Tuesday, May 19, 2009

Damning Demographics…

As if the collapse of the biggest credit bubble in the history of mankind wasn’t enough, there are very negative demographics adding to the malaise that go unrecognized by most, and I will demonstrate that demographics are one of the root causes of the current bubble dynamic, and its subsequent collapse. Hang with me for this lengthy article, this is fascinating stuff which you MUST UNDERSTAND to have any chance of understanding what the future may have in store.

Styx – Crystal Ball:


The size and composition of the population, what I’m referring to as “demographics,” definitely falls into the category of REAL and KNOWABLE FACTS. Demography is the study of trends in population. Dr. David Foot, who wrote Boom Bust & Echo, said that demographics may not explain all economic happenings, but, to quote Dr. Foot, “Demographics explain about two-thirds of everything: which products will be in demand, where job opportunities will occur, what school enrolments will be, when house values will rise or drop, what kinds of food people will buy and what kinds of cars they will drive.”

This paper is not ENTIRELY some wild theory or guess of which so many economists spew. There are censuses conducted every 10 years in the United States and we KNOW how many people there are; how many people are born, when they are born, and thus how old they are. We also know how many people immigrate into this country legally and approximately how many enter illegally.

What is controversial, however, is the impact demographics have on the economy. Unlike Dr. Foot, I would put the impact at something far less than two-thirds. This is because we can look at a country like India or China, both countries with far larger populations, and see that their economic output is not as great as ours with a much smaller population. Thus there is much more to the economic puzzle than demographics. Economic prosperity is not just about natural resources either. If it were, Japan would NOT be the number two economy of the world. Thus there are other things that comprise the economic brew that add up to prosperity or a lack thereof. Take the rule of law, for example – countries without the rule of law (contracts with integrity) are far more likely to be poor because their rule-shifting drives capital away. Most of Africa has great natural resources and a ton of labor (mostly uneducated), but it is the lack of the rule of law that keeps capital formation at bay.

Here’s a chart showing the distribution of the world’s population:



Yet, here is a chart showing the distribution of world GDP:



Follow this link to an interactive version of this GDP chart: Pie Chart of GDP…

So, clearly, the size of the population does not tell us the size of the economy all by itself.

To help us visualize the importance of demographics, let’s do a little mental exercise… I like to take things to their extremes to illustrate what would happen and how things would be different at those extremes. So let’s imagine that we have the United States with all her current natural resources and technologies… nothing’s different EXCEPT we bring the size of the population down from its current 306 million to only 10 people! See, I told you we were going to take it to the extreme! So, you have only 10 people… how large is the economy? How much goods and services do they produce? How large is GDP? Not very large at all, right?! Of course not, 10 people can’t possibly produce hundreds of airplanes and thousands of houses, millions of automobiles, and trillions worth of financial derivatives, lol!! So you cannot deny that demographics profoundly affect the economy (unless, perhaps, you subscribe to the Alice in Wonderland economic theory that so many presently do).

I encourage you to take this example to the other extreme and to “experiment” with money supply, credit, commodities and so on. Those mental experiments at the extreme will help to put things into perspective. Keep the extremes in mind as we begin to take a look at the BIG picture… The very BIG picture, as in that of the entire history of mankind! Just look at where we are today:



Simply put, the world’s population is exploding!

It is roughly estimated that 2000 years ago the world’s population was about 300 million, about what the U.S. population is now. Over the next ONE THOUSAND YEARS, the population only grew about another 10 million. The real acceleration began only 500 years ago. This growth can be seen dramatically if you look at the time it took for each milestone of a billion people to be reached. It took over 200,000 years before we finally passed the one billion mark in about the year 1804. The second billion arrived in 1927 taking only 123 years, and we reached the three billion mark in the year 1960, a mere 33 years later. Since then, rapid acceleration is an understatement… we have been adding a billion people to our planet every 13 or 14 years since. We passed the six billion mark in 1999 and now stand at about 6.8 billion people.

Put another way, just prior to 1940 the world’s population was doubling about every 125 years. It is now doubling every 40 years! While birth rates in America and a lot of the western world have slowed, in many other countries they have not. This trend is hugely and rapidly changing the investment landscape (click here for a good Wikipedia entry on world population).

And look at this chart that shows the current curve and how the population would grow if the current exponential math continues to build upon itself – world population would double by the year 2040!



Of course those who have Spent some Time with the Good Dr. Bartlett… instantly recognize that global population curve as one which has entered a parabolic (exponential) growth phase. ALL parabolic curves eventually collapse upon themselves – no exceptions, this is simply a function of math within a physical reality. Numbers grow until they become so heavy and consuming that they collapse upon themselves as they must.

