US tax cuts will fail as Trump’s demographic deficit replaces Reagan’s demographic dividend

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.

Chemical industry downturn challenges stock market optimism

ACC Jun17Stock markets used to be a reliable indicator for the global economy, and for national economies. But that was before the central banks started targeting them as part of their stimulus programmes.  They have increased debt levels by around $30tn since the start of the Crisis in 2008, and much of this money has gone directly into financial markets.  Today, Japan is a great example of the distortions this has produced, as the Financial Times reports:

□  The Bank of Japan (BoJ) has been buying stocks via its purchases of Exchange Traded Funds (ETFs) since 2010
□   Last July, it doubled its purchases to ¥6tn of ETFs($58bn) per year, focused on supporting Abenomics policy
□   Analysis by Japanese bank Nomura suggests its purchases have since boosted the Nikkei Index by 1400 points

Even more importantly, the BoJ is particularly active if the market looks weak.  Between April 2013 – March 2017, it bought on more than half of the days when the market was down.

The distortion ins’t just limited to direct buying by the BoJ, of course.  It is magnified by the fact that everyone else in the market knows that the BoJ is buying.  So going short is a losing proposition.  Equally, investors know that the BoJ is guarding their back – so they are guaranteed to win when they buy.

This manipulation by the BoJ is just an extreme form of the intervention carried out by all the central banks.  It means that the stock market has lost its role as an indicator of the economy.  And so all those models which include stock market prices in their calculations are also over-optimistic.

This is why the global chemical industry has become the best real-time indicator for the real economy.  As I noted back in January, it has an 88% correlation with IMF data for global growth – far better than any other indicator:

The logic behind the correlation is partly because of the industry’s size.  But it also benefits from its global and application reach. Every country in the world uses relatively large volumes of chemicals, and their applications cover virtually all sectors of the economy, from plastics, energy and agriculture to pharmaceuticals, detergents and textiles.

Latest data on Capacity Utilisation (CU%) from the American Chemistry Council is therefore very worrying, as the chart shows:

□   Since 2009, the CU% has never recovered even to the 1987 – 2008 low of 86.4%
□   It has been in a downward trend since January 2016, when it peaked at 81.4%
□   April’s CU% fell to 79.9% versus 80.7% in April last year
□   This was very close to the all-time low of 77% seen in March 2009

The problem is that central banks have moved from the pragmatism of the 1980s to ideology.  They have become, in Keynes’s famous phrase “slaves to some defunct economist” – in this case, Milton Friedman and Franco Modigliani, as we argued in our evidence earlier this year to the UK House of Commons Treasury Committee:

“Friedman’s analysis of the effectiveness of monetary policy, when he argued that “inflation is always and everywhere a monetary phenomenon”, is therefore no longer valid.  Modigliani’s “Life Cycle theory of consumption” is similarly out of date. … Friedman and Modigliani’s theories appeared to make sense at the time they were being developed, but they clearly do not fit the facts today.”

Instead of the promised economic growth, the central banks have in fact simply piled up more and more debt – which can never be repaid.  2 years ago, the global total was already $199tn, and 3x global GDP, according to McKinsey. Just in the US, this means net interest payments will cost $270bn this year, and total $1.7tn over the next 5 years, according to the impartial Congressional Budget Office.

Stock markets may continue in their optimistic mode for a while longer.  But in the end, the lack of promised growth will force the central banks to stop printing money.  They will then have to abandon their ideological approach, and instead accept the common sense argument of our Treasury Committee evidence:

Monetary policy should no longer be regarded as the key element of economic policy.   This would then free policymakers to focus on the real demographic issues that will determine growth in the future – namely how to encourage people to retrain in their 50s and 60s to take advantage of the extra 20 years of life expectancy that we can all now hope to enjoy.”

Older people are being forced to spend less

The Financial Times has kindly today printed my letter below, commenting on the change taking place in demand patterns as a result of ageing populations.

FTSir, It was interesting to see the UK’s employment and pension ministers reminding FT readers that “by 2022, there will be 3.7m more people aged between 50 and state pension age in the UK, yet 0.7m fewer people aged 16 to 49” (Letters, August 1).

Their message about the need to adapt to this change needs to be heard more widely than just by employers. For example, Office for National Statistics data tell us that household spending decreases quite sharply past the age of 50. It shows that average weekly spend falls from a peak of £610 for households headed by someone in the 30-49 age bracket to £565 for those headed by someone aged 50-64, and to just £453 for those aged 65-74.

