US GDP growth is slowing, again, as the chart of the Atlanta Federal Reserve’s “GDP Now” forecast shows:
Forecast Q1 growth has slipped to just 0.6% from an initial 3.4% at the end of January
Consensus economic forecasts are still much higher, but even they have fallen to 1.7% from 2.2%
The decline has been accelerating, due to disappointing data from a range of key indicators. as the Atlanta Fed note:
“The forecast for first-quarter real GDP growth fell 0.4% after the light vehicle sales release from the U.S. Bureau of Economic Analysis and the ISM Non-Manufacturing Report On Business from the Institute for Supply Management on Wednesday and 0.2% after the employment release from the U.S. Bureau of Labor Statistics and the wholesale trade release from the U.S. Census Bureau this morning. Since April 4, the forecasts for first-quarter real consumer spending growth and real nonresidential equipment investment growth have fallen from 1.2% and 9.7% to 0.6% and 5.6% respectively.”
Worryingly, therefore, we seem to be repeating the usual pattern of disappointment – with New Year optimism being followed by harsh reality – as the US Federal Reserve’s deputy chairman, Stanley Fischer, noted nearly 3 years ago:
“Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back.”
The key issue, of course, is that policymakers have still not accepted that the US economy is inevitably moving into a low-growth mode, due to its ageing population. As the Chief Economist of the Bank of England, Andy Haldane noted recently, the impact of:
“Demographics in mainstream economics has been under-emphasized for too long”
There is little sign of the new policies that are urgently required to take account of the changes that have taken place in life expectancy and fertility rate. As a result, forecasts continue to be made on the basis of wishful thinking at the start of each New Year. As I noted in December:
□ Increasing life expectancy means people no longer routinely die around pension age. Instead, a whole New Old generation of people in the low spending, low earning 55+ generation is emerging for the first time in history. The average western BabyBoomer can now expect to live for another 20 years on reaching the age of 65
□ Fertility rates in the developed world have fallen by 40% since 1950. They have also been below replacement levels (2.1 babies per woman) for the past 45 years. Inevitably, therefore, this has reduced the relative numbers of those in today’s Wealth Creator cohort, just as the New Old generation is expanding exponentially
Friday’s US jobs numbers confirmed this obvious truth, as the second chart shows:
□ Less than 2/3rds of the US over-16s population now have jobs. The current percentage of 62.9% is back at 1978 levels – when the median age was 30 years, compared to today’s 38 years – and so relatively more young people were still in school and college
□ The picture for men is particularly worrying, with just 68.9% at work, an all-time low. The dcline seems to have accelerated since the Finanical Crisis began, with the participation rate falling from 73.2% in 2007
□ The percentage of women working is also still in decline, although at a slower rate. It is at 57.2% today compared to the 60% peak in 1999 before Boomer women began to retire
Even more worrying is the data shown on the 3rd chart, which highlights the changes in real wages, adjusted for inflation, since records began in 1979:
□ Average earnings in 2016 were only just higher than in 2009, at $347/week versus $345/week
□ Average earnings for men at $381/week are well below the peak of $402/week in 1979
□ Only women’s earnings are moving in the right direction, with 2016 at a new high of $312/week
□ But, of course, this highlights how women’s earnings still average only 82% of men’s earnings
It is no great surprise that US and global GDP continue to disappoint, given this evidence from the jobs market. And nothing will change until policymakers accept that today’s ageing populations require completely new policies.
Monetary policy used to be the main focus for running the economy. If demand and inflation rose too quickly, then interest rates would be raised to cool things down. When demand and inflation slowed, interest rates would be reduced to encourage “pent-up demand” to return.
After the start of the Financial Crisis, central banks promised that lower interest rates and money-printing would have the same impact. They were sure that reducing interest rates to near-zero levels would create vast amounts of “pent-up demand”, and get the economy moving again. But as the chart shows for US GDP, they were wrong:
□ It shows the rolling 10-year average for US GDP since 1950, to highlight longer-term trends
□ It confirms the stability seen between 1983 – 2007 during the BabyBoomer-led economic SuperCycle
□ The economy suffered just 16 months of recession in 25 years, as monetary policy balanced supply and demand
□ But the trend has been steadily downwards since 2008, despite the record levels of stimulus
The clear conclusion is that monetary policy is no longer effective for managing the economy.
