“The 1950-2000 period is like no other in human or financial history in terms of population growth, economic growth, inflation or asset prices.”
This quote isn’t from ‘Boom, Gloom and the New Normal: How Western BabyBoomers are Changing Demand Patterns, Again‘, the very popular ebook that John Richardson and I published in 2011. Nor is the chart from one of the hundreds of presentations that we have since been privileged to give at industry and company events around the world.
It’s from the highly-respected Jim Reid and his team at Deutsche Bank in their latest in-depth Long-Term Asset Return Study, ‘The History (and future) of inflation’. As MoneyWeek editor, John Stepek, reports in an excellent summary:
“The only economic environment that almost all of us alive today have ever known, is a whopping great historical outlier….inflation has positively exploded during all of our lifetimes. And not just general price inflation – asset prices have surged too. What is this down to? Reid and his team conclude that at its root, this is down to rampant population growth.” (my emphasis)
As Stepek reports, the world’s population growth since 1950’s has been far more than phenomenal:
“From 5000BC, it took the global population 2,000 years to double; it took another 2,000 years for it to double again. There weren’t that many of us, and lots of us died very young, so it took a long time for the population to expand. Fast forward another few centuries, though, and it’s a different story.
“As a result of the Industrial Revolution, lifespans and survival rates improved – the population doubled again in the period between 1760-1900, for example. That’s just 140 years. Yet that pales compared to the growth we’ve seen in the 20th century. Between 1950-2000, a mere 50 years, the population more than doubled from 2.5bn to 6.1bn.”
Actually, it was almost certainly Jenner’s discovery of smallpox vaccination that led to the Industrial Revolution, as discussed here in detail in February 2015, Rising life expectancy enabled Industrial Revolution to occur’:
“Vaccination against smallpox was almost certainly the critical factor in enabling the Industrial Revolution to take place. It created a virtuous circle, which is still with us today:
- Increased life expectancy meant adults could learn from experience instead of dying at an early age
- Even more importantly, they could pass on this experience to their children via education
- Thus children stopped being seen as ’little adults’ whose role was to work as soon as they could walk
- By 1900, the concept of ‘childhood’ was becoming widely accepted for the first time in history*
The last point is especially striking, as US sociologist Viviana Zelizer has shown in Pricing the Priceless Child: The Changing Social Value of Children. We take the concept of childhood for granted today, but even a century ago, New York insurance firms refused to pay death awards to the parents of non-working children, and argued that non-working children had no value.
Deutsche’s topic is inflation, and as Stepek notes, they also take issue with the narrative that says central banks have been responsible for taming this in recent years:
“The Deutsche team notes that inflation became less fierce from the 1980s. We all think of this as being the point at which Paul Volcker – the heroic Federal Reserve chairman – jacked up interest rates to kill off inflation. But you know what else happened in the 1980s?
“China rejoined the global economy, and added a huge quantity of people to the working age population. A bigger labour supply means cheaper workers. And this factor is now reversing. “The consequence of this is that labour will likely regain some pricing power in the years ahead as the supply of it now plateaus and then starts to slowly fall”.”
THE CENTRAL BANK DEBT BUBBLE IS THE MAIN RISK
The chart above from the New York Times confirms that that the good times are ending. Debt brings forward demand from the future. And since 2000 central banks have been bringing forward $tns of demand via their debt-based stimulus programmes. But they couldn’t “print babies” who would grow up to boost the economy.
Today, we just have the legacy of the debt left by the central banks’ failed experiment. In the US, this means that the Federal government is almost at the point where it will be spending more on interest payments than any other part of the budget – defence, education, Medicaid etc.
Relatively soon, as the Congressional Budget Office has warned, the US will face decisions on whether to default on the Highway Trust Fund (2020), the Social Security Disability Insurance Trust Fund (2025), Medicare Hospital Insurance Trust Fund (2026) and then Social Security itself (2031). If it decides to bail them out, then it will either have to make cuts elsewhere, or raise taxes, or default on the debt itself.
