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 But policymakers should certainly have released his theories were out of date.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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Rising life expectancy, and falling fertility rates, mean that a third of the Western population is now in the low spending 55-plus age group. Given that consumer spending is around two-thirds of the economy in developed countries, the above charts provide critically important information on the prospects for economic growth.
They show official data for household spending in 3 of the major G7 economies in 2017 – the USA, Japan and the UK:
- Each country reports on a slightly different basis in terms of age range and headings, but the basics are similar
- US spending peaks in the 45 – 54 age group: Japanese spending peaks at age 55; UK spending peaks at age 50
- After the age of 75, US spending falls 46% from its peak and UK spend falls 53%: after the age of 70, Japanese spending falls 34%
The data confirms the common sense conclusion that youthful populations create a potential demographic dividend in terms of economic growth. Conversely, ageing populations have a demographic deficit and will see lower growth, as.older people already own most of what they need, and their incomes go down as they enter retirement.
The Western world has been, and still is, a classic case study for this demographic effect in action, as the second chart shows:
- In 1950, only 16% of Westerners were in the New Old 55-plus age group; 39% were in the 25-54 age group that drives economic growth and wealth creation; and 45% were under 25 as the BabyBoom got underway
- But by 2015, the percentage of New Olders had doubled to 31%, whilst the percentage of Wealth Creators was virtually unchanged at 41% and only 28% were under 25 (as fertility rates collapsed after 1970)
The Boomers were the largest and wealthiest generation that the world has ever seen, and as they joined the workforce they created an economic Super-Cycle. This was turbo-charged by the fact that, for the first time in history, Western women began to re-enter the workforce after childbirth:
- In the US, for example, women’s participation rate nearly doubled from 34% in 1950 to a peak of 60% in 1999
- And after the Equal Pay Act of 1963, their earnings rose to 62% of men’s by 1979 and to 81% by 2005 (since when it has flatlined)
But since 2001, the oldest Boomer, born in 1946, has been leaving the Wealth Creator age group. By 2013, the average Boomer had left it. And since 1970, Western fertility rates have been below replacement levels (2.1 babies/woman). So the Western economy now faces a double squeeze:
- The Boomers who created the SuperCycle are no longer making a major contribution to economic growth
- The number of new Wealth Creators is now relatively smaller, due to the collapse of fertility rates
In the past, very few Boomers would have lived beyond retirement age, as the 3rd chart confirms based on UN Population Division data. So, sadly, they would have been irrelevant in terms of economic growth. But, wonderfully, this is no longer true today:
- In 1950, average US life expectancy for men was just 66 years and 72 years for women. UK men died at age 67, and women at age 72. Japanese men died at age 61, and women at age 65
- Today, US men are living an extra 11 years and women 9 years more. UK men are living an extra 12 years and women 11 years more. Japanese men are living an extra 19 years and women 22 years more
- By 2030, the UN forecasts suggest US men will be living 20% longer than in 1950, and women 16% longer. In the UK, men will be living 23% longer and women 18% longer. In Japan, men will be living 35% longer, and women 37% longer
By 2030, 36% of the Western population will be New Olders, almost equal to the 37% who are Wealth Creators.
Clearly there is no going back to SuperCycle growth levels. I will look at this critical issue in more detail next week.
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“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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No country in the world now has a top quality pension system. That’s the conclusion from the latest Report by pensions consultants Melbourne Mercer. As the chart above shows:
- Denmark and The Netherlands have fallen out of the top category
- In the G7 wealthy nations: Canada is in category B; Germany and UK in C+; France, US and Italy in C; Japan in D
- In the BRICS emerging economies: Brazil is in category C; India, China and S Africa are D; and Russia’s system is so poor it is unclassified
Unsurprisingly, the cause of the problems is today’s ‘demographic deficit’, as the authors highlight:
“The provision of financial security in retirement is critical for both individuals and societies as most countries are now grappling with the social, economic and financial effects of ageing populations. The major causes of this demographic shift are declining birth rates and increasing longevity. Inevitably these developments are placing financial pressure on current retirement income systems. Indeed, the sustainability of some current systems is under threat.”
These problems have been building for years, as politicians have not wanted to have difficult conversations with voters over raising the retirement age. Instead, they have preferred to ignore the issue, hoping that it will go away.
But, of course, problems that are ignored tend to get worse over time, rather than go away. In the US, public pension funds saw their deficits jump $343bn last year to $3.85tn – making it almost certain that, eventually, pension benefits will have to be cut and taxes raised.
