The Financial Times has kindly printed my letter below, wondering why the US Federal Reserve still fails to appreciate the impact of the ageing BabyBoomers on the economy
Sir, It was surprising to read that the US Federal Reserve is still puzzled by today’s persistently low levels of inflation, given that the impact of the ageing baby boomers on the economy is now becoming well understood (“An inflation enigma”, Big Read, September 19).
As the article notes, factors such as globalisation and technological advances have all helped to moderate price increases for more than two decades. But the real paradigm shift began in 2001, when the oldest boomers began to join the lower-spending, lower-earning over-55 generation. As the excellent Consumer Expenditure Survey from the Bureau of Labor Statistics (BLS) confirms, Americans’ household spending is dominated by people in the wealth creating 25-54 age cohort. Spending then begins to decline quite dramatically, with latest data showing a near 50 per cent fall from peak levels after the age of 74.
This decline was less important when the boomers were all in the younger cohort. BLS data show it contained 65m households in 2000, with only 36m in the older cohort. But today, lower fertility rates have effectively capped the younger generation at 66m, while the size of the boomer generation, combined with their increased life expectancy, means there are now 56m older households.
Consumer spending is around 70 per cent of the US economy. Thus the post-2001 period has inevitably seen a major shift in supply/demand balances and therefore the inflation outlook. So it is disappointing that the Fed has failed to go up the learning curve in this area. Demographics are not the only factor driving today’s New Normal economy, but central bankers should surely have led the way in recognising their impact.
China is now developing a used car market for the first time in its history. This means the end of global auto sales growth, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
China’s car market has been key to the recovery in global auto sales growth since 2009, as the chart shows.
Its passenger car sales in the first half of each year have risen threefold between 2007 and 2017, from 3.1m to 11.3m today, while sales in the other top six markets have only just managed to recover to 2007 levels.
But now major change is coming to China’s market from two directions.
The first sign of change is the fact that H1 sales rose just 2.7% this year. This is the lowest increase since our records began in 2005 (when sales were just 1.8m), and compares with an 11% rise last year.
Official forecasts for full-year growth have also been revised down, to between 1% and 4%, by the manufacturers’ association. A further sign of the slowdown is the rise in price discounting, with Ford China suggesting prices were down 4% on average in the first half.
The second change may be even more important from a longer-term perspective. It seems likely that China’s used car market is poised for major growth. As the second chart shows, only 10m used cars were sold last year, versus 24m new cars.
Yet used car sales are typically between 2 and 2.5 times new car sales in other large markets such as the US, where 2016 saw 39m used car sales versus 18m new car sales.
The background to this unusual situation is that China’s new car sales were relatively small until the government’s stimulus programme began in 2009. Their quality was also poor, as most cars were produced domestically and only lasted an average of three years. As a result:
The auto market only really began to take off in 2009 under the influence of the stimulus packages, when annual new car sales jumped 53% from 6.7m to 10.3m. About 200m Chinese were able to drive a car in that year, and the stimulus programme suddenly provided them with the cash to buy one
Used car sales were much slower to develop, as it took time for the introduction of western manufacturing techniques to gradually extend the average life of a car from 3 years in 2012 to 4.5 years today. But now the pace of change is rising, and it is expected to reach 10 years by 2020
The chart also shows our forecasts for the used car market out to 2020, when we expect used car sales to equal new car sales at 23.5m. This would still only represent a 1x ratio, but the forecast is in line with a new report from Guangzhou-based analysts Piston, who told WardsAuto:
“The used-car market in China is expected to have an explosion in the coming decade, because the ratio of used to new is [the opposite of that in] the US.”
One sign of the change under way was seen last month, when Guazi.com, China’s largest used car trading site, was able to raise a further $400m from investors to expand its service.
Guazi, like BMW and others, have seen that the used car market offers very favourable prospects for growth prospect — as long as attention is paid to boosting buyer confidence by providing sensible warranties and service packages.
Local governments have also played their part under pressure from central government. The state-owned China Daily reports that 135 local authorities have now removed barriers that prevented used cars from one province being sold in another. The effect of these changes is having an effect, with used car sales in January-May jumping 21% versus 2016.
Such strong growth rates, and the slowdown in new car sales, suggest China’s auto market may have reached a tipping point.
All good things come to an end eventually, and it seems prudent to assume that China will no longer be the main support for global auto sales. We expect China’s new car sales to plateau because of the combined impact of the end of stimulus (as discussed here in June), and the rise of used car sales, as these will inevitably cannibalise their volumes to some extent.