THE ENDGAME FOR THE DEBT BUBBLE IS NEARING – AND IT INVOLVES DEFAULT
Global interest rates are already rising as investors refocus on “return of capital”. Investors are becoming aware of the risk that many countries, including the USA, could decide to default – as I noted back in 2016 when quoting William White of the OECD, “World faces wave of epic debt defaults” – central bank veteran:
“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.”
The next recession is just round the corner, as President Reagan’s former adviser, Prof Martin Feldstein, warned last week. This will increase the temptation for Congress to effectively default by refusing to raise the debt ceiling. Ernest Hemingway’s The Sun also Rises probably therefore describes the end-game we have entered:
“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said. “Gradually and then suddenly.”
President Trump’s auto trade tariffs are bad news for the US and global auto industry, as the chart highlights:
- It shows H1 sales in the 7 major markets, which account for 87% of global volume
- Sales in China have risen nearly 4x since 2007 from 3.1m to 11.8m this year
- Sales in the other 6 markets are almost unchanged at 23m versus 22.1m in 2007
Formerly high-flying growth markets such as Russia and Brazil have disappointed. Even after this year’s recovery, their H1 sales were still 35% – 39% below their 2011 peak.
Growth in the mature markets of the USA, Europe and Japan has only been achieved via $tns of stimulus programmes, which have left all 3 areas with vast debt burdens. Now, of course, higher interest rates are causing sales to slow again.
Only China – and India, with its very young population and relatively cheap prices – has seen steady sales growth.
Equally important is the global nature of the auto industry supply chain, where parts manufacture is as important as final assembly. And as the New York Times reports:
“General Motors now sells many more cars in China than it does in the United States, and the largest exporter of cars from the United States by value is not an American brand, but BMW. By some calculations, the car with the highest proportion of United States and Canadian-made content is the Honda Odyssey — and even that includes roughly a quarter of foreign-made parts.”
The sanctions couldn’t have come at a worse time for the US industry, where domestic steel and aluminium users are already suing the Administration over Trump’s earlier tariff decisions. Higher prices will only accelerate the current decline in domestic auto demand, which is being hit by 2 major negative trends.
THE AVERAGE AMERICAN IS NO LONGER DRIVING MORE MILES EACH YEAR
The second chart highlights the key longer-term issue, that Americans are driving less each year:
- It shows annual US vehicle miles/adult versus the $/gallon gasoline price since 1970
- Historically, Americans tended to drive more each year, unless gasoline prices rose sharply
- Average miles driven rose from 8k miles in the 1970s to 11k miles in the 1980s, and 13k in the 1990s
- The BabyBoomers (born 1946-64) were moving out to the suburbs and having children – so the “automobile was king”
- Higher prices during the 1973-5 and 1980-85 oil crises slowed the trend, but didn’t change it
But in 2001, the oldest Boomers became 55, when people leave the Wealth Creator 25 – 54 age group which drives economic growth. Average miles per adult peaked in 2004 at 13.3k miles and have since fallen by 1k to the current 12.3k level. Mileage is back at 2011 levels, when gasoline prices were a third higher at nearly $4/gal.
The issue is that the ageing Boomers no longer have to drive to work each day, or provide a taxi service for their children. And car ownership is no longer a key “rite of passage” for younger Millennials. New business models (eg Uber/Lyft services and car-sharing) are far more affordable, given the high costs of car purchase and insurance.
USED CAR SALES ARE SET TO GAIN, WITH AUTO DEBT AT NEAR-RECORD LEVELS AND INTEREST RATES RISING
The third chart confirms how US auto sales have become dependent on rising levels of debt:
- It shows average auto loans based on the total over-16 age population (most Americans can drive from 16)
- The average loan was already rising in the Boomer-led SuperCycle, with each peak higher than before
- But the Fed’s subprime and QE bubbles have caused it to accelerate
- In 2006, it averaged $4k at the height of subprime bubble; since the crash, it has risen back to $3.8k
The QE bubble was great news for US auto sales at the time, as was subprime. But now. interest rates are rising again.
