Companies and investors are starting to finalise their plans for the coming year. Many are assuming that the global economy will grow by 3% – 3.5%, and are setting targets on the basis of “business as usual”. This has been a reasonable assumption for the past 25 years, as the chart confirms for the US economy:
- US GDP has been recorded since 1929, and the pink shading shows periods of recession
- Until the early 1980’s, recessions used to occur about once every 4 – 5 years
- But then the BabyBoomer-led economic SuperCycle began in 1983, as the average Western Boomer moved into the Wealth Creator 25 – 54 age group that drives economic growth
- Between 1983 – 2000, there was one, very short, recession of 8 months. And that was only due to the first Gulf War, when Iraq invaded Kuwait.
Since then, the central banks have taken over from the Boomers as the engine of growth. They cut interest rates after the 2001 recession, deliberately pumping up the housing and auto markets to stimulate growth. And since the 2008 financial crisis, they have focused on supporting stock markets, believing this will return the economy to stable growth:
- The above chart of the S&P 500 highlights the extraordinary nature of its post-2008 rally
- Every time it has looked like falling, the Federal Reserve has rushed to its support
- First there was co-ordinated G20 support in the form of low interest rates and easy credit
- This initial Quantitative Easing (QE) was followed by QE2 and Operation Twist
- Then there was QE3, otherwise known as QE Infinity, followed by President Trump’s tax cuts
In total, the Fed has added $3.8tn to its balance sheet since 2009, whilst China, the European Central Bank and the Bank of Japan added nearly $30tn of their own stimulus. Effectively, they ensured that credit was freely available to anyone with a pulse, and that the cost of borrowing was very close to zero. As a result, debt has soared and credit quality collapsed. One statistic tells the story:
“83% of U.S. companies going public in the first nine months of this year lost money in the 12 months leading up to the IPO, according to data compiled by University of Florida finance professor Jay Ritter. Ritter, whose data goes back to 1980, said this is the highest proportion on record. The previous highest rate of money-losing companies going public had been 81% in 2000, at the height of the dot-com bubble.”
And more than 10% of all US/EU companies are “zombies” according to the Bank of International Settlements (the central banks’ bank), as they:
“Rely on rolling over loans as their interest bill exceeds their EBIT (Earnings before Interest and Taxes). They are most likely to fail as liquidity starts to dry up”.
2019 – 2021 BUDGETS NEED TO FOCUS ON KEY RISKS TO THE BUSINESS
For the past 25 years, the Budget process has tended to assume that the external environment will be stable. 2008 was a shock at the time, of course, but time has blunted memories of the near-collapse that occurred. The issue, however, as I noted here in September 2008 is that:
“A long period of stability, such as that experienced over the past decade, eventually leads to major instability.
“This is because investors forget that higher reward equals higher risk. Instead, they believe that a new paradigm has developed, where high leverage and ‘balance sheet efficiency’ should be the norm. They therefore take on high levels of debt, in order to finance ever more speculative investments.”
This is the great Hyman Minsky’s explanation for financial crises and panics. Essentially, it describes how confidence eventually leads to complacency in the face of mounting risks. And it is clear that today, most of the lessons from 2008 have been forgotten. Sadly, it therefore seems only a matter of “when”, not “if”, a new financial crisis will occur.
So prudent companies will prepare for it now, whilst there is still time. You will not be able to avoid all the risks, but at least you won’t suddenly wake up one morning to find panic all around you.
The chart gives my version of the key risks – you may well have your own list:
- Global auto and housing markets already seem to be in decline; world trade rose just 0.2% in August
- Global liquidity is clearly declining, and Western political debate is ever-more polarised
- Uncertainty means that the US$ is rising, and geopolitical risks are becoming more obvious
- Stock markets have seen sudden and “unexpected” falls, causing investors to worry about “return of capital”
- The risks of a major recession are therefore rising, along with the potential for a rise in bankruptcies
Of course, wise and far-sighted leaders may decide to implement policies that will mitigate these risks, and steer the global economy into calmer waters. Then again, maybe our leaders will decide they are “fake news” and ignore them.
Either way, prudent companies and investors may want to face up to these potential risks ahead of time. That is why I have titled this year’s Outlook, ‘Budgeting for the end of “Business as Usual“. As always, please contact me at email@example.com if you would like to discuss these issues in more depth.
