Angola - A new best friend forever for China

In recent years, it has become increasingly common to read mainstream media coverage regarding the increasing involvement of China in the economic affairs of the African continent as China scours the globe for new sources of much needed natural resources.  Unlike western nations, China has no qualms about dealing with countries that have been shunned because of human rights abuses or corrupted dictatorships.  In one prime example, the China National Petroleum Company (CNPC) and Talisman Energy, a Canadian oil company, partnered in petroleum exploration and development in the Sudan where a civil war led to human rights abuses and genocide.  Talisman's shareholders forced the company to leave the Sudan in 2003 and their interests in the project were acquired by an Indian oil company.  Since that time, CNPC has markedly increased its activity and investment in Sudan.  

Africa has seen all of this before; in decades past, western nations were heavily involved in African political and economic affairs and all Africa had to show for these efforts was unserviceable levels of debt, crushing poverty for its citizens and outbreaks of civil war from the north of the continent to the south.  One of the countries that suffered the most was Angola.

Angola was originally a Portuguese colony.  The Angolan War of Independence started in 1961 and ended in 1975 when Angola was granted its independence after a military-led April 1974 coup in Portugal overthrew the country's dictator and created a democracy.  During the War of Independence, three main groups, the National Uniion for the Total Independence of Angola (UNITA), the Popular Movement for the Liberation of Angola (MPLA) and the National Liberation Front of Angola (FNLA) fought a guerilla war against the Portuguese Armed Forces.  Once the War of Independence was over, the communist MPLA fought for control of the Angola with the anti-communist UNITA faction.  Several other factions were also involved in the fighting with outside countries attempting to influence the outcome.  The communist MPLA was supported by Cuba, the Soviet Union and the eastern bloc countries while the UNITA forces were supported by the United States, China, South Africa and Zaire.  The civil war was viewed by many as a proxy for the Cold War with both the United States and the Soviet Union viewing it as a battle of communism versus democracy.  The civil war lasted for 27 years with interludes of relative peace until 2002; during that time, an estimated 500,000 people were killed.

Back to the subject of this posting; the cozy relationship between China and Angola.  By way of introduction, I'll give you some background information on the country of Angola.  Angola is located on the southwest coast of Africa.  In 2008, Angola had a population of 18.021 million people and its GDP at market prices in 2009 was $68.76 billion, well less than one-third of the American deficit for the month of November 2010 alone!  Diamonds are an important source of economic activity for Angola as is iron ore, phosphate, marble and black granite.  According to UNICEF, average life expectancy at birth for both genders is 47 years, and the country's under 5 mortality rate was the second worst in the world.  Of 774,000 children born in 2008, 165,000 under the age of five perished.  The total adult literacy rate is 67 percent and Gross National Income per capita in 2008 was $3450 (USD).  It is estimated that 2.1 percent of the population is HIV positive with and estimated 190,000 people living with HIV in 2007.  Angola has one of the highest total fertility rates in the world with an average of 5.8 children per woman.  To put that into perspective, Japan's fertility rate is 1.29 children per woman.

As an oil producing country, Angola flies well under the scrutiny of the mainstream media.  Surprisingly enough, Angola is now Africa's largest oil producer, surpassing Nigeria which is currently producing 1.8 million BOPD because of attacks on their oil infrastructure in the Niger Delta.   Since Angola joined OPEC in 2007; oil has become its main driver of economic growth, in fact, in 2009 Angola held the Organization's presidency.  Here is a chart from the United States Energy Information Administration (EIA) showing OPEC's production by country for the year 2009:

As you can see, Angola is the seventh largest oil producer in OPEC with their capacity falling just below Iraq, the U.A.E., Kuwait and Venezuela.  Note that the chart shows that Angola produced only 1.82 million BOPD.  As a response to OPEC's production allocation, Angola shut-in roughly 200,000 BOPD of its capacity.  According to OPEC, Angola's proven oil reserves stand at 9.5 billion barrels and, according to the EIA, proven natural gas reserves stands at 9.6 TCF, the second largest natural gas reserves in sub-Saharan Africa.  Most natural gas is produced along with oil is flared or re-injected into oil reservoirs to maintain pressure and aid in oil recovery.  Of the 355 BCF produced in 2008, 244 BCF was flared, 81 BCF was re-injected and 28 BCF was used for domestic consumption.  Plans are underway to convert the natural gas into LPG for export by the year 2012.  The facility under construction will process 1 BCF of natural gas daily.