For example, let’s visit the curve of corporate profits since about 1940. Here we find a typical chart that went through its three primary growth phases (just like the population chart above). Growth started out slow and controlled, it then accelerated into a more rapid growth phase and then went parabolic as the exponential math built upon itself:



And how are corporate profits today, following that parabolic phase?



THAT is what happens to all parabolic growth curves. They do not simply top out and come down like a pretty bell shaped curve that you may have read about in school:



No, in the real world, the backside of a parabolic curve looks NOTHING like the front side. The decline is much more rapid and steep, and usually returns to the point at which the parabolic growth phase began – at a minimum.

Here’s another mental experiment… Picture a small island only one acre in size with only a bunch of dirt and grass on top. You place a pair of mating bunny rabbits on the island and come back each year for 30 years. You plot the population growth and you will find a parabolic curve, much like our population curve! But, if you watch over time you’ll find that as the food supply runs out the population will crash. This example comes from the San Juan Islands where such things happen in reality all the time, not just to bunny rabbits either.

The purpose of this exercise is not to say that the population is imminently going to crash, it is to say simply that we are in a parabolic growth phase and that the implications are that at some point natural resources will not be able to sustain the exponential population growth. Thus I would not expect the population to double by 1940, we will likely begin to plateau within our lifetimes, but until then there is much greater demand, an EXPLOSION IN DEMAND for things that come from the earth – commodities. Thus it is very likely that in the long run you will see continued escalation in demand for the THINGS YOU NEED. Things like oil, food, and water.



At this point I would like to introduce you to the work of Harry S. Dent. If you are not familiar, he has done A LOT of demographic study and has written many books and articles on the subject. While his earlier models overestimated how high the markets would run, his underlying work is terrific. Forecasting the future is very, very difficult, miss one or two items and you will be wrong. In Dent’s case, what he missed is an understanding of the backside of parabolic growth, and also the fact that DEBT had PULLED FUTURE EARNINGS FORWARD IN TIME. I will get into this more, but I want to point out a terrific article he wrote, A Brief History of Human Evolution and Economic Progress.pdf , that covers most of the history that Bernanke should have studying instead of wasting his time studying an incorrect thesis about the Great Depression!

Whew! That was just the intro, LOL, now we get to taste the meat! Some of the following excerpts are extracted from my book Flight to Financial Freedom. Let’s start by examining the…

DEMOGRAPHICS OF THE UNITED STATES

The next chart shows the U.S. birth index, corrected for immigration, for the entire Twentieth Century through about 1998. The peak in births that occurred during 1961 is the height of the baby boom generation. Notice how much larger it is than the generations that preceded it. From 1961 until the mid 1970s, birth rates fell dramatically. This too produced consequences.

The rise that is seen from the mid 1970s on represents the baby boomer’s kids, thus they are known as the echo-boomers. The year 2008 was the first year to top the 1961 number of births in the United States!


Harry S. Dent Foundation

Demographics are very powerful for forecasting the future. For example, I’m a baby boomer. Baby boomers are generally considered to be those born between the years of 1946 and 1964. All factors considered, the baby boom generation is over four times the size of the generation that preceded it, the Bob Hope generation! This size differential is enormous, and it has far reaching affects.

PEAK EARNINGS EQUALS PEAK SPENDING

Obviously, a person born in 2008 isn’t going to contribute as much to our economy as one who was born in 1970! Demographers have learned that the average person peaks in their earning power when they are statistically 48.5 years old. They also know that a peak in earnings also equates to a peak in spending. Mr. Dent discovered that when you take the birth index and lag it by 48 years, the result looks very similar to the growth in the stock market! It also resembles the size of the economy as a whole. The following chart shows this phenomenon,


Harry S. Dent Foundation

So you can BEGIN to predict the overall trend for the economy, whether it will grow or shrink and approximately to what degree, as well as approximately when. This is the type of thing that Martin Armstrong is discussing when he says it’s possible to model our economy – which it is, but our government (central bankers) won’t back it.

FOOT STOMPING POINT…

Peter Lynch, of Fidelity Investments, once accurately said that, “…it is [corporate] earnings that drive the market.” He is 100% correct on that point.

Now we can start to infer that the aggregate number of people in their peak EARNINGS years equals the amount in their peak SPENDING years.

People who spend buy things from corporations.

Thus, corporate profits are going to peak when the size of the peak earners peak!

Guess what just happened?



