Never let reality get in the way of a good theory. That’s been the policy of western central banks since the end of the BabyBoomer-led SuperCycle in 2000, when the oldest Boomer moved out of the Wealth Creator 25-54 age group and into the Perennial 55+ cohort.
Inevitably this led to a slowdown in growth, as the Perennials already own most of what they need, and their incomes decline as they enter retirement. 40% of Americans aged 65+ would have incomes below the poverty line, if Social Security didn’t exist.
The well-meaning folk at the US Federal Reserve chose to ignore this development, and instead launched their subprime experiment But demographics are destiny, and their first attempt to effectively “print babies” ended in 2008’s near-disaster for the global economy.
Their problem, as John Maynard Keynes noted in his conclusion to his 1936 General Theory, was that:
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”
And in the case of today’s central bankers, they are enslaved to the theories of 2 defunct economists:
- One is Franco Modigliani, who won the 1955 Nobel Prize with his “life-cycle hypothesis”, which suggested individuals plan out their lifetime income and spending in advance, so as to even out their consumption over their entire lifetime
- The other is Milton Friedman, who won the 1975 Prize for his argument that “inflation is always and everywhere a monetary phenomenon”, ignoring the importance of supply and demand balances
Modigliani and Friedman were working before anyone realised a BabyBoom had taken place. When John Richardson and I were researching our book ‘Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’ in 2010, the authoritative Oxford English Dictionary gave the earliest use of the word as being in 1979.
So they might have some excuse for not being aware of the demand pressures caused by the fact that the number of US babies rose by 52% in 1946-64, compared to the previous 18 years. But today’s central bankers have no such excuse. Common sense, or a quick glance at the charts above would immediately confirm:
- Increasing life expectancy and falling fertility rates mean that an entirely new generation, the Perennials 55+, is alive today for the first time in history
- And the data shows very clearly that their spending falls off away once they turn 55, and is down 43% by the time they reach the age of 75
Similarly, common sense suggests that inflation is not a monetary phenomenon, but a function of supply and demand balances. The post-War BabyBoom was inevitably going to create a lot of demand and hence inflation, particularly as factories had first to be converted back from military production.
Similarly, when all these babies moved into the workforce, it was almost inevitable that:
- We would see more or less constant demand, as the Boomers reached their Wealth Creator years
- This demand would be turbo-charged as women went back into the workforce after starting a family, creating the two-income family for the first time in history
Fertility rates fell below replacement levels of 2.1 babies/woman as long ago as 1970. Inevitably, therefore, the number of Wealth Creators has plateaued – just as increasing life expectancy means that the number of Perennials is growing rapidly.
Since 2008, the Fed has completely failed to recognise this critical development for supply/demand balances.
Instead it has “doubled down” on the subprime policy, via record levels of stimulus. If you ask them why, they will tell you their core economic model – the Dynamic Stochastic General Equilibrium model – doesn’t need to include demographic detail, as it is based on Modigliani and Friedman’s theories.
We are therefore now almost certainly approaching a new crisis. As the chart on the left from Charlie Bilello confirms :
- The total of government bonds with negative interest rates has now reached $13tn
- The stock market is ignoring this evidence of slowing demand, and is still powering ahead
One or the other is soon going to be proved wrong.
THE END-GAME FOR THE STIMULUS POLICIES WILL LIKELY BE MAJOR DEFLATION
The central banks have spent the past 10 years following Friedman’s theory, believing they could create inflation via stimulus policies. Instead, their low interest rates encouraged companies to boost supply, at a time when the rise of the Perennials meant demand growth was already slowing.
Unsurprisingly, therefore, interest rates are going negative, as the Fed’s policies have effectively proved deflationary. Very worryingly, around 14% of US companies are already unable to service their debt, because their earnings are not enough to pay their interest bills.
Had the Fed focused on demographics, it would have been obvious that the best way to create demand was to increase the spending power of the Perennials, who typically rely on savings for extra income. But instead of allowing markets to set higher interest rates, the Fed chose to lower them, making deflation almost inevitable.
History suggests their next round of stimulus policy, if/when the S&P 500 weakens again, will be to introduce Friedman’s idea of “helicopter money” – and electronically transfer perhaps $500 to every American’s bank account. This will be the ultimate test for Friedman’s theory, as if it doesn’t magically create inflation, the Fed will have nothing more to do.
Maybe, this final burst of stimulus will work. But probably most Perennials, and many Wealth Creators, will instead save the money – alarmed by the Fed’s sense of desperation. In turn, this will turbocharge the deflationary cycle – forcing interest rates even lower and risking major economic turmoil.