The issue has been that politicians preferred to believe central bank stimulus programmes could solve the deficit by cutting interest rates and printing large amounts of virtually free cash. And unfortunately, when it became clear this policy was failing to work, the banks “doubled down” and pursued negative interest rates rather than admitting defeat:
- Currently, 17% of all bonds (worth $8tn), trade at negative rates
- Swiss bond yields are negative out to 2027, as the Pensions Partners chart shows
- Most major European countries, and Japan, suffer from negative rates
2 years ago, Swiss pension experts suggested that its pension system would be bankrupt within 10 years, due to the requirement to pay retirees an annuity of 6.8% of their total savings each year. This rate is clearly unaffordable with negative interest rates, unless the funds take massive risks with their capital.
The US faces similar problems with Social Security, which is the major source of income for most retirees. The Trustees forecast its reserves will be depleted by 2034, when benefits will need to be cut by around a quarter. Medicare funds for hospital and nursing will be depleted by 2029. And as the Social Security Administration reports:
“173 million workers are covered under Social Security. 46% of the workforce in private industry has no private pension coverage. 39% of workers report that they and/or their spouse have not personally saved any money for retirement.”
Rising life expectancy is a key part of the problem, as the World Economic Forum (WEF) reported in May. Back in 1889, life expectancy was under 50 when Bismarck introduced the world’s first state pension in Germany. Today, the average baby born in the G7 countries can expect to live to be 100. As WEF conclude:
“One obvious implication of living longer is that we are going to have to spend longer working. The expectation that retirement will start early- to mid-60s is likely to be a thing of the past, or a privilege of the very wealthy.”
Sadly, politicians are still in denial, as President Trump’s proposed tax cuts confirm.
Today is not 1986, when President Reagan cut taxes in his October 1986 Tax Reform Act and was rewarded with higher tax revenues. 30 years ago, more and more BabyBoomers were entering the wealth creating 25 – 54 age group, as the chart from the Atlanta Fed confirms:
The issue is the ageing of the Boomers combined with the collapse of fertility rates:
- The oldest Boomers left the Wealth Creator cohort in 2001, and the average Boomer (born in 1955) left in 2010
- The relative number of Wealth Creators is also in decline, as US fertility rates have been below replacement level (2.1 babies/woman) for 45 years since 1970
Inevitably, therefore, Reagan’s demographic dividend has become Trump’s demographic deficit.
As I warned back in May, debt and demographics are set to destroy Trump’s growth dream. And without immigration, the US working age population will fall by 18m by 2035, making a bad situation even worse. Instead of tax cuts, Trump should instead be focused on 3 key priorities to:
- “Design measures to support older Boomers to stay in the workforce
- Reverse the decline that has taken place in corporate funding for pensions
- Tackle looming deficits in Social Security and Medicare”
Future retirees will not thank him for creating yet further debt headwinds by proposing unfunded tax cuts. These might boost GDP in the short-term. But they will certainly make it even more difficult to solve tomorrow’s pension deficits.
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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The Financial Times has kindly printed my letter below, wondering why the US Federal Reserve still fails to appreciate the impact of the ageing BabyBoomers on the economy
Sir, It was surprising to read that the US Federal Reserve is still puzzled by today’s persistently low levels of inflation, given that the impact of the ageing baby boomers on the economy is now becoming well understood (“An inflation enigma”, Big Read, September 19).
As the article notes, factors such as globalisation and technological advances have all helped to moderate price increases for more than two decades. But the real paradigm shift began in 2001, when the oldest boomers began to join the lower-spending, lower-earning over-55 generation. As the excellent Consumer Expenditure Survey from the Bureau of Labor Statistics (BLS) confirms, Americans’ household spending is dominated by people in the wealth creating 25-54 age cohort. Spending then begins to decline quite dramatically, with latest data showing a near 50 per cent fall from peak levels after the age of 74.
This decline was less important when the boomers were all in the younger cohort. BLS data show it contained 65m households in 2000, with only 36m in the older cohort. But today, lower fertility rates have effectively capped the younger generation at 66m, while the size of the boomer generation, combined with their increased life expectancy, means there are now 56m older households.
Consumer spending is around 70 per cent of the US economy. Thus the post-2001 period has inevitably seen a major shift in supply/demand balances and therefore the inflation outlook. So it is disappointing that the Fed has failed to go up the learning curve in this area. Demographics are not the only factor driving today’s New Normal economy, but central bankers should surely have led the way in recognising their impact.