“Demographics in mainstream economics has been under-emphasized for too long” – Andy Haldane, Chief Economist, Bank of England

Haldane Jan17“Will economists start to consider demographics when making their forecasts and developing government policies?”

This was the question on my mind at a recent discussion on the topic of “An economy that works for everyone” at the UK’s Institute for Government.  The speaker was the Chief Economist of the Bank of England, Andy Haldane, and the Institute’s Director, Bronwen Maddox kindly invited me to ask my question as part of the discussion.  You can watch the Q&A by clicking here.  The transcript is below.

Critically, Haldane acknowledges that economists need to rethink their approach.  Until now, they have focused on developing policies that impact “the average person”.  Instead, he agrees that they now “need to be super-granular, household by household”, in terms of demographics and other relevant detail.

Andy Haldane is a leading central banker.  His statement that “we shouldn’t have fixed views on how monetary policy works” is therefore very important.  New ideas are urgently needed, and his comment opens the door for debate.    As I have discussed here in earlier posts (Policymakers’ out-of-date economic models fail to create growth, againAge range and income level key to future corporate profits), I believe there is an urgent need to develop an alternative economic model based on the ”competing populations” concept developed by the biologists.

Paul Hodges
Andy. Thank you very much indeed for the stimulating talk. You made a comment just now about “is it something else” (that is causing the post-2008 recovery to be so slow and uncertain), and at the start you talked about the need perhaps to reinvent or rethink economics. You also made a point about the failure of conventional economics to explain this difference between the frontier companies (who are leading in their fields) and the others.

Just before Christmas the bank put out a survey of spending with relation to interest rates and monetary policy which suggested that again and I quote almost exactly “conventional economics would have said that if you pass on lower interest rates, people will spend more. “But in fact only 10% of people did. So what I wanted to ask you was,

“Is this something else” to do with really significant demographic changes in the economy – that we now have a group of BabyBoomers, the largest-ever group of people in the population, who are refusing to die at 65 as they would have done in the past. In fact they are living now for another 20 years, and we have around one in five of the population in that age group.”

My question really is therefore “do you think that investigating this demographic impact, which has never happened before in the world, could be useful”? Because I think that it might provide the key (a) to the new type of economics and also (b) to the question of how we raise UK productivity.

Andy Haldane
“Paul, your work on this is a very good example of how demographics in mainstream economics has been under-emphasized for too long.

That I think is changing by the way – that I think is changing and we are seeing for example when people tell the story that I mentioned earlier on about secular stagnation – the kind of Bob Gordon, Larry Summers-type hypothesis – one of the facts that is pointed towards would be demographic factors nudging us in that direction.

When we’re trying to make sense of why it is that interest rates globally – not ones set by central banks, ones set by financial markets – why they are so low, for as far as the eye can see, part of the explanation, I think, lies in evolving demographics and the implications that has about saving and for investment. 

The study you mention, I think of households, which we conduct a regular basis to try and understand their patterns of spending and saving is, in some ways, a brief example of all we discussed today. It’s a vertical distribution. It’s saying we can’t take the average person, the so-called representative agent and hope that by studying them we can make sense of what’s going on. We need to be super-granular, household by household:

 Conditioning on whether they are a borrower or a saver, whether they are young or whether they are old, whether they live in the North East or whether they live in the South West
 And using that to condition our policy responses including our monetary policy responses

It could be the case we reach the point where interest rates are a bit less potent in stimulating spending than was the case in the past. We shouldn’t have fixed views or fixed multipliers about how monetary policy works.

It can change as the economy can change and by looking at this more granular data, like Michael Fish* did after 1987, we can perhaps tomorrow, or failing that the day after tomorrow, do a somewhat better job of making sense of what happens next in the economy.”

 

* Michael Fish was the BBC weather forecaster who famously denied on-air in October 1987 that a hurricane was about to hit the UK. Haldane had earlier noted that this failure had prompted a complete rethink of weather forecasting, which was now much better as a result. He hoped that economists’ failure to forecast the 2008 Crisis might end up causing a similar process of rethinking and reinvention to take place.

