The world is fast approaching a potential reckoning for policymakers’ failure to consider the consequences of their long-running stimulus policies. As long-time major investor, Jeremy Grantham, has warned in an interview with CNN:
“Jeremy Grantham made his name predicting the dot-com crash in 2000 and the financial crisis in 2008. Now, the famous investor warns another epic bubble in financial markets is bursting — and the turmoil that swept through the banking sector last month is just the beginning. “We’re by no means finished with the stress to the financial system”.”
The issue is relatively simple:
- Growth in an advanced economy depends on consumer spending, which is 60%-70% of GDP
- In turn, this growth is dependent on the Wealth Creators 25-54 generation
- Their needs and spending grow as they settle down, often have kids and see their incomes grow
But today, the number of Wealth Creators is plateauing in the world, as the chart shows. It is actually falling in China, as discussed last month. Instead, the major increase in life expectancy since 1950 means an entirely new generation, the Perennials 55+, are alive today for the first time in history.
Their numbers are growing very fast. And they are lovely people. But they have one major drawback when it comes to the economy. They don’t spend very much, relative to when they were younger.
Of course, today’s Wealth Creator couples – struggling with the cost of living – might envy their ownership of a house that has dramatically increased in value thanks to the stimulus programmes.
But in terms of spending and actual cash, they already own most of what they need, aren’t having kids, and their incomes decline as they retire
The problem is that most economic models were originally built in the 1960s/70s, when people still died around pension age, and are out-of-date. They were heavily influenced by Keynes’ General Theory of Employment, Interest and Money which recommended in times of crisis that:
“The government should pay people to dig holes in the ground and then fill them up.”
Today’s stimulus programmes have moved on from this 1936 Depression concept, and focus on boosting asset prices rather than digging holes. But the core principle is still the same – that adults all have equal ability and willingness to spend.
In practice, this means the models assume that a downturn is effectively a liquidity issue. Fed Chairman Ben Bernanke highlighted this rationale in October 2010 for his stimulus programme:
“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”
And he then took an early “victory lap” in 2011, highlighting the success of the programme:
“Policies have contributed to a stronger stock market just as they did in March 2009, when we did the last iteration of this. The S&P 500 is up 20%-plus and the Russell 2000, which is about small cap stocks, is up 30%-plus.”
But the increase in life expectancy, and the rise of the Perennials, means that Keynes’ concept and the models are no longer true.
Instead, they have pushed up prices for stocks, houses and many other assets to unsustainable and record levels. But the debt involved cannot be repaid by GDP growth. Today’s ageing populations mean that the old rules no longer apply.
So the debt isn’t going away anytime soon. And the risk of a debt crisis is growing as interest rates rise in response to rising inflation.