Clearly this is not good news for those western manufacturers that have made China the focus of their growth plans in recent years. And there may be worse news in store, given the government’s determination to combat urban pollution by promoting sales of electric vehicles and car-sharing.
Yet it will be good news for those prepared to develop new, more service-related business models. Used-car sales themselves can be highly profitable, while servicing and spare parts supply are likely to become equally attractive opportunities.
Paul Hodges publishes The pH Report.
Western central bankers are convinced reflation and economic growth are finally underway as a result of their $14tn stimulus programmes. But the best leading indicator for the global economy – capacity utilisation (CU%) in the global chemical industry – is saying they are wrong. The CU% has an 88% correlation with actual GDP growth, far better than any IMF or central bank forecast.
The chart shows June data from the American Chemistry Council, and confirms the CU% remains stuck at the 80% level, well below the 91% average between 1987 – 2008, and below the 82% average since then. This is particularly concerning as H1 is seasonally the strongest part of the year – July/August are typically weak due to the holiday season, and then December is slow as firms de-stock before Christmas.
The interesting issue is why these historically low CU% have effectively been ignored by companies and investors. They are still pouring money into new capacity for which there is effectively no market – one example being the 4.5 million tonnes of new N American polyethylene capacity due online this year, as I discussed in March.
The reason is likely shown in the above chart of force majeures (FMs) – incidents when plants go suddenly offline, creating temporary shortages. These are at record levels, with H1 2017 seeing 4x the number of FMs in H1 2009.
In the past, most companies prided themselves on their operating record, having absorbed the message of the Quality movement that “there is no such thing as an accident”. Companies such as DuPont and ICI led the way in the 1980s with the introduction of Total Quality Management. They consciously put safety ahead of short-term profit and at the top of management agendas. As the Chartered Quality Institute notes:
“Total quality management is a management approach centred on quality, based on the participation of an organisation’s people and aiming at long-term success.”
Today, however, the pressure for short-term financial success has become intense
The average “investor” now only holds their shares for 8 months, according to World Bank data
This time horizon is very different from that of the 1980s, when the average NYSE holding period was 33 months
And it is a very long way from the 1960s average of 100 months
As a result, even some major companies appear to have changed their policy in this critical area, prioritising concepts such as “smart maintenance”. Such cutbacks in maintenance spend mean plants are more likely to break down, as managers take the risk of using equipment beyond its scheduled working life. Similarly, essential training is delayed, or reduced in length, to keep within a budget.
ICIS Insight editor Nigel Davies highlighted the key issue 2 years ago as the problems began to become more widespread around the world:
“The situation in Europe has exposed underlying trends and issues that will need to be addressed. Companies appear not to have sustained an adequate pace of maintenance capital expenditure. That has been for economic as well as structural (cost) reasons. Spending in high feedstock and energy cost Europe has certainly not been considered de rigeur….Having maintained plants to run at between 80% and 85% of capacity, suddenly pushing them hard does little good. Sometimes, they fail.”
The end-result has been to mask the growing problem of over-capacity, as plants fail to operate at their normal rates. This has supported profits in the short-term by making actual supply/demand balances far tighter than the nominal figures would suggest. But this trend cannot continue forever.
THE END OF CHINA’S STIMULUS WILL HIGHLIGHT TODAY’S EXCESS CAPACITY
The 3rd chart suggests its end is now fast approaching. It shows developments in China’s shadow banking sector, which has been the real cause of the apparent “recovery” and reflation seen in recent months:
Premier Li began a major stimulus programme a year ago, hoping to boost his Populist faction ahead of October’s 5-yearly National People’s Congress, which decides the new Politburo and Politburo Standing Committee (PSC)
Populist Premier Wen did the same in 2011-2 – shadow lending rose six-fold to average $174bn/month
But Wen’s tactic backfired and President Xi’s Princeling faction won a majority in the 7-man PSC, although the Populist Li still had responsibility for the economy as Premier
Li’s efforts have similarly run into the sand
As the 3-month average confirms (red line), Li’s stimulus programme saw shadow lending leap to $150bn/month. Unsurprisingly, as in 2011-2, commodity and asset prices rocketed around the world,funding ever-more speculative investments. But in February, Xi effectively took control of the economy from Li and put his foot on the brakes. Lending is already down to $25bn/month and may well go negative in H2, with Xi highlighting last week that:
“China’s development is standing at a new historical starting point, and … entered a new development stage”.
