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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“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.