Thursday, April 3, 2014

Rising Dependency Ratios in Developed World and China Will Put Pressure on Credit Growth, Asset Prices and Economic Growth For Decades: Demographics Alert

After various credit and asset bubbles burst in the developed world (and now in China) and fueled deleveraging cycles, negative demographic forces could also put pressure on credit growth, asset prices and global economic growth going forward. The total dependency ratio, which, according to the United Nations, is the total number of people aged 0-14 and 65+ versus those aged 15-64, in most developed economies is going to bottom out and start rising between now and 2020 (or already has when looking at the graphs of Japan, the U.S. and many European countries). If you do a Google search on demographics, you can see that many advanced economies are facing what Harry Dent calls a "demographic cliff," which is mainly being fueled by the "elderly dependency ratio" (people retiring from the workforce).

So, I looked at the potential negative effects in a few different ways. First, the United Nations explained it well on their fact sheet: "As populations grow older, increases in old-age dependency ratios are indicators of the added pressures that social security and public health systems have to withstand." This is a well known issue for U.S. fiscal policy going forward, which, according to the Congressional Budget Office (CBO), will increase the deficit and debt/gdp ratio after 2016/2017 and sharply after 2024.
Projected deficits and debt for the coming decade reflect some of the long-term budgetary pressures facing the nation. The aging of the population, the rising costs of health care, and the expansion in federal subsidies for health insurance that is now under way will substantially boost federal spending on Social Security and the government’s major health care programs by 2 percentage points of GDP over the next 10 years (see the figure below). But the pressures of aging and the rising costs of health care will intensify during the next few decades. Unless the laws governing those programs are changed—or the increased spending is accompanied by corresponding reductions in other spending relative to GDP, by sufficiently higher tax revenues, or by a combination of those changes—debt will rise sharply relative to GDP after 2024. (For a more detailed discussion of the long-term budget situation, see CBO’s September 2013 report The 2013 Long-Term Budget Outlook.)

But these forces will also directly affect economic growth if there's less demand for credit, goods, services and assets in the economy, which is deflationary in nature. To me this sounds like what happens during a deleveraging cycle. It's interesting that the massive asset price bubble in Japan popped a few years before its total dependency ratio bottomed in the early 1990s, and it looks like the same exact thing happened in the U.S., Eurozone and UK in the 2000s-2010s. Today, it seems like the deleveraging cycle as well as these negative demographic forces are what's holding back economic growth in countries that had leveraged asset price bubbles that burst (even with massive fiscal and monetary stimulus injections). The problem now is that total dependency ratios, mainly based on aging populations, keep rising for decades to come, according to the UN. So we are currently in the middle of a strong demographic storm right now. Central banks are trying their hardest to stimulate growth, but the growth in the money supply hasn't been boosting GDP. For example, look at the velocity of money (quarterly nominal GDP/quarterly average of the money supply) versus the money supply (M2) in the U.S.



In 2012, Business Insider posted a chart of what Matt King, Global Head of Credit Products at Citigroup, called "the most depressing slide I have ever created" which had charts of "real house prices versus inverse dependency ratios" for the U.S., UK, Australia, Japan, and Ireland. In his slide, you can see that real house price indices fell in tandem with the inverse dependency ratios, and today it looks like real estate prices (inflation adjusted) are especially at risk in the UK and Australia.

Source: Citigroup's Matt King via Business Insider

Of course, there are many other trends at the moment that could possibly negate the deflationary effects of a rising dependency ratio, or make it worse. First, according to the UN:
In many populations, however, people do not stop being economically active at age 65, nor is it true that all persons aged 15-64 are economically active. Although older persons often require economic support from others, in many societies they have economic resources of their own and provide support to their adult children. Furthermore, as the period of training for a productive life increases, most adolescents and young adults remain in school and out of the labour force, effectively extending the period of young-age dependency well beyond age 15.

And immigration reform could cause emerging market dependency ratios, which are currently trending down if you look at the UN's data, to help close the gaps worldwide (not sure if that would work). But how will the use of robotics, which are currently being used to boost productivity and profits, affect the economy if the active working-age population is falling? Will domestic consumption in emerging economies pick up all the slack in the U.S.? Will it indirectly create more jobs and income to boost the use of money and credit in the economy? If all else fails, I'm sure the tech industry could figure out a way to create government-backed humanoid robots with WATSON brains to boost credit growth, consumer and investment spending, and economic growth. Here are the UN's dependency ratio projections. Thoughts?


Total Dependency Ratio (0 to 14 yrs + 65 yrs+ / 15 to 64 yrs)
(Australia, China, Germany, United Kingdom, Europe, United States of America, More Developed Regions, World)

Source: United Nations via DataMarket.com

Total Dependency Ratio
(Portugal, Ireland, Italy, Greece, Spain, France, Denmark, Belgium, Poland, Czech Republic)

Source: United Nations via DataMarket.com

Total Dependency Ratio
(Canada, Australia, New Zealand, Japan, Singapore, Thailand, Russia, Ukraine,)

Source: United Nations via DataMarket.com

Total Dependency Ratio (added Hungary and Puerto Rico, deleted Europe)

Source: United Nations via DataMarket.com

Elderly Dependency Ratio (65+ yrs / 15 to 64 yrs)
(Australia, China, Germany, United Kingdom, Europe, United States of America, More Developed Regions, World)

Source: United Nations via DataMarket.com

Related new post: Nomura's Richard Koo on Balance Sheet Recessions (Deleveraging), QE Traps and Economic Growth

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