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.
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.
It is is 10 years since the US subprime bubble began to burst, with disastrous results for the US and global economy.
The US Federal Reserve had created the bubble in the belief that higher house prices would boost the economy. It then made a bad situation into a disaster by refusing to accept that a bubble existed:
Alan Greenspan, then Chairman of the Fed, told Congress in June 2005, at the height of the bubble:
“Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications”
Ben Bernanke, Greenspan’s successor as Fed chairman, then continued to argue that there was “no housing bubble to go bust”
Yet US housing starts have never returned to the 2.0 – 2.3 million/year level seen between 2003 – 2006. Last month, they were just half this level at 1.1 million/year.
The Fed’s failure has had important implications for US housing policy. Both President Clinton and President Bush had focused on increasing home-ownership. When Clinton’s 67.5% target was reached in 2000, Bush was keen to achieve higher levels. But instead, as the chart shows, ownership peaked at 69.2% in 2005, and then began to collapse as the subprime bubble burst:
It is now back at 62.9%, equal to the lowest level seen since records began in 1965
The trend is clearly downwards, and so it seems likely the rate will fall to new lows later this year
Housing therefore represents an excellent example of the importance of demographics in driving demand, rather than monetary policy. Since 2008, the Fed has taken interest rates to their lowest level in history, and printed money at an extraordinary rate, in order to create consumer demand.
But it has completely failed to restore the housing market to its former levels, for the simple reason that demand patterns are driven by issues of lifestyle and affordability – rather than just interest rates. As the second chart shows, housing starts have not only halved since their 2006 peak, but the type of homes being built has changed quite dramatically:
Today’s Millennials are not following their Boomer parents in wanting to buy McMansions in the suburbs
They have much higher debt levels due to the cost of tuition fees, and they are having fewer children
The recovery in house prices fostered by Fed policy has also reduced their ability to buy single homes
The Boomers themselves are also no longer so keen on suburban living, and prefer to be town/city-based
As a result, over a third of all new homes are multi-unit – twice the level seen in the boom years of 1990 – 2007
A new study from Corelogic confirms that affordability issues also impact existing homeowners:
Homeowners making moves out of state are increasingly selling out of expensive markets like California, where price escalation is steep, and buying into lower-cost markets such as Texas and Arizona. Overall between 2000 and 2015, 2.5 home sellers left California for every out-of-state buyer coming into the state”.
The US housing market thus confirms the profound changes taking place in Western demand patterns. It also highlights the risk of believing that the Fed is able to guide developments in its preferred direction. Or, indeed, of believing that the Fed has a good grasp of what is actually happening in the real economy.
Suddenly, people are starting to talk about China and the risks it creates for the global economy. There is a lifecycle to the way that such issues develop in the general consciousness, as John Mauldin has observed. And so this development suggests that we are now well along the process, as highlighted in the chart above:
- Typically, issues develop over time, but nobody cares. This was the case with China as its lending post-2009 reached the $6tn level by the end of 2011
- People assumed that China was an unique country, with far-sighted leaders and vast potential. They didn’t want to ask too many questions
- Then, from 2012, some people began to raise questions about whether all this money was being spent wisely, and if it could be repaid
- But most people believed the consensus view, that maintained China was just cleverer and better organised than anyone else
Today, however, this consensus is beginning to be broken. Of course, many analysts still believe that another stimulus is inevitable and will solve any problems that might emerge. But others ask the awkward question of how the current $10tn of total lending will ever be repaid.
China’s new leadership are amongst those asking the awkward questions. Thus Premier Li Keqiang said last week that there will be defaults:
“It is indeed difficult to avoid a few default cases. We must tighten monitoring to prevent regional and systemic financial risks.”
The problem is that nobody really knows how bad the situation has become. Logic suggests that it is impossible to run proper credit checks when handing out $10tn in 5 years. As Li went on to say:
“We decided to audit government debt last year, which showed our firm conviction to face the problem.”
Whilst the South China Morning Post summarised the position as follows:
“In the lending spree in the wake of the 2008-09 global financial meltdown, funds poured into local governments and state-owned enterprises, leading to redundant projects and overcapacity in steel, cement, shipbuilding and other industries. Local government debt had swollen to Rmb17.9tn ($2.9tn) by the middle of last year, the National Audit Office said at the end of last year. This was nearly 70% more than at the end of 2010, and accounted for 31% of GDP last year. Li said the debt level was “generally controllable”, but the rising trend should not be overlooked. Local debt would be included in budget management and local government financing vehicles would be regulated, he said. The lending binge from both banks and the shadow banking system has increased China’s leverage. Fitch Ratings predicted its credit-to-GDP ratio at the end of 2017 would be close to 250%, compared with 130% in 2008.”