Populism rises as global dynamics drive market shifts

Populists Nov16

We are living in a New Normal world.  Populists such as Nigel Farage, Donald Trump, Marine le Pen and Beppe Grillo are gaining support as economic growth slows and social/political unrest becomes common.  My presentation at our annual conference last week in Vienna highlighted some of the key issues, as Jessie Waldheim of ICIS news reports.

VIENNA (ICIS)–Markets face a period of increased volatility as political and demographic changes result in a paradigm shift from globalisation to sustainability as the driver for chemical markets, the chairman of consultancy International eChem said on Tuesday.

“The world is at a tipping point,” said International eChem chairman Paul Hodges. “Everything we’ve known, everything we’ve lived with for the last 50-70 years is now changing.”

In 1987, then US president Ronald Reagan stood in front of the Berlin Wall in Germany and demanded that it be torn down. In 2017, US president-elect Donald Trump is expected to build a wall.  In Europe, the Brexit vote for the UK to leave the EU and the upcoming referendum in Italy could cause further turmoil for the EU.

These political changes are being driven by demographic changes which are also going to effect petrochemical and other markets. Essentially, as life expectancies have increased and birth rates have lowered, a larger percentage of populations are older.

US consumer Nov16For example, as the second chart shows, the number of US households in the 25-54 age bracket has been steady while the number in the 55-and-up age bracket has risen by nearly 50%. The older households tend to spend less money, having already made most major purchases.

This is in contrast to recent decades, when major population growth in the younger age brackets drove global demand.  ”We don’t have lots of young people, so you don’t need as much stuff,” Hodges said, speaking at the 15th annual World Aromatics & Derivatives Conference in Vienna, Austria.

According to figures from the American Chemistry Council, we’re seeing a drop-off in capacity utilisation, which is the “best single predictor we have” of global GDP, Hodges said.  With the capacity utilisation numbers in September 2016 nearly as low as in 2009, we’re likely to see a global recession next year, he added.

Our economy has not yet adapted to the new demographics. This adaptation will mean uncertainty and political risk.  ”We’re seeing the rise of protectionism. Sustainability is replacing globalisation,” Hodges said.

Trump has said he has plans to declare China a currency manipulator and to withdraw from or renegotiate trade deals. The Brexit vote is part of this same paradigm shift. “We need to be planning for this,” Hodges said.

Specifically for aromatics markets, benzene price spreads have already come down. Benzene is a byproduct and refineries don’t increase production when benzene is tight and won’t slow production if less benzene is needed. ”We’ve seen benzene below naphtha before. We could see benzene trading below naphtha again,” Hodges said. “We have to accept the volatility is there.”

Companies will need to consider how trade flows will change with China no longer the major importer and manufacturing capital of the world. And companies will need to consider inter-polymer competition from lower polypropylene prices.  Businesses models will have to change and restructuring will be inevitable.

Key chemical hubs will have to be made more robust, and being near customers may become more important, Hodges said.  With the change comes opportunities. For instance, businesses could focus on designing solutions with new materials or by repurposing materials already in the market.

“Aging populations are an opportunity. Why are we not developing new services and products for them?” Hodges said.

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

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

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

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

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

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

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

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

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

100 year life

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

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

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

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

Fed’s economic models applied to a past era

FTThe Financial Times has kindly printed my letter below, welcoming the Fed’s decision to address the impact of demographics, but arguing that it needs to focus on demand issues, given the impact of today’s ageing populations.

Sir, It is good to see the US Federal Reserve is finally beginning to address the impact of demographics on the economy, after years of denying its relevance. But as John Authers confirms in his excellent analysis of the Fed’s new research paper (“The effects of ageing”, The Big Read, October 26), its continued focus on supply-side issues means it is looking down the wrong end of the telescope.

The Fed’s approach might have made sense in the past, when demand was on a growth trajectory as the baby boomers joined the 25-54 cohort, which drives wealth creation. But today’s problem is growing overcapacity, not lack of supply, given that the ageing baby boomers already own most of what they need, while their incomes are declining as they enter retirement.

The problem is that the Fed’s economic models were developed at a time when the population effectively contained only two main segments — the under-25s and the 25-54 cohort. From a policy perspective, the number of over-55s was too small to be of interest. But this is no longer true, as increasing life expectancy means the baby boomers can now hope to live for another 20 years after reaching retirement age.