“Follow the money” is always a good option if one wants to survive the business cycle. We can all hope that the IMF and other cheerleaders for the economy are finally about to be proved right. But the CU% data suggests there is no hard evidence for their optimism.
There is also little reason to doubt Xi’s determination to finally start getting China’s vast debts under control, by cutting back on the wasteful stimulus policies of the Populists. With China’s debt/GDP now over 300%, and the prospect of a US trade war looming, Xi simply has to act now – or risk financial meltdown during his second term of office.
Prudent investors are already planning for a difficult H2 and 2018. Companies who have cut back on maintenance now need to quickly reverse course, before the potential collapse in profits makes this difficult to afford.
Unsurprisingly, Friday’s US GDP report showed Q1 growth was just 0.7%, as the New York Times reported:
“The U.S. economy turned in the weakest performance in three years in the January-March quarter as consumers sharply slowed their spending. The result fell far short of President Donald Trump’s ambitious growth targets and underscores the challenges of accelerating economic expansion.”
And as the Wall Street Journal (WSJ) added:
“The worrisome thing about the GDP report is where the weakness was. Consumer spending grew at just a 0.3% annual rate—its slowest showing since the fourth quarter of 2009… As confirmed by soft monthly retail sales and the drop off in car sales, the first-quarter spending slowdown was real“.
The problem is simple. Economic policy since 2000 under both Democrat and Republican Presidents has been dominated by wishful thinking, as I discussed in my Financial Times letter last week.
The good news is that there are now signs this wishful thinking is finally starting to be questioned. As the WSJ reported Friday, BlackRock CEO Larry Fink, who runs the world’s largest asset manager, told investors:
“Part of the challenge the U.S. faces, Mr. Fink said, is demographics. Baby boomers, the largest living generation in the country are aging, reaching retirement age. “With our demographics it seems pretty improbable to see sustainable 3% growth.””
And earlier this year, the chief economist at the Bank of England, Andy Haldane, suggested that the importance of:
“Demographics in mainstream economics has been under-emphasized for too long.”
Policymakers should have focused on demographics after 2001, as the oldest Boomers (born in 1946) began to join the low-spending, low-earning New Old 55+ generation. The budget surplus created during the SuperCycle should have been saved to fund future needs such as Social Security costs.
But instead, President George W Bush and the Federal Reserve wasted the surplus on futile stimulus policies based on tax cuts and low interest rates. And when this wishful thinking led to the 2008 financial crisis, President Obama and the Fed doubled down with even lower interest rates and $4tn of money-printing via quantitative easing.
This wishful thinking has therefore created a debt burden on top of the demographic deficit, as the chart confirms:
Between 1966 – 1979, each $1 increase in US public debt created $4.49 of GDP growth, as supply and infrastructure investment grew to meet the needs of the Boomer generation
Debt still added to GDP in 1980 – 1999 during the SuperCycle: each $1 of debt created $1.15 of GDP growth
But since 2000, debt has risen by $13.9tn, whilst GDP has risen by just $4.6tn
Each $1 of new debt has therefore only created $0.33c of GDP growth – value destruction on a massive scale
It is therefore vital that President Trump learns from the mistakes of Presidents Bush and Obama. Further stimulus policies such as tax cuts will only make today’s position worse in terms of debt and growth. Instead, he needs to develop new policies that focus on the challenges created by today’s ageing population. as I suggested last August:
“3 key issues will therefore confront the next President. He or she:
□ Will have to design measures to support older Boomers to stay in the workforce
□ Must reverse the decline that has taken place in corporate funding for pensions
□ Must also tackle looming deficits in Social Security and Medicare, as benefits will otherwise be cut by 29% in 2030
It has always been 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.”
The Financial Times has kindly printed my letter below, suggesting that President Trump’s focus on tax cuts is misplaced, given the headwinds created for spending and economic growth by today’s ageing US BabyBoomers.
Sir, Gillian Tett provides an excellent analysis of the wishful thinking that seems to dominate US economic policy today (“Trump tested as hard economic data spell trouble”, April 21). The “sugar highs” she identifies in sentiment readings are probably as reliable as polling results in today’s febrile environment.
The underlying cause of both phenomena goes back to 2001, when the oldest baby boomers began to leave the “wealth creator” 25-54 cohort that drives consumer spending. As the Bureau of Labor Statistics confirmed again last week in its annual Consumer Expenditure Survey, spending nearly halves by the age of 75 versus the wealth creators’ peak of $70,000. Consumer spending is more than two-thirds of the economy, and so the vast size of the boomer generation made it inevitable that growth would then start to slow.
