First of all, I should apologize for readers for probably the longet hiatus ever on this blog. I am still trying to balance a busy day job with having time to pen blog posts. I am sure that I will manage to get a nice rythm going at some point.
As such, I thought that I would return to a topic that I actually do know a little about and this interesting piece in the WSJ by Carl Bialik on US fertility and the idea of a crisis driven birth collapse in the US.
A recent report said the U.S. birth rate has dipped to a record low level. But another measure of the nation’s fertility remains comfortably above its historic low. The mismatch shows that even in a country with comprehensive birth statistics, summarizing population trends is far from straightforward.
The article makes no judgement either way and essentially keeps to lining up the arguments without making a statement about which measures are most correct. The main debate is driven by reports that the US birth rate has plummeted since the financial crisis and that this negative shock could have a lasting impact on US population dynamics.
However, as the article suggests, measuring fertility is not straightforward and indeed while the article builds its discussion around the notion of total births per 1000 women (crude birth rate) and the total fertility rate (average children born to women in their childrearing age), no mention is given of total cohort fertility which is the completed fertility per cohort. Arguably, this last measure is the most important one, but also the most difficult one to observe since we can only see this after the fact (although we can make qualified guesses of where this is headed for a given cohort based on the interaction between tempo and quantum effects of fertility).
So, what is the story in the US? Well, the crude birth rate recently hit all time lows, but the total fertility rate remains stable and close to replacement levels and this latter point is, in my view, giving too little credence in relation to the most recent concerns raised on US fertility.
However, there is no doubt that the financial crisis appears to have had a noticeable impact on US fertility patterns. In theory, an economic recession should not have a lasting impact on completed fertility. This is mainly because a normal economic recession does not have a lasting impact of families’ life course trajectory and decisions to have children. It may lead to an increase in postponement, but that effect should be reversed once the recession ends.
The key question is whether this particular economic crisis is different and whether we can expect a lasting impact on fertility in the US (and perhaps elsewhere)?
I would venture a hesitant no here, but the jury is still out, and there is no doubt that the specific nature of the recent economic crisis as one of being associated with a structural level of too much debt is a worry. A prolonged period of deleveraging which now appears to have begun the US and elsewhere in the OECD could lead to a permanent and irreversible postponement of fertility decisions in the US, but so far the fact that US fertility remains close to replacement levels (and never dipped below) is a definite positive that has, so far, received too little attention I think.
Grantham Lays Down the Gauntlet on US Growth and Demographics
If Carl Bilak’s article does little to come up with an argument for or against the notion of the sturdiness of US demographic fundamentals a recent piece from GMO by Grantham is much more vocal in its worry that the US economy may be headed for zero growth and that demographics are to blame.
First of all, Grantham is fundamentally pointing to falling trend growth in the US. This is the case not only in the US but across the OECD. Indeed, trend growth if measured with a very broad stroke is probably falling in all major global economies, developed as well as so called emerging economies. The reasons for this are pretty simple. All the things we use to calculate or account for growth are slowing down; demographics, capital formation and technology/productivity although this last bit is surrounded by a huge uncertainty and could surge or slump. Most economists would see productivity as a part of the process (i.e. it is endogenous) and thus something we can affect, but technological progress does tend to have an unpredictable and disruptive cycle which is difficult to account for.
Still, to take such a broad sweep at growth and apply equally across global economies is too general a narrative to hold up to closer scrutiny.
Enter US population dynamics and its coming “growth” effect.
On US demographics, I think Grantham focuses on long term trends of working age population growth which are obviously down in the US. However, they are down for all countries and over such a long time frame that it becomes meaningless to discuss them without some aspect of relativity. Retiring baby boomers are a drag on US growth and the lack of rising female labour force participation (because it has already happened) is also a minus, but this is also pushing the narrative a little bit.
Surely, a boost in growth from increasing female labour force participation can only happen once and is not strictly a “drag” on growth when it ends. Crucially however, Grantham interprets exhibit 1 depicting growth in the US working age population in a “glass half empty” kind of way. We are told to focus on the declining trend, but I would note the remarkable fact that the US working age population is set to enjoy positive growth beyond 2030. That is a major relative tailwind compared to the rest of the developed world and indeed emerging markets. All countries in the world have a large challenge in the context of the compatibility between ageing and a market economy with pension schemes and health care systems, but the US seems in a relatively good position to cope with this from the point of view of demographics.
Going back to the discussion on fertility, I am surprised that Grantham does not focus a bit more on the fact that it never slumped massively below replacement level in the US which augurs for strong tailwinds to household formation. If you combine this with intra-US labour mobility you get a strong foundation for growth I think. Or at least, you get a more nuanced view of the US compared to for example many other OECD economies (Japan and Europe) where demographics are much more decisively manifesting themselves in the form of headwinds.
Two charts from the GMO piece that should make us worry a bit though are ex 2 and 3. Working less hours and falling labour force participation (and it is falling not only for women) are poison for growth because it reduces the potential growth rate per unit rate of inflation. Popular speaking, it reduces the natural level of output before the output gap turns positive (and you get excess inflation and no real growth). This is a huge challenge in the US and the persistently falling labour force participation rate in the US in a post crisis is a worrying development which needs some sort of structural/reform response as it is completely unrealistic to expect the Fed’s quanto easing policies to lead to a structurally better labour market.
In the end, I would say that it is difficult to disagree with the overall narrative set out by Grantham because it really sticks to the straight and narrow and basically says what we already know, name that trend growth will fall.
Critically however, Grantham notes the concept of “zero growth” and thus refers to the idea that trend growth in the US may fall to zero. I don’t see that and this is an important qualifier.
I think there are a lot of economies in the OECD where “trend growth” as defined by conventional economic models and theories may be zero (Japan, Italy, Spain and some parts of Eastern Europe). But I would not put the US in that group and demographics represent one of the main reasons for this. There may be many reasons why the US economy may slump to zero growth in the future, but demographics aren’t one of them.
China and India have always been crazy for gold and the yellow metal remains the choice store of value in those two countries, says Don Coxe, a strategic advisor to the BMO Financial Group. In an exclusive interview with The Gold Report, Coxe explains how demographic shifts are affecting the price of gold and delves into the logic of investing in gold as a long-term strategy. Coxe also draws an important lesson in economics from his reading of Lenin.
The Gold Report: What fundamentally attracts you to gold?
Don Coxe: There are many serious reasons why I like gold, but one very important reason has to do with the shift in the share of world gross domestic product away from the highly industrialized nations toward emerging economies in Asia. For thousands of years, people in China and in India have respected gold. The Western countries, on the other hand, were captivated some decades ago by economists who claimed that gold had become irrelevant as money. But the Chinese and Indian people hoard gold as a store of value and trade it as a treasured commodity.
TGR: Are the pricing mechanisms for gold shifting toward control by the East?
DC: Consider an art auction. If a bidder who 10 years ago only bought one painting suddenly buys 50 paintings, that bidder will greatly influence subsequent bids for the art. In China and India there are suddenly many more wealthy people than they’ve had for millennia. In a culture that values gold, newly rich middle class people will buy the yellow metal not only for personal adornment, but also as a form of savings that is safer than paper money.
“In a culture that values gold, newly rich middle class people will buy the yellow metal not only for personal adornment, but also as a form of savings that is safer than paper money.”
On a trip to India a few years ago, I was fascinated to see poor peasant women wearing armbands of gold as they toiled in the fields. I asked my guide, “Is that actually gold on their arms?” And he said, “Oh, yes, that’s gold.” I said, “Well, aren’t they at risk? I mean, these are really poor peasants, and here they are brandishing all of this gold!” He looked at me in horror and said, “No criminal would be so evil as to steal gold from a poor woman, because that’s her dowry.” There are some pretty powerful taboos in Hinduism, apparently.
Intrigued, I found out that under Indian law, when there’s a Hindu marriage, whatever personal possessions, real estate and investments the woman has become the husband’s except for her gold. That remains hers. So if you’re marrying off your daughter, whom you love, you’re going to make sure that she has some gold in her possession because if the husband turns out to be a wastrel, the dowry might save her from starvation.
As a result, the Indians are the biggest consumers of gold in the world. The Chinese are moving up fast, though. Plus, there are simply more rich people in the world. Hundreds of millions of people now have some form of savings. The best single investment anyone could have made, since the year 2000—apart from buying Apple stock—was in gold. It has gone from $300/oz to $1,650/oz. It’s gone up every year, including this year. So every year in this millennium the price of gold has gone up.
TGR: Let’s talk about the Eurozone problems. How does the euro crisis affect the commodity space in general?
DC: Probably the only commodity that can benefit from the euro meltdown is gold, because the euro is the first currency ever to be backed by no government, no tax system, no army and no navy. It is backed only by a theory and a set of rules, and the people behind it have violated the theory and the rules. I doubt there is any intrinsic value behind the euro. But take the exact opposite extreme from the euro and go to something that’s been a store of value for as long as there has been civilization, gold.
TGR: Do you think we’re in a triple-dip recession in North America?
“The best single investment anyone could have made, since the year 2000—apart from buying Apple stock—was in gold.”
DC: I don’t think so. We have zero interest rates. Every recession we’ve had has always been preceded by a situation of tightening monetary policy because there was just too much spending going on, the yield curve inverted and credit problems developed. In this case, we’ve been getting along with zero interest rates now for more than four years. What we have is lassitude, but I don’t think there is going to be a recession.
That said, it’s going to look like a recession a lot of the time because—particularly as a result of the presidential election campaigns—the Democrats who are against developing power plants, against the oil industry and against the mining industry are going to feel that they have more room to carry out their crusades. That could prove to be a negative for the economy. But in general, we’re going to bump along. We’re going to be better off than the Eurozone is for sure.
TGR: Do you have thoughts about why so much corporate cash is sitting idle and what might change that?
DC: One of the biggest arguments used against gold is that gold does not pay any interest. The monetarists said you might as well keep your money in a bank account. OK, so now that we are getting zero interest on short-term deposits, the single biggest argument against owning gold is gone. As an asset class, gold has gone up every year of this millennium, and it seems to me that investing in gold makes much more sense than holding on to a lot of idle cash.
TGR: Do you think that bullion or gold stocks are the best bet?
