The World in 2030: Super-cycle or Grey Age?27 January, 2011, 23:15. Posted by Zarathustra
Tags: Africa, Economy, Global, India, United States, World
Back in November 2010, Standard Chartered published the big “Syper-cycle Report”, claiming that we are now in a big super-cycle which has started in 2000, in which economic growth will be higher than the previous 26 years or so. According to StanChart, there have only been 2 such instances when the average economic growth were higher than the average growth of other times. The previous two super-cycles were in the period when the British Empire was at its peak of its power and influence until the eve of the First World War (1870-1913), and the post Second World War period until the oil crisis (1946-1973). And from 2000 onwards to 2030, StanChart believes is yet another age of higher growth. While they acknowledged that short-term volatility exists, the general trend, they think, is upward. As a result of the super-cycle, they recommended a long-term asset allocation of overweighting equities, commodities and real estate while underweighting bonds, and additional favour on emerging markets over developed markets.
Source: Angus Maddison and my own estimations, resulting a chart which only matches the StanChart’s chart in shape but not in numbers
And I am not sure if anyone remember that back in September 2010, Jim Reid and Nick Burns of Deutsche Bank published another long report titled “From the Golden to the Grey Age”. They asserted that the “Great Moderation” of low economic volatility and consistent growth in developed economies with the accompanied strong returns from almost all asset classes over the past 25 years or so were possible because of, among other things, demographics, credit expansion and globalisation, and the credit fuelled “Great Moderation” should have ended with the great financial crisis. In the age of “Great Moderation” from November 1982 till 2007, the US economy has been in recessions for only 16 months, or 5% of the time. Now, in the age of post-“Great Moderation”, the US economy will revert back to the pre-“Great Moderation” normal. This is the chilling fact about this “normal”: the US economy from 1854 to 1982 was in recessions for 35% of the time. Along with other reasons, they expect shorter business cycle, and sub-average returns in many asset classes. As a result of that, they believe that timing the market becomes more important and picking one asset class and use a buy-and-hold strategy.
So, Super-cycle or Grey Age?
Emerging economies: the Case for Super-cycle
When I cut history in the same way as the Super-Cycle Report did (i.e. post-WWII to 1973, 1973 to 1999, and 2000 to present), we will realise that the average growth rate in the United States for each big cycle has been declining steadily.
Source: St. Louis Fed
And of course, on the other side of the planet, China’s growth rate does seem to go higher and higher (if you believe the numbers).
Source: National Bureau of Statistics
And so does India:
Source: World Bank
Very little doubt, of course, that the emerging economies are now the growth driver of the global economy. Some folks at the IMF has already suggested that for every 1% increased growth in China, the rest of the world would grow 0.4% faster after five years, and we have been hearing enough of the two-speed recovery after the financial crisis. Even the somewhat gloomy Deutsche Bank report suggested the following:
… by 2050 the (now) Developed World will only make up around 32% of the World’s wealth (81.7% of the population), with the now Developing World the dominant Economic force (68% of wealth)…
There are many reasons for that. The Super-cycle report also cited urbanisation and trade as the driver for global growth, and in particular, the growth of trade among emerging economies. Also, most of the world population growth will now be driven by in emerging economies, while that of developed world is declining, thus most of the growth will be coming from the emerging markets.
Source: UN Population Division
However the rosy picture it is under this Super-cycle scenario, there are many reasons to feel gloomy.
Grey Age: Reasons to Feel Gloomy
Slower Population Growth and Ageing
Despite being the main driver, even the population growth in the less developed world is slowing, and there are huge variations among countries even in the emerging economies. Looking into the details, it is not all that favourable. Part of it, of course, can be attributed to the one-child policy of China in their hope to control population, with an unintended consequence of creating a rapidly ageing demographics. Previously I have compared the demographics between China and Japan and noted some striking similarities. Ten years from now, China will look increasingly like the Japan on 2011 as far as demographics are concerned.
On the whole, to look for longer term growth driver in terms of population, you have to look elsewhere, like India, which has a much younger population.
Another place where strong growth in population is expected is Sub-Sahara Africa, with the growth rate well above the average of both the more developed world and less developed world as a whole.
Source: UN Population Division
We can also look at the proportion of working-age population to the total population over time to look at the trend. Overall, we can see that the developed has enjoyed a demographic advantage of having large working age population relative to total population in the 1980s and 1990s, but this advantage was overtaken by China in the 2000s. Unfortunately, China has had an increasing proportion of working-age population (15-64 years old) only till 2010, and the working proportion relative to total population will drop afterwards. By 2030, we will see India having clear advantage in this respect over developed world and China.
Source: UN Population Division
In the life-cycle hypothesis, it is assumed that people in the early twenties to thirties are in general net borrowers as they have relatively low income and more debt. After that period till they retire, they would become net savers and investors and they accumulate wealth to prepare themselves for retirement. And they retire, they would become net spenders as they use (or dissave) the assets they accumulated and invested over years.