Unfortunately, policymakers failed to update their economic models to recognise the growing influence of demographics. Instead, they chose to assume that stimulus programmes, initially via the subprime experiment and then via quantitative easing, could replace this lost spending power. But they cannot print babies and the result has been a major increase in the debt burden, as growth and inflation failed to respond in the way predicted by their models.
It is therefore disappointing that President Donald Trump is hoping to launch a third wave of stimulus, this time via tax cuts. Today is not 1986, when the average boomer was 31 and President Ronald Reagan’s cuts reinforced his “Morning in America” campaign theme. The average boomer is now 62, and the US urgently needs new models and policies to reflect this critical fact.
The clash of priorities between President Xi and Premier Li over the role of stimulus in China’s economy is close to being decided, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
The stakes are rising in China’s power battle ahead of October’s 19th Party Congress. Normally, the meeting would simply reappoint President Xi Jinping and Premier Li Keqiang for their second five-year terms. Its main business would then be to anoint their likely successors in 2022 and to replace the other five members of the powerful Politburo Standing Committee (PSC) who, by the convention known as qishang baxia, have reached the unofficial age limit of 68.
But, most unusually, signs are emerging that all may not proceed according to historical precedent. Instead, it seems that the president’s Princeling faction may have won the battle against the premier’s Populists for control of the politburo and the PSC.
Following Li’s failed “dash for growth” last year, a recent report in Xinhua, the official news agency, has suggested that Li may move to become chairman of the Standing Committee of the National People’s Congress and be replaced by vice-premier Wang Yang as premier.
This would allow Xi to consolidate his control of economic policy at Li’s expense. Top of his agenda must be the need to stem the decline in foreign exchange reserves, which have fallen by $1tn to below $3tn since their June 2014 peak. The issue is particularly urgent given President Trump’s threat to label China a currency manipulator, as the government cannot take the risk of allowing the renminbi to fall below 7 to the US dollar. As we suggested in January, interest rates have already started to rise, while capital controls have been intensified.
Commodity markets therefore seem likely to find themselves in a new round of the snakes and ladders game that began with China’s first stimulus programme in 2009. As the first chart shows, this provided a firm ladder for commodities to climb, until Xi’s first effort at reform from 2013 sent them down a snake again.
Not only did the reforms lead to a decline in total social financing (TSF) but, even more importantly, the shadow banking sector — the main source of finance for property speculation — saw its share of TSF lending collapse from 48 per cent in 2012 to 24 per cent in 2015.
Last year, however, a new ladder appeared thanks to the “dash for growth”, as the second chart shows. TSF lending increased by 14 per cent in renminbi terms, and the share lent by shadow banks rose to 28 per cent. Unsurprisingly, housing markets boomed, and Old Normal industries enjoyed a new lease of life. Oil markets also appeared to benefit as imports rose — although in reality, as Reuters has reported, “China’s additional imports of crude oil were simply processed and exported as refined products”.
Now, commodity markets may be about to find themselves at the top of a new snake. Last year’s inflationary mini-rally in commodities, sparked by Li’s policy reversal, is already running out of steam.
In oil, for example, the contango has disappeared, leading traders to start selling out of floating storage in Singapore before their profit disappears. In the west, the housing market bubbles in London and New York are also feeling the chill, as the intensification of capital controls marks the end of the Chinese-led property speculation that has powered recent gains.
The power struggle also highlights the potential importance of Xi’s recent elevation to the status of “core leader”, a title only previously held by Mao Zedong, Deng Xiaoping and Jiang Zemin. It implies that Xi’s leadership style will move away from “consensus-building” towards autocracy. In turn, this suggests that although Xi’s New Normal reforms will probably be put on hold until the Congress to avoid upsetting critical vested interests, he may well then focus on pushing through key reforms, especially the restructuring of the state-owned enterprises.
The connection was made explicit in a recent lengthy Xinhua analysis: “The new position is key for China to keep itself and the Party on the right track of development, and it marks the turning of a new chapter in the long march toward achieving the Chinese dream of national rejuvenation.”
Understandably, many investors have become entranced by the “will she, won’t she” debate now under way on whether Janet Yellen is about to raise US interest rates again. But they would be prudent to keep at least one eye on developments in China’s lending policies. Any new clampdown is likely to have a far greater and more immediate impact than any minor increases in the Fed funds rate.