Angola's first oil was produced in 1955 so you can see that the country has come a long way from rather humble beginnings.  When Angola's independence was proclaimed in 1975, the country was third on the list of Africa's oil producing countries after Nigeria and Gabon.  In 2009, oil production and related activities comprised over half of the nation's total GDP with oil exports reaching $38.81 billion out of total Angolan exports of $40.99 billion.  Local consumption of oil is rather insignificant with the country consuming only 62,000 BOPD out of the 1.82 million BOPD produced in 2009.  In 2009, according to the United States Energy Information Administration (EIA), Angola's production capacity had reached 2.1 million BOPD (barrels of oil per day), up from 750,000 BOPD in 1999.  Here is a chart showing Angola's production and consumption for the past 10 years:

In 2010, Angola has supplied the United States with approximately 409,000 BOPD, making it America's seventh largest supplier of oil after Canada, Nigeria, Mexico, Saudi Arabia, Venezuela and Iraq.  Angola also exports approximately 500,000 BOPD to China, the third largest supplier to that country after Saudi Arabia and Iran.

Most of Angola's oil production and exploration activities are located in offshore blocks with water depths up to 3000 metres.  Operators in the country include ExxonMobil, Total, BP and Chevron.  Pending exploration and development activity could result in significant production increases; based on existing discoveries, production capacity could reach between 2.5 million and 3.0 million BOPD by 2015 as shown in this chart from the EIA:

From this background information, we can see that Angola is rapidly becoming a world energy power.  Both the United States and China will be competing for this resource.  Unfortunately for the United States, Angola's past experience with Western "assistance" has been less than positive.  China is (and has been) making substantial overtures toward Angola.  According to the World Bank, China has offered loans and infrastructure worth about $9 billion to help the Angolan government to rebuild roads, bridges, schools and hospitals destroyed in nearly 3 decades of civil war.  In late November 2010, China and Angola announced that they had entered into a strategic co-operative arrangement that will enhance the level and quality of their economic and trade relationship with the result that both countries will mutually benefit.  The agreement prioritizes agriculture, industry, infrastructure, urbanization and the all important energy and mineral resources exploration.  I think that we can imagine where China will be emphasizing its assistance.  This became most evident in March 2010 when Sinopec purchased a stake in one of Angola's deepwater fields for $2.46 billion from China Petrochemical Corp. in a move that will increase Sinopec's ability to supply China's fuel needs.  The Angola Number 18 block holds proven oil reserves totalling 100 million barrels and is one of the fastest growing areas for production and exploration.

Angola is most certainly going to be an interesting country to watch over the next decade.  It is definitely going to play a very important role in the world's energy markets, particularly as the world approaches (or passes) peak cheap oil.

China's Demography: A Brewing Storm

Thanks to an idea from a reader, I've done some research into the demographics of China.  The country's one child policy of the 1980s has markedly impacted the population distribution of the country and will impact its economic future and, by extension, that of the world.

Before we look at China, I'd like to take a quick look at the use of population pyramids.  These graphic tools can be used to very quickly understand the age distribution of a country's population and can be used to project that country's population over time.  By convention, population pyramids show males on the left and females on the right.  The horizontal axis is the number of each gender (usually in millions) and the vertical axis is age categories, usually in five year increments.

Now let's look at what population pyramids can tell us.  The first type we'll look at is an expansive or expanding population pyramid.  A broad base tells us that there are more young people in the population  and a narrow top tells us that there are fewer older people.  The broader the base, the higher the birth rate and the narrower and lower the top, the higher the death rate.  As well, where the sides of the pyramid are concave, a high death rate is indicated and where the sides of the pyramid are convex, a low death rate is indicated.  A rapidly expanding population (very broad-based pyramid) is generally indicative of a lower standard of living where there is limited access to birth control and a very narrow top indicates that there is poor medical care and that nutritional deficiency might be an issue.  Note that in this type of pyramid there are more children than there are males and females in the ages where reproduction is most likely to take place meaning that the population is more than replacing itself over time.

Here's an example of an expanding population pyramid showing the population of Japan in 1950:

 

Notice how there are fewer males and females as the population ages.  This type of pyramid is quite typical of many European nations, the United States, Canada and Australia after the Second World War and, as stated above, is an expanding population pyramid.

The second type of pyramid is the stable or stationary population pyramid.  The base of the population pyramid is the same width as the age range where reproduction is most likely to take place.  This is generally indicative of a higher standard of living where there is ready access to birth control.  The relatively wide and high top to the pyramid indicates that there is a low death rate due to good nutrition throughout life and access to good medical care.

Here's an example of a stationary population pyramid for the country of Iceland in the year 2000:

 

The third type of pyramid is a contracting or contractive population pyramid.  These pyramids have a narrower base than the age range where reproduction is most likely to take place, in fact, these diagrams don't really resemble a pyramid at all.  Notice how the population of the age groups between 0 and 14 years of age are much narrower than those of the reproductive age groups between 15 and 44 years of age.  In these cases, the population is not replacing itself; very low birthrates mean that the population is likely to drop in the future.  These population distributions are usually found in developed nations.  

Here's an example of a contracting population pyramid for the country of Japan in the year 2000:

As time progresses, this population will shrink because Japan faces the three issues of having a very low birthrate, a long lifespan and a very low immigration rate.  Here is the population pyramid showing the projected population groups for Japan in the year 2050:

Notice how there are many more senior citizens (39.6 percent of the total population) than there are young children under the age of 15 (8.6 percent of the population).

Irregularities in the sides of a population pyramid can be indicative of various issues.  Bumps in the side can indicate sudden growth in the population.  As shown in this example of France, the circled bump accompanying the birth of baby boomers after World War II travels up the pyramid with time from the year 1970 to the year 1985:

As well, because population pyramids show the distribution of males versus females, one can see how the distribution of the two genders changes with age.  In the 2050 chart for Japan shown above, note that the pyramid is asymmetrical at the top.  In this case, the asymmetry results from the fact that there are many more females over 80 years of age than there are males.  This too seems to be typical of developed nations.  On the upside, senior men are pretty much going to have their pick of female partners!

On to China.  As you may recall, China instituted a one child policy in 1979.  This policy was brought about because of the massive population growth that China experienced during the 1960s and 1970s.  By 1963, the average Chinese woman had given birth to 7.5 children.  While that rate had dropped to 2.7 births per mother by 1979, there was still great concern about the future security of the nation's food supply.  WIth 20 percent of the world's population and only 7 percent of the world's arable land, the government instituted a policy that would ensure that the country would be able to feed its own people.  Today, the policy is still in place and nearly two thirds of Chinese couples are required to have only one child; statistically there are around 150 million families with only one child.  China claims that their one child policy has averted roughly 400 million births although there is no real way to independently confirm that number.  China's country-wide fertility rate is well below the replacement rate of 2.1 children per woman; it has decreased to an estimated 1.5 children per woman and in developed urban areas, it has dropped to an average of one child per woman.  To put this number into perspective, the country of Japan which is projected to have a massive drop in population over the next 40 years, has the world's fifth lowest total fertility rate at 1.2 children per woman.  Macau (a special administrative region of China) has the world's lowest fertility rate at 0.91 children per woman.

The one child policy has had unintended consequences; the sex ratio among children at birth has changed from 108 boys for every 100 girls in 1980 to 120 boys for every 100 girls today resulting in 20 to 30 million excess males.  As well, the single child families will have to rely on their sole child to provide for their parents as they age.  This will place a social and economic burden on the next generation as fewer of them will be required to fund the growing pension, health care and social welfare benefits of an increasingly aging population.  The number of elderly Chinese aged 65 and older stood at 144 million in 2007 and is expected to rise to 391 million by 2035 when seniors will comprise 25 percent of the total population.  The doubling of the number of people over the age of 65 will take only 27 years, much faster than the doubling of the number of seniors in the United States.

Here is what the population pyramid for China looked like in 1970 before the one child policy was adopted:

Notice the nice broad base and narrowing through the ages where reproduction is most likely to take place.  This is a typical population pyramid for an expanding population.

Here is what the population pyramid for China is projected to look like in 2050:

Notice the narrow base, the relatively wide top and the narrowing from ages 0 to 19 years.  This is a typical population pyramid for a contracting population.