Encouragingly, the UK Parliament’s Treasury Committee has now launched a formal Inquiry to investigate ‘The Effectiveness and impact of post-2008 UK monetary policy‘. We have therefore taken the opportunity to submit our evidence, showing that demographics, not monetary policy, is now key to economic performance. We argue that:
It was clearly important until 2000, when the great majority of people were in the Wealth Creator 25 – 54 age group (which dominates consumption and therefore drives GDP growth). But its impact is now declining year by year as more and more BabyBoomers move into the 55+ age group – when incomes and spending begin to decline quite rapidly
Friedman’s analysis of the effectiveness of monetary policy, when he argued that “inflation is always and everywhere a monetary phenomenon”, is therefore no longer valid. Modigliani’s “Life Cycle theory of consumption” is similarly out of date
The issue is simply that both Friedman and Modigliani were working in an environment which assumed that people were born, educated, worked – and then died soon after reaching pension age. In these circumstance, their theories were perfectly valid and extremely useful for modelling the economy
Today, however, the rapid increase in life expectancy, together with the collapse of Western fertility rates below replacement level, means that a paradigm shift has taken place. People are now born, educated, work – and then continue to live for another 20 years after retirement, before dying
The essential issue is that “you can’t print babies”. Monetary policy cannot solve the demographic challenges that now face the UK (and global) economy
We therefore hope that the Committee will conclude that monetary policy should no longer be regarded as the major mechanism for sustaining UK growth
Please click here if you would like to read the evidence in detail.
The Financial Times has kindly printed my letter below
, welcoming the Fed’s decision to address the impact of demographics, but arguing that it needs to focus on demand issues, given the impact of today’s ageing populations.
Sir, It is good to see the US Federal Reserve is finally beginning to address the impact of demographics on the economy, after years of denying its relevance. But as John Authers confirms in his excellent analysis of the Fed’s new research paper (“The effects of ageing”, The Big Read, October 26), its continued focus on supply-side issues means it is looking down the wrong end of the telescope.
The Fed’s approach might have made sense in the past, when demand was on a growth trajectory as the baby boomers joined the 25-54 cohort, which drives wealth creation. But today’s problem is growing overcapacity, not lack of supply, given that the ageing baby boomers already own most of what they need, while their incomes are declining as they enter retirement.
The problem is that the Fed’s economic models were developed at a time when the population effectively contained only two main segments — the under-25s and the 25-54 cohort. From a policy perspective, the number of over-55s was too small to be of interest. But this is no longer true, as increasing life expectancy means the baby boomers can now hope to live for another 20 years after reaching retirement age.
Equally important is that since 1970, fertility rates have been below the replacement level of 2.1 babies per woman in the developed world. Thus the relative size of the wealth creator cohort has been reducing for the past 45 years, while the numbers in the 55-plus cohort have been increasing. The result is that the ageing baby boomers are now nearly a third of the developed world’s population.
Policymakers therefore need to urgently refocus on the demand-side implications of ageing, if they want to craft suitable policies for this New Normal world.
Finally, one of the major Western central banks has agreed that the ageing of the BabyBoomers does indeed have an impact on the economy. John Fernald of the San Francisco Federal Reserve Bank, wrote in a new paper this week:
“Estimates suggest the new normal for U.S. GDP growth has dropped to between 1½ and 1¾%, noticeably slower than the typical postwar pace. The slowdown stems mainly from demographics and educational attainment. As baby boomers retire, employment growth shrinks. And educational attainment of the workforce has plateaued, reducing its contribution to productivity growth through labor quality. The GDP growth forecast assumes that, apart from these effects, the modest productivity growth is relatively “normal”—in line with its pace for most of the period since 1973.”
The paper only takes a limited view of the impact, just focusing on the labour market implications, as the second chart shows. This highlights, exactly as we discussed in Boom, Gloom and the New Normal; How the Western BabyBoomers are Changing Demand Patterns, Again, the enormous impact of the Boomers on the US labour force. As Fernald rightly notes:
“In the 1950s and 1960s, population (yellow line) grew more rapidly than the working-age population ages 15 to 64 (blue line) or the labor force (red line). In contrast, in the 1970s and 1980s, the labor force grew much more rapidly than the population as the baby boom generation reached working age and as female labor force participation rose. Those drivers of labor force growth largely subsided by the early 1990s. Since then, the labor force, working-age population, and overall population have all seen slower growth rates.”
