More people left poverty in the past 70 years than in the whole of history, thanks to the BabyBoomer-led economic SuperCycle. World Bank and OECD data show that less than 10% of the world’s population now live below the extreme poverty line of $1.90/day, compared to 55% in 1950.
Globalisation has been a key element in enabling this progress, as countries and regions began to trade with each other. But now global trade is starting to decline, as the chart from the authoritative Dutch World Trade Monitor shows:
- After a good start to 2018, February saw trade fall 0.7% in February and 1.2% in March
- The major slowdown was in Asia, particularly China, as its lending began to slow
And then on Friday, President Trump confirmed the opening of his long-planned trade wars:
- He imposed 25% import tariffs on steel and 10% on aluminium from Canada, Mexico and the European Union
- Similar tariffs were already in place on imports from China, Russia and other countries
- America’s longest standing allies have since imposed their own sanctions in retaliation
- The stage is now set for a developing global trade war as more countries join in
PRESIDENT TRUMP IS IMPLEMENTING THE POLICIES ON WHICH HE WAS ELECTED
None of this should have been a surprise, as it simply follows the agenda that President Trump set out in his Gettysburg speech just before the election. His policy proposals then, which I featured here in depth in January 2017, were crystal clear about his objectives, as the slide shows:
- Those policies marked in red are now being introduced
- Only 2 of them – around China being a currency manipulator, and infrastructure – are still to be delivered
- Yet companies, commentators and analysts have preferred to ignore the obvious
It was clear then, and is even clearer today, that Trump intends to abandon the policies followed by all post-War Republican and Democratic presidents including Eisenhower, Reagan and Clinton, and summarised in President Kennedy’s 1961 Inauguration Speech:
“To those old allies whose cultural and spiritual origins we share, we pledge the loyalty of faithful friends. United there is little we cannot do in a host of cooperative ventures. Divided there is little we can do–for we dare not meet a powerful challenge at odds and split asunder.”
As I noted after Trump’s own Inauguration Speech in January last year, he broke very explicitly with these policies:
“We assembled here today are issuing a new decree to be heard in every city in every foreign capital and in every hall of power. From this day forward, a new vision will govern our land. From this day forward, it’s going to be only America first, America first. Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families.”
BAD NEWS HAS ALWAYS LED TO MORE STIMULUS IN THE PAST
Unsurprisingly, financial markets have chosen to ignore this rise in protectionism. For them, bad news is always good news, as they expect the central banks to provide more stimulus via their money-printing policies. As the left-hand chart shows of Prof Robert Shiller’s CAPE Index (Cyclically Adjusted Price/Earnings ratio) since 1881:
- When Trump took office, the ratio was already at 28.5 – above the 1901 and 1966 peaks
- Since then it has peaked at 33.3, above the 1929 peak
- Only 2000 was higher at 44, when the end of the SuperCycle coincided with the Fed’s first liquidity programme to prevent any problems with the Y2K issue
The right-hand chart confirms the bubble nature of the rally:
- It compares S&P 500 developments with the level of margin debt in the New York Stock Exchange
- Until 1985, the Fed operated on the principle of “taking away the punchbowl as the party gets going“
- Since then, it has increasingly believed, as then Fed Chairman Ben Bernanke said in November 2010
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
As a result, the S&P 500 has risen along with margin debt, which peaked at $659bn in January ($2018).
FINANCIAL MARKETS HAVE AN UNPLEASANT “SURPRISE” AHEAD AS CHINA SLOWS
It is therefore no great surprise that financial markets have continued to ignore developments in the real world.
Yet a decline in world trade, and the rise in protectionism, will inevitably produce Winners and Losers. This will be quite different from the SuperCycle, when the rise of globalisation created “win-win opportunities” for countries and regions:
- Essentially the deal was that consumers in richer countries got cheaper, well-made, products
- People in poorer countries gained paid employment for the first time in history by making these products
History also suggests President Trump will be proved wrong with his March suggestion that: “Trade wars are good and easy to win”. Like all wars, they are easy to start and increasingly difficult to end.