The fact that this type of analysis is now appearing on the main pages of major media confirms that the issue no longer just ‘Matters To Some’. Another sign was the BBC’s documentary last month, ‘How China fooled the world’.
Local government debt equal to 31% of GDP last year, and up by 70% in 3 years, doesn’t sound good. Nor does a near-doubling of debt to GDP ratios in 5 years. If this wasn’t China, imagine what the press and policymakers would be saying, and the panic that would be taking place at these sudden revalations.
If Fitch is right, China’s debt is already now bigger than the entire US economy.
Another factor is that the government is now starting to depreciate the currency to protect exports, as we forecast in the recent Research Note. In turn, China is now starting to see a reversal of the ‘hot money’ flows attracted since 2009 by the combination of “guaranteed” currency appreciation and sky-high shadow banking interest rates.
Equally alarming for these speculators is that the first default is now taking place in the real estate sector. Real estate is now 16% of GDP on its own, before counting all the other industries such as consumer durables that benefited from its rise. So this is China’s Bear Stearns moment, when its ‘wealth effect’ machine moves into reverse.
But most people haven’t yet begun to think in detail about the potential problems, or how these might impact them. That is only now starting to happen as we move into Phase 3. Quite suddenly, more and more people will begin to realise it ‘Matters To Everyone – Too Late’.
So far, commodity markets have remained calm, but clearly the pressures are growing as the blog discussed yesterday. Equally, as the blog highlighted Monday, most policymakers continue to only focus on their own silo. They have not started to consider how major defaults and a general economic slowdown in China would impact their rosy forecasts.
The key is that everyone wanted to believe that China was somehow different. Just as they wanted to believe that US subprime lending was somehow different. But the blog will continue to argue the simple truth – “If something is too good to be true, it usually is”.
The US housing market collapse has wiped out $6tn in wealth since it began in 2006. But even today, little is being done to solve the critical issue – that homeowners took on too much debt, which will never be repaid.
As a result, the situation continues to get worse, not better. And some influential commentators are beginning to worry that today’s falling prices, and rising debt levels, present a real challenge to key elements of the post-war American Dream:
• Prices fell again in December, and are now down 34% since their peak
• S&P warn that “we might have re-entered a period of decline”
• 5 million homes have owners who are either delinquent on payments, or already in foreclosure
• In addition, 3 million homes are vacant but not yet listed for sale
One key problem is highlighted in the chart from the Wall Street Journal. It shows how foreclosure delays have risen dramatically since 2008:
• In 2008, the foreclosure process took an average 251 days for mortgages under $250k, and 261 days for those over $1m
• Last year, it took 611 days for $250k mortgages, and 782 days for $1m
• Most people heading for foreclosure stop paying the mortgage. So those with $250k mortgages gained an extra 12 months of ‘rent-free living’, and those with $1m mortgages gained 18 months
• This gave them more money to spend in the shops and on new cars
• But this is not ‘real demand’, as it relies on people not paying rent
There are many reasons for the extra delays. The system is overloaded by the large volumes of homes now threatened with foreclosure, and the paperwork covering the loans is often faulty. But now it seems to be moving back into top gear again. 24% of all home sales were foreclosures in Q4 2011, compared to 20% in Q3.
Equally, as former US Labor Secretary Robert Reich notes:
“We are witnessing a fundamental change in the consciousness of Americans about their homes. In the late 1960s and 1970s, baby boomers took out the largest mortgages they could afford. Homes morphed into ATMs, as Americans used them as collateral for additional loans. Most assumed their homes would become their retirement savings.
“The plunge in home values has changed all this. Young couples are no longer buying homes; they are renting because they are not confident they can get, or hold, jobs that will reliably allow them to pay a mortgage. Middle-aged couples are underwater or unable to sell their homes at prices that allow them to recover their initial investments. They cannot relocate to find employment. They cannot retire.”It clearly suits policy makers and financial markets to ignore these issues and hope they will go away. But their lack of attention is making an already difficult problem even worse as we transition to the New Normal.