Lately, Goldman's economists and strategists have been looking at the long-overlooked topic of demographic shifts within a society as a major driver to shaping consumption trends, economic outcomes, and, as a result, investment decisions. A few days ago, Goldman's Anthony Carpet penned "Demographic Dynamics: A case study for equity investors" in which he did an extensive analysis of what the demographic shift of America, driven primarily by the tide of baby boomer retirement which commences this year, means, and presented several stock choices that would likely benefit the most from this generational transition. We will present that report in the immediate future, but for now we wanted to bring your attention to the Goldman economic paper, "Current Accounts and Demographics: The Road Ahead" in which Goldman takes off the investment advisor suit, and puts on that of the economist. The study has some interesting observations as pertains primarily to the ever critical Current Account (which as we pointed out yesterday hit a two year high $49 billion deficit). In a nutshell the current account, or trade balance, is a proxy for the marginal savings or consumption that occur in a given country. The US has ran a current account deficit for as long as it can remember, with the result, as recently as several years ago, being a negative savings rate. The Current Account also tracks the international flow of capital, as global savers (Emerging Markets), tend to fund the deficits of global spenders (using their own recycled money) courtesy of the "spenders" flooding the world with their own currency. This phenomenon is the primary reason for the symbiotic relationship between China's saving society and the US consumer base. As is well-known, one of Obama's more ambitious plans is to double US exports over the next five years which means a collapse in the current account deficit. Yet as more and more Americans exit the prime savings age bucket, and become spenders, is Obama's current account reshaping plan doomed from the start? Goldman explains.
Over the past few years, global capital and current account imbalances have played a major role in a number of important macro debates. The perception of unsustainable imbalances between the US and the rest of the world; the unusual low of capital from the emerging (EM) to the developed world (DM); and the so-called ‘global savings glut’ and its impact on real interest rates have all been key forces that may have played a role in the recent global recession. We have focused on the longer-term drivers of shifts in the world economy, particularly in our work on the BRICs and the N-11. Demographic trends are a key component of that work. As we show here, demographic shifts also play an important role in determining long-term trends in global current account balances and the flow of global capital. An economy’s current account is literally equal to its ‘net’ saving (total savings minus total investment). So a tendency to save more across an economy will translate into pressure for current account surpluses and a flow of capital to other countries. Because people’s savings behaviour is generally different at different points in their life, the relative age structure of an economy plays a significant role in explaining their borrowing and lending to the rest of the world.
Using a model that links demographics, growth and current accounts, we illustrate here how demographic shifts have driven global current account trends in the last 30 years, and what they imply about current imbalances. We then look at how the influence of demographics over the next 20 years and beyond may affect current account positions. Importantly, it is the portion of a population of ‘prime saving’ age (on our estimates, roughly 35-69 years old) that matters most, and not the size of the working age population, as is commonly discussed in policy debates. That group is still growing globally, even in the developed world, and will likely rise in most of the EM world, including China, for at least two decades. Interestingly, the common intuition that China is demographically more like a developed market than a typical emerging market is only true with respect to working age population. In terms of ‘prime saving’ dynamics, China is more like an EM than a DM economy.
Our results confirm that the recent situation involved what look like ‘excessive’ current account surpluses in some of the oil producers, and in parts of Northern Europe and China, with ‘excessive’ deficits in some of the well-known offenders, such as the US, Greece and Spain. Those imbalances have narrowed substantially in the past two years but are still visible to a degree. However, demographic trends have also been influencing what is an ‘appropriate’ balance, and will likely continue to influence changes in the future. In particular, demographics have generally reinforced a shift towards greater surpluses in some large EM countries and deficits in some DM economies, even if today’s reality is poorly captured by a simple EM/DM split (see box on page 5). And although that dynamic has overshot, demographic projections suggest that pressure for capital to flow from EM to DM—far from being an anomaly—may be more persistent than people realise and may become more uniform over time.
The rise in ‘prime age’ savers globally may also have played an important role in the story of the ‘savings glut’, putting downward pressure on global real interest rates. Here too, the demographic underpinnings of that story could intensify in the next 10-15 years. Perennial worries about the impact on asset markets of dis-saving by US (and other OECD) retirees also need to be seen in this global context, both because current account shifts may provide a safety valve and because global pressures are likely to move in the other direction. As with our work in many of these areas, the global picture looks quite different to the (usually better-known) US or OECD story, given that the importance of non-OECD economies continues to increase.
