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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Time to recognise the economic impact of ageing populations

Is global economic growth really controlled by monetary policy and interest rates?  Can you create constant growth simply by adjusting government tax and spending policy?  Do we know enough about how the economy operates to be able to do this?  Or has something more fundamental been at work in recent decades, to create the extraordinary growth that we have seen until recently?

  • As the chart shows for US GDP, regular downturns used to occur every 4 or 5 years
  • Then something changed in the early 1980s, and recessions seemed to become a thing of the past
  • Inflation, which had been rampant, also began to slow with interest rates dropping from peaks of 15%+
  • For around 25 years, with just the exception of the 1st Gulf War, growth became almost constant

Why was this?  Was it because we became much cleverer and suddenly able to “do away with boom and bust” as one UK Finance Minister claimed?  Was it luck, that nothing much happened to upset the global economy?  Was it because the Chairman of the US Federal Reserve from 1986 – 2006, Alan Greenspan, was a towering genius?  Perhaps.

THE AVERAGE BABYBOOMER IS NOW 60 YEARS OLD 

Or was it because of the massive demographic change that took place in the Western world after World War 2, shown in the second chart?

  • 1921 – 1945.  Births in the G7 countries (US, Japan, Germany, France, UK, Italy, Canada) averaged 8.8m/year
  • 1946 – 1970.  Births averaged 10.1m/year, a 15% increase over 25 years
  • 1970 – 2016.  Births averaged only 8.5m/year, a 16% fall, with 2016 seeing just 8.13m born

Babies, as we all know, are important for many reasons.

Economically, these babies were born in the wealthy developed countries, responsible for 60% of global GDP.  So right from their birth, they were set to have an outsize impact on the economy:

  • Their first impact came as they moved into adulthood in the 1970s, causing Western inflation to soar
  • The economy simply couldn’t provide enough “stuff”, quickly enough, to satisfy their growing demand
  • US interest rates jumped by 75% in the 1970s to 7.3%, and doubled to average 10.6% in the 1980s
  • But then they began a sustained fall to today’s record low levels as supply/demand rebalanced

BOOMERS TURBOCHARGED GROWTH, BUT ARE NOW JOINING THE LOWER-SPENDING 55-PLUS COHORT

The key development was the arrival of the Boomers in the Wealth Creator 25-54 age group that drives economic growth.  Consumer spending is 60% – 70% of GDP in most developed economies.  And so both supply and demand began to increase exponentially.  In fact, the Boomers actually turbocharged supply and demand.

Breaking with all historical patterns, women stopped having large numbers of children and instead often returned to the workforce after having 1 or 2 children.  US fertility rates, for example, fell from 3.3 babies/woman in 1950 to just 2.0/babies/women in 1970 – below replacement level.    On average, US women have just 1.9 babies today.

It is hard to imagine today the extraordinary change that this created:

  • Until the 1970s, most women would routinely lose their jobs on getting married
  • As Wikipedia notes, this was “normal” in Western countries from the 19th century till the 1970s
  • But since 1950, life expectancy has increased by around 10 years to average over 75 years today
  • In turn, this meant that women no longer needed to stay at home having babies.
  • Instead, they fought for, and began to gain Equal Pay and Equal Opportunity at work

This turbocharged the economy by creating the phenomenon of the two-income family for the first time in history.

But today, the average G7 Boomer (born between 1946 – 1970) is now 60 years old, as the 3rd chart shows.  Since 2001, the oldest Boomers have been leaving the Wealth Creator generation:

  • In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, who spent an average of $62k ($2017).  There were only 36m households headed by someone in the lower-spending 55-plus cohort, who spent an average of $45k
  • In 2017, low fertility rates meant there were only 66m Wealth Creator households spending $64k each.  But increasing life expectancy meant the number in the 55-plus cohort had risen by 55%.  However, their average spend had only risen to $51k – even though many had only just left the Wealth Creators

CONCLUSION – THE CHOICE BETWEEN ‘DEBT JUBILEES’ AND DISORDERLY DEFAULT IS COMING CLOSE
Policymakers ignored the growing “demographic deficit” as growth slowed after 2000.  But their stimulus policies were instead essentially trying to achieve the impossible, by “printing babies”.  The result has been today’s record levels of global debt, as each new round of stimulus and tax cuts failed to recreate the Boomer-led economic SuperCycle.

As I warned back in January 2016 using the words of the OECD’s William White:

“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.”

That recession is now coming close.  There is very little time left to recognise the impact of demographic changes, and to adopt policies that will minimise the risk of disorderly global defaults.

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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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West faces “demographic deficit” as populations age

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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