It’s a mad, mad, mad, mad world, part 3

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Anyone who had listened to what the Bank for International Settlements was saying since 2005 would have been well prepared for the shocks that began towards the end of 2007 and then blew up in 2008. They issued a new warning in their September 2011 report, The Real Effects of Debt. We should heed this warning. They conclude, “Our examination of debt and economic activity in industrial countries leads us to conclude that there is a clear linkage: high debt is bad for growth. When public debt is in a range of 85% of GDP, further increases in debt may begin to have a significant impact on growth (in 1st qtr 2010 USA’s debt: GDP ratio was 117%)… A clear implication of these results is that debt problems facing advanced economies are even worse than we thought. Given the benefits that governments have promised to their populations, ageing will sharply raise public debt to much higher levels in the next few decades. At the same time, ageing may reduce future growth and may raise interest rates, further undermining debt sustainability.

“So, as public debt rises and populations age, growth will fall. As growth falls, debt rises even more, reinforcing the downward impact on an already low growth rate.”

They conclude, “In the end, the only way out is to increase saving.” This is part of the process of de-leveraging which is likely to take until around 2018 to run its course. These years will be characterised by rolling recessions and deflating asset prices interspaced by short periods of recovery.

The second dynamic which will help shape the world economy will be the demographic changes with so many countries’ population age profiles changing for the worse and far outnumbering those that will continue to have positive demographic profiles, India, Indonesia and Brazil to name just three.

Demographic change is not an abstract development; it will have serious consequences for future growth. The OECD, for instance, estimates that the impact of aging on GDP growth rates will be a decrease of growth in Europe to 0.5% a year, in Japan to 0.6% a year and in the USA to 1.5% a year in the period 2025-2050.

Demographic changes will impact household wealth creation. In their report, The Coming Demographic Deficit: How Aging Populations will Reduce Global Savings, they wrote: “Aging will cause growth in household financial wealth to slow by more than two-thirds across countries we studied (USA, Japan, and W Europe), from 4.5% historically to 1.2% going forward. The slowing growth will cause the level of household financial wealth in 2024 to fall some 36% or by $31 trillion, below what it would have been had the higher historical growth rates persisted.”

For Europe, the demographic profile is worrisome. According to data by Dr Clint Laurent and his team at Global Demographics, the number of 65+ aged group rises from around 19.6% of the population in 2011 to 29.1% in 2031 with the dependency ratio standing at just 2% by then.

A surprising development is that the demographic profile of the USA is so much better than that of China. Once the USA puts its financial house in better order, which it will if not willingly, its growth expectations will be better than China’s.

For China, based on simple fundamentals, growth has peaked. The years of circa 10% growth are over because such growth is unsustainable and brings in its wake a package of problems. “One approach to forecasting total real GDP of a country is to combine the projected trend in the number of persons employed with the projected trend in the gross productivity per worker,” writes Dr Laurent. He calculates that the trends in the education index of the country should give an expected productivity growth of 7.8% a year to 2016 and 5.8% a year to 2021.

This slowdown will have a huge impact on China’s future requirements of imported metals like copper. This trend is likely to be magnified also by US and other foreign companies vacating China and returning to their home bases – in the USA once the political system rolls back much of the red tape, health care costs and tax issues, etc. There is a fundamental reason for companies to return home: it is that multinationals want their supplier chains adjacent to the market, not on the other side of the world.

Thus, demographics and debt will be huge constraints on world growth. As I said at the start of this article, “It’s a mad, mad, mad, mad world” where there is more individual selfishness and greed rather than the collective good. Until this changes we will have to wait along time for the world to get it right.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]