Please click here to download a copy of all my Budget Outlooks 2007 – 2018.
“Average UK wages in 2022 could still be lower than in 2008”
UK Office for Budget Responsibility
While Western stock markets boom under the influence of central bank money-printing, wages for ordinary people are not doing so well. So it is no wonder that Populism is rising, as voters worry their children will be worse off than themselves at a similar age.
The chart above is the key to the story. It shows births in the G7 countries (Canada, France, Germany, Italy, Japan, UK, USA) since 1921. They are important as until recently, they represented around 50% of the global economy. Equally important is the fact that consumer spending represents 60% – 70% of total GDP in each country.
As the chart shows, the absolute number of consumers saw a massive boost during what became known as the BabyBoom after the end of World War 2:
- The US Boom lasted from 1946 – 1964, and saw a 52% increase in births versus the previous 18 years
- The Boom lasted longer in the other G7 countries, from 1946 – 1970, but was less intense
- In total, there were 33 million more G7 births in 1946 – 1970 versus the previous 25 years
- This was the equivalent of adding a new G7 country the size of Canada to the global economy
Today’s dominant economic theories were also developed during the BabyBoom period, as academics tried to understand the major changes that were taking place in the economy:
- Milton Friedman’s classic ‘A Monetary History of the United States’ was published in 1963, and led him to argue that “inflation is always and everywhere a monetary phenomenon”
- Franco Modigliani’s ‘The Life Cycle Hypothesis of Saving‘ was published in 1966, and argued that consumers deliberately balanced out their spending through their lives
Today’s problem is that although both theories appeared to fit the facts when written, they were wrong.
We cannot blame them, as nobody during the 1960s realised the extraordinary nature of the BabyBoom. The word “BabyBoom” was only invented after it had finished, in 1970, according to the Oxford English Dictionary.
Friedman had no way of knowing that the number of US babies had risen by such an extraordinary amount. As these babies grew up, they created major inflation as demand massively outgrew supply. But once they entered the Wealth Creator 25 – 54 age cohort in large numbers and began working, supply began to catch up – and inflation to fall.
Similarly, Modigliani had no way of knowing that people’s spending began to decline dramatically after the age 55, as average US life expectancy during the BabyBoom was only around 68 years.
But today, average US life expectancy is over 10 years higher. And as the second chart shows, the number of households in the 55+ age group is rocketing, up by 55% since 2000. At 56m, it is fast approaching the 66m households in the critical 25 – 54 Wealth Creator cohort, who dominate consumer spending:
- Each Wealth Creator household spent an average of $64k in 2017, versus just $51k for those aged 55+
- Even this $51k figure is flattered by the large number of Boomers moving out of the Wealth Creator cohort
- Someone aged 56 spends almost the same as when they were 55. But at 75+, they are spending 47% less
- Older people already own most of what they need, and their incomes decline as they approach retirement
Unfortunately, today’s central bankers still base policy on these theories, just as Keynes’ warned:
“Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”.
The result is seen in the third chart from the Brookings Institute. It highlights how labour’s share of income has collapsed from 64% in 2000 to 57% today. The date is particularly significant, given that the oldest Boomers (born in 1946), reached 55 in 2001 and the average US Boomer became 55 in 2010.
- Fed Chairman Alan Greenspan tried to compensate for this paradigm shift from 2003 by boosting house prices – but this only led to the 2008 subprime crisis which nearly collapsed the global economy
- Since then, Fed Chairs Ben Bernanke and Janet Yellen have focused on boosting the stock market, as Bernanke noted 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 fewer Americans own stocks than houses – only 54% versus 64% for homes. So “printing babies” cannot work.
The real issue is that the dramatic increase in life expectancy has created a paradigm change in our life cycle:
- It is no longer based on our being born, educated, working, retiring and then dying
- Instead, we have a new stage, where we are born, educated, work, and then retrain in our 50s/60s, before working again until we retire and then die
This transition would have been a difficult challenge to manage at the best of times. And having now gone in the wrong direction for the past 15 years, we are, as I warned last year, much closer to the point when it becomes:
“Obvious that the Fed could not possibly control the economic fortunes of 321m Americans. Common sense tells us that demographics, not monetary policy, drive demand. Unfortunately, vast amounts of time and money have been wasted as a result. The path back to fiscal sanity will be very hard indeed.”