So far, financial markets have ignored these uncomfortable facts. They still believe that any bad news will lead to even more central bank stimulus, and a further rise in margin debt.
But as I noted last week, China – not the Fed – was in fact the major source of stimulus lending. Now its lending bubble is history, the party in financial markets is inevitably entering its end-game.
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As China’s shadow banking is reined in, the impact on the global economy is already clear, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
China’s shadow banking sector has been a major source of speculative lending to the global economy. But 2018 has seen it entering its end-game, as our first chart shows, collapsing by 64% in renminbi terms in January to April from the same period last year (by $274bn in dollar terms).
The start of the year is usually a peak period for lending, with banks getting new quotas for the year.
The downturn was also noteworthy as it marked the end of China’s lending bubble, which began in 2009 after the financial crisis. Before then, China’s total social financing (TSF), which includes official and shadow lending, had averaged 2 times gross domestic product in the period from 2002 to 2008. But between 2009 and 2013, it jumped to 3.2 times GDP as China’s stimulus programme took off.
It is no accident, for example, that China’s Tier 1 cities boast some of the highest house price-to-earnings ratios in the world or, indeed, that Chinese buyers have dominated key areas of the global property market in recent years.
The picture began to change with the start of President Xi Jinping’s first term in 2013, as our second chart confirms. Shadow banking’s share of TSF has since fallen from nearly 50% to just 15% by April, almost back to the 8% level of 2002. TSF had already slowed to 2.4 times GDP in 2014 to 2017.
The start of Mr Xi’s second term has seen him in effect take charge of the economy through the mechanism of his central leading groups. He has also been able to place his supporters in key positions to help ensure alignment as the policy changes are rolled out.
This year’s lending data are therefore likely to set a precedent for the future, rather than being a one-off blip. Although some of the shadow lending was reabsorbed in the official sector, TSF actually fell 14% ($110bn) in the first four months of the year. Already the economy is noticing the impact. Auto sales, for example, which at the height of the stimulus programme grew more than 50% in 2009 and by a third in 2010, have seen just 3% growth so far this year.
The downturn also confirms the importance of Mr Xi’s decision to make “financial deleveraging” the first of his promised “three tough battles” to secure China’s goal of becoming a “moderately prosperous society” by 2020, as we discussed in February.
It maps on to the IMF’s warning in its latest Global Stability Financial Report that:
“In China, regulators have taken a number of steps to reduce risks in the financial system. Despite these efforts, however, vulnerabilities remain elevated. The use of leverage and liquidity transformation in risky investment products remains widespread, with risks residing in opaque corners of the financial system.”
The problems relate to the close linkage between China’s Rmb250tn ($40tn) banking sector and the shadow banks, through its exposure to the Rmb75tn off-balance-sheet investment vehicles. The recent decision to create a new Banking and Insurance Regulatory Commission is another sign of the changes under way, as this will eliminate the previous opportunity for arbitrage created by the existence of separate standards in the banking and insurance industries for the same activity, such as leasing.
As the IMF’s chart below highlights, lightly regulated vehicles have played a critical role in China’s credit boom. Banks, for example, have been able to use the shadow sector to repackage high-risk credit investments as low-risk retail savings products, which are then made available in turn to consumers at the touch of their smartphone button. This development has heightened liquidity risks among the small and medium-sized banks, whose reliance on short-term non-deposit funding remains high. The IMF notes, for example, that “more than 80% of outstanding wealth management products are billed as low risk”.
Mr Xi clearly knows he faces a tough battle to rein-in leverage, given the creativity that has been shown by the banks in ramping up their lending over the past decade. The stimulus programme has also created its own supporters in the construction and related industries, as large amounts of cash have been washing around China’s property markets, and finding its way into overseas markets.
But Mr Xi is now China’s most powerful leader since Mao, and it would seem unwise to bet against him succeeding with his deleveraging objective, even if it does create short-term pain for the economy as shadow banking is brought back under control.