DEBT PULLS EARNINGS FORWARD IN TIME

According to Dent’s Spending Wave, the peak should have occurred in late 2009 or early 2010. But it didn’t. Both the markets and corporate profits peaked in late 2007 – proving Peter Lynch right in that earnings drive the markets. Why was Dent late in his estimate?

The reason is DEBT! As derivatives and the securitization of debt process grew, the pigmen, err, I mean central bankers were able to force more and more debt into the system. This pulled the baby boomer’s FUTURE incomes into the NOW. The effect of which was to over accentuate the growth phase and now to over accentuate the decline as well as to make the decline lengthier in time as future incomes will be servicing the interest on all that debt.

ON THE WHOLE, PEOPLE ARE TYPICAL AND PREDICTABLE

After you graduate from college, where is the first place you live after obtaining your first job? That’s right; it’s very likely an apartment. Generally, once you earn a little more, you eventually meet your spouse and move into your first home. This house is relatively small and modest. Usually, as you move into your peak earning/spending years, you have children who are getting older and you move into a larger, more luxurious home. After your kids are grown, you no longer need your large luxury home and you look for a low maintenance, high quality living quarters that suits your lifestyle. This is all very predictable. If you are a baby boomer, and now own a luxury home, you need to examine the graph carefully and ask yourself, “What’s in store for luxury home demand, and thus prices?”

So it is all predictable. The baby boomer’s kids (echo boomers) are now moving through or past college and people who represent the leading edge of this wave are already moving into their first homes. What impact will this have? If you are going to invest in real estate, you should know. Thus, it is fair to say that for the near-term, luxury home prices will languish and starter home prices will hold up better. This is an application of what I mean by building your foundation of investment knowledge.

Corporations would love to have this type of knowledge. Let’s look at Levitz Furniture as an example of a company who ignored shifting demographics.

For those who may not be familiar with this chain, you should know that Levitz was a pioneer in the 1960s when they developed the concept of placing furniture galleries directly inside of a warehouse. Levitz grew like crazy in the late 1970s into the 1980s because baby boomers were moving into their starter homes and buying furniture. What kind of furniture? The inexpensive kind… Levitz opened new stores almost everywhere. Then the baby boomers aged and no longer wanted inexpensive furniture. Now they wanted, and could afford, the good stuff. Levitz was forced to contract in size and sell stores… Multiple bankruptcies eventually followed. Did they understand what was happening? Could it have been forecast? Today it could be, no doubt. It can be forecast because it is real and it is knowable. Could Levitz have a future going forward? Well, here’s a link to their old website; Levitz.com. That’s what happens when you ignore demographics! Now who’s going to sell all the inexpensive furniture that the echo boomers are going to need?

MONEY SUPPLY AND DEMOGRAPHICS

For those who understand how CREDIT money is created, imagine a population bubble of peak earners all showing up to the commercial banks at the same time. As loans are taken out to house and car those peak spenders, surely credit creation is going to expand, or at least try to expand. This is why I think that the size of the population of peak earners (not just the size of the total population) needs to be considered against any system that attempts to control the size of the money supply.

KNOW YOUR PLACE… DEMOGRAPHICALLY

Where you fit into the demographic scheme of things is very important to understand. Trailing edge baby boomers will experience economic happenings differently than leading edge baby boomers. Certain areas of price inflation, for example, may benefit the leading edge while harming those on the trailing edge.

Let’s look at trailing edge boomers for a moment: As they enter their peak earning years, like their predecessors, they generally look to upgrade to a larger, more luxurious home… but the leading edge boomers have already driven luxury home prices through the roof. Many of the leading edger’s bought low and sold high (taking their equity with them into retirement), while the trailing edger’s are forced to buy high and will not enjoy decades of ever increasing prices. See the difference? Inflation benefited the leading edge, but hurt the trailing edge. Same thing happens for investing in the stock market, same for luxury cars, boats, etc. Bringing up the rear sucks… demographically speaking!

The leading edge ECHO boomers are also likely to do better with their investments than trailing edge echo boomers. This is a function of math! You are far better off experiencing LOSSES EARLY in your investment career than late! This is true for all compounding assets.

If you know your place, demographically, you can adjust your strategy to take advantage of what you know will happen… What segments should you be investing in now? Remember, real and knowable!

So, if you understand demographics, you can start to see the future. But your crystal ball may still be a little hazy, so let’s broaden our horizon and look at Japan as a case study.

CASE STUDY: JAPAN

Following WWII, most allied countries, like the U.S. and Great Britain, were left relatively unscathed compared to Japan. Our soldiers came home and produced the baby boom generation. Japan’s soldiers came home and had to rebuild their country. They eventually had a baby boom generation, but theirs started twenty years after ours. Japan also had a relatively sizable generation prior to entering the war. After they rebuilt the country, they developed their industries and were quite accomplished at doing so. Their automobiles and electronics went from being synonymous with low quality to being synonymous with high quality.

