“Central banks have to be mindful that too long a period of very low interest rates can have undesirable consequences in the context of ageing societies. For pensioners, and those saving ahead of retirement, low interest rates may not be an inducement to bring consumption forward. They may on the contrary be an inducement to save more, to compensate for a slower rate of accumulation of pension assets.” Mario Draghi, President, European Central Bank
It is now exactly 4 years since we published Chapter 1 of Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again. When writing it, John Richardson and I thought our basic premise – that demographics drive demand – was simply a statement of the obvious. We didn’t write the book to make this argument. We wrote it with the aim of helping companies and investors to develop the new business models needed to profit from these new demand patterns.
How wrong we were! Very few policymakers took us seriously, with the exception of Governor Shirakawa of the Bank of Japan. He had already made the same argument when taking office in December 2008.
Instead, they maintained that the stimulus provided by Quantitative Easing (QE) was already returning the global economy to “normal” levels of economic growth. And when, as was inevitable, this first round of QE failed, the US Federal Reserve simply did QE2 and then QE3, whilst China and the UK followed. Even worse, new premier Abe replaced Shirakawa in 2012 as a prelude to QE in Japan, and Mario Draghi followed at the ECB this year.
But of course, there has been no sustained recovery. And finally, on Friday, Draghi half-conceded that there just might be some downside to the policy in a world of ageing societies. His statement above thus stands as the first faint recognition by a Western policymaker of the fact that stimulus has been exactly the wrong policy since 2008.
Unfortunately, however, this recognition on its own is “too little, too late”. The Great Unwinding of these stimulus policies began 9 months ago, and we are already seeing rising volatility in the 4 key markets of oil, the US$, interest rates and stock markets. These are the warning tremors of the debt-fueled Ring of Fire created by the central banks.
China, the world’s 2nd largest economy, has been moving away from QE since the new leadership took office in 2013, due to the dangers that it creates. As premier Li warned last month:
“It is quite easy for one to introduce QE policy, as it is little more than printing money. When QE is in place, there may be all sorts of players managing to stay afloat in this big ocean. Yet it is difficult to predict now what may come out of it when QE is withdrawn.”
The chart highlights the problem, based on Bloomberg data. It shows that the G7 group of the world’s major economies can now be best described as the Ageing and High Debt group. Their gross government debt per person ranges from a minimum of $36k/person in Germany to $100k/person in Japan. It is hard to believe all this debt will be repaid. As I noted in February, after the Greek election:
“We all learnt one crucial lesson from Syriza’s victory in the Greek election last week – voters can halt the European Central Bank (ECB). Or in other words, protest coalitions can trump elite consensus. In places like Spain and France, this effect may not work through immediately, but it is being absorbed.”
Draghi has realised very late that the economic rules change in an ageing society. Older people already own most of what they need, and their incomes decline as they near retirement. They also have to save more. None of them ever expected that average life expectancy at age 65 would double during their lifetime, from 10 to 20 years.
There are only 3 ways that the debt burden can be resolved – by major rises in taxation, cuts in services, or default. Greece has shown that electorates will not support the first two options forever. The recent tremors in government bond markets are thus a first sign that investors are realising the 3rd option may eventually prove inevitable.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 45%. “Prices have moved lower this week with excess product in Asia and the US said to be the key causes”
Brent crude oil, down 37%
Naphtha Europe, down 34%. “The naphtha arbitrage window from Europe to Asia is only marginally open but is described by traders as the best money-making option this week”
PTA China, down 27%. “Domestic prices were largely on a downtrend, attributed mainly by weaker downstream polyester conditions.”
HDPE US export, down 18%. “Domestic export prices remained stable during the week, though there were reports of increased trading”
¥:$, down 18%
S&P 500 stock market index, up 9%
The world’s major shipping index, the Baltic Dry (BDI), has collapsed by 2/3rds since November, and by 80% since its earlier December 2013 peak, as the chart shows. It is now at an all-time low of 509, almost half of its initial 1000 level when established in January 1985.
Shipping is the major mode of transport for world trade, so this sudden collapse is potentially very worrying. Reuters reports 2 shipping companies have already gone bankrupt. No doubt, more will follow.
The key to the collapse, of course, is China’s move into the New Normal. Shipping markets were slower to wake up to the implications of this than oil markets, but the BDI’s collapse shows they are now making up for lost time.
As with energy, mining and chemicals, the shipping industry wanted to believe in the myth that China had suddenly become “middle class” by Western standards, and was about to deliver perpetual growth. So it has vastly over-ordered new capacity, with brokers Clarkson estimating 39% will be added to fleets over the next 3 years.