DC: Gold stocks are the best investments, but if you want to put your savings into bullion, the easiest way to do it is to buy the SPDR Gold Trust (GLD) listing on the stock exchange, which is backed by the World Gold Council. It’s very convenient, and you can sell the bullion at any time, because it trades during the day. Bullion is a good substitute for having extra cash in hand, but as an investment, I believe you’re better off owning stocks of the well-managed gold companies that do not have political risk. It takes a lot of research to pick out the best ones, but that’s one of the things we do.
TGR: Are there any junior firms involved in these spaces that you would recommend to our investors?
DC: I’m not allowed by the Securities and Exchange Commission rules to be specific about individual stock, but I am bullish on the gold space in general.
TGR: A lot of the larger gold mining companies are moving into politically risky zones like the Democratic Republic of the Congo, Eritrea and Haiti, trying to replace their reserves.
DC: We don’t invest in companies like that, and I don’t recommend that anybody who doesn’t have a very high-risk profile do so.
TGR: In terms of investing in junior mining companies, whether it’s energy or gold, do you think that we’re looking at a period of mergers and acquisitions coming up or are explorers going to be able to make it on their own for a while?
DC: Both will happen. There will undoubtedly be lots of mergers and acquisitions. We look at which of the juniors are most likely to be acquired. So far, we’ve had some pretty good success with doing just that. There will be more of them. But right now, it’s pretty desperate for a lot of the juniors. There is no capital available. They can’t float stock. Their shares are selling at discounts to net asset value on the exchanges. However, if we get to $2,000/oz gold again, which probably won’t be too far off in the future, you’ll be amazed at how much these little gold and mining stocks will suddenly go up. They come back fast.
TGR: China has its own precious and base metal resources and it has growing demand. Do you think in a global sense China is going to start looking more internally to satisfy its metal resource needs, or will it keep looking outward?
DC: After thousands of years living on their land mass, the Chinese understand the limits of their own natural resources. China will reach out to find commodity resources wherever it can in the world. The Nexen acquisition in Canada is a recent example.
TGR: That sounds like a kind of reverse imperialism.
DC: Speaking of which, I highly recommend that investors interested in natural resource commodities read one of the most important books of the 20th century, which is V.I. Lenin’s “Imperialism: the Highest Stage of Capitalism,” written in 1915. It analyzes World War I as being caused by cartels set up in the capitalist nations. It’s a brilliant analysis of the way the world was divided up into empires prior to WWI.
“Bullion is a good substitute for having extra cash in hand, but as an investment, I believe you’re better off owning stocks of the well-managed gold companies that do not have political risk.”
It’s also a textbook for the Politburo, because it sets out the Chinese strategy for economic domination, which is not to be reliant on the big capitalist corporations, but to go into the countries where those companies cannot operate.
For example, BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) and Rio Tinto (RIO:NYSE; RIO:ASX) tried to merge their Australian iron ore operations. That would have meant that two-thirds of all Chinese iron ore imports would have emanated from one organization, which is precisely what Lenin had predicted. The Chinese were horrified by this possibility. They found a way of getting a block on that merger. They are prepared to fight cartelization.
Imperialism is the final stage of capitalism, Lenin said. So the Chinese are saying, we’re going to go out there and do capitalism better than ever during the final stage. We’re going to places around the developing world where American companies can’t go. When the Chinese dig copper out of the Congo, that copper competes with the copper being produced in Arizona by American companies. And it is cheaper.
TGR: You’re one of the speakers at the upcoming Casey seminar, talking about navigating the politicized economy. Could you give us a preview of what you’ll be focusing on in your presentation that relates to gold?
DC: I tell people as rule number one of investing in any commodity, do not invest in companies that produce what China produces or is likely to produce. Rule number two: Invest in companies that produce what China needs to buy. I’ve been saying that for 14 years, and it hasn’t changed. China needs gold.
TGR: Good advice. Thank you very much.
Read Don Coxe’s advice on investing in the energy sector.
If you can’t attend the “Navigating the Politicized Economy Summit,” you can still benefit from the information the 28 experts have to impart in the Audio Collection. Right now you can save $100 when you pre-order the 20+ hours of audio.
Donald Coxe has more than 39 years of institutional investment experience in Canada and the U.S. He is strategy advisor to BMO Financial Group with $500 billion under management. From his office in Chicago, Coxe heads up the Global Commodity Strategy Investment Management Team–a collaboration of Coxe Advisors and Harris Investments to create and market commodity-oriented solutions for investors. He is advisor to the Coxe Commodity Strategy Fund and the Coxe Global Agribusiness Income Fund in Canada, and to the Virtus Global Commodity Stock fund in the U.S. Coxe has consistently been named as a top portfolio strategist by Brendan Wood International; in 2011, he was awarded a lifetime achievement award and he was ranked number one in the 2007, 2008, and 2009 surveys.
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With a perfect storm brewing on the horizon, investors should be building their cash cache and running for cover, warns Harry Dent, author of The Great Crash Ahead. In this exclusive interview with The Gold Report, Dent explains how central bank stimulus programs are fighting a futile battle because a huge army of aging baby boomers has reached the stage in their economic lifecycles when they curb spending. How is Dent preparing for the gathering storm? Read on. . .
The Gold Report: Your considerable research over many years indicates that the size and age of its citizens drive a country’s economic growth or decline. Because people have predictable consumption patterns throughout life, you can predict well in advance national economic growth or decline. How does that work?
Harry Dent: We’ve identified a peak spending wave indicator that correlates strongly with the stock market and the economy. It doesn’t apply so much to emerging countries, where we look at urbanization rates, which greatly affect incomes, and workforce growth because emerging nations don’t have a middle-class curve where typical consumers earn $60,000 a year at the peak of their careers.
In developed countries, though—countries with higher-tech infrastructures and a solid middle class—this spending wave indicator peaks at around age 46. People slow in spending way ahead of retirement, from 46 on. That is basically when the average person’s kids are leaving the nest. In fact, the greatest slowing comes from age 50 on. That’s the correlation, that people earn and spend more money dramatically as they approach midlife. On average, they enter the workforce at about age 20, marry at 26, have their first child when they’re 28, and hit 46–50 when that child gets out of school. Then their spending drops like a rock. Part of that is because they’re saving for retirement but, more importantly, they don’t need bigger houses and don’t drive their cars nearly as much. It’s just a natural life cycle in developed countries. It’s the ultimate leading indicator.
We saw the spending slowdown we’re experiencing now coming 20-some years ago, when we came up with this tool. We said baby boomers’ spending would peak around 2007 and slow down from 2020–2023.
TGR: Is the pattern the same across the globe, or do slowdown years differ from country to country?
HD: There’s some degree of variation, but the post-World War II baby boom pretty much happened around the world. Birth rates in most developed countries peaked in the late 1950s to early 1960s, so the whole developed world is pretty much synched on this baby boom, all peaking together. Japan is the one exception, where births peaked twice, once in 1942 and again in 1949.
TGR: So you’ve gone back through history and now can predict that every 40 years or so a country’s economy slows as waves of babies come through. Is the age-related consumption pattern the only demographic you use to evaluate what influences economies?
HD: Another cycle comes into play as well. It’s an 80-year economic cycle consisting of two generational booms and busts, like the Bob Hope generation that drove the U.S. economy up from 1942–1968 and then down from 1969–1982, and then the baby boomers who drove it up again from 1983–2007 after that 46-year lag, and now down again from 2008–2023. Additionally, these boom-and-bust pairs go through a pattern we relate to the four seasons.
“We’ve identified a peak spending wave indicator that correlates strongly with the stock market and the economy.”
If you think of the consumer price index (CPI) in temperature terms, a high CPI is hot, or inflationary, and a low CPI is cold, or deflationary. A deflationary period or depression, as we’re going into now, is the winter season. A spring boom follows, with a new generational spending pattern and the modest inflation that comes with it.
In the summer, with that generation entering the workforce, inflation continues to rise. We do a lot of research to demonstrate that young people are inflationary. They have more to do with inflation than any other factor, and nobody has a clue of this in economics. The last summer in the U.S. occurred when the baby boomers entered the workforce in large numbers, basically from the late 1960s through the early 1980s.
The fall boom brings bubbles and the resulting expansion of debt. Stocks, real estate and so on bubble up and when that boom ends, those bubbles burst. Winter sets in again, with restructuring and deleveraging of debt, which create deflation.
The 1970s was a difficult recession time, but it was inflationary, not deflationary, and not similar to the downturn that the Federal Reserve is trying to prevent now. The Fed is actively and constantly inflating the economy to prevent deflation to avoid a replay of the Great Depression. But it won’t be able to hold it off indefinitely.
TGR: Let’s talk a bit about the debt issue.
HD: In the U.S., most people focus on government debt. Under George Bush, the national debt grew from $5 trillion (T) to $10T in 2000–2008. At the same time, the banking system, financial systems and shadow banking—in the private sector—created $22T in debt. That was the greatest debt bubble in history, and it occurred in developed countries all around the world. So we have this global debt crisis and this debt has to deleverage. Everybody is in too much debt—financial institutions, consumers, businesses and governments, with central banks propping them up and bailing them out. Obviously, this can’t go on forever.
If the demographics weren’t working against the Fed and the other central banks, it might be different. But they’re fighting a battle they can’t win because the baby boomers are working against them. How do you stimulate an economy when the largest part of its workforce, the aging baby boomers, wants to save and not spend, to pay down debt?
“How do you stimulate an economy when the largest part of the workforce, the aging baby boomers, wants to save and not spend, to pay down debt?”
That’s the problem. The money the Fed creates gooses up the markets, but doesn’t do much for the economy, and banks aren’t lending. It’s crystal clear in history. Every time you see a big debt bubble in a fall boom—as in the 1860s and 1870s—a depression follows. We saw this from 1873–1877 and into the early 1880s. We saw the next big bubble into the roaring 1920s, followed by the Great Depression and debt deleveraging after that. In short, debt bubbles ultimately burst and then deleverage. Deleveraging debt destroys money, so there’s less money in the system and it means deflation in prices.
That’s very important for investors to understand. In a deflationary crisis—whether in the 1930s or what started in 2008—everything goes down: commodities, stocks, real estate, even gold and silver in many cases. In deleveraging an asset bubble, all assets go down and there’s nowhere to hide. Investors have to be in the U.S. dollar and very safe bonds and cash and wait for the crash, and then buy at the bottom. That’s the trick. Cash is king—cash and cash flow.