Do you remember, during the Sixties, everything seemed to be stamped “made in Japan?” (much like China today). Back then, “made in Japan” was synonymous with “JUNK,” you know, cheap and shoddy. Today, Japanese products are synonymous with “quality,” and are prized possessions.

Anyway, the Nikkei index and land valuations soared. The Nikkei hit a high of 40,000 in 1989; and then the bottom fell out. Real estate prices plunged and the Nikkei fell over 80%. The Nikkei bottomed at 7,603 in 2003 – a 13 year fall. For the Nikkei to get back to 40,000 from that low, it would have to gain 425%! It then rebounded with our markets and has since fallen to even lower lows. If your money was invested in Japanese stocks in 1990, would you have seen this coming? Would you have known when to sell or when to buy back in?

Their entire economy, not just the Nikkei, has now languished for over 20 years. The Japanese Government tried everything to stimulate their economy. They lowered interest rates literally to zero percent and left them there. They flooded the country with yen hoping to stimulate spending. Their efforts had little effect, despite a booming global market. One of the reasons was because Japan had a contracting population that was in their peak earning and spending years! The Japanese simply did not have an economic engine that could keep up with the previous larger generation.

The same demographic conditions that hit Japan are here in the United States and in much of the western world. And, just as the U.S. economy is headed down demographically, Japan will be headed back up, but now they will face plummeting global demand!

Is this useful knowledge? Is it based on knowable facts? Is your 401k safe, and will it be there in all its booming glory to take care of you in retirement?

The same effects can be examined in every country on the entire planet. Look at China. Huge growth now and in the near future, but they have a one child only law. What does that mean for their long term future? As two parents produce one child across an entire generation, that means that the next generation will be cut in half, and so on. Will the economic growth and power transfer that’s occurring now last forever in China?

Certainly not and this too is predictable.

POPULATION WAVES RIPPLE THROUGH TIME

So, we have a wave of peak earners/spenders that we call the baby boom generation. There is a lull, a valley, on the backside that means the number of peak earners are just not there to power corporate earnings.

Because there was a lull in that wave, there is bound to be a subsequent wave in the future where a similar lull takes place, just as there IS A KNOWN PEAK with the rise of the boomer's kids, the echo boomers. Isn’t that a cycle? Why yes it is.

Harry Dent produced this chart he calls the New Economy Cycle:



He correlates inflationary periods with periods of rising numbers of peak earners, and deflationary times with dropping numbers of peak earners. Accordingly, if you disregard debt, the bottom of this current deflation cycle will be about the year 2022.

Now, that’s just the cycle caused by the fluctuation in population. Are there other cycles that come into play? Of course there are, and those cycles overlap the demographic cycle. This is where modeling via computers comes into play; it is exactly what Martin Armstrong has been addressing in his recent papers. And I agree fully with him that there is a concerted effort to NOT make models that work. Keeping people blind and ignorant is exactly how you steal from and control them.

For government officials, or anyone for that matter, to stand up and say that “no one could have seen this coming” is just completely ingenuous to be polite, full of it to be less polite! Housing cost to rent ratios at never before seen extremes? Commercial property CAP rates at historic lows? Give me a break – no one saw it coming? Bull. They were all just too greedy to adjust downwards before they were forced to.

People who didn’t see this downturn coming; Levitz, GM, GE, Ford, Chrysler, the homebuilders, all the banks, all levels of government and most of the western world… they all need to have their heads examined. Sailing the ship at full speed into a demographic void is like the Titanic accelerating to ramming speed just prior to hitting the iceberg! Surely we are sailing with a ship of fools…

World Party - Ship of Fools (ht Frank):




Post Script: PONZI IMPLICATIONS

Social Security and Medicare are both schemes that depend on never ending growth because they require the money of current contributors to pay back past contributors. These schemes work well UNTIL the day the amount of money coming in no longer satisfies the obligations. A shrinking population of peak earners means that the day will soon arrive when the Ponzi scheme breaks down. This is the fatal flaw in developing such systems.

Chris Martenson developed an excellent course called the “Crash Course” in which he also touches on the implications of demographics. They start about 10 minutes into this 13 minute video…

Crash Course: Chapter 14 - Assets & Demographics by Chris Martenson


I HIGHLY recommend Chris’s Crash Course. Here’s a link for those who have yet to view it: Chris Martenson’s Crash Course…