Demographic Time Bomb

Since I first understood economics (not that I don’t learn something every day) I recognized that the baby Boomers have re-shaped the economy in every stage of their life cycle and that they will reshape retirement as they age. Equally my study of economic history told me that like a plague of locusts moving through the landscape the “boomers” were likely to consume an inordinate amount of resources on the way through and leave the generation behind them paying for them as they age.

It is not a criticism of the Boomers, they are what they, to quote a great old boss of mine. They can only do the best for themselves as they move through life – who would have it otherwise.  But it is simply that their cohort was so much bigger than the one before them or subsequent that they have so remade and are remaking economic history.

That’s why I liken them to locusts, not to be rude but to access a visual metaphor that I thing every reader should be able to grasp.

I must say though that I truly didn’t think I would have to deal with this belief in my early 40’s, but there you have it, it’s happened and it appears that given they control the political power of the globe they remain intent on kicking the burden of the current economic debts and problems down the road to be dealt with by the generations behind them. I sure they don’t think of it that way but as with Greece the constant kicking of the can in the hope something will pop up to fix the problem in the mean time can’t be sustained long-term.

The above may sound like a rant rather than an economic view but it is a thin slice of a thought process and research effort that highlights the risk that the current economic malaise last longer than many expect. This is not uncommon in the history of bubble bursting such as we have seen over the past 800 years but it has serious implications for the global economic outlook.

It also highlights why Australia is lucky to be so heavily intertwined with the Chinese and Indian emergence. Obviously there are risks around these two Asian engines of growth slowing materially for Australia and the globe but for now that would be a cyclical slowdown in a structural upswing.

But getting back to the demographics of the so-called developed world this month we wanted to highlight an article by Jason Hsu of Research Affiliates in the US. He went to Uni at Cal Tech, then did a PhD in economics, and is now a professor at UCLA and teaches in China and Taiwan. We picked this piece up from John Mauldin’s “Outside the Box” articles.

Here is an edited transcript:

“Jason Hsu
Chief Investment Officer
Research Affiliates

Debt, deficit, and demographics—the 3-D hurricane—is heading to the shores of all developed economies. It threatens to derail the lukewarm economic recovery and to alter forever the heretofore path of robust growth for the developed world. In a sense, debt, deficit, and demographics will reset the world to a “New Normal”—an extended period of lower economic and return expectations for the aging and debt-ridden developed world. In contrast, emerging economies with healthy government and household balance sheets, responsible fiscal policies, and young labor forces will be the drivers for global growth and will compete with their developed counterparts for economic and political leadership. More importantly, the emerging economies will demand their fair share in the consumption of resources and goods. That competition for resources and goods will lead to higher prices at a time when developed countries are less able to further finance their consumption.

When Deficit becomes Odious Debt

The extensive literature exploring the effects of deficit-driven stimulus programs provides strong evidence that short-term growth, financed by deficit spending, rarely translates into sustained long-term growth. The argument is that government-directed investments are often zero or even negative net present value (NPV) projects—that is, they tend to be suboptimal investments. From that perspective, government stimulus programs are more about creating make-work jobs than investing in infrastructure and education that will drive future growth. The short-term increase in economic activity does not translate into future increases in production of valuable goods and services.

In a true Keynesian sense, government recessionary expenditure aims purely to smooth temporary shocks; it cannot substitute for private sector investments which are necessary to drive long-term growth. Insofar that the government stimulus is financed by more debt, it necessarily translates into higher future tax burdens, which then drains future private sector consumption and investments. By backward induction, a higher future tax burden decreases expected (after-tax) return on investments, which then reduces private sector investments today. Crowding out future and current private sector activities by the public sector growth today bodes ominously for future growth.

Indeed, under standard economic theory, the government either borrows to invest for future growth, and therefore drive future tax revenue, or it borrows to shift future consumption to the present in an attempt to ameliorate shocks to the economy. In reality, deficits have a tendency to become ever-increasing debt. We have been all too willing to believe the story that future growth driven by indomitable American ingenuity will deliver us from our debt. Unfortunately, unless another decade-long period of explosive technology innovation is in the cards for us, we may have just now hit a wall: The debt-to-GDP ratios for many developed countries have become untenable; additional borrowing capacity is small.