Unsurprisingly, used-car sales are now increasing. They were 3.4m in July versus 3.2m in June and the tariffs mean they have a growing price advantage versus new cars. As the PureCars CEO noted:
“Prices for new cars are on the rise, and as leasing continues to grow in popularity, prices continue to go down in the used car market. Put simply, used cars are often the most realistic purchase for car shoppers.
TRUMP’S AUTO TRADE WAR WON’T SOLVE THE DEMOGRAPHIC AND DEBT ISSUES
President Trump’s trade wars confirm his transactional approach to complex issues. As he told Fox News last month:
“You know, the cars are the big one. We can talk steel, we talk everything. The big thing is cars.”
But tariffs are not a “silver bullet” and cannot solve the two key issues facing the US auto industry:
- The “demographic dividend” of the SuperCycle has been replaced by a “demographic deficit”. Ageing Boomers are not suddenly going to start driving more, whilst affordability issues mean younger Millennials cannot “fill the gap”
- Rising debt levels only gave the economy a “sugar high”, which is now ending as interest rates rise
As with the stimulus programmes, they will instead simply make it more difficult to develop the new policies needed for success in today’s New Normal world.
China’s ‘One Belt, One Road’ project and the need to reduce pollution have replaced “growth at any price” as key government priorities, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
Companies and investors are assuming it is “business as usual” in China ahead of the important 19th National Communist Party Congress in October. They look back to the 2012 Congress, and imagine the Party’s leaders are again focused on ensuring economic stability. But in reality, 2012 was the exception not the rule, as it featured two potentially very destabilising events for Communist Party rule:
□ The arrest and subsequent trial of Bo Xilai for corruption. Bo was a very senior Party figure (a so-called Princeling whose father was one of the Party’s “Eight Immortals”), and had been expected to join the Politburo Standing Committee at the 2012 Congress. His wife was separately convicted of murdering British businessman Neil Heywood.
□ The intervention of former president Jiang Zemin in the final preparations for the leadership change. This became essential after President Hu’s top aide was involved in a scandal where he endeavoured to cover up the death of his son — who crashed while driving a Ferrari at high speed through Beijing, accompanied by a woman who also died of her injuries.
No such dramas have occurred this year. And as the chart shows, there has been no need to boost the economy via a repeat of the 50 per cent increase in monthly stimulus lending seen in 2012. Instead, growth in total social financing has actually been slowing.
Companies and investors need instead to focus on the two new areas being promoted by President Xi ahead of his nomination for a second five-year term.
The first is his signature “One Belt, One Road” (OBOR) project. Many have assumed this is simply a mechanism for tackling China’s over-capacity in steel and cement. A measure of its real importance can be seen from the fact that the recent OBOR Summit in Beijing was attended by 20 national leaders and more than 100 countries. It connects 64 countries accounting for 62 per cent of global GDP and has two critical elements:
□ It positions China to resume its geopolitical role as the Middle Kingdom, with the One Belt creating a land link from China to Europe, while the One Road creates a maritime link between the South China Sea, the South Pacific Ocean and the Indian Ocean.
□ Economically, as the map shows, it connects China’s ageing population (its median age will be 43 years by 2030) with the much younger countries along the Belt and Road. Most of them have median ages between 17 and 30 years. The OBOR project enables China to benefit from the demographic dividend potentially available to its neighbours.
OBOR is thus critically important for China as it seeks to avoid becoming old before it becomes rich.
The second new policy is Xi’s decision to move away from the “growth at any price” policies of his predecessors. He knows that reducing pollution, rather than maintaining economic growth, has become key to continued Communist Party rule.
As Alan Clark noted in beyondbrics, “environmental sustainability is rapidly moving up the agenda . . . (as) heavy palls of industrial smog have almost become the norm in some Chinese cities”.
The recent rapid elevation of Beijing’s mayor, Cai Qi, to become party chief for the city is further confirmation of the high priority now being given to tackling air pollution and stabilising house prices.
Taken together, these policies represent a paradigm shift from those put in place 40 years ago by Deng Xiaoping after Mao’s death in 1976. This shift has critically important implications, as it means growth is no longer the main priority of China’s leadership. In turn, this means that stimulus programmes of the type unleashed in 2012, and on a more limited basis by Premier Li last year, are a thing of the past.
Xi’s new priorities have already led to renewed weakness in commodity markets. Their full-scale implementation will probably reconfirm Napoleon’s famous warning that “China is a sleeping giant. Let her sleep, for when she wakes she will move the world.”
One thing is certain about the 2017 – 2019 Budget period. ”Business as usual” is the least likely Scenario to occur. The IMF chart above highlights the key issue: for the past 5 years, all its forecasts of a return to “normal” levels of growth have proved over-optimistic:
Back in 2011, the IMF was forecasting growth of almost 5% in 2016
It was still forecasting 4% growth as recently as 2013
Today, however, it is forecasting just 3.1% as the actual out-turn for 2016
This false optimism has now created some very negative consequences:
Companies committed to major capacity expansions during the 2011 – 2013 period, assuming demand growth would return to “normal” levels
Policymakers committed to vast stimulus programmes, assuming that the debt would be paid off by a mixture of “normal” growth and rising inflation
Today, this means that companies are losing pricing power as this new capacity comes online, whilst governments have found their debt is still rising in real terms
This is the Great Reckoning that now faces investors and companies as they plan their Budgets for 2017 – 2019.
Even more worrying is that most people began work after the start of the BabyBoomer-led economic SuperCycle in 1983. They have no experience of living through today’s more uncertain economic, political and social times:
Economics. Many major countries have already seen growth disappear (Brazil and Russia of the BRIC nations)
Politics. Populists are gaining support everywhere, as people feel failed by current political leaders
Social. Tolerance is breaking down, particularly with regard to immigration
The second chart explains why the IMF have been wrong. It shows the change that has taken place in the population of the Most Developed Regions (Northern America, Europe, Australia/New Zealand and Japan) since 1950. The Regions dominate the global economy with 57% of total global GDP in 2016 ($43tn out of $75tn).
1950. There were 320m in the Wealth Creator 25 – 54 cohort that drives economic growth, and they were 39% of the population. By comparison, there were only 130m in the over-55 cohort (16%), where spending declines as older people already own most of what their need, and their incomes reduce as they enter retirement
2016. Today, there are 515m in the Wealth Creator cohort (41%). But the number of over-55s (the New Old 55+ segment) has trebled to 390m, and they are nearly a third of the population
2030. The UN forecasts there will be 475m in the Wealth Creator segment (37%), almost exactly the same as the 460m New Olders (36%)
The key issue is changing demographics:
Fertility rates. These have been below the replacement level of 2.1 babies/woman for the past 45 years
Life expectancy. Someone aged 65 can now expect to live for another 20 years
As I noted in my Financial Times letter on Friday:
“It is good to see that the US Federal Reserve is finally beginning to address the impact of demographics on the economy, after years of denying its relevance. But its continued focus on supply-side issues means it is looking down the wrong end of the telescope… Policymakers need to urgently refocus on the demand-side implications of ageing, if they want to craft suitable policies for this New Normal world.”
The problem, of course, is that it will take years to undo the damage that has been done. Stimulus policies have created highly dangerous bubbles in many financial markets, which may well burst before too long. They have also meant it is most unlikely that governments will be able to keep their pension promises, as I warned a year ago.
Of course, it is still possible to hope that “something may turn up” to support “business as usual” Budgets. But hope is not a strategy. Today’s economic problems are already creating political and social unrest. And unfortunately, the outlook for 2017 – 2019 is that the economic, political and social landscape will become ever more uncertain.
I always prefer to be optimistic. But I fear that this is one of those occasions when it is better to plan for the worst, even whilst hoping that it might not happen. Those who took this advice in October 2007, when I suggested Budgeting for a Downturn, will not need reminding of its potential value.