Thursday, June 9, 2016

Why This Time is Completely, Utterly, Totally Different...Like the Difference between a Hurricane and an Ice Age

A destructive storm like a hurricane can do significant short term damage and leave long term issues to be resolved.  But when it is done and over, life generally returns to "normal".  However, what we are facing economically, financially, societally is not a storm but instead more akin to an ice age.  The changes taking place and culminating now have been millennium in the making and will be many decades more before some new "norm" is established. 


Why is this important?  Context.  The combined OECD+China+Russia+Brazil (which make up 43% of the global population but consume 70% of all the oil) are in the midst of a demographic transition which will change everything...not like a temporary storm or hurricane but like a climate shifting ice age that will require massive change and realignment to sustain ourselves.  The long period of population growth, and specifically of the growth of the core 15-64yr/old population among these nations, which has driven economic activity for millennia and certainly since WWII has come to an end.  But not only come to an end but this core is about to start shrinking significantly.  The implications of a pie no longer growing but moving to outright shrinkage will change everything.


To explain why this time truly is different (and why new, entirely different thinking & solutions are necessary), I'm going to use oil consumption as a proxy for general global consumption.  Oil consumption is broken down among four groups: 
  1. The wealthy 35 OECD members (membership HERE)
  2. China, Russia, Brazil
  3. India, Africa
  4. Rest of World
Outlined below are the groupings 2013 population (% of global total) vs. changing oil consumption.  The OECD nations with 17% of global population consume 50% of the oil.  China, Russia, Brazil combined are 24% of global population and consume 19% of the oil.  India and Africa are 33% of the population and consume 8% of the oil.  A growing India and Africa simply haven't the income, savings, access to or utilization of credit to allow their growth to offset the loss of the growth among the OECD, China, Russia, & Brazil.

The Demographic Ice Age
The chart below shows the annual change in the 15-64yr/old adult combined population of all 35 OECD nations, plus China, Brazil, and Russia (blue changing to red columns).  These nations represents 3+ billion people (43% of earth's population), 70% of global oil consumption (as of 2014), and likely 75% of all disposable income.   This is simple arithmetic adding how many are moving into the core on one side minus how many are exiting on the other.  The baby boom was a global phenomenon as is the global baby bust.  WWII's global destruction and the post war period of cheap energy collectively brought all these nations onto a shared cycle unlike ever before.  All nations saw massive #'s perish in the war, all saw significant dips in birthrates during the war, all saw huge population bursts post war, and now all have seen massive, ongoing baby busts.  In the post war period, cheap energy enabled global trade and economic connectivity on a scale never before seen.  Thus, the federal funds rate (representing the global de-facto currency) peaking in '81 was no national or coincidental occurrence.  1981 was also the peak of annual core population growth among these critical nations.  The annual peak in new adult consumer growth was also the peak in the growth of demand.  The growth in global debt (encouraged by the lowering of central bank interest rates) was incented by the nearly 100% drop in the cost of borrowing to maintain a goal seeked global GDP growth rate.
The chart below shows adult population growth as a % of the entire adult 15-64yr/old population.  It is even more pronounced in the relationship of federal funds rate peaking and then slowing growth.

Total change by period to the 15-64yr/old population, below.  Massive population and demand growth has turned to shrinkage.
The average annual change during each period to the 15-64yr/old core, below.

But what about India?  India represents 1.3 billion or almost 20% of earths population.  While the adult population of the OECD, China, Brazil, Russia have ceased growing...India has not and is the primary remaining population growth engine alongside Africa.  Indian growth by period, below.
Indian average annual population growth, by period, below.  Noteworthy that India has already seen peak core population growth and continues decelerating from here on.

So, India plus Africa and the poorest parts of the world are still growing...but alas, they simply haven't (and won't have) the income, the savings, the access to credit to ever consume at Western or even BRICS levels of consumption.  Nor will they have the healthy, growing global markets to utilize their cheap labor to export their way to prosperity.
 
The chart below highlights the population growth, by nation over three separate periods.  The current period has only a single column remaining (representing growth)...India.

Below, the change in core population growth, in % terms.  The deceleration should be getting a bit obvious by now.
If we widen out to the total annual 0-64yr/old global population growth (yellow columns below), we see annual growth peaked in 1988.  The annual growth breakdown between OECD+China+Brazil+Russia (green line) and the Rest of the World (black line) is detailed.  The slowdown is undeniable and makes it plain why the central bank remedies are simply infantile and incapable of resolving a demographic shift with monetary policy.
Finally, as of 1990 the youngest segment of the global population (yellow columns below) essentially ceased growing but few seemed to notice due to the elderly (blue line) living so much longer than previous generations.
M2 Money & CB Balance Sheets
Tragically, the Fed and CB's are applying the wrong remedy for an ailment the Fed won't openly acknowledge.  As population growth decelerated, CB's and the Fed encouraged ever cheaper credit, money growth, and debt in the place of population growth (and the demand it creates.  US, EU, and Japan all compared below.
But when China is included (below), the growth in Chinese currency is spectacular relative to the US, EU, and Japan.  The PBoC is apparently no better and likely no worse than its central banking brethren.
Remember the 15-64yr/old population growth above...not quite running anything like the growth in the money supply below.

But since money creation is far in advance of the population growth (and outright shrinkage in many locations), CB's have set their course to buy and remove assets from the market to maintain a falsely created demand and valuation.  The Federal Reserve purchases as a % of US GDP, below.

Japanese asset buying.  The Bank of Japan simply prints the money to purchase and permanently "retire" the assets, below.

Finally, the rising tide of ECB QE and asset purchases spreading through the EU.  The ECB balance sheet will soon hit new peaks with no slow down in sight as it buys up both sovereign and corporate bonds.  Otherwise, a free market would be left to set prices, something wholly unacceptable to the central bankers now in power around the world.

Perhaps all this helps explain why when full time job creation is at it's lowest in cycle history adding only 300k net new FT employees over 9 years, the stock markets are more closely following the Fed's and central bank balance sheets at all time highs.  In total vs. each other, below.
And highlighting the change per cycle, below.
Conclusion:
An economic and financial system premised on growth over sustainability may not have been wise.  And for all the Fed's intelligence and intellectual firepower, the Federal Reserve seems to be entirely lacking when it come to wisdom.  It certainly pulled forward decades of consumption with huge advancements made that would not have otherwise come to be.  However, the bill was always going to come and it was simply awaiting the trigger mechanism.  Decelerating and outright population declines in many locations were that trigger.  I have made every effort to outline the change and unfortunately, that is the easy part.  The hard part is the courage and cohesion to outline a course of corrections and adjustments which  allow for a war-free transition from this flawed non-market based (centrally planned economy) to a true free market.  If we will not acknowledge and face the flaws of our current system (with its clear minority of winners and majority of losers), allow an orderly wind-down of debts and the flip-side obligations that cannot be paid...then we are almost sure to end in conflicts (internal and/or external) of which the possible outcomes are truly awful.  We still have a chance to do the right thing as hard and painful as the adjustments will be...or a chance to do nothing with almost sure terrible consequence.