For the past two decades we have seen unprecedented growth in demand for consumer items and housing with large emerging economies like China playing a focal point in the supply to global consumers.
But what happens next when the predominantly western aging consumers decide to reduce their spendthrift habits? Western consumption is waning as is China’s ability to satisfy demand along with its thirst for credit. We are witnessing a very special time in the global economy. We are witnessing ‘The Great Unwinding’.
Before 2008 vast sums of credit swamped the global economy which culminated in the ‘credit crunch’. This was a bubble of what was an overdue hangover from the irresponsible acts of banking institutions. Although the Western world suffered destructive economic shockwaves that saw large scale bankruptcies and bailouts (Lehman Brothers, Northern Rock), China and the emerging markets remained relatively stable. The Chinese public were not teased into overleveraging their income into buying property and the banking institutions had not caught up with the greed-filled practices of their Western counterparts. The whole world was deceived into thinking that the emerging economies had to be looked at with awe and learn from their large manufacturing and services output. However the focus on manufacturing and service output meant that not enough attention was given to the warning signals reflected in the amount of debt these countries were taking.
In the early 2000s China began an aggressive economic expansion policy that saw its borrowing grow by 1000%; from USD 1 trillion to 10 trillion. The Chinese leadership began building large scale sky scrapers and huge housing projects. This led the world to believe that the Chinese had begun to see a growth in the number of middle class citizens, masking the fact that in some parts of the country, yearly salaries were a mere USD 1000. Indeed the unrealistic ambitions of the leadership to achieve greatness overnight was, and remains, doomed to end in heartache. Abandoned apartment blocks and sky scrapers are but a few signs that the monetary policy employed in China has simply not worked. Milton Freidman, who lived through the baby boom era during which 50% of the US population were born naively advised policy makers that an increase in the money supply would ignite the economy and produce a middle class, as long as inflation could be curbed. It worked in the US for Freidman because there were enough participants of working age to fuel a boom. But this is not the case in other parts of the world where the demographic is very different. Applying this policy narrow-mindedly led China to max out its credit card; nature took its course and the shocking results were recently reflected in the economic slowdown and sudden crash in the Shanghai stock exchange.
The most crucial element in this whole equation was most evident in the events that took place after the Second World War. Much of Britain and the rest of Europe was war torn and took several years to rebuild. During this period an astonishing 900,000 babies were being born every year for 25 years. This is quite possibly one of the most important social events that has taken place in our modern history. To put this into comparison, only up to 700,000 babies were born each year in the 25 years to follow. With this large scale population surge, there was naturally a surge in demand that was met by a surge in supply. These consumers peaked in their earning capacity and consumption during the late 90s and 00s. We now have 1 in 2 people in the UK over the age 55 and coming close to if not already in retirement.
Does all this sound familiar? A housing boom over the 2000s? A credit crisis in the same period? Technology surging with new iPods, phones and computers launched in the same period? Surging fuel prices? Increase in budget airlines and air travel? All these events occurred in the same period of time the baby boomers were peaking in their earning capacity. Their large and increasing pay packets were helping them to buy and sell their homes amongst each other, helping the UK’s housing market to reach laughable heights. They aided this with a thirst for credit resulting in wide spread demand for consumables. Technology developed at a faster rate than we have ever seen in our post-war history. Fuel prices reached record highs as these consumers maximised their leisure activities in conjunction with the excess money supply in the economy pumping the price of fuel. Every one of these events has been a result of the consumption culture which the emerging economies like China were helping to prop up. This was our ‘Sugar High’, but as is always the case in life, it had to come to an end at some point.
In 2008 reality set in as the credit bubble burst. The harsh reality now is that the largest demographic of consumers in the economy-the baby boomers-are no longer consuming as much as they were. From 1983 onwards more jobs and more money was created which resulted in greater supply for goods and services. It’s often said that an economy is quite simply made by the people. So if today you have 1 in 2 people over the age of 55, are they going to be consuming as much now as they were 10-15 years ago?
The new normal?
We are now entering what is known as the ‘New Normal’, a phrase coined by Paul Hodges, a leading demographic economist. He argues that those past the age of 55 have everything they need-reducing demand-and thus incomes are being made smaller leading to less growth. This is an argument for what we are currently seeing in the form of deflation. This is happening now and it’s going to continue happening. The fall in oil prices from 120 US dollars a barrel to less than 50 a year later; top traders in the city citing the devaluation as an oversupply in the economy. The fact that this has coincided during the same time as when we have 1 in 2 over the age of 55 is no coincidence. The Times on 11 June 2015 highlighted that the Housing Market has come to a halt because there are simply not as many houses on the market as there were. Again, this is a sign that this generation’s consumption levels is not what it was and on a macro level is a reversion to the mean.
Paul Hodges goes as far as to say house prices over the coming years and decade could fall by up to 50% as fewer participants in the economy have the capacity to buy houses at the rate the baby boomers were able to. A reversion to the mean is well overdue and this could be a sign of things to come. Let us not forget that the land outside the Emperor’s Palace in Japan was once worth the value of California. Today Japan has the lowest house prices of anywhere in the OECD. London’s house price bubble is no different, however, many would argue with foreign investment from Oligarchs and Oil rich Arabs buying prestigious post codes this may not matter. But as mentioned above the emerging economies are dependent on Western consumption and so if this decreases as with oil prices we may soon need to have a collection for the Oligarchs and Arabs.
Of course it is not all gloom for the emerging markets. Indeed China is learning to align to the ‘New Normal’. They have reduced their borrowing consumption from 10 trillion US dollars back to 1 trillion. They are now looking for new ways to increase the living standard of their people in real terms not just by pumping money into the economy as Freidman proposed. President Chi has proposed a new Silk Road; a new railway which links to Europe to help business into China and marine links to Africa. A substantive way to increase living standards than borrowing 10 trillion dollars to artificially prop up its economy and build homes and sky scrapers nobody can afford.
The reality for the ‘New Normal’ is that we will see ‘The Great Unwinding’ happen right here, right now. Black Monday is the beginning of the end for the heavily inflated Chinese stock market. Property tax in China has fallen 30% in the last year. Economies all over the world are experiencing reduced growth. US ‘artificial growth’ in the form of its energy sector will come to a grinding halt. The big US oil refineries brought widespread prosperity to the countries’ oil regions in the Gulf of Mexico. In Houston large scale properties and developments were being built for the swarm of new people coming to the region. However, with oil prices at devastating lows, these projects are not able to go ahead leaving deserted projects as America’s energy sector continues to take a hit. Janet Yellen is likely to postpone the widely anticipated interest rate hike in September due to the current state of global affairs across the emerging economies and the slow movement in US growth.
The world has changed immensely over the past 35 years. It seems as though the years of promiscuous economic hegemony are finally coming to an end. As more common sense is employed by understanding the wide scale demographic of the economy rather than news bites, short term fluxes and statistics. It’s incredible how we have become obsessed with facts and figures rather than looking holistically at what is happening. Until 1929 GDP was not even measured; now it’s become the be all and end all of our lives and prosperity. We look to be entering a slower paced economic environment where we see The Great Unwinding taking place. The aging population with less of an appetite to buy and sell, creating the ‘New Normal’. If the past 10-15 years have taught us anything it’s that large scale debt fuelled by greed and the emergency plaster of printing money are the poisons, not the cure.