In hindsight, the policy of persistent deficit spending seems utterly irrational and short-sighted. On the other hand, one might argue that this outcome is exactly rational in the context of baby boom demographics prevalent in the developed countries. Deficit spending gives an instant and immediate boost to GDP, which can feel like prosperity and good government stewardship. The natural conflict between the future non-taxpayers and the future taxpayers means that Boomers, who have controlled the elections and politics, have rationally chosen a path of more consumption today at the expense of the future generations. Whether deficit spending truly has any significant impact on subsequent growth is rather irrelevant to the discussion; voters and politicians alike would simply misinterpret the economic literature and assume more consumption today will drive more growth tomorrow. In other words, and as scientific as one can put it—the Boomers have screwed Generation X.

Democracy is one of the great equalizers for income inequality in the cross-section of population. The poor have a mechanism to instigate wealth transfers by voting for welfare and public goods production and to avoid exploitation by voting for pro-labor regulations. Democracy seems to serve quite the opposite role, however, when it comes to equalizing the inequality between generational cohorts. There is no doubt that our future generations have become extremely poor; they are each responsible for tens of thousands of dollars in national debt—in some countries, Gen Xers are staring at outright national bankruptcy. But today, our political process continues to allow the Boomers to pile on new debt for the next generation in order to fund their current consumption and future retirement. It appears that democracy has facilitated the exploitation of our future poor by the current rich and indeed has been a strong contributor to what will become the Boomer’s legacy of odious debt.

The great deleveraging, which has been proposed as the only responsible course of action for the developed countries after the global financial crisis, never materialized and calls for fiscal austerity have largely fallen on deaf ears. The Boomers around the world have written into law rich benefits for themselves, which have to be financed by tax dollars from future generations. Adding insult to injury, they have also pre-spent future tax revenues through massive deficit spending today. The combined weight of the explicit debt and implicit government-guaranteed obligations (such as state pensions and healthcare benefits) has begun to stress most of the developed economies and is already crushing some….

Changing Demographics

As the country prepares for retiring Boomers (and the debt and deficits associated with them), it will also need to prepare for changing demographics—specifically, the adverse effects driven by the dramatic decline in the support ratio associated with an aging population. It is projected that the support ratio in developed countries will decline from 3.5 working age adults per retiree to below 2:1 by 2050. In comparison, in 1970, the support ratio was 5.3:1. By 2025, at the height of Boomer retirement cycle in the United States, there will be 10 new retirees for each new entrant into the workforce. Not only does the future appear unenviable poor in aggregate, it also appears predictably unproductive.

People consume goods and services which are produced by workers. A sharp decline in the United States and developed country workforce means that Americans, and their European and Japanese counterparts, must either reduce consumption drastically or increase reliance on imports from emerging countries. Thus, the trade deficit between developed countries and the emerging countries must continue to widen aggressively or the standard of living for developed countries must decline precipitously.

Instead, what we observe today is inadequate retirement savings. It is long understood that the pay-as-you-go social security scheme cannot work effectively as a credible mechanism for intergenerational risk-sharing in the face of declining support ratios; as the population ages and fewer workers enter the workforce relative to workers exiting into retirement. There are insufficient numbers of young people paying into the system to support the social security payments for those who have retired. Pension schemes, or forced retirement savings, should have protected workers from the problems associated with aging demographics. Unfortunately, low contributions, high costs, and poor governance and institutional design have generally led to poor funding and adequacy ratios. The problem is further compounded by an inability to further borrow against the production of the future generation. This failure is not due to a lack of political will and mechanism to exploit the future, but by the inconvenient reality that the future has already been fully monetized—rating agencies and international lenders are starting to be uncomfortable with the debt capacity of the developed countries.”

Clearly there are a few things to note here:

  • The impacts of this on developed economies will be difficult for other developed economies to escape; but
  • Australia has –
    • a good fiscal balance,
    • strong debt position,
    • culture of saving for retirement and crucially
    • is tied into the emerging world and the income it will generate

So the GFC may have many years to work through yet.  Not the late 2008 early 2009 catastrophe but something more akin to the false start and pullback of the past 12 months or so. In Australia we need to wary of a Chinese misstep – they are not immune to the influences of supply and demand and at some point will suffer a downturn.

It’s a muddle through world – we’ll write a post next week on whether or not austerity is actually rational on the above basis.

 

greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

, , , , ,

Subscribe

Subscribe to our RSS feed and social profiles to receive updates.

No comments yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: