Monday, February 23, 2015

Fundamentally Flawed - Chapter 1, “Advanced Economies” vs. Developing Economies

by Chris Hamilton, February 2015

To put things in perspective, let’s start with global debt vs. global GDP (gross domestic product).  As shown in the below chart, debt continues growing faster than economic underlying growth.  Globally, no net deleveraging taking place and in fact global leverage is still rising.
SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS
And a quick look at the four sources of the global debt in the chart below; Household, Government, Corporate, and Financial.  No net deleveraging among any of the four sources of debt.

SOURCE: Haver Analytics; national sources; World economic outlook, IMF; BIS

Global debt in total dollar terms and as a % of debt to GDP continues to ramp.  Globally, debt continues growing faster than the economic activity it spurs.  Debt growth in advanced economies is coming almost exclusively via government debt but there is no intention to repay this type of advanced economy debt...only perpetually service it at lower interest rates.  Developing nation’s net debt is rising (and in many cases spectacularly) but primarily via consumer, corporate, and financial debt.

"Developing economy", China, has quadrupled its total debt from 2007 to present and up 14x's since '00 ($2 trillion in '00, $7 trillion in '07, and $28 trillion presently) primarily via corporate, financial, and household debt.  Over 50% of all this new Chinese debt is funding real estate related loans…and the boom-->bust-->government bailout / take over of credit creation can't be far behind as the housing bust in China is already underway!

Net-net, deleveraging simply isn’t happening as the $57 trillion rise in total global debt since ’07 should make eminently clear.  With China's continued housing bubble credit growth in jeopardy (and China created over 1/3rd of all global credit from '07 til present)...where will the new credit come from to maintain demand?

Advanced Economies

America, Japan, France, Italy, UK, and Spain (and many more advanced nations) share characteristics and problems that brought on the 2008/2009 bust and reasons times are likely to get far more difficult over the coming decade. This isn’t simply an American issue, this is a global post WWII baby boom and subsequent baby bust phenomenon layered with bad assumptions and bad governance.  And now as those nations most impacted by WWII are getting older, they tend to make more promises and tax themselves less for these promises…better known as deep deficits and debt. 

Japan’s 230% debt to GDP and 25%+ of its population 65+ years old is truly worst in class and shows the absolute worst governance and preparedness for the entirely predictable negative demographic situation they now find themselves.  Shocker, Germany with the second largest % of 65+ year olds of any major economy has only one quarter Japan’s debt to GDP and seems far better prepared for the entirely predictable demographic situation they now find themselves. 

Staying in Europe, Italy is the European equivalent of the economic walking dead (Japan).  Japan and Italy have approximately 21.5% of all global public debt, horrible demographics, no economic growth to speak of…and no good answers.  In fact; Japan, Italy, France, UK, and Spain collectively have the equivalent total public debt to the US…collectively holding 32% of global government debt.  Or said differently, with the US added in…these 6 nations hold 64% of all global government debt although comprising only about 10% of earth’s population (see chart below).

The reason this is so important is due to the fact governments have a very bad habit of not repaying their debts and instead defaulting…either directly (declaring debts null and void) but more typically indirectly via monetization (printing money and buying assets to artificially avoid spending cuts or higher taxation).  Spiking, un-repayable global government debt is the economic equivalent to Dante's lowest level of the inferno where fraudulent and treacherous governance exist.

All six “advanced economies” are too old and too indebted to realistically grow their way out from under this debt.  The only answer is a bankruptcy where present and future available national income is paired up with the most critical present and future national needs…but let’s not get ahead of ourselves.
A point of order regarding the debt…this is money owed by the governments to its people and creditors.  But every debt owed by the government is someone else’s asset…either as social security checks or Medicare or pensions or a plethora of programs or Treasury bond re-payments.  Certainly nations can (and often have) cancel their debts and declare them null and void.  But, the economic impact of, for instance, social security recipients not getting their checks means a significant economic slowdown leading to declining tax revenue making further spending cuts necessary.  Every action has a reaction and cutting present debt is the same as cutting future economic activity.  I do advocate for this bankruptcy but I don’t claim it will be nice or easy…it will suck!  But it’s necessary none the less.
On the other side of the coin are the BRIICT (Brazil, Russia, India, Indonesia, China, & Turkey) nations.  They generally have low levels of government debt, a lower percentage of the world’s total debt, and about 45% of all citizens on earth.

Advanced vs. BRIICT 65+ year old populations

The chart below shows the % of these advanced nation’s 65+ years old populations.  Generally speaking, at 65 years old folks move into retirement, cease accumulating assets, begin drawing from social programs and pensions, begin liquidating 401k’s / IRA’s, and paying relatively little into the system…your results may vary.  And as the percentage of 65+ year olds rises, the %’s in the younger population segments correspondingly declines.

Source: World Bank; The United Nations Population Division's World Population Prospects.
As a reminder, 2007 was the year the 25-54 year old US total population peaked…both in total population and employment.  And in lieu of population, wage, or job growth to maintain demand for assets, the Federal Reserve and Federal government created massive debt to disguise the falling organic demand via QE / ZIRP.

Population Source; OECD, Main Economic Indicators; Federal Debt Source, Dept. of Treasury
Below, the impact of the US 25-54 year old population peaking and beginning its fall.  Oil consumption, mortgage debt both fall in unison with the falling 25-54 year old population.

Population Source; OECD, Main Economic Indicators; Oil Source; IEA; Mortgage Debt Source; Federal Reserve System; Federal Debt Source, Dept. of Treasury
But the big adjustment is just beginning.  The chart below of the US population breakdown over the next decade shows 2015 is likely be the peak for the 25-64 year old segment of the population…and the decline of US and advanced economy 25-64 year old populations will likely go on for a decade before stabilizing.  More sellers and fewer buyers…central banks and governments will need to significantly pick up the pace of monetization to disguise this waning demand and growing supply.

Source; OECD, Main Economic Indicators; Data from 2015-2024 is the authors estimate
Again, this is global advanced economy wide.  See US, EU, Japan peaking 25-54yr/old populations below.

Source; OECD, Main Economic Indicators
A much better view of the leading nations of the EU below (UK is the only nation that has not peaked in either the 25-54 or 15-64 year/old segments).  What could be more “DEFLATIONARY” than falling populations of working age citizens???

Source; OECD, Main Economic Indicators
The decline from each nations peak 25-54 and larger 15-64 yr/old populations.  Japan has been falling since the ‘90’s while the US and Spain are the newest to begin declining (below).

Source; OECD, Main Economic Indicators
In contrast, the BRIICT are relatively younger nations (below) with most their populations in consumption and accumulation mode and relatively few in the 65+ year old retirement liquidation zone.

Source: World Bank; United Nations Population Division's World Population Prospects.
A very big detail that is little understood is that almost all (if not all) of the US population growth for the next decade (and next 5 decades) is intended to be via ongoing immigration and the significantly higher birthrates of these immigrants and their offspring (high birth rates is the Census way of saying these immigrant’s will come from Mexico, Latin America, and the Caribbean…and the percentage of Hispanic US population to soar from the present 15% to double that @ 30% by 2050).  However, when the US (and other advanced nations) are no longer creating anywhere near enough jobs for even its own citizens, particularly for those with low skill and lower levels of education…the draw of economic advancement will draw and employ fewer than expected…and those that do come rather than finding plentiful work will likely fill lines drawing from the social safety net…creating even greater societal strains and tensions of native born vs. immigrants (US for sure but particularly across the EU where much greater cultural and religious differences will be magnified).  But slowing immigration on top of tumbling birth rates means even greater deceleration of advanced populations and even greater economic slowdown.  
Below, global debt to GDP vs. the % of each nations’ population that is 65+ years old.  There is a very strong relationship between aging nations and the amount of debt they incur.