As Gabriel Wildau has reported, the official sector is already under pressure from Beijing to boost its capital base. Analysts are suggesting that $170bn of new capital may be required by the mid-sized banks, whilst Moody’s estimates the four megabanks may require more than double this amount by 2025 in terms of “special debt” to meet new Financial Stability Board rules.
Essentially, therefore, China’s lending bubble is now history and the tide of capital flows is reversing. It is therefore no surprise that global interest rates are now on the rise, with the US 10-year rate breaking through 3%. Investors and companies might be well advised to prepare for some big shocks ahead. As Warren Buffett once wisely remarked, it is “only when the tide goes out, do you discover who’s been swimming naked”.
Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.
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The US 10-year Treasury bond is the benchmark for global interest rates and stock markets. And for the past 30 years it has been heading steadily downwards as the chart shows:
- US inflation rates finally peaked at 13.6% in 1980 (having been just 1.3% in 1960) as the BabyBoomers began to move en masse into the Wealth Creator 25 – 54 age group
- Instead of simply boosting demand, as during the 1960s-1970s, they began to work and create new supply
- This meant supply/demand began to rebalance and interest rates then peaked at 16% in 1981
By 1983, the average Western Boomer (born between 1946-1970) had arrived in the Wealth Creator cohort, which dominates consumer spending, and the economy really began to hum. There was a final inflation scare in 1984, when US inflation suddenly jumped from 3% to 5%, but after that the trend was downwards all the way.
The Boomers were the largest and wealthiest generation that the world had ever seen. Their move to become Wealth Creators completely transformed the inflation outlook, as more and more Boomers joined the workforce. And they transformed the economy by moving it into the NICE era of Non-Inflationary Constant Expansion.
Central bankers took credit for this move, claiming it was due to monetary policy. But in reality, people are the key element in an economy, not monetary policy. You can’t have an economy without people. And sadly, the idea that the US Fed Chairman Alan Greenspan had somehow become a Maestro, blinded everyone to 2 key issues for the future:
- Life expectancy was rising rapidly, meaning that the Boomers would not normally die just after retirement. Instead, they would likely live for another 15 – 20 years after reaching age 65
- From 1970, fertility rates had fallen below replacement level (2.1 babies/woman) across the Western world
This combination of a rise in life expectancy and a collapse in fertility rates was creating a timebomb for the economy.
THE RISE IN LIFE EXPECTANCY AND COLLAPSE OF FERTILITY RATES CREATED AN ECONOMIC TIMEBOMB
Western economies are based on consumer spending. And spending declines once people reach the age of 55 – they already own most of what they need, and their incomes decline as they approach retirement, as the second chart shows:
- There were 65m US Wealth Creator households in 2000, who spent an average of $62k ($2017)
- There were only 36m in the 55+ cohort, who spent just $45k each
- In 2017, there were 66m Wealth Creators (almost the same as in 2000) who spent $64k each
- But there were now 56m in the 55+ cohort, who spent just $51k each
The rise in 55+ spending was also only temporary, as large numbers of Boomers have just reached 55+ and have not yet retired. Spending by those aged 74+ was down by nearly 50% versus the peak spending 45-54 age group.
BELIEF IN MONETARISM LED TO THE DOTCOM AND SUBPRIME DISASTERS
The dot-com crash in 2000 should have been a wake-up call for the failure of monetarism. It also, after all, marked the moment when the oldest Boomers began to join the 55+ cohort. But instead, policymakers thought monetarism could solve “the problem” and cut interest rates to boost the housing market – causing the subprime crash in 2008.
One might have thought – as we wrote in Boom, Gloom and the New Normal in 2011 – that this disaster would have destroyed the monetarism myth. But no. Abandoning monetarism would have led to a difficult conversation with voters about the need for everyone to retrain in their 50s, and prepare to take on new, and less physically demanding, roles.
Instead, policymakers tried to replace lost BabyBoomer demand by printing vast amounts of free money via the Quantitative Easing and Zero Interest Rate Policies. Their aim was to avoid deflation, as inflation had fallen to just 0.6% in 2010 – although why this was a “bad thing” was never explained. But in reality, they were running uphill, and the pace of the climb was becoming more vertical, as the average Western Boomer joined the 55+ cohort in 2013.
