By John Richardson
YOU cannot fix a blocked plughole by pouring in more water.
This is the core message of this very important FT Alphaville blog post, which tells us that:
- While Western central banks have done their best to stimulate new credit creation, a lack of good-enough returns from the real economy means that Quantitative Easing (QE) etc. have done little more than boost the value of financial assets, including crude oil.
- Banks and other speculators have preferred to gamble on oil, other commodities and the S&P 500 because, as long as the Fed’s policies remained accommodative, this was a one-way bet. Why bother with all the hard work, and risk, of lending money to a real company, which makes things that people actually need, when you make can make a fortune at the touch of a button on an electronic trading screen?
- Some credit has, of course, flowed through to companies who actually make things that people need.
- But the trouble is that companies haven’t bothered to use most of this money to make the things that people really need.
- Instead, they have spent the majority of their cheap lending on what the FT aptly characterises as “artificially synthesised” big bonuses for their top executives and strong dividends for their shareholders.
- This has involved lots of share buybacks that led to stock appreciation. “They take from the future to flatter the bottom line today. Other stakeholders be damned,” writes Edward in this second, equally important, FT article on share buybacks..
Why has this happened?
It is because of “the decline in the quality of corporate governance. The average tenure of the US CEO is falling,” writes Luce.
“Buying back shares instead of investing makes sense if you do not expect to be around for the pay-off. It is a no-brainer if you measure the time horizons of most executive reward packages.
“ In 2012, the 500 highest paid US executives made on average $30.3m each, according to Prof Lazonick. More than 80% of it came in the form of stock options or stock awards. Their incentives are skewed towards extracting value from the companies they run, rather than creating future value.”
One can just blame executive greed for all of this, shrug your shoulders and say, “nothing will ever change”.
But Luce argues that it is the job of politicians to introduce legislation that addresses this skewed incentive system. This was the same argument we made our book, Boom, Gloom & The New Normal.
Luce also makes the point that we have been making for the last four years: That the reason why companies would rather financially innovate than innovate in manufacturing is because the returns from the real economy are in a secular, long-term decline.
This secular, long term decline in demand is the result of demographics in the West.
Here are a few key facts on demographics, based on International eChem analysis of UN data:
- Since 1950, fertility rates in the West have fallen by 50%, with each woman now having an average of just 2.5 children.
- Until 2000, the post-World War II baby boom disguised the problem, as the proportion of “New Old” in the adult population (see below for a definition of “New Old) remained constant at around one in five.
- But since then, it has been rising very rapidly, such that the proportion of New Old will be almost one in three people by 2030.
Why does this matter? Because:
- The world’s “Wealth Creators” are in the 25-34 age range, when their average annual spending is $48,000.
- Their spending then increases to $58,000 in the 45-54 age range, as the kids grow up and income levels increase.
- But spending drops to just $45,000 as people join the New Old – the 65-74 age.
- The reason why spending drops to this level is because the New Old mainly buy replacement products as their incomes fall during retirement.
But what about all the Hispanic and black people in America, and the other ethnic minorities across the Western world, who tend to have more children? Won’t these people inevitably replace all these lost Bayboomers, as their birth rates tend to be higher?
No, because, in the case of the US:
- 12% of Black Americans and 8% of Hispanics are unemployed
- This compares with just 5% of Whites and Asians.
- Blacks are 14% of the US population, and Hispanics are 17%. .
We are certain that if you produced comparative data for minorities across Europe, the story would be the same.
And so what has gone wrong here? It is that:
- The retirement of the Babyboomers has reduced aggregate demand. This has created less job opportunities for the average middle class worker in the US.
- The policy response to this demographic crisis has been entirely wrong because it has only involved throwing lots of cheap money at the problem.
- But you cannot make turn the clock back, and make all the retiring Babyboomers younger, by printing more and more money.
- And so you still end up with 12% of Black Americans and 8% of Hispanics who are unemployed.
- This policy response has created huge social and political tensions that could end up creating major unrest that further damages growth.
- Why? Because, as we said, Fed stimulus had done little more than make lots of money for speculators, senior company executives and the small number of people who own shares.
- This has widened the gap between this rich elite and everyone else, as middle class incomes in the US stagnate. Hence, lots of people are, quite rightly, very angry.
So, what are the solutions:
- It is legislation that incentivises companies to invest more money in R&D, and so they are more motivated to develop the products and services of the future.
- But companies should not wait for this legislation to happen. They should take the lead now because the opportunity is nothing short of fantastic.
- The opportunity is this: Life expectancy has increased by 50% since 1950, to around 70 years. Today there are already 1 billion ‘New Olders’ compared with just 300 million in 1950. This is a huge number of new customers.
Your response, if you work for a chemicals company might be: Why should I bother to take the lead?
You should bother because the Fed, and also crucially the Chinese government, have stopped pouring money down a blocked plughole.
We are, as a result, entering a world where only “real demand” will always matter.