Equally important is that since 1970, fertility rates have been below the replacement level of 2.1 babies per woman in the developed world. Thus the relative size of the wealth creator cohort has been reducing for the past 45 years, while the numbers in the 55-plus cohort have been increasing. The result is that the ageing baby boomers are now nearly a third of the developed world’s population.

Policymakers therefore need to urgently refocus on the demand-side implications of ageing, if they want to craft suitable policies for this New Normal world.

Paul Hodges
Chairman,
International eChem

Markets doubt Carney’s claim to have saved 500k UK jobs

Brexit Oct16

Last week as the BBC reported, Bank of England Governor, Mark Carney, explained to an audience in Birmingham that the Bank had saved the UK economy after the Brexit vote in June:

Between 400,000 and 500,000 jobs could have been at risk if the Bank had not taken action after the referendum, he said.  ”We are willing to tolerate a bit of an overshoot [on inflation] to avoid unnecessary unemployment. We moved interest rates down to support the economy.”

Imagine that!  How wonderful, that one man and his Monetary Policy Committee could save “between 400,000 and 500,000 jobs“, just with a speech, an interest rate cut, and more money-printing.

There was only one problem, as the chart above shows.  Markets didn’t applaud by buying more UK government bonds and so reducing interest rates.  They sold off again (red line)*, panicked by the idea that debt was rising whilst growth was slowing and the currency falling (blue line):

  Interest rates had fallen after the June 23 vote, as traders bet that Carney would add more stimulus
  They fell to 1.09% on June 24, and then to 0.65% after his August confirmation that this was underway
  But then, in a departure from the Bank’s script, they bottomed at 0.53% a week later, and began to rise
  Premier Theresa May caused further alarm at the Conservative Conference, suggesting Brexit might be for real
  They closed on Friday after Carney’s speech at 1.1% – nearly twice the August level, and above the June 24 close

Over the weekend, traders were then able to read the previously unpublished comments of Foreign Secretary, Boris Johnson, on the implications of a Brexit vote:

There are some big questions that the “out” side need to answer. Almost everyone expects there to be some sort of economic shock as a result of a Brexit. How big would it be? I am sure that the doomsters are exaggerating the fallout — but are they completely wrong? And how can we know?

“And then there is the worry about Scotland, and the possibility that an English-only “leave” vote could lead to the break-up of the union. There is the Putin factor: we don’t want to do anything to encourage more shirtless swaggering from the Russian leader, not in the Middle East, not anywhere.

“And then there is the whole geostrategic anxiety. Britain is a great nation, a global force for good. It is surely a boon for the world and for Europe that she should be intimately engaged in the EU. This is a market on our doorstep, ready for further exploitation by British firms: the membership fee seems rather small for all that access.

“Why are we so determined to turn our back on it?”

Its just a pity that it was left until now for Johnson’s “alternative view” on Brexit to emerge.  It confirms my fear immediately after the Brexit vote, that Brexit will prove to be:

The canary in the coalmine.  It is the equivalent of the “Bear Stearns collapse” in March 2008, ahead of the financial crisis.    And as I have argued for some time, the global economy is in far worse shape today than in 2008, due to the debt created by the world’s major central banks.

The sad conclusion is that the world is now likely to suffer some very difficult years.  Markets will have to relearn their true role of price discovery, based on supply and demand fundamentals, rather than central bank money-printing.  On Wednesday, I will look at some of the wider implications for global interest rates.

* Bond prices move inversely to interest rates, so a higher rate means a lower price

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 50%
Naphtha Europe, down 48%.“Petrochemical demand high despite margin drop”
Benzene Europe, down 53%. “Prices have ebbed and flowed with the crude oil/energy market as well as market developments in the US”
PTA China, down 40%. “Bottle chip producers in China have been staying away from purchasing import cargoes, with traders describing demand for PET producers as ‘soft”
HDPE US export, down 31%. “The depreciation of Chinese Yuan dampened buying interest for import cargoes”
S&P 500 stock market index, up 9%

 

Central bankers create debt, not growth, by ignoring demographic reality

Japan Sept16The world’s 4 main central bankers love being in the media spotlight.  After decades climbing the academic ladder, or earning millions with investment banks, they have the opportunity to rule the world’s economy – or so they think.