Of course, flooding the market with cheap money boosted asset prices, as they intended. Stock markets and house prices soared for a second time. But it also created a major new risk. More and more investors began to panic as they hunted through the markets, trying to obtain a decent “return on capital”. They assumed central banks would never let markets fall, and so gave up worrying about the risk of making a dud investment.
INTEREST RATES ARE NOW HEADED HIGHER AS PEOPLE WORRY ABOUT RETURN OF CAPITAL
The end of the Bitcoin bubble has highlighted the fact that that risk and reward are normally related. Most investments that offer potentially high rewards are also high risk – a lot has to go right, for them to make the possible return. This process of price discovery – the balance of risk and reward – is the key role of markets.
Left to themselves, markets will price risk properly. But they have been swamped for the past decade by central bank liquidity and their crucial role has been temporarily destroyed. Now, the fact that the US 10-year bond has broken out of its 30-year downtrend tells us that markets they are finally starting to regain their role.
How high will interest rates now go? We cannot yet know, and we can also be sure they will not move in a straight line as central banks will continue to intervene. But as more and more investments, like Bitcoin, prove to be duds, so more and more investors will start to worry about return of capital when they invest.
4% therefore looks like the next level for rates, as we are now trading within the blue bars on the chart. It may not take very long for this level to be reached, given the fact that the world now has a record $233tn of debt – 3x the size of the global economy. After that, we shall have to wait and see.
I strongly believe that forecasts should be monitored, which is why I always review the previous Annual Budget forecast before issuing the next Outlook, and always publish the complete list of Annual Budget Outlooks.
I now plan to begin monitoring my blog forecasts, using the percentage mechanism highlighted in Philip Tetlock’s masterly “Superforecasting” book. The first forecasts relate to last week’s post on US polyethylene exports and today’s forecast for the US 10-year Treasury bond. I will change confidence levels as and when circumstances change.
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Last year it was the near-doubling in US 10-year interest rates. In 2015, it was the oil price fall. This year, there is really only one candidate for ‘Chart of the Year’ – it has to be Bitcoin:
- It was trading at around $1000 at the start of 2017 and had reached $5000 by August
- Then, after a brief correction, it stormed ever-higher, reaching $7000 last month
- On Friday it was trading around $19000 – fortunes are being made and lost all the time
The beauty of the concept is that nobody really has a clue about what it is all about. You can read the Wikipedia entry as many times as you like, and still not gain a clear picture of what Bitcoin is, and what it does. But why would you want to know such boring details?
All anyone has to know is that its price is going higher and higher. Plus, of course, there is the opportunity to laugh at stories of people who bought Bitcoins, but then lost the code – for an excellent example by a former editor of WIRED (with a happy ending), click here.
But there is another side to the story, as the second chart suggests. “Mining” Bitcoins now uses more electricity than a number of real countries, like Ireland, for example:
- On Friday, Bitcoin’s current annual consumption reached 33.73TWh – equivalent to Belarus’ 9 million people
- Each transaction produces 117.5kg of CO2, as the network is powered by cheap coal-fired power plants in China
- It also uses thousands of times more energy than a credit card swipe
And, of course, interest is growing all the time as people rush to get rich. Today sees the start of Bitcoin futures trading on the CME, a week after they began on the CBOE and CME. Bloomberg suggests Exchange Traded Funds based on Bitcoin will be next. In turn, these developments create more and more demand, and push prices ever-higher.
Comparisons have been made with the Dutch tulip mania in 1836-7, when prices peaked at 5200 guilders. At that time, Rembrandt’s famous Night Watch painting was being sold for 1600 guilders, and at its peak a tulip bulb would have bought 156000lbs of bread. Bitcoin probably won’t equal this ratio until next year, if its current price climb continues.