Demographic changes have already been noted at the elementary school level; in 1995, there were 25.3 million new students enrolled in school.  By 2008, that number had dropped by one-third to 16.7 million.  The one child policy is also impacting China's industries.  China is on the cusp of experiencing a decline in new entrants into its labour force.  The days of the seemingly endless supply of young and cheap Chinese labour is drawing to a close.  The number of young labourers between the ages of 20 and 29 has already dropped by 14 percent in the past 10 years and is expected to drop by an additional 17 percent in the next 20 years.  Not only will China's demographic changes have a marked impact on China, it will have a marked impact on the world's economy.  Most nations in the world have regarded China as the world's manufacturer; should a shortage of labour occur, it will definitely impact the price of labour resulting in an impact on prices of goods around the world.

While the rest of the world will be adjusting to a changing demography as baby boomers reach their senior years over the next 2 decades, the impact on the world's economy of that demographic change will be relatively minor compared to the massive impact felt when China's massive population reaches the same point.

References:

Brookings Institute:  China's One Child Policy at 30 by Feng Wang

Brookings Institute:  China's Population Destiny: The Looming Crisis by Feng Wang

Here is the link for a cool, little animated population pyramid for China from 1950 to 2050.

Flint: A City in Crisis

Recent media reports about the debt crisis facing American cities outlines the problems that could bring many American cities to their knees.  Meredith Whitney, a United States-based research analyst describes the ticking time bomb of both municipal and state debt as the next big problem threatening the United States' economy.  Michigan's economy seems particularly hard-hit with massive job losses; in November of 2010, Michigan's unemployment rate stood at 12.4 percent, 2.6 percentage points over the national average as shown in this chart:

Notice that Michigan's unemployment rate ranges from 2.6 percent to 4.5 percent above the national average and that it has dropped 2 percentage points over the past 12 months bringing it closer to the national average.

In light of that, I thought I'd take a brief look at the real estate market in another American city.  Flint Michigan is a city located 65 miles northwest of Detroit and is the seventh largest city in Michigan.  Flint is best known as the birthplace of General Motors.  Flint is also renowned as the birthplace of filmmaker Michael Moore, the director and producer of movies like Fahrenheit 9/11, Bowling for Columbine and Capitalism: A Love Story.  The city has a population of 117,068 (2006 estimate from the United States Census Bureau), down from 124,943 in the year 2000, a drop of 6.3 percent. In 2008, Flint ranked third in the state of Michigan for the greatest number of residents lost.  In 1999, 26.4 percent of Flint's population was living below the poverty line compared to a state-wide average of 10.5 percent.  In the year 2000, the median home value was pegged at $49,700 and 58.8 percent of residents owned their homes.

As I stated, Flint was the birthplace of General Motors with the founding of the Buick Motor Division in 1904 and the Chevrolet Motor Division in 1913.  General Motors was the main employer in Flint for decades; at one time, the company employed 82,000 workers in Flint (out of a peak population of nearly 200,000 people in the 1960s and 1970s).  By 2008, the 100th Anniversary of General Motors, the company had downsized to the point where only 14,500 workers in Flint were employed by GM.  The drop in the number of employees by the "only show in town" and the de-industrialization of the heartland of America defines the issues facing the city today.

Now, on to Flint's real estate market.  I'm using the Realtor.com website to search for properties.  As an introduction, of the 1365 homes listed on the website, nearly 250 homes have an asking price of $10,000 or less.  The Demographia "6th Annual International Housing Affordability Survey:  2010" ranks metropolitan real estate markets in Australia, Canada, the Republic of Ireland, New Zealand, the United Kingdom and the United States by their respective median house price as a multiple of their median household income.  Severely unaffordable housing has a median multiple of 5.1 or more and affordable cities have a median multiple of 3.0 or less.  Flint, Michigan comes in sixth place with a multiple of 1.8 as shown on this chart:

Like Detroit, there are a lot of houses listed at fire-sale prices.  There are houses for as little as $900  like this one located at 2539 Mount Elliot Avenue:

  

It's a two story, 1188 square foot single family dwelling with 3 bedrooms.  There are no interior photos so we have no idea what condition the house is in.  It is interesting to click on the property history tab; for the years 2009 and 2010, the home is assessed at $14,300 for property tax purposes and the $942 taxes assessed for the property were more than the asking price of the house.

Here's one for sale at 1383 Cleveland Drive - its asking price is $2900.  It's a foreclosure but from what we can see on the photos of the interior it looks reasonably well cared for other than the rather hideous paint in the bedrooms:

One last listing.  This two bedroom, 1185 square foot home is located at 1630 Dupont Street.  From the photos, it looks very well cared for and it appears to be occupied.  Its asking price is $11,000 and it has been listed for 385 days.  This two bedroom home is assessed at $9931 in 2010 and the property taxes were $409:

What is particularly heart-breaking about Flint, Michigan is seeing what happens to a city when it is de-industrialized.  With property values plummeting and many homes being unoccupied simply because the mortgage is worth way more than the value of the property to any buyer, revenues from property taxes drop making it more and more difficult for the city to provide programs necessary to keep its population from dropping even further.  A drop in revenue from business taxes accompanies the drop in residential taxes compounding the fiscal issues facing any city undergoing urban devastation.  Despite the fact that Flint has dropped its spending from $66.3 million last year to $57.1 million this year, it still needs to borrow between $13 million and $18 million to pay off its general fund deficit that reached $10.1 million in fiscal 2009.


The coming year will be an interesting one for municipal bond holders.  Many American cities are facing debt crises that will result in them begging for help from their state governments.  With both state and federal governments already heavily indebted, it will be interesting to see if anyone can come to the rescue of America's municipal governments.

The Rich Keep on Working - A Socio-economic look at American Unemployment

Once again, since apparently I have nothing better to do, I was surfing and came across this interesting article.  Since the advent of the Great Recession, one of the factors that has kept commenters commenting and economists scratching their heads has been the intransigence of the United States unemployment numbers.  No matter how much quantitative easing (i.e. paper money) Mr. Bernanke throws at the economy and no matter how much he drops interest rates, people who are out of work seem to stay out of work and companies just don't seem to be hiring.  This has to really annoy Mr. Bernanke; without jobs, people are unlikely to borrow too much money, buy too much house and otherwise spend way over their heads.  That leads to stagnancy in the economy and could possibly bring about the central banker's worst nightmare; the dreaded spectre of deflation.  Just think of the sleep that would be lost by central bankers around the world if prices would actually drop!  Why consumers would stop spending and wait until prices became more attractive before they parted with their hard-earned dollars.

The team of Andrew Sum and Ishwar Khatiwada at the Centre for Labor Market Studies at Northeastern University completed a study entitled "Labor Underutilization Problems of U.S. Workers Across Household Income Groups at the End of the Great Recession: A Truly Great Depression Among the Nation's Low Income Workers Amidst Full Employment Among the Most Affluent" (pant, pant - my fingers are tired now) in February 2010.  While the title is a bit of a mouthful, the paper is a gem among gems when it comes to explaining the socio-economic disparity among the unemployed in America.

Before I go into what the paper outlines, let me briefly give you the most recent unemployment statistics for the month of November 2010 from the Bureau of Labor Statistics (BLS).  The unemployment rate (U3 rate) edged up 0.2 percentage points to 9.8 percent and there were 15.1 million unemployed Americans.  There were 6.3 million long term unemployed (at 27 weeks or longer) and they made up 41.9 percent of the total unemployed.  According to the Shadow Government Statistics (SGS) website, the broadest measure of unemployment (U6) stood at 17 percent and the SGS Alternate unemployment rate (includes those who are long-term discouraged workers) stood at nearly 23 percent.  Now that we have the numbers in perspective, we'll go back to the "Labor Underutilization..." paper.

In their paper, Sum and Khatiwada examine which American workers have been most affected by the Great Recession.  From BLS statistics, we can readily see which age group, gender or race have the highest unemployment rates.  For example, the unemployment rate of African American males over 20 years of age was 16.7 percent in November and that the unemployment rate for laborers that did not have a high school diploma was 15.7 percent in November compared to 5.1 percent of the work force that had a Bachelor's degree or higher.  BLS statistics show us that, generally, if you have a poorer education and are Black or Hispanic, you are more likely to suffer from unemployment.  What we don't see from government statistics is an analysis of unemployment and underemployment (those who are working part-time for economic reasons) by income group/socio-economic status.  As background information, on average, underemployed workers only get 22 to 23 hours of work per week compared to 43 hours per week for full-time workers. 