The ageing of the UK population is thus inevitably reducing the outlook for economic growth, as consumer spending is nearly two-thirds of gross domestic product. It also throws into question the logic behind today’s artificially low levels of interest rates, given that the majority of UK households are now headed by someone over the age of 50.

Increasing life expectancy means the policy is effectively forcing older people to save more today, and spend less, if they want to protect their lifestyle in retirement.

Paul Hodges
Chairman, International eChem

India’s WTO veto marks end of global trade deals

Deflation Jul13The Cycle of Deflation has taken another lurch forward.  The reason was India’s decision to veto last year’s Bali deal to streamline customs procedures.  Almost certainly, this will prove the dying effort of the World Trade Organisation, which sponsored the proposal.

The blog is particularly sad at this outcome.  It has always believed that free trade provides the best possible basis for improving global living standards.

The problem, of course, is that compromise becomes increasingly difficult as the economic outlook worsens:

Thus WTO’s ‘Doha Round’ began in 2001 in Doha, and has since gone nowhere.

It was hoped in Bali that a small deal, allowing everyone to benefit from easier customs procedures, might restore momentum.  But India refused to agree this without guarantees that it could continue with its food subsidies.

This of course, is an unrelated issue.  But it is very important to the new Modi government, anxious to be seen as champions of the poor.  Thus India’s Trade Minister argued:

We cannot wait endlessly in a state of uncertainty while the WTO engages in an academic debate on the subject of food security. Issues of development and food security are critical to a vast swath of humanity and cannot be sacrificed to mercantilist considerations”.

Other major global trade deals look equally unlikely to deliver real progress:

The reason is simple – politicians are failing to spell out potential benefits and are instead leading from behind.

Thus as the blog warned back in February, protectionism is gaining ground around the world.  As the chart suggests, we have moved through the period of devaluation and have now arrived at the period of competitive devaluation, where everyone tries to out-compete their rivals.

This process began more than a decade ago, when companies and policymakers failed to recognise that demand would inevitably slow as global populations aged, and the Boomers joined the New Old 55+ generation.  Even today, major expansions are underway in many industries, regardless of the fact that demand growth is already very weak.

Once the money is spent, countries will close their borders to protect jobs.  Only then, when too late, will we all look back and wonder what we could have done differently.

China’s housing market enters New Normal as prices slide

D'turn 10Aug14

Markets appear to be continuing to move, slowly but surely, into their expected ‘scary phase’.  The reason is the massive distortions that have been created in financial markets, and in China’s housing market, by the $35tn+ of stimulus from governments and central banks since 2009.

Unwinding these distortions will not be simple.  The stimulus has not returned us to SuperCycle growth levels, but has instead created extreme levels of debt.  And without SuperCycle levels of growth, it is becoming clear that this debt can never be repaid.

The chart highlights how the markets now seem to be breaking down, one by one:

  • At the beginning of 2013, the S&P 500 (purple); the $: ¥ exchange rate (brown); Brent oil (blue); and naphtha (black) were all still moving together
  • This was the famous “correlation trade” under which all markets rose together, due to the amount of market support being provided
  • But during 2013, oil and naphtha markets disengaged, leaving only the $: ¥ and the S&P500 still moving higher
  • A year ago, traders thought they saw an opportunity to reconnect them, using their previously successful ‘buy on dips’ strategy
  • But although they pushed hard with hype about imminent shortages, the reconnection never happened
  • Instead, the yen then became the next market to break the correlation, leaving the S&P 500 on its own

This was the first part of the unwinding of the ‘correlation trade’.

The problem was, and is, that the ‘correlation trade’ meant supply/demand balances in individual markets no longer mattered:

  • It kept crude oil prices at record levels, even though supply was increasing and demand growth slowing
  • In currency markets, it meant the dollar remained weak to support US exports, despite major problems in the Eurozone and Japanese economies

But now the liquidity tap is being turned off as China cuts back lending and the US Federal Reserve completes its “taper”.

Most importantly, China’s leadership is moving in a new direction. As a result, its economy is slowing fast.  Railcar movements are always a good real-time indicator of the economy.  They fell 1.4% in June versus 2013, whilst steel production managed just a 0.4% gain in H1.

The key China housing market is also now entering a “New Normal“, according to the head of the National Economic Research Institute.   July saw house prices falling in all 10 major cities.  And as China Daily reports, “Gone are the days when Chinese property developers could make a killing simply by building more houses.