Two related questions would be, first of all, the implication of shrinking population of “economically active” people on asset markets. In the Deutsche Bank report, they suggested that because people from mid-thirties to mid-fifties are the main group of people under the life-cycle hypothesis who would invest, thus the proportion of of this cohort of people relative to the total population would correlate with asset prices. If this cohort is large, there is more money available for investment, thus asset prices would be higher (or prone to bubble?). Although the world as a whole will still see this group of people growing by 38% over the next 40 years, most of the growth come from less developed world ex. China. And consistent with the chart above, China will be losing this cohort of “Net Investors” in the next 40 years or so. The chart below shows the proportion of population of age between 35 to 54.
Source: UN Population Division
If the above chart is plotted against the stock market indices, we can see the following:
Better Still, if we plot the percentage of “Net Investors” Cohort against the cyclically-adjusted price-to-earning ratio (or Shiller P/E), we can see this:
Source: Robert Shiller
So the life-cycle hypothesis seems to be quite right in this regard.
The second question is whether rapidly ageing population really means increased consumption as the life-cycle hypothesis predicted. This is particularly relevant in China as everyone is arguing that China needs to consume more and save less in order to re-balance the global economy. Reality is, of course, not always as straightforward. In Japan, arguably one of the most aged populations, Claus Vistesen found that while household saving rates did drop over time, consumption has hardly grown. And a detailed look discovered that there has been no meaningful dissaving or destocking of household balance sheet. On the other hand, corporates balance sheets and retained earnings in Japan increase over years, and it seems that much of this money has gone to “investment securities”, which should include Japanese and foreign government bonds and other securities. Even if these corporates give out more money as dividend instead of purchasing securities, it is hardly certain that the money, when put into households’ pocket, will be spent as consumption. In this regard, the life-cycle hypothesis seems to be not working.
The world as a whole will see population in this cohort shrinking, while some countries and regions like India and Sub-Sahara Africa will still see growth on this cohort for another few decades. If the UN forecast is right, and if history is going to repeat itself, we will probably see below-average return on equities, and will offer very little hope for those who wish Chinese people would spend more.
Peak Oil: Limiting factor for Growth?
The chart above shows the global consumption of oil. While global consumption dropped in 2009 during the recession, we see consistent increase in consumption from China. Indeed, the super-cycle report agreed that demand of oil (or energy in general) will rise if their super-cycle thesis is right. Whether we have already reached the point where oil production has reached its limit will certainly be debatable, and it will pretty much depend on whether you are an optimist or pessimist. Unfortunately, even the Super-cycle report acknowledged that oil production in the coming 20 years will not keep up with the demand. Sceptics and pessimists have suggested that the point where oil production hit its maximum is only 5 or 10 years away, and the world will run out of oil completely in 2041. And unfortunately, any viable alternatives to oil will not come until 100 years after we have used up all oil. Even before we truly run out of oil, if we cannot use oil much more efficiently and if we cannot find any commercially viable alternatives until one and a half century later, we will probably see oil prices going through the roof. Given the reliance on oil, it is hard to see why we can be optimistic.
Next Crisis in China?
There’s rarely a instance that investors agree on whether something is a bubble. Today, Bloomberg reported that 45% of investors believe the next major crisis will be in China. I have argued for countless times that China economy is a credit-fuelled bubble, and eventually will burst for sure. This is, despite being a big short-term risk, is going to be consequential for the next 20 years for a number of reasons.
First of all, we shall not forget how integrated the global economy is today. Now as the Chinese economy is becoming the second largest economy, any slowdown or recession in China will be felt by the rest of the world. While the usual argument for decoupling suggests that emerging economies are relatively unaffected by shocks from the West, relatively little people have raised the question on whether developed economies can stay afloat from a shock from China. I have no definite answer as to how big the impact would be, but given China and other emerging economies are not the global growth driver, any problems with these economies will undoubtedly slow the global economy markedly.
Second, we have to understand what the implications are for a credit-fuelled economic bubble to burst. Real Estate bubble, for example, is danger to the economy in many ways, and it is particularly hard for one economy to recover from a burst of a real estate bubble. When a burst of real estate bubble is accompanied by a banking crisis (which is not unusual given the highly leveraged nature of home-buying), the recovery will be long and painful. If the China bubble does crash, we may see a pro-longed recession in China just like the United States faced after the subprime crisis. Global economy will then grow slower than they should for an extended period.
So, Super-cycle or Grey Age?
On the whole, I am somewhat more pessimistic. I believe that overall economic growth will be somewhat slower in many of the countries, including most of the developed world and China. There will huge variations, however, between different countries even in the emerging markets. India should still be favourable, and Sub-Sahara Africa might be interesting with the potential of converging the the world average given the low base. Shocks from oil prices will probably be around from time to time as we are indeed running out of it, so economic volatility will be high. And currently, one of the biggest risks would be a hard-landing in the Chinese economy, which will undoubtedly drag down the global economic growth even if it does not affect the Developed World (which is not likely).