Of course, one key difference between tulips and Bitcoin is supposedly that there were always more tulips to buy – whilst there are just 21 million Bitcoins available to be mined. And apparently, around 80% of these have been mined. Bitcoin enthusiasts therefore suggest Bitcoins will have increasing scarcity value. But, of course, anyone can create a crypto-currency and many people have – such as Bitcoin Cash and Bitcoin Gold, and the Ethereum family.
Yet already, Bitcoin’s market capitalisation* is getting close to that of the “tech stocks” such as Apple, Alphabet (formerly Google), Microsoft, Amazon and Facebook as the chart from Pension Partners shows:
- On 7 December, less than 2 weeks ago, its market cap was already higher than major US stocks such as Home Depot and Pfizer
- On Friday, it hit $323bn, above Wal-Mart and P&G and close to ExxonMobil
- This also made it worth more than the IMF’s Special Drawing Rights
- And the total market cap of the 10 largest crypto-currencies has now reached $500bn, equal to Facebook
This is an amazing amount of money to be tied up in an asset which has no intrinsic value. After all, what is Bitcoin? It certainly isn’t real, although the media like to picture it as a gold coin:
- Although it is called a crypto-currency, its volatility makes it unattractive as a currency – major changes in a currency’s value can easily cause businesses (and countries) to go bust, and Bitcoin’s value has moved by 1900% just this year
- Nor is it a method of settling transactions, as its value is increasing all the time – obviously a good deal for the person who receives the Bitcoin when its price is rising, but why would any sensible person pay with a Bitcoin?
- So essentially, therefore, Bitcoin is simply a speculative asset, where its value is based on the “greater fool theory”, which says “I know its not really worth anything, but I am clever enough to sell out before it hits the top”
The “story” behind its boom is also powerful because it is linked to the great investment theme of our time, the internet. We have all seen the fortunes that can be made by investing in companies such as Apple. Now, Bitcoin supposedly offers us the chance to invest in the Next Big Thing – a new currency, entirely based on the internet.
BITCOIN HAS MANY PARALLELS WITH OTHER MANIAS IN HISTORY, SUCH AS THE SOUTH SEA BUBBLE
The Bitcoin mania has many parallels, such as with the South Sea Bubble from 1719 – 1720. Its power was also based on “the greater fool theory”, and its linkage to the great investment theme of its time – the opening up of foreign trade. As the chart from Marc Faber shows, one of its early investors was Sir Isaac Newton – one of the most intelligent people ever to live on the planet, who discovered Newton’s laws of motion and invented calculus. Newton doubled his money very quickly when he first invested, but then re-invested at a higher price – and lost the lot.
Of course, all the dreams associated with Bitcoin and the other crypto-currencies may come true. That is part of their attraction. Another part of their attraction is for criminals, who can launder money without being traced. So most likely, prices will continue rising for some time as more and more people around the world see a chance of getting rich very quickly. We have never seen a global mania before, so nobody can tell how long it will last.
The question for governments, however, is what would happen to the economy if the mania collapsed? Only China has so far banned Bitcoin trading, as Pan Gongsheng, a deputy governor of the People’s Bank of China, explained:
“If we had not shut down bitcoin exchanges and cracked down on ICOs several months ago, if China still accounted for more than 80% of the world’s bitcoin trading and ICO fundraising, everyone, what would happen today? Thinking of this question makes me scared.”
Having let the mania develop this far, other governments are in a difficult position – millions of people would complain if they closed down these currencies today. And most governments are reluctant to intervene as, in reality, crypto-currencies are essentially the creation of central bank stimulus policies, as explained by US Federal Reserve chairman, Ben Bernanke, in November 2010:
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
But by letting the mania continue, the potential impact from its collapse will increase. Added together, crypto-currencies already have the same market cap as Facebook – and could soon overtake Apple to become the most valuable “stock” in the world. Yet unlike Apple, they have no sales, no income and no assets.
Bernanke and the major central banks wanted to stimulate investors’ “animal spirits”, so that they would take on more and more risk. Crypto-currencies are therefore the logical end result of their post-crisis strategy. The end of the Bitcoin mania, whenever it occurs, will therefore also mark the end of stimulus policies.