Hopefully, Fernald or his colleagues will now go on to look at the issue of demand patterns. This is more critical than the labour issue in a consumer-based society such as the USA – where consumption is 70% of GDP.
As I noted in the Financial Times last year, those aged 55+ consume very much less than younger people, and essentially create demographic headwinds for the economy. They already own most of what they need, and their incomes decline as they enter retirement. So the Fed’s policy of printing money to boost demand is inevitably going to fail, as we have seen over the past decade.
But, after all these years, it is good that a start has been made, and that someone in a major central bank has recognised that the issue exists. It is impossible to move forward when everyone is in denial. The fact that Fernald works for the San Francisco Fed may also be a hopeful sign, as this was formerly the home of the current Fed Chair, Janet Yellen.
The problem, of course, as I discuss in this new interview with Will Beacham, Deputy Editor of ICIS Chemical Business, is that much of the damage has already been done. The chemical industry is the 3rd largest in the world after energy and agriculture, and it now faces major issues of over-capacity at a time of slowing (or perhaps even negative) demand growth.
The UK’s Brexit vote to leave the European Union has been the catalyst for a sudden realisation that all is not well in the global economy. It seems likely that 2017 will prove to be a difficult year. I hope that the interview may help you to prepare for this.
Markets have one main function in life – price discovery. If I want to buy, and you want to sell, the existence of a market allows us to discover the price at which the market will balance in terms of supply and demand.
History, however, provides many examples of times when rulers decided they knew best, and destroyed market economics. The Soviet Union was one recent example, where the Central Committee of the Communist Party would decide what was going to be made and where, and the price at which it was being sold. That system of course collapsed with the Berlin Wall in 1989, but the collapse took decades to happen.
Today, we have another central organisation which is attempting to carry out the same manoeuvre – the main central banks in the West. They have also destroyed price discovery by flooding markets with endless supplies of free cash. The evidence for this statement is in the 3 charts shown here.
The chart above shows capacity utilisation (CU%) in the global chemical industry – the best real-time indicator that we have for the global economy. New data from the American Chemistry Council shows CU% fell yet again in August to 78.7%, nearly 2 percentage points below August 2015:
This pattern has only been seen before in 2001 and 2008, which were not good years for the industry or the global economy
It has now fallen every month this year, and the 2009 – 2016 average is nearly 10 percentage points below the average seen before the Financial Crisis began in 2008
The second chart confirms the downturn underway. It shows earnings for the UK’s FT 500 Index since 1985, set against the price/earnings ratio. As one would expect, given the CU% decline, earnings have been tumbling in the past year:
They peaked at almost 400 in mid-2011, and had eased to around 200 by mid-2015
Since then, they have more than halved to just 93 on Friday
Normally, of course, this would mean that market prices also fell, as the outlook for earnings worsened.
But the opposite has in fact happened, as the central banks have simply pumped out more and more free cash. They have even taken interest rates to negative levels in many major markets such as Japan, Germany and the UK.
Investors, increasingly desperate to try and meet their target returns for paying pensions etc, have responded by bidding up the price/earnings ratio from 18 a year ago to 49 today – easily the highest level ever seen in the period.
This takes us to the 3rd chart, showing the IeC Boom/Gloom Index. It measures sentiment versus the US S&P 500 Index, and shows this has fallen back to danger levels once more.
All the investors to whom I talk, recognise that the market is being completely rigged by the central banks. But, they say, “what can we do? We cannot go into cash, as it yields nothing, and benchmark Western government bonds also yield nothing”: $12tn of bonds even have negative yields. The fact that some of the best performing US$ debt markets in Q3 were El Salvador, Mongolia and Zambia highlights how desperate the “search for yield” has become.
How long will the central banks be able to keep markets artificially high and defy economic reality? We cannot know. But we do know they are providing a fertile breeding ground for populist politicians, as I will discuss 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 54%
Naphtha Europe, down 52%. “Petchem demand remains strong”
Benzene Europe, down 54%. “European derivative demand was struggling after the traditional seasonal slowdown in August. Many in the market had been braced for a strong upturn this month and into the fourth quarter, but this has yet to materialise”
PTA China, down 41%. “Some producers increasing their offers due to turnarounds in China and South Korea”
HDPE US export, down 27%. “China’s import prices fell in the week tracking lower offers of import cargoes from some suppliers”
S&P 500 stock market index, up 11%
The world’s 4 main central bankers love being in the media spotlight. After decades climbing the academic ladder, or earning millions with investment banks, they have the opportunity to rule the world’s economy – or so they think.
But their background is rather strange preparation to take on this role – even if it was achievable:
Janet Yellen, Chair of the US Federal Reserve, is a former academic
Haruhiko Kuroda, Governor of the Bank of Japan, is a career civil servant
Mario Draghi, President of the European Central Bank; and Mark Carney, Governor of the Bank of England, are former Goldman Sachs bankers
None of these roles are noted for their contact with ordinary people. Nor does their habit of flying First Class and staying in top-class hotels, or being chauffeur-driven to meetings, help them to engage with the real world. Mark Carney’s travel expenses currently average £100k/year ($130k), in addition to his £250k/year housing allowance.
But the main disadvantage is simply that common sense is not a core requirement for the job. If it was, then none of the stimulus policies enacted since 2000 – subprime, QE, Abenomics etc – would ever have been considered.
Common sense would have told them that people create demand – not economic models or financial markets. And anyone used to working with real people would know that the key to demand is (a) the existence of a “need”, or at least a “want” and (b) the ability to afford the purchase.
Last week’s announcements by the Federal Reserve and the Bank of Japan highlight the disconnect. Unsurprisingly, Yellen and Kuroda’s stimulus policies have completely failed to create sustained demand. Instead, they have destroyed price discovery in financial markets and created asset bubbles instead.
The above chart highlights the irrelevance of their current policies. As Bloomberg comment in respect of Japan:
“Japan’s economy has been in trouble for decades. Massive monetary and fiscal stimulus have so far failed to spur faster growth. (Last) week, the Bank of Japan met to decide whether to apply yet more economic shock therapy. Here’s the situation the country’s leaders face:
“Japan has the world’s oldest population, as well as a low birth rate and little immigration, but its growth problems go far deeper. In the early 1990s, the country’s postwar growth boom collapsed—decades of deflation followed and Japan started to suffer a shortage of workers….
“Japan’s debt burden far outstrips that of other countries, largely a result of the stimulus introduced to help fix the economy. Abenomics, Prime Minister Shinzo Abe’s rescue plan, has helped to weaken the yen and boost corporate profits but wages and domestic spending have remained fragile.
“Higher debt led the government to consider a sales tax increase for revenue. But the last time it was imposed in 2014, consumer spending and gross domestic product fell, sending the economy into a recession.”
The chart (interactive on Bloomberg itself) confirms this analysis:
26% of Japan’s population is aged over-65. And the OECD median is now 18%. People of this age already own most of what they need or want, and their incomes are declining as they enter retirement
Japan’s fertility rate is just 1.4 babies/woman, only 2/3rds of the 2.1 replacement level needed to maintain a stable population. The OECD median is almost as low at 1.7 babies
Immigration might just be a way of compensating for these factors, but only 1.6% of Japan’s population are immigrants. The OECD median is also too low to really make a difference at just 12%
Japanese government debt is more than twice GDP at 247%. The OECD median is equally worrying at 82%: debt in the other G7 economies ranges from 82% (Germany) up to 156% for Italy.
Slowly but surely, the world is realising that central bank policies have been a disaster for the global economy.
Common sense tells us that simplistic “solutions”, such as printing money and lowering interest rates, will never succeed in creating sustainable economic growth. The real need is for policy to address the cause of the growth slowdown – the impact of the 50% rise in global life expectancy since 1950, and the 50% fall in fertility rates.
Until discussion takes place around the implications of these key facts (highlighted in the second chart), nothing will change, and the debt will continue to rise. And as the Financial Times commented at the weekend:
“The problem with the authorities rigging the markets is it could be painful when they stop doing it.”
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 56%
Naphtha Europe, down 53%. “A build-up in products supply has punctured refiners’ margins, according to the International Energy Agency, which warned that global refinery runs are experiencing their lowest growth rates in a decade.”
Benzene Europe, down 54%. “A drop in consumption was felt by numerous players”
PTA China, down 41%. “Bearish demand for spot cargoes as endusers laid off buying due to the proximity to the upcoming week-long National Day celebrations in China”
HDPE US export, down 27%. “Weak overall demand in China weighed down on prices”
S&P 500 stock market index, up 11%