But their background is rather strange preparation to take on this role – even if it was achievable:

  Janet Yellen, Chair of the US Federal Reserve, is a former academic
  Haruhiko Kuroda, Governor of the Bank of Japan, is a career civil servant
  Mario Draghi, President of the European Central Bank; and Mark Carney, Governor of the Bank of England, are former Goldman Sachs bankers

None of these roles are noted for their contact with ordinary people.  Nor does their habit of flying First Class and staying in top-class hotels, or being chauffeur-driven to meetings, help them to engage with the real world.  Mark Carney’s travel expenses currently average £100k/year ($130k), in addition to his £250k/year housing allowance.

But the main disadvantage is simply that common sense is not a core requirement for the job.  If it was, then none of the stimulus policies enacted since 2000 – subprime, QE, Abenomics etc – would ever have been considered.

Common sense would have told them that people create demand – not economic models or financial markets.  And anyone used to working with real people would know that the key to demand is (a) the existence of a “need”, or at least a “want” and (b) the ability to afford the purchase.

Last week’s announcements by the Federal Reserve and the Bank of Japan highlight the disconnect.  Unsurprisingly, Yellen and Kuroda’s stimulus policies have completely failed to create sustained demand.  Instead, they have destroyed price discovery in financial markets and created asset bubbles instead.

The above chart highlights the irrelevance of their current policies.  As Bloomberg comment in respect of Japan:

Japan’s economy has been in trouble for decades. Massive monetary and fiscal stimulus have so far failed to spur faster growth. (Last) week, the Bank of Japan met to decide whether to apply yet more economic shock therapy. Here’s the situation the country’s leaders face:

“Japan has the world’s oldest population, as well as a low birth rate and little immigration, but its growth problems go far deeper. In the early 1990s, the country’s postwar growth boom collapsed—decades of deflation followed and Japan started to suffer a shortage of workers….

“Japan’s debt burden far outstrips that of other countries, largely a result of the stimulus introduced to help fix the economy. Abenomics, Prime Minister Shinzo Abe’s rescue plan, has helped to weaken the yen and boost corporate profits but wages and domestic spending have remained fragile.

“Higher debt led the government to consider a sales tax increase for revenue. But the last time it was imposed in 2014, consumer spending and gross domestic product fell, sending the economy into a recession.”

The chart (interactive on Bloomberg itself) confirms this analysis:

  26% of Japan’s population is aged over-65.  And the OECD median is now 18%.  People of this age already own most of what they need or want, and their incomes are declining as they enter retirement
  Japan’s fertility rate is just 1.4 babies/woman, only 2/3rds of the 2.1 replacement level needed to maintain a stable population.  The OECD median is almost as low at 1.7 babies
  Immigration might just be a way of compensating for these factors, but only 1.6% of Japan’s population are immigrants.  The OECD median is also too low to really make a difference at just 12%
  Japanese government debt is more than twice GDP at 247%.  The OECD median is equally worrying at 82%: debt in the other G7 economies ranges from 82% (Germany) up to 156% for Italy.

Fertility Oct13Slowly but surely, the world is realising that central bank policies have been a disaster for the global economy.

Common sense tells us that simplistic “solutions”, such as printing money and lowering interest rates, will never succeed in creating sustainable economic growth.  The real need is for policy to address the cause of the growth slowdown – the impact of the 50% rise in global life expectancy since 1950, and the  50% fall in fertility rates.

Until discussion takes place around the implications of these key facts (highlighted in the second chart), nothing will change, and the debt will continue to rise.  And as the Financial Times commented at the weekend:

The problem with the authorities rigging the markets is it could be painful when they stop doing it.”

 

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 56%
Naphtha Europe, down 53%. “A build-up in products supply has punctured refiners’ margins, according to the International Energy Agency, which warned that global refinery runs are experiencing their lowest growth rates in a decade.”
Benzene Europe, down 54%. “A drop in consumption was felt by numerous players”
PTA China, down 41%. “Bearish demand for spot cargoes as endusers laid off buying due to the proximity to the upcoming week-long National Day celebrations in China”
HDPE US export, down 27%. “Weak overall demand in China weighed down on prices”
S&P 500 stock market index, up 11%