2016 saw the start of the Great Reckoning for the failure of stimulus policies.
Political and social issues are now beginning to dominate the landscape. As we saw in the UK’s Brexit vote to leave the European Union, voters no longer see economics as the sole issue in elections. This paradigm shift was then followed by Donald Trump winning the US Presidency and Italy voting against premier Renzi’s constitutional reforms.
Polls confirm this, as the Ipsos MORI chart above shows. Most people feel the current economic/political/social system is no longer working for them. Worryingly, given the votes due in 2017, the survey also highlights that French voters (89%), Italians (82%) and Germans (69%) are even more upset than American (63%) and British voters (60%).
Voters are increasingly giving up on the “consensus wisdom” that ignores demographics, and which believes the world can somehow go back to the constant growth seen during the BabyBoomer-led SuperCycle. As I wrote in August:
“The critical issue is that central banks have been in denial about the changes taking place in demand patterns as a result of ageing populations and falling fertility rates. Their Federal Reserve/US-type forecasting models still assume that raising interest rates will reduce demand, and lowering them will release this pent-up demand. But today’s increasing life expectancy and falling fertility rates are completely changing historical demand patterns. We are no longer in a world where the vast majority of the adult population belongs to the Wealth Creator cohort of those aged 25–54, which dominates consumer spending:
□ Increasing life expectancy means people no longer routinely die around pension age. Instead, a whole New Old generation of people in the low spending, low earning 55+ generation is emerging for the first time in history. The average western BabyBoomer can now expect to live for another 20 years on reaching the age of 65
□ Fertility rates in the developed world have fallen by 40% since 1950. They have also been below replacement levels (2.1 babies per woman) for the past 45 years. Inevitably, therefore, this has reduced the relative numbers of those in today’s Wealth Creator cohort, just as the New Old generation is expanding exponentially
“You cannot print babies” should be the motto hanging on every central bankers’ wall. Unfortunately, it is too late to quickly reverse their demographic myopia. Instead, the Great Unwinding is now set to evolve into the Great Reckoning. Investors, companies and individuals must prepare for heightened levels of volatility, as markets continue their return to being based on the fundamentals of supply and demand, rather than central bank liquidity.”
2017 is therefore likely to be a difficult year, contrary to the optimism of Western stock markets, as the landscape becomes ever more uncertain. But the world has been through difficult years in the past. And in time, no doubt, the need to adapt to the positive impact of today’s demographic changes will become more obvious. The issue is simple:
Today, Western life expectancy is around 80, and is around 20 years at age 65. Due to the collapse of fertility rates, a G7 economy such as Italy has nearly as many people in the New Old 55+ cohort as in the Wealth Creator 25 – 54 cohort. Another new stage therefore needs to be added to our life cycle – whereby we are born, are educated, work, and then retrain in our 50s/60s, before working again until we retire and then die.
We need new leaders, with the vision and common sense required to help explain and manage this New Normal world, so that the benefits of the 100-year life are understood and welcomed.
Ronald Coase is one of those great thinkers whose ideas have influenced the business world, even though most people have never heard their name.
The blog only heard of him in the early 1990s, and was astounded when it read his work. The book had the rather dry title of “The firm, the market and the law”, but it provides wonderful insight as soon as one opens its pages.
The reason is that although Coase won the Nobel Prize for Economics, he was never a technician, concerned to develop and justify a particular model of the economy. Instead, he was a philosopher, concerned to understand ‘why’ things happened, and to propose practical ways of dealing with them.
Thus his most famous work, ‘The nature of the firm’, written in 1937, identified for the first time why firms existed. His key insight was that firms were necessary because of the need to deal with the costs of transactions. Thus in his view, the boundaries of the modern company were determined by the relative costs of producing goods or services, and of then selling these in the market.
Most companies today operate on the basis of Coase’s analysis, even though they may not recognise his contribution:
- Every discussion about a firm’s ‘core competences’ and its fundamental positioning in the market is influenced by his arguments
- Today’s major debates about the benefits or otherwise of outsourcing/offshoring, or around the management of supply chains, all reflect his concepts
On a personal level, Coase seems to have been an attractive figure. The son of two London postal workers, he wore leg irons as a boy, but overcame this disability to build a successful career in both Britain and the US. He also illustrates the benefits of today’s increased longevity, finally receiving his Nobel Prize at the age of 81 in 1991.
He died this week aged 102, having published his latest book only last year.
The blog’s Boom, Gloom and the New Normal eBook highlights the impact of the ageing Western babyboomers on future demand patterns.
Yet central banks such as the US Federal Reserve and the European Central Bank believe demographics have nothing to do with demand. For them, as one former central banker told the blog “demand is a constant”.
They have invested years of effort, and $millions, in developing complex mathematical models of demand. The algebra behind these is the equivalent of the alchemists’ search for the philosophers’ stone, as shown in the example above from a May 2006 Fed paper .
But a mathematical model based on algebra cannot replicate human behaviour. Therefore the modeller needs to believe that human nature can safely be ignored as a input into the model.
Any reader who doubts this argument might like to read the latest speech by US Fed chief Ben Bernanke. It analyses the background to today’s economic weakness. And it then goes on to ask the critical question, “Why has this recovery been so slow and erratic?”
It answers this question by referring to the idea of ‘pent-up demand’.
This concept is a cornerstone of economic models, and was developed during the babyboomer-led supercycle, when interest rate changes really did lead to temporary ebbs and flows in demand for housing, autos etc:
• Higher mortgage rates led boomers to postpone major purchases
• Their demand quickly revived when interest rates were reduced
• Meantime, more boomers had also entered the 25-54 age group
• So the release of pent-up demand was even greater
The Federal Reserve and the European Central Bank have not changed their models since the end of the supercycle, to reflect changing demographics. So they believe that the same level of demand for housing, autos etc, still exists today.
On this basis, they have assumed that more buying of near-worthless Greek bonds, or more liquidity via a QE2 programme to boost financial markets, will ensure economic recovery in the end. They are sincere people, but the blog believes they are terribly wrong in this assumption.
As John Richardson, the co-author of Boom, Gloom and the New Normal has commented:
“If you’ve spent your whole career – and built your whole reputation – on pushing a particular model it must be really hard to stand back and say, ‘Wow, I’ve been wrong for the last few years and everything has changed’.
“Its probably easier for outsiders without any baggage to challenge conventional thinking – and probably easier for non-central bankers.
“We all need to get past the phase of thinking that ‘central bankers have lots of qualifications, have published books, and advised presidents and prime ministers, and so they must be right’.
“We also need to get past our own self-doubts, as it is really difficult for anyone less academically qualified than them (which is 99.9999% of us) to imagine that they could be wrong”.The need to challenge the power of the models is urgent. Until this happens, the global economy will get worse, not better.