*Bitcoin’s market capitalisation is its equity valuation – the current dollar price multiplied by the number of Bitcoins in existence
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The world is coming to the end of probably the greatest financial bubble ever seen. Since the financial crisis began in 2008, central banks in China, the USA, Europe, the UK and Japan have created over $30tn of debt.
China has created more than half of this debt as the chart shows, and its total debt is now around 260% of GDP. Its actions are therefore far more important for global financial markets than anything done by the Western central banks – just as China’s initial stimulus was the original motor for the post-2008 “recovery”.
Historians are therefore likely to look back at last month’s National People’s Congress as a key turning point.
It is clear that although Premier Li retained his post, he has effectively been sidelined in terms of economic policy. This is important as he was the architect of the stimulus policy. Now, President Xi Jinping appears to have taken full charge of the economy, and it seems that a crackdown may be underway, as its central bank chief governor Zhou Xiaochuan has been explaining:
- Zhou first raised the issue at the National Congress last month, warning of the risk of a “Minsky Moment” in the economy, where debt or currency pressures could park a sudden collapse in asset prices – as occurred in the US subprime crisis. “If there are too many pro-cyclical factors in the economy, cyclical fluctuations are magnified and there is excessive optimism during the period, accumulating contradictions that could lead to the so-called Minsky Moment. We should focus on preventing a dramatic adjustment.”
- Then last week, he published a warning that “China’s financial sector is and will be in a period with high risks that are easily triggered. Under pressure from multiple factors at home and abroad, the risks are multiple, broad, hidden, complex, sudden, contagious, and hazardous. The structural unbalance is salient; law-breaking and disorders are rampant; latent risks are accumulating; [and the financial system’s] vulnerability is obviously increasing. [China] should prevent both the “black swan” events and the “gray rhino” risks.”
We can be sure that Zhou was not speaking “off the cuff” or just in a personal capacity when he made these statements, as his comments have been carried on both the official Xinhua news agency and on the People’s Bank of China website. As Bloomberg report, he went on to set out 10 key areas for action:
- “China’s financial system faces domestic and overseas pressures; structural imbalance is a serious problem and regulations are frequently violated
- Some state-owned enterprises face severe debt risks, the problem of “zombie companies” is being solved slowly, and some local governments are adding leverage
- Financial institutions are not competitive and pricing of risk is weak; the financial system cannot soothe herd behaviors, asset bubbles and risks by itself
- Some high-risk activities are creating market bubbles under the cover of “financial innovation”
- More companies have been defaulting on bonds, and issuance has been slowing; credit risks are impacting the public’s and even foreigners’ confidence in China’s financial health
- Some Internet companies that claim to help people access finance are actually Ponzi schemes; and some regulators are too close to the firms and people they are supposed to oversee
- China’s financial regulation lags behind international standards and focuses too much on fostering certain industries; there’s a lack of clarity in what central and regional government should be responsible for, so some activities are not well regulated
- China should increase direct financing as well as expand the bond market; reduce intervention in the equity market and reform the initial public offering system; pursue yuan internationalization and capital account convertibility
- China should let the market play a decisive role in the allocation of financial resources, and reduce the distortion effect of any intervention
- China should improve coordination among financial regulators”
Clearly, Xi’s reappointment as President means the end of “business as usual” for China, and for the support provided to the global economy by Li’s stimulus policies. Xi’s own comments at the Congress confirm the change of direction, particularly his decision to abandon the idea of setting targets for GDP growth. As the press conference following the Congress confirmed, the focus is now on the quality of growth:
“China’s main social contradiction has changed and its economic development is moving to a stage of high-quality growth from a high-rate of expansion of the GDP,” said Yang Weimin, deputy head of the Office of the Central Leading Group on Financial and Economic Affairs. “The biggest problem facing us now … is the inadequate quality of development.”
Companies and investors should not ignore the warnings now coming out from Beijing about the change of strategy. China’s lending bubble – particularly in property, is likely coming to an end. In turn, this will lead to a bumpy ride for the global economy.
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.