Source; World Bank, World Development Indicators
Below, the progression of the largest economies aging from 1960 vs. 2013.  The already relatively older advanced nations are set to hit peak % of their populations 65+ years old over the next decade.

Source: World Bank; United Nations Population Division's World Population Prospects.
Advanced vs. BRIICT Oil Consumption
The below chart highlights the falling consumption of oil by all six advanced nations despite larger populations, more cars, etc.  Some portion of the decline may be attributed to substituting nuclear (France, Japan) or eco-friendly (Germany)…however, oil has few substitutes so generally a falling consumption of oil is a good indicator of slowing activity within an economy.  The chart shows both how far consumption has fallen (as a % from peak) and when that peak consumption occurred.  That France is using less oil now than at least 35 years ago is astounding…but Japan and the UK peaked in ’96.  Italy peaked in ’99 after flat lining since at least 1980 and total Italian consumption has plunged by 32% since.  The US peaked in ’05 and Spain in ’07 but Spain’s 25% reduction in consumption is so short a time is stunning (although I’ll admit I spent a week in N. Spain cycling last fall and had noticeably less traffic to deal with).

Source; US EIA
The line chart (below) showing the advanced economy oil consumption peaks and subsequently declining consumption.

Source; US EIA
BRIICT oil consumption (below) is on the rise despite record prices over the last decade.  All but Russia have never consumed more oil than they do now.  Russia peaked in the Soviet Union period, bottomed in ’98 and is moving to higher annual consumption since.

Source; US EIA
Advanced vs. BRIICT Debt to GDP & Interest Rate Impacts
Below, the six “advanced economy” nations all have the same answer to deal with slowing economies, aging populations, and excessive debt…more debt.  Below, spiking debt to GDP.

Source; Trading Economics
BRIICT nations are generally decreasing their government debt loads over the same period.

Source; Trading Economics
Below you can see how that debt in America is made serviceable…over 3 decades of interest rate suppression, boosting asset prices, and encouraging ever more debt.

Federal Debt Source, Dept. of Treasury
Below all six advanced economy nations are following the same path to zero or even negative “yielding” 10 year debt.  Below is the collapsing 10yr sovereign debt of all six…lucky for them this has happened as their debt loads have spiked to record highs. 

BRIICT interest rates remain flat or even rising…which probably isn’t a big deal from a debt service perspective since they have relatively little debt.

Rising Debts and Shrinking Interest Payments…Global Advanced Economy Phenomenon
  • Interestingly, the highly indebted, low growth EU, UK, US, and Japanese economies have ramped Debt-to-GDP levels about 50% since ’00 and have been rewarded with huge reductions in their interest costs on that debt!?!  Surprisingly, non-Euro currency European nations and the BRICS have reduced their debt-to-GDP levels by about 20% and been penalized by relatively smaller reductions in the cost of their debt and rising debt costs!?!

Source; Trading Economics
So who bought all that record low yielding US Treasury debt since July 2011 (the chart below is the stuff of cult classic films...and our modern day reality)?  Those with excess dollar reserves sell and those without any excess dollars do the buying?!?

Source, US Treasury, TIC Report

Europe is nearly unanimously in a “depression” state but those within the EU (& UK) on average added 50% to their debt / GDP ratios from ’00 to present while those outside the Euro currency decreased their debt to GDP ratios by 2%!?!  Seems those who joined the Euro currency were incented to take out ever more debt at ever lower rates.

The next chart shows just how active advanced economy central banks have been...

Spoiler Alert - Or more simply put, as Morgan Stanley Research showed last week, in 2015, in excess of 100% of advanced economy newly issued sovereign debts will be purchased by the central banks of these nations.  That is how you avoid a market based re-pricing of sovereign debt…print the digital dollars, yen, euro's, etc. to buy all that debt, effectively close the markets, and claim the non-market "market" valuations as proof to the policies efficacy.