In the very short-term, of course, the developing port strike on the US West Coast is also a negative influence.
But the core issue is the collapse underway in China’s trade. January data showed China’s exports were down 3% versus 2014, and its imports down 20%. Whilst Q4 data showed China suffered its largest capital outflow on record, with $91bn leaving the country.
THIS TIME, THE COLLAPSE MAY BE FOR REAL
Long-term readers will remember we have been here before, only for policymakers to introduce major new stimulus measures:
- The BDI fell 90% from its May peak by October 2008, but then recovered after the G20 summit in April 2009
- It fell sharply again in Q1 2010, before China and the US both increased their lending
- And it fell sharply again in late 2011/2012, before Japan added its Abenomics stimulus to the US Federal Reserve’s Twist programme
So is the BDI’s collapse simply the prelude to another, even larger, stimulus effort?
We cannot rule this out. But the Fed at the moment is trapped in a web of its own making:
- It has boasted for months that its policy has proved successful and restored the US economy to health
- Intensive planning is now underway about the timing of its expected interest rate rise
- So it seems most unlikely this policy could suddenly be reversed
Instead, it seems more likely that the Fed is repeating its mistake of July 2007, and believing its own propaganda. Then Chairman Bernanke was insisting the cost of any sub-prime housing problem would only be $100bn at most.
It also seems unlikely that China will change course from its New Normal, with its main policy conference next month.
So this time, the BDI’s fall may not be countered by more stimulus aimed at producing another ‘wealth effect’ in financial markets. After all, debt has already soared to 3x global GDP as a result of all these stimulus efforts.
Instead, policymakers may begin to realise how difficult it will be to repay all this debt, as deflation causes its value to rise day-by-day.
“The big picture remains unchanged. Four years after the recession officially ended, per capita output and income have yet to return to their pre-crisis highs. The recovery still ranks as the worst since World War II. And despite the modest acceleration in the past two quarters, the recovery shows little sign of gaining momentum.”
The above isn’t a blog forecast about the likely economic impact of the West’s transition to the New Normal. It is instead the conclusion of Thursday’s main story in the Wall Street Journal, reporting that Q2 GDP grew just 1.7%. The Journal also warned:
“There are some signs the overall economy’s acceleration could be short-lived. More than 24% of the quarter’s growth came from an increase in inventories—a buildup that is unlikely to be repeated and could even be erased in subsequent data revisions. Consumer spending, which has been the backbone of the recovery recently, grew at a slower pace in the second quarter, with Americans cutting spending on hotels and restaurants—a possible indication families are pulling back on discretionary items. It is also possible federal-government agencies may make more cuts in coming quarters.”
This is yet further confirmation of the way that the blog’s views on the economic outlook are now becoming mainstream consensus thinking. The pity is that the demographic rationale for these developments is still not being properly discussed. Policymakers seem most unwilling to accept there can be no return to the SuperCycle period of constant growth. As a result, companies and the media continue to be given the wrong outlook.
The chart above shows the most likely outlook for GDP growth and interest rates. It focuses on the average 5 year percentage growth in the critical Wealth Creator generation of 25 – 54 year-olds (blue column) as the key dimension. When this cohort is growing fast, then interest rates (black line) and GDP (red) also increase quickly. When growth is the cohort slows, then growth and interest rates also slow.
The reason is obvious. A sustained surge in the number of Wealth Creators (as happened from 1971 as a result of the 1946-64 US BabyBoom) means that demand starts to increase faster than supply. So interest rates need to rise, to allow the price mechanism to ration available supply. Then once growth in the number of Wealth Creators starts to slow, supply begins to catch up with demand, and so interest rates can fall back to normal levels.
If President Obama decided to add the blog to the shortlist to become the next Federal Reserve Chairman, this is the one chart it would take to the interview. Unlike most economic models, it has been accurate for the past 50 years. And its ability to continue to forecast the outlook depends only on knowing how many people will be entering or leaving the 25 – 54 age group – something which is very well understood.
Latest benchmark price movements since the IeC Downturn Monitor launch on 29 April 2011, with ICIS pricing comments below:
Naphtha Europe, down 20%. “Petrochemical demand for naphtha is higher than a couple of weeks ago.”
PTA China, down 17%. “Chinese domestic PTA prices were relatively softer than import prices because of abundant supply and weak spot requirements from end-users”
HDPE USA export, down 15%. “Global demand is weak, with buyers purchasing only as needed”
Brent crude oil, down 13%.
