In reality, only two choices lie ahead:

  • The past decade’s borrowing brought forward consumption from the future, so repaying the debt means growth will slow very dramatically – adding to the demand deficit created by today’s globally ageing populations
  • Failing to pay back the debt risks creating chaos in financial markets, as we are starting to see with the crises in Argentina and Turkey, as lenders suddenly realise their loans cannot be repaid

But, of course, I can’t yet say exactly ‘When?’ this simple fact will finally impact the economy and markets.  For the moment, as between 2006 – March 2008, I can only tell you:

‘Why?’ it is going to happen, ‘What?’ it involves and ‘How?’ you can recognise the warning signs.

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Financial crises and the five stages of loss

The Financial Times has kindly printed my letter as their lead letter, arguing that the rise of the populists emphasises the risk of continuing to deny the impact of today’s ageing populations on the economy.

Sir,  Martin Wolf’s sobering analysis of policymakers’ post-crisis decision to “go back to the past”, ( “Why so little has changed since the financial crash”, September 5), brings to mind the celebrated “Paradigm of Loss” model developed by Elizabeth Kübler-Ross. Originally designed to describe how people come to terms with loss and death, it has since been more widely applied, including to economic and financial market developments.

His description of the post-1918 period appears to be a classic example of the paradigm’s denial stage, with policymakers ignoring the economic impact of the earlier carnage. Young people are the prime source of future demand as they enter the wealth creator 25-54 age group, when people typically settle down, have children and develop their careers. The war cruelly destroyed the lives of millions of young men before they could realise this potential.

As the paradigm would suggest, this denial then led to anger, and the rise of fascism and communism. This proved so intense that the next stage, bargaining, was delayed until 1945, when the adoption of Keynes’s new thinking finally allowed the cycle to complete.

Today, we are again seeing a demand deficit created by demographic change. Thankfully, it is not due to war, but to the post-1945 increase in life expectancy and collapse in fertility rates. Inevitably, therefore, consumer spending — the motor of developed economies — is now slowing as we have an ageing population for the first time in history. Older people already own most of what they need, and their incomes decline as they retire.

Just as in 1918, this means we need new policies to create “a better future”, as Mr Wolf notes. In their absence, the rise of the populists suggests that we instead risk moving into a new anger phase. It is not yet too late for new thinking to emerge, but time is starting to run out.

Paul Hodges

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The blog’s 11th birthday – and a look forward to 2021

The blog has now been running for 11 years since the first post was written from Thailand at the end of June 2007.  And quite 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 have not changed their basic belief that the right combination of tax and spending policies can always create growth.

As a result, the world has become a much more complex and confusing place.  None of us can be sure what will happen over the next 12 months, given today’s rising geo-political tensions.

In times of short-term uncertainly, it can be useful to take a longer-term view.  It is therefore perhaps helpful to look back at Chapter 4 of Boom, Gloom, which gave Our 10 predictions for how the world would look from 2021: 

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

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

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

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

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

Most of these forecasts are now well on the way to becoming reality, and the pace of change is accelerating all the time.  It may therefore be helpful to include them in your planning processes for the 2019 – 2021 period, to test how your business (and your personal life) might be impacted if they become real.

THANK YOU FOR YOUR SUPPORT OVER THE PAST 11 YEARS
It is a great privilege to write the blog, and to be able to meet many readers at speaking events and conferences around the world.   Thank you for all your support.

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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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West’s household spending heads for decline as population ages and trade war looms

As promised last week, today’s post looks at the impact of the ageing of the BabyBoomers on the prospects for economic growth.

The fact that people are living up to a third longer than in 1950 should be something to celebrate.  But as I noted in my Financial Times letter, policymakers are in denial about the importance of demographic changes for the economy.

Instead, their thinking remains stuck in the past, with the focus on economists such as Franco Modigliani, who won a Nobel Prize for “The Life Cycle Hypothesis of Savings”, published in 1966.  This argued there was no real difference in spending patterns at different age groups.

Today, it is clear that his Hypothesis was wrong.  He can’t be blamed for this, as he could only work with the data that was available in the post-War period.  But policymakers should certainly have released his theories were out of date.

The chart highlights the key issue, by comparing average US and UK household spending in 2000 v 2017:

  • In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, and 12.5m in the UK.  They spent an average of $62k and £33.5k each ($2017/£2017)
  • There were 36m US households headed by someone in the 55-plus New Older cohort, and 12.4m in the UK, who spent an average of $45k and £22.8k each
  • In 2017, the number of Wealth Creator households was almost unchanged at 66m in the US and 11.9m in the UK.  Their average spend was also very similar at $64k and £31.9k each
  • But the number of New Older householders had risen by 55% in the US, and by 24% in the UK, and their average spend was still well below that of the Wealth Creators at $51k and £26.4k respectively

Amazingly, despite this data, many policymakers still only see the impact of today’s ageing Western populations in terms of  likely increases in pension and health spending.  They appear unaware of the fact that ageing populations also impact economic growth, and that they need to abandon Modigliani’s Hypothesis.

As a result, they have spent trillions of dollars on stimulus policies in the belief that Modigliani was right.  Effectively, of course, this means they have been trying to “print babies” to return to SuperCycle levels of growth.  The policy could never work, and did not work.  Sadly, therefore, for all of us, the debt they have created can never be repaid.

This will likely have major consequences for financial markets.

As the chart from Ed Yardeni shows, company earnings estimates by financial analysts have become absurdly optimistic since the US tax cut was passed.

The analysts have also completely ignored the likely impact of China’s deleveraging, discussed last month. 

And they have been blind to potential for a global trade war, once President Trump began to introduce the populist trade policies he had promised in the election.  Last week’s moves on steel and aluminium are likely only the start.

Policymakers’ misguided faith in Modigliani’s Hypothesis and stimulus has instead fed the growth of populism, as the middle classes worry their interests are being ignored. This is why the return of volatility is the key market risk for 2018.

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