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ECONOMIC TRENDS Danny Hakim @dannyhakim FEB. 8, 2016
“LONDON — Did global output rise or fall last year?”
That’s the critical question asked by the New York Times today.
It follows my recent blog post, suggesting we shouldn’t ignore the fact that IMF data shows a record $3.8tn fall in global GDP last year, when measured in current dollars. The article goes on to quote my comment on the issue:
“Can one imagine what investors would say if Exxon Mobil announced that everything was fine in the oil industry, as their revenues were actually up if one calculated them in euros or rubles?” said Paul Hodges, chairman of International eChem, a London consulting firm. “Most people believe that the dollar value of global G.D.P. is a critically important indicator of the health of the global economy.”
You can click here to read the full report.
Central bankers remain in Denial about the failure of their stimulus policies. Yet new IMF data for global GDP shows GDP fell by $3.8tn in 2015 – the biggest fall on record – as the world hits the “demographic cliff”. We have now seen 2 record falls in 6 years, as the previous record was $3.3tn in 2009.
This confirms that the fault lines are now opening in the ‘Ring of Fire’, as discussed on Monday. As William White has warned:
“The global financial system has become dangerously unstable and faces an avalanche of bankruptcies that will test social and political stability. The situation is worse than it was in 2007. Our macroeconomic ammunition to fight downturns is essentially all used up.”
Sadly, today’s central bankers are just as blind to his warnings as they were in 2007-8. Thus European Central Bank head Mario Draghi set off another mini-rally in shares and oil markets on Thursday, promising he would print more money to boost financial markets. He made the same promise last month, also causing markets to rally sharply.
Yet common sense tells us that you cannot have the same levels of growth today as in the past. As the chart shows, the world has now reached the “demographic cliff“. We now have 1bn people moving into the low-spending, low-earning New Old 55+ generation for the first time in history. They will be more than 1 in 5 of the population by 2030, twice the percentage in 1950.
So as White warns, the next recession will reveal that many of today’s debts will never be repaid:
- White mentions a major Chinese devaluation as one potential cause of recession
- The European refugee crisis is anther potential flashpoint, with the President of the European Commission continually warning that “a single currency does not exist if the Schengen (open European border Treaty) fails“. This problem is increasingly urgent, as more and more countries re-introduce border controls, and public opinion polarises after the Paris and Cologne attacks
- Then there are potential flashpoints in the Middle East and, of course, in Eastern Europe
- Plus, there is the vast debt associated with US financial markets, which complacently believe the central banks will never let prices fall
I am sure White is right again this time. It is very hard to see how this debt can possibly be repaid, as the global economy continues to slow under the influence of its rapidly ageing population. Historically, as he says, debt Jubilees used to occur every 50 years, going back to Sumerian times, and were when all debts were forgiven.
This will have to happen again in our society. McKinsey’s report last year highlighted the vast debt that has been built up since 2007 – which is now 3x world GDP. A simple calculation reveals the scale of the problem:
- McKinsey estimated world debt increased by $57tn between 2007 – 2014
- Global GDP grew by $19.8tn from $57.5tn to $77.3tn over the same period (IMF data)
- It therefore took $2.9tn of debt to add $1tn of GDP growth
- To put it another way round, $1 of debt gave only 35 cents of GDP growth
- In the 2000-7 period, each $1 of debt gave 45 cents of growth – so the trend is clearly getting worse
And yet, of course, central bankers still insist that adding more debt is the way to solve today’s crisis. They seem to be in total Denial about the fact that if $1 of lending creates only 35 cents of growth, you are effectively wasting the other 65 cents. I therefore fear that White’s warning supports the forecast in my 2016-18 Budget Outlook:
“2016 will see China putting its foot hard on the brakes of the Old Normal economy – whilst Western policymakers compete to ramp up stimulus to compensate. It could easily prove to be as difficult a year as 2008. Companies owe it to themselves to plan ahead for this Scenario. ’Flash crashes’ take place in a flash, not over months. It could prove too late afterwards to regret that you had failed to put the necessary contingency plan in place.”