Instead, a new type of market is developing according to Pan Jun, president and CEO of Fantasia Holdings Group:

Don’t call us ‘property developers.’ We should try to be ‘community designers,’ offering comprehensive services to improve residence comfort”

The good news is that China’s new leadership clearly understand what needs to be done, and have developed detailed plans to allow market forces to play a bigger role in the economy.

But it would be naïve to assume this can be done by simply waving a magic wand.  Unwinding China’s past mistakes, as in the West, will be a long and hard road.


The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:

Brent crude oil, down 4%
Naphtha Europe, down 4%.  “Market is suffering from a combination of falling upstream ICE Brent crude oil prices and slow downstream demand, leading to a sharp drop in prices.”
US$: yen, down 3%
PTA China, up 1%. ”Squeezed margins restricted the volume of sales, as producers were unwilling to sell below their costs”
Benzene Europe, up 1%Prices fell to a six-week low, reflecting downward movement in global markets and limited demand for August”
S&P 500 stock market index, up 6%
HDPE US export, up 9%. “For now, US prices are workable to Latin America”

Cotton prices suffer worst crash in 55 years

Cotton Jul14aJust as forecast in March, world cotton prices have crashed.

Prices peaked at 97.35c/lb on 24 March, just 3 days after the post was published.  Since then, they have fallen by a third to 65c/lb.  They have now fallen for 11 straight weeks – the longest slump in 55 years, according to Bloomberg.

There is no need to repeat the rationale for this collapse, which was covered in detail in March and September.  The key was the stimulus policies which created stockpiles equal to 3 pairs of jeans for every person in the world.

Today’s crash is unlikely to reach bottom for some time.  Current US government forecasts suggest warehouse stocks will reach an all-time record high of 105.6 million bales next year, versus 94m in 2013:

  • US production is rising sharply, as the drought has ended in the cotton states of Texas and Louisiana
  • India is also now expected to have a good crop
  • China’s imports are forecast to fall from 20m bales to 13.5m this year

Cotton, of course, competes primarily with polyester in the fibre market.  And China’s polyester capacity has also increased dramatically under the stimulus economy of its former leadership:

  • It is expected to rise by 75% between 2010 – 2015, from 27.5MT to 48.3MT, according to ICIS data
  • Over the same period, its PTA capacity will almost treble from 17MT to 50MT
  • 14MT of PTA is scheduled to come onstream this year alone

Thus we have vast over-supply in cotton matched by vast over-supply in the polyester chain.

Trade data from Global Trade Information Services highlight the dramatic change now underway:

  • China has been the world’s largest importer of PTA, buying 3.1MT in H1 2012
  • Last year, these volumes halved to just 1.6MT in H1 as the new capacity began to come online
  • This year, volumes have halved again, to only 750KT

And the data also shows that China has begun to export major volumes of PTA for the first time in history, selling 230KT to India and the Middle East.

This parallels developments in other key markets, where China is also now becoming a significant exporter.  As GTIS data shows, it became a net exporter of PVC in H1, with exports reaching 550KT versus 415KT of imports.

The reason is that China needs to move up the value chain.  It has to replace textile factory jobs lost by its need to boost wages to increase domestic consumption.  And it is being successful, as new estimates for export growth show.

Back in February, when launching its major Research Note on the 7 global impacts of China’s new policies, the blog posed a key question:

“Why did nobody notice that China was the ‘elephant in the room’, in terms of being the main cause of today’s downturn in global demand and financial markets?”   Answer: “Because we were all wearing rose-tinted glasses”.

Current developments in cotton and polyester highlight how we are all still wearing the same glasses.

Cotton, polyester – and the fibre market they supply – are all major world markets.  Financial players should therefore be panicking about what this downturn means for other parts of the global economy.  But instead they remain convinced that ”central banks now rule”:

  • They are therefore cheering China’s latest export data
  • They fail to understand this is not due to the sudden return of robust growth in the West
  • Instead it is driven by China’s need to support its own employment

This delusion may not continue much longer.  But in the meantime, the blog fears that cotton’s price collapse is opening another fault-line in the debt-fuelled ‘ring of fire’.

Will textile mills honour the contracts they signed at higher prices?  If they don’t, what will happen to all the traders who sold them this cotton?  And what will happen to all those who funded the speculative bubble that has kept prices at unrealistic levels for so long?

And, perhaps more importantly, will players now start to worry that other markets, like oil, might start to be ruled again by the laws of supply and demand, and not by central banks?