In contrast, in an inflationary crisis such as the one we had in the 1970s, commodities, gold and silver were booming. Japan was in a positive demographic cycle. Emerging countries benefited. Real estate loves inflation. In that environment, a lot of things go up, but stocks and bonds go down. In this environment, though, there’s nowhere to hide.
So people just have to get out of the way. Even with all the stimulus, the Fed has no way to restore normalcy with this debt level and this demographic downturn. The stimulus has merely created bubbles in stocks and commodities, and commodities are already going down pretty fast. We think stocks are next, so we expect another stock crash within the next few years. And the next crash will be worse than in 2008–2009 because the Fed has pumped everything up and stretched the system to the max.
This is what happens in the winter season. It’s a survival-of-the-fittest struggle for businesses to see who will dominate their industries for decades to come. So it’s a huge payoff for the companies that simply survive and it deleverages the whole debt and asset cycle and brings things back to affordability. So it’s a difficult season, but it’s necessary and actually good in the long term. Lower prices in general will increase the standard of living.
The government is trying to skip winter. It keeps heating things up, pouring the money into the economy so the banks don’t deleverage debt and the banking system doesn’t collapse as it did in the 1930s. The truth is, it’s only keeping us in high debt and maintaining a bubble that’s not sustainable. Sooner or later, this stimulus will result in a crash that takes down the economy.
The top 10% of consumers are the only ones still spending. We know from demographics that wealthier people marry and have kids a little later. Their kids go to school a little longer, so their spending peaks four to five years after the average person’s. After these folks’ spending peaks, which will be by the end of this year, we’ll have a second demographic drag on the economy.
TGR: So we’re basically just getting into this 2008–2023 winter depression. How deep will the trough go? Will it bottom at the midway point? What should consumers expect over the next 20 years?
HD: A winter season lasts from 13 to 15 years or so. The worst collapses in stock prices and real estate hit when the banking system deleverages. In the 1930s, that happened early on. In this case, the government took a lesson from the 1930s and decided to keep pouring money into the banking system to prevent its meltdown. But it can’t be done. There’s a limit to how much you can stimulate. It’s like a drug. It takes more and more of the drug and it has less and less effect until it has almost no effect, and then the drug itself kills you.
We’re seeing that in Europe already. The last round of stimulus there—Qualitative Easing (QE) 2—was massive and came well after QE2 in the U.S., but Europe’s already back in trouble again and is having to implement all sorts of emergency procedures. There’s no bailing out Spain. It has one of the biggest real estate bubbles in the world and a rapidly aging population. The Spanish people won’t be buying housing for decades.
TGR: What do you see in terms of stocks?
HD: The worst is likely to hit in the next two years. It’s a matter of when the stimulus stops working or when governments throw in the towel. At some point, for example, German citizens may just say they won’t bail out another country. They’ve been doing it to protect exports and avoid defaults on all of the money they’ve loaned out already, but considering the demographics, it’s a losing game.
We’ve studied all of the major debt bubbles and depressions in history, and this one is different because Keynesian economics, which came out of the Great Depression, wasn’t adopted as economic policy until the 1970s recessions. So now, for the first time in history, central banks around the world—the European Central Bank (ECB), the U.S. Federal Reserve, the Bank of China and the Bank of Japan—are actively fighting deflation. When banks start to deleverage or when deflation starts to step in, they just push money into the system. The question is: Do they lose control?
Japan has been through all of this before, but when it came into its crisis in the 1990s, it had budget and trade surpluses. The rest of the world was experiencing the greatest boom in history, which we’d predicted. There was mild inflationary pressure and everybody thought Japan was about to take over the world when it was about to collapse. We were among the few who predicted that ahead of time in the late 1980s.
Japan continued to push money into the system and never let private debt deleverage at all in either consumer or financial sectors. Japan is still carrying very high private debt, and its government debt has risen from 60% of gross domestic product (GDP) to 230% and still climbing. So Japan didn’t really go through a depression. It was more an on-and-off mild deflationary recession because the stimulus eased the pain. But now Japan’s debt is much larger than before the crisis and deleveraging still looms ahead. Japan has been a lost economy for 22 years now. Real estate is down 60% and stocks are still down nearly 80%, 22 years later.
Demographics say the Japanese economy will weaken even further after 2020. The interest on its debt will go up in a spring boom with rising inflation worldwide, and it will be bankrupt immediately because its debt is so high. It’s only because it’s borrowing at 1% or less that it can handle its deficits now. Sooner or later, this game has to end.
TGR: So Japan’s QE has raised government debt to more than 200% of GDP but only managed to postpone a depression?
HD: Yes, it kicked the can a couple of decades down the road. It’s like trying to resuscitate a patient with a defibrillator. You keep hitting the chest, clear, boom. At some point, the patient dies. If the bond markets allow the U.S. to keep putting in money like Japan, we’d end up with a balance sheet on the Fed at $5–6T and up with QE of $4–5T before this is over. We’ve only gone about $2T so far. The Fed stimulus pushes money into the banking system, but the banks don’t lend it to fuel economic growth. They cover their losses and reserves, and then turn around and reinvest the rest in government bonds and stocks. They’re speculating. The money ends up in the stock markets. It’s like crack in the markets, and the markets just want more crack. But the markets can’t continue to go up when demographic trends are pointing down.
TGR: Your earlier mention of losing control brings to mind the people of Greece out in the streets rioting because demands for further sacrifices and more fiscal austerity have become unbearable.
HD: It is true. One of our financial advisers who was there recently reported every third store is closed or boarded up. Greece is in a depression and Spain’s headed there. The ECB has already pumped $270 billion into Spain and Greece just to cover its bank runs, which may happen faster than the governments can fend them off. In the U.S., the vulnerability is much more in real estate, as in Spain. We have a backlog of close to 4 million foreclosures already in the system. At some point, the banks will realize that home prices are not coming back. That they haven’t come back in Japan after 21 years gives us a hint. But if the banks start dumping these millions of foreclosures that aren’t on the market, it would kill the housing market and trigger a bank crisis that the Fed couldn’t stop with stimulus.
China also is vulnerable. Exports, which drive most of its economy, are declining rapidly while government spending on vacant buildings and empty cities has created a real estate bubble. If that bubble begins to seriously break down, Chinese consumers with disposable income, the top 10% of the population, own the real estate that will lose its value.
TGR: A while ago, you said businesses that manage to survive the winter would dominate their industries for decades to follow. What advice do you have for those running companies to help them come out the other side of a depression?
HD: First, those who are running a company and thinking about retirement within five years should sell their companies and retire now. Those who want to keep their companies and hand them down to the next generation or continue to grow them should hunker down, cut costs, cut overhead and put off capital expenditures. Rent your building; don’t own it. Sell real estate. Sell marginal product lines. In fact, sell everything you don’t need. Do everything to raise cash because, as I said before, cash and cash flow are king. Be lean and mean. Office space, real estate, factories, warehouses, anything you want to invest in your company will be a lot cheaper after deleveraging. Even if your business weakens, if your competitors weaken more rapidly, you’re winning. At some point, a lot of your competition, just like a lot of banks, will fail.
“Investors should be looking to invest more in emerging countries because they’re going to outperform.”
We saw this phenomenon after the Great Depression. There was a big payoff for the companies that survived; they dominated their industries for decades to come. Everybody thinks the market leaders were born in the technology revolution in automobiles and electricity in the early 1900s and into the roaring ’20s. Certainly, the race was on then, but the shakeout of the Great Depression decided who was left standing. General Motors survived and absolutely dominated the automobile industry from the 1930s through the 1970s. In electronics, it was General Electric.
TGR: You’ve also emphasized the importance of cash and cash flow for investors, advising them to either exit the equity markets or greatly reduce their exposure to stocks.
HD: Yes. Take advantage of the fact that the Fed has revived stocks and sell when the market is high. Reinvest when the prices are low. Joseph Kennedy made his fortune in the early 1930s, getting out at the top of the market when his shoeshine boy was giving him advice. When stocks were down 87%, he was buying at $0.10–0.20 on the dollar.
TGR: What are you doing personally to preserve or grow your wealth during this winter?
HD: I moved from Miami to Tampa in 2005, at the top of the real estate bubble and I’ve been renting, so I avoided a huge loss. Real estate in my neighborhood is down about 50%, and probably will fall another 20–30% before it’s over. I’m just looking at investments to actually be short stocks. I’m looking at ProShares Ultra Short MSCI Europe (EPV), which is an exchange-traded fund (ETF) at two times short the MSCI Europe index. The ProShares UltraShort Financials ETF (SKF) is another good one, two times short financials, because the financials in Europe are tending to get hit the worst. I think there’s a rising chance in Europe in the next few months of either a mini-crash, about 20% off the top, or a major crash like 2008–2009, where Europe just blows up. One way or the other, you need to either be out of stocks or you need to bet on things going down.
TGR: Any other insights?
HD: We’re buying natural gas, which seems to be going up since it bottomed out at $2. We’re buying agricultural commodities because that’s the last thing to go down in demand, and emerging market demand is still strong. Apart from natural gas and agriculture, though, pretty much everything else we see going down.
TGR: What about gold?
HD: I think gold has another run in it. It’s trending down right now, but I’d expect gold to benefit from the early stage of this crisis. If we have one more big QE coming in the U.S. and Europe—especially in Europe—gold is likely to rally. We told people to sell silver when it hit $50/ounce (oz) in April of last year. Now we’re suggesting selling gold if we see a good rally, say, $2,000/oz or higher.
Ultimately, there’s a natural instinct to expect gold to go up in a crisis, but if you look at 2008, gold and silver went up in anticipation of a financial crisis. But when the crisis actually hit and debt started deleveraging and money supply started contracting, which happened in the second half of 2008 and early 2009, gold went down I think 32% and silver went down 50%.
TGR: Everything went down.
HD: Exactly. That’s the point. The only thing that went up was the U.S. Dollar Index and Treasury bonds. This time, I think Treasury bonds may turn around. People act as if German, U.S. bonds and United Kingdom bonds are risk free. They are not. These U.S. and UK governments are in terrible debt, and Germany is holding the bag for Europe. People are throwing money at negative yields just because they don’t know where else to go. A better bet might be to go long the dollar or, even better, short the euro. That would be a good hedge.
TGR: What’s the best investing advice you ever received, Harry?
HD: Basically, I think you have to think contrarian, because it’s just human nature for people to pile into something, especially in these bubbles we’ve seen. They pile into tech stocks or real estate, thinking they can’t go down, and then the bubbles burst. I learned early on to think contrary to the crowd, something like Joseph Kennedy. Right now, most investors think these markets can’t go down because the Fed won’t allow them to. They call it “the Bernanke Put.” Well, if everybody’s thinking that, I don’t think that.
TGR: Whom do you view as the best investors?
HD: The classic ones are Benjamin Graham back in the good old days and Warren Buffett these days, although I think Buffett’s off base now that he’s become a cheerleader for the U.S. government.
TGR: You’re speaking at the MoneyShow in San Francisco in late August. What major themes will you cover?
HD: Basically three things: debt, demographics and deflation. People who argue that hyperinflation is ahead are dead wrong. Japan had zero inflation for the last decade despite massively more QE than we’ve done relative to its economy. It would have been a deflation if it hadn’t stimulated so much and the world hadn’t been in an inflationary mode. Debt deleveraging leads to deflation, and aging societies are deflationary. Old people are deflationary, young people are inflationary. The inflation of the 1970s had nothing to do with monetary policy. It was the baby-boom generation partying in college, spending their parents’ money. It’s expensive to raise kids, who don’t contribute economically until they get into the productivity curve in the workforce. At that point, productivity drives down inflation.
TGR: Do you expect the U.S. to fare better than Europe over the next two decades because of the echo boom, as the millennial generation gets into a serious spending cycle?
HD: Yes. The echo boom kicks in from about 2023 forward in the U.S. and in a lot of countries. It’s nowhere near the size of the baby boom generation, but enough to create growth again. But there’s no echo boom in Southern Europe or in China, where the workforce will start shrinking like Japan’s after 2015. Japan’s little echo boom runs out by 2020, and because Japan never deleveraged its economy, it’s not even benefiting much from it.
But, yes, there should be a worldwide boom with the stronger developed countries—Northern Europe, North America and Australia—doing fairly well, though as I say, not as strong as the boom we saw in the 1980s, 1990s and early 2000s. Excluding the developed countries of East Asia—Japan, Korea, China—the emerging world will really dominate in terms of demographics and workforce growth. Investors should be looking to invest more in emerging countries because they’re going to outperform. I would look first at India and Southeast Asia.
TGR: Should we be doing that now?
HD: Not yet. I’d wait until after the shakeout. China’s slowdown is hurting emerging countries, which depend on exporting resources, and so are the collapsing commodity prices. By the way, the 29–30-year commodity cycle has nothing to do with the 40-year demographic cycle, but they happened to peak in the same timeframe, around 2007–2008.
TGR: Other than going to cash, what else should people be doing to prepare for the depression/deflationary period ahead?
HD: Cut expenses and high-interest debt. I wouldn’t cut a mortgage if I’m paying 4–5% tax deductible on it, but get rid of credit card debt with interest at 22%. Don’t make any big capital expenditures. Don’t buy a house and don’t let your kid buy a house. If you’re more aggressive, you can bet on markets going down. For example, you actually can make money in the downturn if you short the euro, European stocks and U.S. financial stocks. But for most people, it’s just better to be safe.
TGR: Easier said than done these days.
HD: Unfortunately, the government is making it very difficult. The stimulus programs are knocking down interest rates on safer, long-term bonds so people can’t get yield anymore. If they go after yield, if they rush into bonds, stocks, commodities or especially dividend-paying stocks—which are the most popular thing now—they’ll get creamed when the stock market crashes. The alternative is to give up the dividends and low yields. Just be safe. You’d be crazy to buy a 10-year Treasury at 1.4% yield or a 10-year bond at 1.3% yield. All the countries are going to be in trouble.
TGR: Thank you, Harry, for your time and your insights.
Harry Dent will be a keynote speaker at the upcoming MoneyShow in San Francisco on August 24–26, 2012. Click here to register for free.
Harry S. Dent, Jr. is founder and CEO of the economic research and forecasting organization that bears his name and publisher of the HS Economic Forecast and the HS Dent Perspective. During the early 1980s, while a strategy consultant for Fortune 100 companies and new ventures at Bain & Co., Dent recognized the force that baby boomers exerted on the trends of the time, which led to his development of The Dent Method, a long-term forecasting technique based on the study of and changes in demographic trends and their economic impact that financial advisers and individual investors use via Dent’s Monthly Economic Forecast, Economic Special Reports, Demographics School and The Financial Advisors Network. HS Dent also provides two newsletter services. Former CEO of several entrepreneurial growth companies and a new venture investor, Dent also is a sought-after speaker and best-selling author. Since 1988 he has been presenting to executives and investors around the world, appearing on Good Morning America, PBS, CNBC, CNN and FOX and featured in Barron’s, Investor’s Business Daily, Entrepreneur, Fortune, Success, US News and World Report, Business Week, The Wall Street Journal, American Demographics, Gentlemen’s Quarterly, and Omni. Dent’s books include The Great Crash Ahead (2011), The Great Depression Ahead (2009), The Next Great Bubble Boom (2006), The Roaring 2000s Investor (1999), The Roaring 2000s (1998), The Great Jobs Ahead (1995), The Great Boom Ahead (1993) and Our Power to Predict (1989). Dent received his Bachelor of Arts degree from the University of South Carolina, graduating first in his class, and his Master of Business Administration from Harvard Business School, where he was a Baker Scholar and was elected to the Century Club for leadership excellence.
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Just reading the Sunday paper(s)………
PG is focusing on veterans in the SW Pennsylvania in a set of articles today: Weak economy, lack of opportunities have returning vets fighting for jobs. A different angle, but last year some colleagues looked at: The Impact of Veterans Returning to the Pittsburgh Region. I myself am amazed at how much the world has changed since I wrote this old piece.
Trib is running a WashPo story that looks at demographic issues impacting the labor force nationally: Diminishing work force bad sign for economy. I just looked at the past, present and future of demographic changes impacting just the Pittsburgh region’s labor force in: Projecting the Impact of Demographic Change in Pittsburgh’s Labor Force.
PG looks at what is in a sense a perpetual story: Heard Off the Street: Manufacturing jobs await skilled workers. Which if you want to dig into more there was an interesting piece on the PBS newshour recently that I was going to post on and then forgot. The piece was laudably in depth, yet in the end incredibly conflicted piece on the state of the national labor force and this particular theme of how hard it is for manufacturers to find workers. Suffice it to say it’s not a simple issue. The piece is also based in an Ohio town not far away: Galion, Ohio, which is outside the heart of Cleveburgh, but not too too far away. It gets to this great confusion that is not new in any way. Jobs out there going unfilled all while lots of folks unable to get to work. I’ll embed the video below.
Just catching up on some things. A few have asked me about an article a couple weeks ago covering some work from Harold on how Pittsburgh’s medicare spending per capita compares to other regions. In summary read: it’s really high.
It just got me thinking. Whenever I see anything like this I wonder about the impact of age demographics. I can’t tell from the PG’s coverage if there is a fuller reference to look at as it does not give a specific cite, but I think it all follows directly from the data in the map at the the Dartmouth Atlas . So this isn’t really intended as a reaction to that article as a general look at what is going on within the elderly population here compared to elsewhere. Still that map there on the Dartmouth Atlast sure appears to me superficially to have a strong correlation to maps of age in the US; at least that big older swath through Appalachia. I can’t begin to say much about what is going on in Texas and the Gulf Coast.
Even just looking at the local elderly population it is not quite the same as the elderly populations elsewhere. I made a graph of how Pittsburgh’s elder population compares to other metropolitan regions. This is what I get for the breakdown of “Older Old” population, I’ll use the population age 85 and over here, as a propoprtion of the population age 65 and over.
So that is a pretty significant range across metro areas. Some have much older elderly populations than others. Hard to imagine that does impact expendtures on health care here compared to elsewhere. That would especially be true of a Medicare served population which is older to begin with. It may be an age factor that is accounted for in the initial benchmarking of this data, I don’t know.
This all would matter in the health care context a lot since at least the economists have worked out that a large chunk of Medicare spending is all tied up in end of life care
. So if you have a lot bigger proportion of your population nearing mortality, then you might expect that to show up in the health care costs in aggregate. Since Pittsburgh remains the only large metro area with a natural population decline (more deaths than births) we remain an outlier across a lot these demographics.
Just to think about is all.
It’s possible that I may have contributed to a few stories not making ink. If even partially true, it wasn’t my intention. I believe there was interest in a report Brookings released today: Education, Demand, and Unemployment in Metropolitan America. You can see a selection of those stories from around the country.
The curious thing was that they had Pittsburgh listed in the top for their categorization of regions listed as “unfavorable Education Match; Favorable Industry Compostion“. That group was defined as having an ‘overall education gap’ that was a big contributor to local unemloyment. Basically their point is that Pittsburgh is undereducated in its workforce. Education being the broad taxonomy of high school, college, graduate school; basically years of education. It was not talking about skills mismatch in very specific occupational categories. These regions are also described as having “unemployment rates above the national average will tend to persist until they can either boost educational attainment”.
Problem is that as readers here know, the regional unemployment rate is below the national unemployment rate by a lot, and has been for what is now a historical length of time. As for educational attainment, you can look at parts of the labor force, the younger parts, and conclude we are among the most highly educated in the nation. If you look at the highest levels of education, those with graduate and professional degrees, I think the Pittsburgh region’s younger workforce is the single most highly educated inthe nation.
So what gives? Educational attainment is typically measured across the entire labor force. Some standard measures of educational attainment actually look at the population age 25 and over which is even broader. Our older demographic, coupled with what was a very blue collar labor demand a generation ago means our older generations don’t quite have the credentialed education of the folks finishing school today. The younger parts of the workforce is what truly represents how we have been doing as a region in terms of supplying workers. It’s not to say the methodology was wrong in the broad report in the news today. Pittsburgh is an outlier in the scale of change in this sense. So for most regions it is a decent measure to look at the educational attainment broadly, but for Pittsburgh it misses some very fundamental changes that have taken place in a very recent timeframe. So the Brookings numbers I am sure are correct, but broadly speaking are reflective of our economic legacy as much as anything else.
If you want to see a really remarkable graph we first put out here, take a look at the shift over generations in how Pittsburgh compares in this:
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One of the reasons that I have always had a problem with Goldman Sachs’ infamous notion of the BRIC economies was not the fact that it excluded other important economies such as e.g Chile or Indonesia, but rather that Brazil, India, Russia and China never belonged in the same group. The reason for this is largely because of demographics. Both Russia and China are consequently set to age much more rapidly than India and Brazil due to very rapid fertility transition in the 1990s. The demographic situation is especially dire in Russia which not only saw a dramatic and lingering decline in fertility in the 1990s but also saw a corresponding increase in mortality (aids and alcohol as big culprits).
A recent piece by Carl Haub suggests however tha while doom and gloom used to be the prevailing tone on the state of Russian demographics recent trends suggest that this should change.
Back in 2000, Russia achieved what Russians consider a dubious milestone, deaths (2,225,300) outnumbered births (1,266,800) by an astounding 958,500. The crude birth rate had sunk to 8.7 births per 1,000 population. Along with a crude death rate of 15.3, natural increase hit an all-time low of –6.6 per 1,000, or –0.7 percent rounded off. The total fertility rate (TFR) bottomed out at 1.195 children per woman. The crisis, as it was seen to be, was definitely noticed, but nothing really effective was done until 2007 when Vladimir Putin announced a baby bonus of the equivalent of $9,000 for second and further births. Putin has been an outspoken advocate for raising the birth rate and improving health conditions in order to avoid the consequences of sustained very low fertility. The program must have worked since births in 2007 jumped to 1,610,100 from 1,479,600 the previous year and have rising ever since. This is one of the very few “success stories” in the industrialized countries’ efforts to raise the birth rate.
Together with the rest of Eastern Europe that was re-joined with the West after the fall of the Soviet Union, Russia experienced one of the most brutal fertility transitions ever seen. Indeed, history seems to have been extraordinarily cruel to many countries in Eastern Europe in handing them a second chance at the end of the 1980s just to take it away with the other hand as their demographic fundamentals collapsed. The birth dearth in the East even stretched into Eastern Germany where the total number of live births fell from 215700 to 88300 in the period 1988 to 1992.
I have previously mused that perhaps those multinationals eager to expand eastwards would have to go all the way to Kamchatka to find qualified labour and perhaps even fail entirely and back in 2006, the only silver lining that the Economist’s Berlin correspondent could find was how a residing population had led to a revival of wildlife with the lynx returning to Germany’s Eastern borders.
Perhaps though, it is time to put this discourse to rest?
Russia in Transition
From 1989 to 1999/2001 the total fertility rate in Russia fell from replacement levels to around 1.1/1.3 and notable effort  has been put into explaining why birth rates fell so much, so quickly.
Grogan (2006) uses a household survey tracking data from 1994 to 2001 and finds that a large part of the decline in fertility among married couples can be attributed to the decline in household income in the same period. Grogan (2006) however also sheds light on other aspects of Russia’s fertility during the Soviet era. In particular, the paper sets out to explain completed cohort fertility for women born between 1936 and 1961 and finds that women with higher education had considerably lower completed cohort fertility rates than their counterparts. This squares well with the notion of the quantity/quality tradeoff of fertility famously developed by Gary S Becker  and how parents substitute quantity for quality as their income levels rise (with education), but it comes with an important twist in the Russian case. Since female labour force participation was almost universal during the Soviet era and since women with less than higher education often earned the same (or more) than their better educated peers, Grogan (2006) seems to imply an inherent demand, by part of well educated women, for quality rather than quantity in their fertility decisions.
The other driver of fertility decline in the form of the tempo effect is also present in Russia, but Grogan (2006) is skeptical as to its merits in explaining the sharp fall in fertility in the 1990s. It does appear to coincide with a change in attitude towards marriage and, specifically, births outside marriage, but from 1988 to 2000, mariage rates declined for the broad category of women (aged 15-44) as well as the share of total live births taking place outside marriage rose from about 14% to 26%.
In essence, the tempo effect over the period in question is not linear and seems to neutralize itself over time.
From 1989 to 1994, the share of births to mothers under 20 actually rose and then declined to just above 1989 levels in 2000. Not surprisingly, the share of total non marital live births among mothers aged less than 20 years rose sharply from 1989 to 2000. This suggests that the extent to which non-marital live births increased, it resulted in children being borne to young mothers. From a theoretical perspective, this is important in relation to how a change in the life course towards postponing marriage also leads to a postponement of childrearing. A norm of non-marriage child births may then serve to weigh against the tempo effect of fertility.
This non-linearity of the tempo effect throughout what was essentially a sharp linear decline in fertility is interesting. The charts produced in Grogan (2006, p. 65 fig XI) clearly suggests that from 1989 to 1994 total live births for young mothers aged under 20 as well as those from 20-24 rose as share of overall birhts. This reverses somewhat in 1994 where live births for mothers aged 25-29 starts to increase as well as those aged 30-34. Yet Grogan (2006) notes that since there is no meaningful change in the fraction of total live births of “older” mothers in 2000 relative to 1989, the decline in fertility in Russia is not a postponement phenomenon.
Brainerd (2006) builds on the points above by similarly latching on to the idea that the economic hardship bestowed on Russian citizens in the 1990s contributed to the decline in fertility. This suggests again a more permanent negative quantum effect at work rather than merely a postponement phenomenon. But the underlying causes of the fertility decline is cut very finely by Brainerd (2006). Notably, the paper argues for a pure negative income effect on birth rates and thus a reversal of the standard quantity-quality tradeoff as developed by Becker. The interesting thing here is that little evidence is found that general macroeconomic uncertainty (of the future) affect fertility even if women with more negative expectations of the future had a higher propensity of abortion.
Quantitatively, Brainerd (2006) finds strong evidence for how marriage and a higher income per capita positively affects fertility using a fixed effect estimation with age specific fertility rates as dependent variable. Since marriage rates and income declined in the period 1989 to 1999, it leads to the conclusion that this caused the decline in fertility. I find this plausible, but would note that the estimation results suggests that underlying uncertainty of the future might still be affecting these results. For example, Brainerd (2006) shows how the effect of income on fertility is strongest for young mothers which indicates that permanent income may be a more useful proxy for linking fertility to income levels than the traditional method of using fluctuations in current income. It also sugggests that the income effect might be lower over time in the aggregate if we assume a general process of postponement, but this is dubious in Russia’s case following Grogan (2006).
And now lets go make some kids … ?
In general, the tendency of non-marital births is interesting to dwell on and Perelli-Harris (2008)  draws a sharp distinction between two reasons to explain it. The first relates to the notion of the second demographic transition  which postulates that the extent to which non-marital births occur in stabile cohabitations, as e.g. in the Scandinavian countries, it reflects a change in value towards marriage and thus a change in the life course. Contrary to this stands evidence, largely from the US, that non-marital births are associated with much less stable unions and, generally, poorer levels of society.
Not surprisingly, Perelli-Harris et al (2008) do not ascribe either of these explanations to the rise of non-marital fertility in Russia, but rather; a mixture of both. One important aspect here is the extent to which, after a non-marital contraception, women with higher education tend to enter into marriage with a much higher probability than women with lower education. But everyone will be able to find sources to support their argument with for example this article by Sergei V. Zakharov and Elena I. Ivanova arguing for a more traditional second demographic transition process in Russia.
One overarching conclusion which emerges on the fertility decline in Russia is that it was not driven primarily by birth postponement but seems to have been pushed by a more lingering quantum effect. The more specific driving forces of this quantum effect is much more difficult to get a hold on, but from the perspective of the macroeconomist it appears as if Russia entered a sinister spiral of increasing mortality and declining fertility just as the economy was meant to rebuild and then later take off on the much hailed wave of convergence. In particular, it appears as if the general adverse economic environment in Russia in the 1990s may have caused fertility rates to “undershoot”.
Pro-natalism in Russia, Action and Reaction?
While we may certainly look upon Russia’s demographic experience as a frightening example of the effect of negative population momentum, it would be unfair to say that the Russian leadership has been sitting idle. In 2006, Vladimir Putin announced a number of pro-natalist initiatives targeted at reversing the the decline of Russia’s population. The plan included longer maternity leave, increased child benefits and most notably a full USD 9000 payment to women opting to have a second child Brainerd (2006).
In May 2009, president Medvedev arranged for eigth families to be courted at the Kremlin where they were awarded the Order of Parental Glory; the Levyokin family chosen to represent the Moscow region had, at the time, given birth to no less than 6 children.
Getting his Priorities Straight
The question is whether it has worked?
According to Carl Haub it has (see above), and if this is indeed one of the few success stories of how ageing economies can reverse their birth rate, it is worth paying more than scant attention to. The data here is subject to some uncertainty, but following Haub’s lead the total fertility rate in Russia stood at 1.54 in 2010 which is up from a low point of 1.2 in 2000. In addition, Haub notes an important distinction between rural and urban fertility rates with the former standing at 1.9 in 2010 and the latter at 1.42. This last point is difficult to underestimate since it shines a rather pessimistic initial light on the strides to increase fertility in Russia. In particular, it casts russia in a more classic emerging market context witha a very abrupt quantity/quality trade-off at work whereby especially urban fertililty undershoots significantly below the replacement level.
Still, the aggregate picture is improving.
(click on charts for better viewing)
In the jargon of the profession we must now be seriously asking whether Russia is about to join the very few nations that has managed to break free of the fertility trap defined here as how total fertility rates often don’t recover (or has not recovered yet!) once they fall below 1.5. The only two other countries which have seen their fertility levels rebound from below 1.5 are Denmark and France.
I would happily announce that this is the case, but the plot is just about to thicken.
On the positive side and given evidence from the academic literature that the tempo effect is not a relevant phenomenon in a Russian context, it stands to reason that this rebound can be interpreted as a real change in sentiment towards having children.
Score one for Russia’s pro-natalist policies then?
To some extent though Carl Haub pours water on this idea noting that the second derivative of the fertility increase is falling which leads him to ponder whether the rise of Russian births is losing steam. This argument is taken further by Kumo (2010)  who suggests that not only did Russia’s pro-natal policies not work in the first place, but also that the rise in the number of births can be attributed entirely to fluctuations in the number of women in their reproductive age. More importantly however, Kumo (2010) emphasizes the difficulties of micro managing fertility and specifically the issue of just how difficult it is to get a lasting impact on fertility from cash transfers. In short, empirical evidence shows that pro-natalist policies rarely have a permanent effect. This is even more likely to be significant in a Russian context as the fund set up to dole out money to fertile mothers expires in 2016.
Ageing in Russia, Adjusting for Mortality
To assume that the Russian government’s attempt to push up fertility rates will have a lasting permanent effect is probably as dubious as assuming that it will have no effect at all. In addition, if Russia is serious about securing a future balanced population pyramid, what is to say that there won’t be more initiatives?
Still, it appears that just as Russia seem to be making strides in the fertility department, the appalling situation for adult male mortality continues to taint the overall picture. Here, the optimists will call foul play and point out how the main story on Russian demographics has recently been a co-movement of improving mortality and fertility rates. This may be true, but overall conditions are still poor.
According to data from the World Bank only a mere 47.4% of a male cohort can expect to celebrate their 65th birthday which contrasts with 78.5% for women. On average (from 1998 to 2009) only 44.5% of a given male cohort could expect to reach 65 years.
Despite the visible improvement since the mid 2000s, the evidence from a birds eye view has not changed. Male life expectancy seems to be mean reverting around 61 to 62 (at birth) and mortality for adult males exhibits an increasing trend. An afinity to Vodka and other spirits as well as too many cigarettes appear to be lingering killers. Recent research (2009) from the medicinal sciences using mortality patterns from Tomsk, Barnaul and Biysk suggests alcohol was a cause of more than half of all Russian deaths at ages 15-54 years.
As a result, the natural increase is still negative as the up-tick in births has still not managed to pip the mortality rate here even if it seems a more lasting change may be underway here.
A Rare Sight
Regardless of the permanency of recent years’ improvement in fertility Russia cannot escape a rapid process of ageing. More than anything, this is why I so ardently argue against lumping Russia together with India and Brazil or more specifically; in Russia there is no positive demographic dividend in sight; rather what we have is a negative one.
Of course, we cannot simply assume that the Russian population will fall from here on as one would assume (and hope) that Russia manages to reverse the trend in mortality. What we can see however is that in terms of the prime age group (35-54), Russia is likely to have peaked already in 2004 even if the effect of the double hump is interesting to consider (a result of assuming a perpetually declining population).
In addition, the process of ageing means that there is almost no chance of Russia being able to contribute to global rebalancing by sustainably running an external deficit. This is one of the single most important macroeconomic characteristics which suggests why we should not label Russia as an “emerging” economy. Russia and the CEE will instead be fighting to escape the mantle that they may just have grown old before they made it to become rich.
Especially the younger part of the labour force will invariably be subject to a swift decline and the composition of the labour force is crucial to consumption smoothing on the aggregate level and thus capital flows.
However, the most important aspect in the context of ageing in Russia is to adjust for the continuing high mortality rate among men. In a recent piece in Sciencemag Warren C. Sanderson and Sergei Scherbov argue that we should rethink ageing given that as the world population ages so does the threshold at which we can consider a person (or population) to be “old”.
(…) as life expectancies increase and people remain healthy longer, measures based solely on fixed chronological ages can be misleading. Recently, we published aging forecasts for all countries based on new measures that account for changes in longevity (5–8). Here, we add new forecasts based on disability status. Both types of forecasts exhibit a slower pace of aging compared with the conventional ones.
This makes perfectly good sense and governments around the world are busy pushing up retirement ages to reflect this, but does this apply in a Russian context? What good would it do to push up the retirement age in Russia if less than half of a male cohort makes it to 65? The principle applied by messieurs Scherbov and Sanderson cuts both ways and in Russia’s case we must incorporate an additional accelerant in our analysis of ageing to account for the continuing high rate of mortality and indeed an effect which will take some decades to pass through the pyramid.
Something Stirring in the East?
The recent improvement in Russia’s demographic indicators begs the question of whether the glass is half full or half empty. On the former I would note two things. Firstly, Russia has indeed seen a noticeable improvement in both fertility and mortality and it seems to have coincided with the government’s strategic aim to actually do something about the country’s decaying demographics. Secondly, I will salute the effort in itself. We can all probably agree that Russia has veered a little too much towards the way of authoritarianism under Putin, but whatever the underlying ambitions to push forward a positive population agenda I think it is extraordinarily important.
On the latter however, I am still worried that the trend in mortality have not been reversed and that, if anything, the situation is improving all too slowly. I am open to a more positive spin, but the data and an, admittedly scant, look at the evidence gives little comfort. As a result, ageing in Russia will be much more acute and its effect will have a much larger and negative impact than if life expectancy was a steadily increasing function of time. Indeed, given the continuing poor state of especially male health in Russia it is questionable whether the measures above of “peak growth” apply at all.
The most important feature of Russia’s demographic rebound is its potential permanency and especially we should watch whether Russia manages to stay above a fertility rate of 1.5. If this turns out to be case, we could harbour a hope that not only lynxes but also a rejuvenated Russian population may be stirring in the East.
* All photos in this essay are taken from Creative Commons License accounts at Flickr. Data for the charts are from the World Bank Database and US Census Bureau (long term population forecasts).
 – In the following I will make extensive use of Louise Grogan (2006) – An Economic Examination of the Post-Transition Fertility Decline in Russia and Elizabeth Brainerd (2006) – Fertility in Transition: Understanding the Fertility Decline in Russia of the 1990s.
 – Becker, G. (1960) – An economic analysis of fertility, In Demographic and Economic Change in Developed Countries. NBER: New York
 – Perelli-Harris, Brienna and Gerber, Theodore P. (2008) Non-marital fertility in Russia: second demographic transition or low human capital? In, Population Association of America 2008 Annual Meeting, New Orleans, US 17 – 19 Apr 2008. , 33pp.
 – The second demographic transition has many sources but these ones by Dirk J. van de Kaa are a good starting place.
 – Kazuhiro Kumo (2010) – Explaining fertility trends in Russia, VOX EU
NYT is reporting on demographics from our so distant neighbor Weirton, WV where the annual number of deaths exceeds births each year: With Death Outpacing Birth, a County Slows to a Shuffle.
Can’t hide from the fact that have long been there already. In fact even in the NYT it has been our story in the the past. See: As Deaths Outpace Births, Cities Adjust. Here is the trend in births minus deaths, also known as natural population change, in Allegheny County over the last 3 decades:
So if you focus on population change as a reflection of how people feel about a region, the voting with their feet argument, realize that for us the voting is not quite the same as it is elsewhere else.. and means something awfully different as well.
This is all part and parcel which is what the real big and understudied story that will impact US politics in the next couple of decades. Read from just the other day: Census estimates show seniors gaining influence .. and again something we are way ahead of the curve. Read: Older Voters Reign at Polls. Especially as the Big Sort continues it means primary elections will become ever more important nationally just as they are here.. and it is in primary elections that young voters really shun the process. Many even register as independents and in closed primaries as Pennsylvania has, can’t even vote in primaries. For us, by the time the primary gets here soon, most students will have finished the term and left town further depressing their impact. Not just the students of course, but a decent chunk of the workforce that is solely associated with education as well. What if the primary was moved up just a few weeks and the students were still around?
The political turmoil in Tunisia and Egypt that precipitated the abrupt end of decades of political dictatorships that governed the vast majority of countires in the MENA (Middle East and North Africa) region. The political revolution, influenced by democratic upheaval in Tunisia and Egypt, facilitated the attempts to overhaul the autocratic regimes in Bahrain, Syria, Yemen and Libya.
One of the most interesting and highlighting puzzles to resolves is which features contributed to the rise of democratic revolutions sweeping across the entire region. In fact, MENA region is world’s largest exporter of oil, enjoying the largest oil reserves in the world. Saudi Arabia, Qatar, Algeria, Libya and Kuwait constitute more than 42 percent of world oil reserves. In recent decades, MENA region experienced a growing degree of macroeconomic stability with low and stable inflation rate and steady economic growth. Large oil inflows, driven by the growing oil consumption in emerging markets such as China and India, boosted local currency appreciation and current account surpluses. The rates of growth in recent decade were remarkable, reflecting the growth of domestic demand as well as robust investment as the engine of growth. Countries in the MENA region also enjoyed favorable demographic conditions with low old-age dependency ratio and high share of working-age population, resulting in a demographic dividend which brought robust economic growth.
The indices of political change in the MENA countries prior to the outburst of the political protests in Tunisia and Egypt were nearly impossible to predict since a variety of macroeconomic, demographic and structural indicators facilitate the course of political change in developing countries, shifting from authoritarian political leadership towards a democratic political institutions with free press, free election and a vibrant civil society. Prior to the onset of the protests against authoratic governments in the MENA countries, the latter experienced benign levels of economic freedom. In the MENA region, the majority of countries experienced rampant corruption, heavily regulated labor markets, financial underdevelopment and inefficient legal systems. Bahrain, Qatar and Saudi Arabia enjoyed the highest degree of economic freedom in the region while Yemen, Syria and Algeria were already suffering from institutional paralysis and bad governance which brought these countries on the brink of failed states. If political change could be predicted on the basis of the level of overall economic freedom, Yemen, Syria, Algeria and Libya would experience the highest likelihood of political protests that would eventually lead to the political change.
Prior to the independence from France, MENA countries have been plagued by authoritarian governments given the extensive reserves of oil and natural gas. The absence of market institutions based on the rule of law under good governance and independent judicial systems eventually intensifed the rise of hybrid political regimes prone to corruption and poor governance. Even though corrupt military rule and political dicatorship precipitated the rise of the protests against authoratic rule, the pattern of structural change could be easily seen from the changing demographic landscape across the MENA region.
For most of the 20th century, countries in the MENA regions experienced rising income per capita levels. In fact, the growth of per capita incomes in North Africa surpassed the regional average given the fact that North African countries enjoyed high relative levels of income per capita at the beginning of the 20th century compared to Sub-Saharan Africa. For instance, in 1913, Tunisia enjoyed higher per capita income than Mauritius. The change in the demographic structure of the population began after 1950s. In all countries of the MENA region, the fertility rate decreased substantially. In Syria, the fertility rate almost halved between 1950-1955 and 2005-2010, from 7.30 to 3.29. The same trend in the fertility rate swept across the entire region. In Libya, the fertility rate between 2005 and 2010 fell below 3 children per women while Tunisia’s fertility rate dropped below 2 children per women in the same period. The astounding drop in fertility rates strongly reflected the growth in per capita incomes which boosted domestic consumption of durable and non-durable goods. In addition, oil-exporting countries such as Libya and Bahrain have experienced a substantial increase in export earnings. Large inflow of oil earnings, in fact, unleashed the income effect, brining higher spending on education and infrastructure. The distribution of literacy rates across countries (link) shows that literacy rates in MENA regions are remarkably high. In fact, Bahrain and Turkey boast of 88 percent literacy rate. Libya remained the North African leader in literacy rate (86.8 percent), ahead of Tunisia, Egypt and Algeria which, given the fragmentation and dichotomy of the population, enjoy literacy rates below 80 percent of the total population.
Countries from the MENA region differ substantially in the demographic projections of old-age dependency ratio. The estimates by the UN suggest that by 2030, the dependency ratio in North Africa and the Middle East is expected to experience a persistent rise. In fact, under constant fertility rates, the share of the population 65+ is expected to increase by 25 percentage points in Bahrain, 24 percentage points in Libya, 23 percentage points in Tunisia, 20 percentage points in Algeria, 15 percentage points in Syria and Saudi Arabia and 14 percentage points in Egypt. In Turkey, favorable fertility assumptions predict 7 percentage point increase in old-age dependency ratio until 2030. The empirics behind the clear explanation of fertility dyanmics across the MENA region reveals a persistent shift towards rapidly aging population across the entire region. The expedience of high fertility rates boosts the demographic dividend alongside the growth in income per capita until the break-even point when the pressure of aging population raises public pension expenditure and the introduction of social security schemes. These schemes, in fact, do not pose a systemic threat to the long-term solvency of public pension system as long as high fertility rates boost stationary population growth. The remarkable decrease in the fertility rates in the MENA is partly beared by the increasing amount spent on education. For instance, Tunisia’s education spending amounted to 7.2 percent of the GDP. The ratio is higher than in many advanced countries in the world. In 2007, Italy spent 4.3 percent of GDP on education, the same ratio as Algeria in the year later. The increasing amount of education expenditure, in both absolute and relative sense, reflects robust literacy rates for middle-income countries of the MENA region. In fact, the increasing amount of education expenditures per inhabitant boosted the information awareness by driving up reading, mathematical and computer literacy. Higher literacy rates, compounded by free access to various Internet applications, could substantiate hypothetically greater awareness of the public demanding political liberties, freedom of assembly and free press.
The demographic transition in the Middle East and North Africa is remarkably uneven, reflecting the variation in income per capita across the region. One of the key drivers of the demographic adjustment is the changing immigration landscape. Traditionally, North African countries have boosted one of the highest outward migration rates, particularly into Italy and France where Muslims account for about 9 percent of the population, the highest share in Western Europe. In addition, with 2.01 children per women, France enjoys one of the highest fertility rates in Europe. A brief overview of the ethnic fertility rates in France shows that French women of the Muslim origin boost significantly higher fertility rates compared to immigrants from Western countries. For instance, the fertility rates for women of Algerian and Moroccan descent exceed the fertility rates of Spanish and Italian immigrants by almost three times. In the next decade, income per capita across the Arab world is expected to increase robustly. Higher incomes would mean a shift towards the increasing amount of expenditures on durable goods. The change in the consumption pattern would be accompanied by a robust decline in the relative amount of income spent on food and other non-durables. Hence, the assumed fertility rates would converge to the Despite the prolonged decline in fertility rates across the Arab world, the demographic transition could precipitate the subsequent decline in robust economic growth rates which exacerbate the rapid rise in per capita incomes in the MENA region.
The peculiar feature of the majority of countries within the MENA region with the exception of Turkey is the presence of natural resource barriers. The abundance of natural resources, such as oil, phosphate and natural gas, is a major constraint on the quality of public sector governance replaced by the seizure of the state by powerful political elites such as the military regime during the Mubarak rule in Egypt prior to the 2011 revolution. Unless accompanied by democratic institutions and systemic constraints on the executive power, the political revolution can eventually result in the organic evolution of the failed state with a strong persistence of the old elites pushing for the status quo to protect the privileges preserved under the old system. The Arab awakening signaled the beginning of the demographic transition with decreasing fertility rates and slowly growing old-age dependency ratios. Hence, diminishing returns to demographic dividend and the gradual relative decline of the share of the working-age population both indicate a tendency towards greater democratic governance.
In a seminal paper  from 1958 Franco Modigliani and Merton H Miller showed why investors should not care about whether firms were financed with debt or equity. This led to the idea of the the debt irrelevance proposition and although the DIP is a theoretical benchmark rather than a real world rule the 1958 paper by Modigliani and Miller remains a key contribution to the finance literature. We should not however extend the same role to the recent attempt by researchers  to re-invent the DIP in a new guise replacing “debt” by “demographics”. Allow me to explain why.
Demographics, Just Forget About It …
My point of departure is Edward Chancellor’s recent GMO letter in which he tackles what he considers to be the non-issue of Japan’s dire demographics. He emphasizes two things; firstly, that economists are notoriously poor at predicting demographic variables and secondly he notes that whatever relevance demographics might have for macroeconomic analysis at large (of which Mr Chancellor appears skeptical) it is irrelevant for the investor;
Besides, long-term demographic forecasts aren’t particularly relevant for equity investors. It’s true that changes in the population have a sizable impact on GDP growth. But stock market returns are not positively correlated with economic growth. Returns from equities are a function of valuation and future returns on capital – a subject to which I will return later – rather than changes in GDP. Nor is there a positive correlation between population growth and stock market returns. In short, investors should not get too hung up on inherently unreliable long-term demographic projections for Japan.
It is important to underline, in fairness to Chancellor, that the points are made with specific focus on Japan but the the argument seems to have a more general hue. This is even more obvious in relation to one of Chancellor’s main references in the form of Morgan Stanley analyst Alexander Kinmont’s note entitled The Irrelevance of “Demographics”? Kinmont puts up the following four points which I will use as my points of reference;
1. It is not clear that demographic estimates are accurate over long time frames. In fact, while spurious specificity is one of the attractions of demographics as a talking point, the fact that neither death rates nor birth rates have proven predictable should caution one against accepting any assertion about demographics.
2. It is not clear that demographics are the critical variable in determining the level of economic growth. That role falls to the growth rate of TFP.
3. It is not clear that equity returns are related to absolute levels of growth. Equity returns are an issue of valuation. Nominal returns are greatly affected by inflation too.
4. It is not clear that demographic change, even if it is allowed as a negative for economic growth, is necessarily negative for stocks, as certain forms of demographic change may be associated with a rising equity market multiple. Demographic change could in fact represent a benign environment for stocks.
On the first point Kinmont makes points to the irony in that the worry about Japanese demographics seems to be peaking just as Japanese fertility is on the mend. This is a cheap shot though and not one which stands up to scrutiny. First of all on the fertility trend itself I get the same chart as Kinmont’s below using data from the World Bank showing a rebound in Japan from a low point of 1.29 in 2003 and 2004 to 1.37 in 2009. However, Indexmundi which takes its data from the CIA World Factbook has fertility much lower and actually declining in Japan. The latest data point from the CIA World Factbook reports an estimate of TFR in 2011 is 1.21. This is a pretty steep difference and I invite comments as to suggest the right number or at least the right trend.
(click on picture for better viewing)
All this is of course underlines Kinmont’s point that we don’t know the future and that economists have a proven track record for abysmal forecast performance. Still, we should get our concepts right at the offset. Long term projections in age structures are likely to be robust as they are a function of people already being born and while migration may change the course of ageing in any given country the fact that we are all ageing at one at the same time means that there are fewer migrants to go around. I would then claim that ageing does matter and that understanding how an economy such as Japan adapts to the ageing of its population remains one of the most vexing and important issues for social scientists and investors alike.
So when Kinmont implies that low fertility in Japan is a non-issue I have to strongly oppose. Just take a look at the chart above Kinmont himself uses. Fertility has been below replacement levels in Japan since 1970 and on current growth rates (assuming a constant growth rate of fertility which in itself is dubious to the extreme) fertility levels would reach replacement levels some time in 2030-40. So, that would be 60 years with below replacement fertility. Even if fertility in Japan (and again in most of the OECD) took a discrete jump to replacement levels it would do very little to change the outlook for ageing in the immediate future.
In claiming that demographics do not matter Chancellor are Kinmont are taking a very wide brush over the general recognition in the academic literature that our economic systems tend to hit a snag once fertility falls below a certain level (a TFR of 1.5). This is also called a fertility trap and what it means is that it becomes very difficult to escape negative population dynamics once they set in. I emphasize this since it highlights that we are not, as a friend of mine likes to point, simply shooting arrows into the void when we point to the importance of these issues. I recommend the following presentation by Wolfgang Lutz et al and the paper that goes with it or this old post at AFOE by Edward if you are still not convinced.
In terms of the postulated increase in Japanese fertility since the mid 2000 it is a positive development, but as is evident from the data this rebound is extremely uncertain. In addition, we need to know whether this is just an echo of the tempo effect (and thus how large the rebound is likely to be) or whether it reflects a real change in attitudes on quantity. I am open to contributions here but the only thing we can for certain is that ageing, in Japan and the rest of the OECD, will continue its march onwards. Here I also feel that Kinmont puts up a straw man when he invokes the idea of Japan’s population going to zero;
The unrevealed assumption, then, behind the mathematics used to arrive at widely-used population estimates is that the Japanese population will drop to zero. One cannot help but suggest that the logic of demographic pessimism is circular.
I want to re-emphasize that the issue here is not predicting fertility and death rates but recognizing the effect that the current and past trends have on ageing today and tomorrow. Try the recent work by Wolfgang Lutz, Warren C. Sanderson, and Sergei Scherbov if you want to see the cutting edge here and while uncertainty is still a key variable ageing remains a tangible reality. The main question issue I would like to get across is then that the demographic transition manifests itself in a transition of ageing and that this essentially becomes our main unit of analysis.
Growth and Demographics, No Connection?
Kinmont and Chancellor argue that demographics are likely to be less important for growth over time as total factor productivity (TFP) growth tends to be the main driver of growth.
Japan could quite easily grow at a good rate, especially in per capita terms, for a high-income developed country even in the face of a falling population (or more precisely a falling working age population). All that is required is for TFP growth to accelerate back to the level of growth enjoyed by Japan prior to the bursting of the Bubble in 1989. TFP slowdown preceded the population peak. Variation in TFP performance not in labour input growth is likely to be larger than the negative effects of population change.
This is an important point and more importantly, Kinmont offers an argument to explain the declining labour input in Japan’s economy which links in with the fact that Japan has been stuck in deflation and at the zero lower bound for the best part of two decades (my emphasis).
Labour input has in fact fallen at an accelerating pace over the past 20 years. It is clear that the fall is principally a decline in man-hours. This cannot be simply a function of a decline in the working age population because that decline only began in 2000. Instead, its origins must lie in rising unemployment and under-employment. A persuasive new paper, The Paradox of Toil, by a researcher at the NY Fed  argues that a decline in labour input is a natural consequence of a deflationary economy with zero (or effectively zero) interest rates.
In short, the declining labor input in Japan is a function of deflation and being stuck at the zero lower bound. In addition, this Fed Researcher Kinmont refers to is Gauti Eggertson who studied under Krugman at Princeton and did most of his initial work on the liquidity trap and the zero lower bound. So, I would be careful getting in his way without a strong look at the argument.
I think however that we might be dealing with the problem of a missing link in the sense that demographics may be one of the primary sources of deflation and the liquidity trap in the first place. This is an argument that has been pushed in Japan’s case in the sense that it was a lack of pent up demand that held Japan back in the 1990s as well as deleveraging. Indeed, Japan may hold a cautionary tale on the effects of a balance sheet recession in an economy where fertility has been below the replacement level for an extended period. The Eurozone periphery (ex Ireland) who have even ceded monetary policy to Frankfurt are case studies to this theory I think.
I would also emphasize that as labour input declines so does, obviously, consumption (aggregate demand) input which again feeds into the the paradox of thrift in the closed economy (or perhaps even a realisation crisis?). In an open economy it leads to export dependency as domestic investment actvity responds to foreign demand as well as the excess income you earn from a positive net foreign asset position (if you are so lucky as to have one) becomes a crucial source of growth.
Another more fundamental point is that if the total factor productivity growth (TFP) is a residual what is actually hidden in this residual? Well, I had a wack at the whole argument a while ago from the perspective of the academic armchair.
Technology and productivity are famously assumed exogenous in the Neo-Classical tradition while New Growth theory as it was developed in the 1980s and 1990s emphasised the need to specifically account for the evolution of technology. Today, I would venture the claim that there is a consensus that productivity and technology is a function of what we could call, broadly, institutional quality which encompass almost anything imaginable from basic property rights to the level of entrepreneurship. Indeed, a large part of research is still devoted to pinning down exactly which determinants that are most important here both across countries and through time. Now, I would argue that, in the context of standard growth theory, this is where the scope for the study of the effect of population dynamics is largest. Thus I don’t think it is unreasonable to expect the level and evolution of productivity growth and technological development to be a function of the current population structure but also its velocity which is a function of e.g. migration (new inputs?), future working age size etc. Also, this is also where human capital and the evolution of technology is joined at the hip through the idea of innovative capacity and readiness.
Once we venture into the notion of endogenous growth theory and thus the attempt to directly explain the sources and components of total factor productivity growth there is growing evidence that age structure/demographics alongside a host of other variables are important. Try this one for a recent literature review, and for the general link between growth and demographics the list of contributions is long. You just need to read around a bit.
I would argue then that growth and prosperity of the modern capitalist welfare state is highly conditional on some form of demographic balance and Japan has long since moved beyond into unbalanced territory. Basically, Japan is stuck in a liquidity trap as well as a fertility trap. The latter works along the lines of depressing consumption demand and making it very difficult to maintain key economic structures such as e.g pension systems. In addition, ageing affect the growth path of an economy and leads to export dependency, this last point however which I concede is not yet an established fact in the literature.
What about stocks then?
We seem to have two intertwined arguments here. Firstly, the extent to which demographics may have an influence on growth it is irrelevant for the investor since you can’t buy GDP growth anyway. Secondly, the evidence of a correlation between demographics and equity prices is weak and indeed, if anything, should be bullish for Japan (this last point is made by Kinmont).
Thus the FT summarized the latest findings of the London Business School team of Dimson, Marsh and Staunton, as published in the Credit Suisse Global Investment Returns Yearbook, 2010. The LBS academics examined all the available data (83 markets), and concluded that “99 per cent of the changes in equity returns could be attributed to factors other than changes in GDP”. (…) Growth is not all that it is cracked up to be. This analysis underscores previous academic findings showing that growth
per se to be of only small importance to stocks.
It would be unwise to disagree with the gist of this point. Even if I can make a connection between demographics, growth and investor performance it is very likely that buying into such a story at too high a valuation will lead to poor returns. Buying at the right value is the most important aspect of any investment decision.
This however is not the same thing as saying that just as you make sure to “buy cheap” poor demographics, low growth etc are completely irrelevant. Rather, I think that the extent to which the modern investor needs to understand a decidedly more complex macro picture with lingering deflation, heightened risk of sovereign defaults and zero lower bounds the understanding of demographic dynamics is key. We are then again discussing the question of deflation and low interest rates in Japan;
The origin of Japan’s problems is falling valuation when compared with the rest of the world. When we note in addition that it is excesses of inflation or the arrival of deflation (that is, monetary phenomena reflecting policy errors) which tend to reduce market average valuations, we feel it safe to conclude that demography will have next to nothing to do with the longer-term return profile of the Japanese market either in nominal or real terms.
I feel this is a very dangerous claim to make because it assumes that the deflation dynamics of Japan and indeed the problems facing the Bank of Japan in reviving credit growth are unrelated to demographics. In addition there is the unintended consequence of BOJ having to monetize an ever greater amount of JGB issuance in the future which in itself becomes more paramount as Japan ages.
On the second point regarding a direct relationship between demographics and stock prices (asset prices in general if you will) I think Kinmont does better especially because he does not fall into the asset meltdown hypothesis trap. In short the asset meltdown hypothesis states, in a US context, that as the baby boomers retire they will dissave and thus need to sell off their financial assets to a market which cannot support the flow, because the generation in the working age years is smaller, and that this will lead to an “asset meltdown”. Generalized, this is then the classic (and naive) nexus between life cycle economics and financial markets which postulate that dissaving into old age is rapid and imminent.
There are two problems here. Firstly, the empirical (and indeed theoretical literature) has found it very difficult to verify that dissaving occur among elderly cohorts to the extent postulated by the standard life cycle theory. Secondly, the relationship between asset prices and broad demographic aggregates appear weak. Results differ from country to country and most studies take place in a US and Anglo-Saxon setting which tend to bias the results further.
Kinmont does however point to a study by Geanakoplos, Magill and Quinzili  which show how the ratio of the 45-54 age group to the 25-34 age group is closely related to P/E ratios. As this ratio is set to increase in Japan, Kinmont ventures the idea that, if anything, perhaps you would want to buy Japan on the basis of demographics.
I have read the research by Geanakoplos et al and I find it intriguing, but my problem is that it does not control for the old age dependency ratio which suggests that the key ratio will be correlated with ageing in general. But I should be hesitant disregarding it on the basis of this hunch. I am preparing a large panel data set at the moment on demographics and stock prices with the aim to essentially rejuvenate a literature which seems too focused on the asset meltdown hypothesis noted above.
On a more general level, demographics and investment has been a core theme in the post crisis flow into emerging markets which, by and large, share the characteristics of being in the middle or at the end of their demographic dividend. Again, this does not nullify the importance of valuation and certainly, the recent soft patch notwithstanding, many emerging markets are still looking expensive.
Where goes the DIP then?
If you build your story up around the notion that investors buy value and not GDP growth you can easily come to the conclusion that demographics are irrelevant for the investor at large. This however would be a mistake.
I would be the first to wish for a return to a state of affairs in which investors needed only to look at valuation and firm fundamentals to make their decisions. Today however, you need to understand the macro backdrop and in order to do that you need a firm grip on how demographics affect macroeconomics. Pointing out that we are poor at predicting birth and death rates as well as pointing to weak evidence between growth and demographics do not cut it. We need not predict fertility and mortality but instead we need to understand the effects of ageing already present and there is plenty of evidence that demographics affect the growth rate and growth path of the economy.
I am more sympathetic to the strict relationship between stocks and demographics which is fickle and not well understood. Clearly, there is not presently any convincing model or framework which suggests how and why you might be able to buy sound demographics on a beta level. My main bet is that demographics should, at least, be used to qualify the notion of the global market portfolio and especially that demographics be used to re-balance such a portfolio over time.
In conclusion, Kinmont and Chancellor bring up some valid and good points in their attempt to brush away demographics as an important input variable to investment and macroeconomic analysis but you shouldn’t be fooled. Just as was the case with the original DIP you accept this new version at your peril.
 – Franco Modigliani and Merton H Miller (1958) – The Cost of Capital, Corporation Finance and the Theory of Investment, American Economic Review 48 (June 1958) pp. 261-297.
 – GMO White Paper – After Tohoku: Do Investors Face Another Lost Decade from Japan?, Edward Chancellor and Morgan Stanley Japan Strategy – The Irrelevance of “Demographics”?, Alexander Kinmont. I realise that I have lately been referring to sources and pieces of research which by nature of their origin (banks, research firms etc) are behind subscription walls. I am sorry, but I will make sure to produce relevant quotes so that my readers can follow the issues and arguments. I cannot upload full PDF versions of the reports for obvious reasons and I hope my readers will understand.
 – The Paradox of Toil, Gauti Eggertsson, Federal Reserve Bank of New York Staff Reports, no. 433, February 2010
 – Demography and the Long-run Predictability of the Stock Market. John Geanakoplos, Michael Magill, and Martine Quinzili; August 2002, Revised: April 2004. Cowles Foundation Discussion Paper No. 1380