Only one central banker spotted the subprime crisis before it occurred – William White. Now he is warning that the world will have to revive the Old Testament concept of “debt jubilees“, with much of today’s debt being written off:
“Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief. Emerging markets were part of the solution after the Lehman crisis. Now they are part of the problem, too.
“It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something. The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”
Long-standing readers will remember that White was one of my guides in 2007-8, when forecasting the subprime crisis. He was then Chief Economist for the central bankers’ bank (the Bank for International Settlements). I summarised his July 2007 Report in ‘4 risks to the world economy’, and the July 2008 Report as ‘The difficult task of damage control’. Unfortunately, I was one of the few to take him seriously.
Today, he is Chairman of the OECD Review committee and continues to speak his mind. His analysis parallels my own concept of the ‘Ring of Fire’ created by central bank stimulus policies, set out in the map above:
- It focuses on the massive changes underway in China, where President Xi has cut back dramatically on stimulus lending since taking office
- Xi has particularly squeezed the shadow banking sector, responsible for most of the speculative property lending that has done such damage to China’s economy
- As a result, commodity-based companies around the world, and countries, are in crisis
- Mining company shares have been in freefall for months, as investors wake up to the fact that stimulus has created vast surpluses in key products
- Even worse is that China’s slowdown is creating major recessions in countries in a wide arc from Brazil through South Africa, Asia, Australia, the Middle East and Russia
I will look at the potential implications of White’s analysis in more detail on Wednesday.
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 72%
Naphtha Europe, down 64%. “European petrochemical producers are maximising propane cracking because of the co-products derived from it”
Benzene Europe, down 58%. “Prices have risen sharply this week, with players now seeing product short for January and early February.”
PTA China, down 47%. “Overall buying appetite continued to be thin in the market”
HDPE US export, down 42%. “Chinese end-users still showed strong resistance to the relatively firm-priced cargoes”
¥:$, down 16%
S&P 500 stock market index, down 3%
China’s reported 7.4% GDP growth for 2014 was the lowest in 25 years. But even so, it probably still overstates the true economic position. How could China possibly produce a final fiigure for GDP within just 20 days of 2015?
Electricity consumption, as Premier Li has advised in the past, is a far more reliable guide to the actual state of the economy. The chart shows how this has grown since 2008:
- Demand was 3.4bn kWh in 2008 (blue column), and grew 6% (red line) to 3.6bn kWh in 2009
- China’s massive stimulus programme in 2009 then caused it to jump 15% in 2010
- Growth remained at a high level in 2011, at 12%, but then began to slow
- It grew 6% in 2012 and 8% in 2013 as the transition to President Xi’s leadership began
- Newly-published data shows 2014 growth halved to just 3.8%, a clear sign that the economy was slowing sharply
The key to the slowdown is the vast demographic change now underway in China, due to the collapse in fertility rates over the past 40 years. As Yi Gang, deputy governor of China’s central bank has noted:
“China’s demographic situation and labor supply have fundamentally changed. The ageing problem will intensify and its impossible for China to sustain double-digit growth rate.”
One key issue is that the working population is now in decline. The number of people aged between 16 – 59 fell by 2.44m in 2013. Within 10 years, the total population will start to fall. The reason is that fertility rates collapsed from 6.1 children/woman in 1950 to just 1.1 child/woman in recent years.
This is nearly half the 2.1 replacement level necessary to keep the population stable over the long-term.
This fundamental issue has been disguised in recent years, as the total population was continuing to increase. But this was due to life expectancy having risen by 50% to 75 years over the same period.
In the short-term, of course, this lack of babies helped to increase economic growth rates, as it meant more women joined the workforce. But now China’s earlier demographic dividend is becoming a demographic deficit:
- Most parents have just 1 child, so there are relatively few children under the age of 25
- The rise in life expectancy is now delivering a vast cohort of people aged over 55 years
So China’s economy is now entering a new paradigm. It has fewer young people, but increasing numbers of older people. All those babies born before 1975 are now living a decade or more longer than their parents. And their incomes are very low, with average urban pensions just $330/month – and rural pensions even lower.
This creates many dangers for the global economy. Most policymakers are only just starting to recognise the far-reaching economic impact of today’s changing demographic profiles. But it also creates major new opportunities for those companies prepared to redesign their business models.