And while the entire paper is quite fascinating for those who tend to ignore populational dynamics in investment decisions (and is attached), the key results and observations are below:
A. The impact of demographics on current accounts and capital flows
- Demographics are a major determinant of long-term trends in current account balances. Despite the popular notion that current accounts are determined by relative growth prospects, demographics seem to play at least as large a role.
- The evidence suggests that those economies with a large proportion of ‘prime savers’—a range we identify as aged between 35 and 69—are more likely to run current account surpluses.
- These shifts in the group of ‘prime savers’ are not identical to the more commonly followed story of shifts in the working age population. Most striking is that China—whose working age population is widely known to be ageing faster than those of most EM markets—is much less distinctive in terms of ‘prime savers’ and looks more like a typical EM than a DM.
B. A demographic perspective on current imbalances
- Prior to the global crisis in 2008, the world’s current accounts appear to have drifted a long way from their long-term demographic anchors. Conventional wisdom—that the US, the Southern Europeans and several EM economies had deficits that were too large, while China, Japan, several Northern European economies and the oil producers were running excessive surpluses—looks fair relative to what slow-moving demographic and growth trends would say was ‘appropriate’.
- We have seen significant progress in reducing these ‘imbalances’ and are closer to the underlying ‘equilibrium’ predicted by our model. But these shifts take the world only partly back to the levels that underlying demographics suggest.
- Although there are excessive surpluses and deficits within both the EM and DM universes, EM surpluses on average have looked too large. That said, demographic pressures have driven larger surpluses in EM economies and validate the notion that they should be running surpluses now. What looks odd about the world is not that EM countries have lent to the developed world on average, but the scale of that lending.
C. Demographic pressures on current accounts
- Demographics hint at fresh current account shifts in the next 20 years. Demographic trends push towards larger surpluses across a broad group of EM countries (including China) and larger DM deficits (including the US), because the proportion of EM ‘prime savers’ rises more and peaks later than for DM
- Because the world is starting from a point where several large EM economies are running ‘excessive’ surpluses and several large DM countries’ deficits are ‘excessive’, those shifts need to be balanced against a tendency for the world to move further back to the underlying equilibrium. If both developments occur, this could blunt the demographic pressures between DM and EM groups.
- These forces potentially show the biggest shifts within DM and EM groups, with big declines in the major surplus groups (the oil producers, China, Japan, Germany) matched by narrower deficits in India, Brazil, Turkey, Greece and Spain. With the exception of China and the oil producers, most EM economies could potentially see improving current account positions.
- These shifts could push towards a cleaner split between EM (mostly in surplus) and DM (mostly in deficit) than is the case in the current, more complex picture. In particular, demographic pressures could see the largest DM surplus countries (Japan and Germany) move into deficit and the largest EM deficit countries (Brazil, India and Turkey) move into surplus.
D. Demographics and the ‘savings glut’
- Demographic forces may have played an important role in the ‘savings glut’ and may have contributed to falling global real interest rates over the last 20 years, as the proportion of ‘prime savers’ globally has risen over that period.
- The global pool of ‘prime savers’ is expected to keep rising, and peak in 20 years. As a result, the ex ante tendency will be for more, rather than less, net saving globally, and the ‘savings glut’ (and lower real rates) may become a more persistent feature of the world than many think.
E. Implications of the shifts ahead
- Even after recent progress, currencies and demand profiles may need to move further to support further rebalancing across the major economies.
- The likely ongoing flow of capital from EM and the demographic component of the ‘savings glut’ story suggest that real rates may stay lower
for longer globally than generally expected, and may even fall further.
- While local markets in DM could see more pressure (and DM real interest rates rise relative to EM rates), increased EM savings could remain an important part of funding DM dis-saving as the population ages, mitigating long-standing worries about the impact on asset markets of ageing populations in developed markets.
- Demographic pressures for capital flows make it even more critical to improve financial/regulatory infrastructure to handle large cross-border flows.
- The development of EM capital markets—a consistent theme in our research—may be important in offsetting the underlying demographic pressures for continued capital flows from the EM to the DM world.
We will next present Goldman's piece which looks at potential investment opportunities when evaluating the "baby-boomer onslaught" factor.