Benzene Europe, down 3%. ”Prices in July reached a yearly low on ample availability and weak derivative offtake
US$: yen, up 21%
S&P 500 stock market index, up 25%
The wrong diagnosis can often make the problem worse not better, as doctors know very well. But the message hasn’t got across to policy makers. They refuse to believe that ageing populations spend less and save more – even though all the evidence confirms this commonsense observation. So instead, they have convinced themselves the world is facing a repeat of the 1930’s Depression.
The tragedy, as future historians may well conclude, is that their wrong diagnosis risks causing the very disaster they are trying to avoid. A first sign of this comes from Italy, currently the world’s 8th largest economy with GDP of $2.2tn. Italian paper Il Sole reports that 2012 oil consumption has dropped 11.4% in one year. It is now back at 1967 levels.
The chart above looks at the G-20 nations, who comprise 79% of the global economy:
• The Y axis shows GDP/capita in US$
• The X axis shows median age for each country
• The blue ‘bubbles’ are the size of each country’s economy versus the USA
As it shows, the countries fall into 3 distinct groups:
• Rich but Old. These wealthy countries have median ages mostly over 40 years
• Poor but Young. These relatively poorer countries have median ages around 25 years
• Poor but Ageing. China and Russia are in their own group: China because it has lost 400m babies due to the one child policy; Russia because of its high cigarette and alcohol consumption
Today’s mix of austerity and stimulus policies ignores these basic demographic facts. Italy’s plight is thus the most obvious example of the failure of policy makers to tackle the real issues.
Hands-up those who remember the G-20? Well done, Mexican readers, you get full points. But other readers seem doubtful. This weekend the world’s Finance Ministers were meeting in Mexico City, as the country concludes its G-20 presidency. But you wouldn’t know it from the rest of the world’s media coverage.
How different from April 2009, when the world’s leaders met in a blaze of publicity to ‘save the global economy’. Then they vowed to do ‘whatever it takes’, just as Mario Draghi repeated recently on behalf of the European Central Bank. This time, however, neither Draghi nor US Treasury Secretary Geithner attended. Nor did China.
Unfortunately, the leaders tried to solve the wrong problem in 2009. They assumed the financial crisis was a liquidity crisis. So they flooded the world with cash, as the 4 orange arrows show on the chart above. This pushed up asset and commodity prices very sharply. But the crisis was not a cash-flow issue. It was a solvency issue. The debts built up prior to 2007 will never be repaid.
The blog’s great concern back in April 2009 was the lack of a Plan B. After all, it was just possible that the blog and others might be right about the solvency issue. Governments should therefore have prepared a back-up plan, just in case. But they preferred to believe their friends in the financial community, who assured them it was now back to ‘business as usual’.
So now we are 4 years into the Crisis. And it is becoming clearer day by day that the problems have not been solved. In fact, the G-20’s ‘solutions’ have made things worse, not better. Adding more debt and pushing up commodity prices has simply destroyed demand. Most worryingly, there is still no Plan B. And so now key players just stay at home when the G-20 meets.
The chart shows benchmark price movements since the IeC Downturn Monitor’s 29 April 2011 launch, with latest ICIS pricing comments below:
HDPE USA export, purple, down 20%. “Producers attempted to push some excess material into the export market, but export demand remained weak”
PTA China, red, down 18%. “Negative margins and limited supply because of continued production cutbacks”
Naphtha Europe, brown, down 15%. “Outbound arbitrages remain closed, requirements for naphtha limited, and refineries #are# coming back online following the maintenance period”
Brent crude oil, blue, down 13%
Benzene NWE, green, up 4%. “Continued restrictions on pygas, as crackers use lighter feedstocks amid bullishness for oil prices”
S&P 500 stock market index, pink, up 4%
3 years ago, many hoped the G20 group of the world’s wealthiest countries might work together to solve the global financial crisis.
Last week’s Cannes meeting ended that illusion.
Instead, its decision to abandon the Doha trade round, launched in 2001, made it clear we have passed the high-water mark of globalisation. This conclusion was reinforced by the fact that only a few of the news media even mentioned the topic.
Two key figures also set out their views on the way forward:
China’s premier Wen, signalled that its lending slowdown will continue: “I will especially stress that there will not be the slightest wavering in China’s property-tightening measures–our target is for prices to return to reasonable levels.” Prices have already begun to fall by 20-40% in the major cities, and clearly more falls are on the way.
Italy’s premier Berlusconi was still in denial, however, claiming the country’s problems with its debt mountain were “a passing fashion“, and noting that “the restaurants are full, the planes are fully booked, and the hotel resorts are fully booked as well“.
And that, as far as the blog can discover, was that.