Sum and Khatiwada took all of the household incomes of the United States for the year 2008 and divided them into 10 groups or deciles with the bottom decile consisting of households making an annual pre-tax income of $12,160 or less and the top decile making an annual pre-tax income of $138,800 or more.  Here's how the deciles break down for 2008 and their accompanying incidence of underemployment for the October to December 2009 period from the United States Census Bureau Current Population Survey (CPS) data for that period:

Decile              Income Range               Incidence of 

                                                          Underemployment

First                 $12,160 or less                   20.6      

Second         $12160 to $20725                  17.2

Third             $20725 to $29680                  12.7

Fourth           $29680 to $39000                   8.3

Fifth              $39000 to $50000                    6.1

Sixth             $50000 to $63000                   5.4

Seventh        $63000 to $79100                   4.4

Eighth          $79100 to $100150                  3.6

Ninth           $100150 to $138700                 2.5

Tenth              $138700 or more                   1.6

Missing                                                         5.3

Notice that the incidence of underemployment falls very steeply as income level rises.  By the time respondents reached the sixth decile, unemployment is negligible especially if one subscribes to the theory that full employment is reached when unemployment stands between 4 and 6 percent.  The underemployment level at the lowest income level is nearly 13 times that at the highest income level.  This tells us that the burden of underemployment in the United States has been borne disproportionately by those in the lowest income levels.  This order of magnitude higher rate of underemployment at lower socio-economic groups impacts the growing division between the haves and the have-nots in American society and at least partly explains the growing socio-economic polarity in the United States.

Sum and Khatiwada go on to calculate how income level relates to hidden unemployment, those workers who wish to work but are not actively looking for work in the survey period so are not counted as unemployed by the Bureau of Labor Statistics.  The authors classified these workers as the under-utilized pool of labour; the sum of the unemployed, underemployed and the hidden unemployed.  Although the income decile ranges changed slightly to accommodate the data from the fourth quarter 2009 CPS survey data (lowest decile is $12,499 or less and highest decile is $150,000 or more), the conclusion is similar.  The lowest income decile suffered from a total unemployment rate of 30.8 percent and the underemployment rate was 20.7 percent.  This compares to 3.2 percent unemployment and 1.6 percent underemployment at the highest income decile as shown in this chart:

Using this analysis, the rate of total unemployed at the lowest income group is the same or higher than the unemployment level that was experienced by all workers during the Great Depression.  Not only do the lowest income Americans suffer from the highest unemployment rates, they also suffer from the highest underemployment rates. 

The impact of the Great Recession has and continues to vary greatly with the socio-economic status of the American workforce.  Workers at the top and bottom of the income ladder have had vastly different experiences during the Great Recession of 2008 - 2009 with workers in the upper income echelons feeling minimal impact on their employment status compared to those at the lower levels.  It will be interesting to see how long it takes for the lowest deciles to benefit from an economic upturn should one take hold.  

References:

Here is the link to the Sum and Khatiwada paper.

Here is the link for the United States Department of Labor Current Population Survey Labor Force Survey website.

Here is the link for the United States Census Bureau Current Population Survey for 2009 webpage.  This chart shows the breakdown of various issues by income grouping including family size, labour force participation etc.

Central Banks and Your Credit Cards

In recent days, the mainstream media has been increasing its coverage of the horrors of over-indebted consumers as noted in my posting found here where the Bank of Canada's Mark Carney gets a bit testy about the amount of debt his fellow Canadians are amassing.  I found this speech given by Federal Reserve Governor Elizabeth A. Duke at the Federal Reserve Bank of Philadelphia Payment Cards Centre Conference (sounds like an edge-of-the-seat gathering to me) on December 2nd, 2010.

First, let's put the number of credit cards in circulation in the United States into perspective.  From the Visa website, the company states that they had 772 million credit cards in circulation (274 million in the United States) and 1065 million debit cards (402 million in the United States).  Between the 2 cards, Visa completed 3.203 billion transactions in the 3 months ended September 30th, 2010.  From the MasterCard website, the company states that they have issued a total of 1.6 billion credit and debit cards.  In the third quarter ending September 30th 2010, they had processed 5.8 billion transactions.  According to statistics on the CreditCards.com website, in a survey completed in February 2010, 29 percent of respondents reported that they do not have a credit card.  This was a 10 percent jump from the number of cardless Americans in June 2009.  The average American (under the age of 35 years of age) get their first credit card at the age of 20.8 years.  Should you have time to peruse this website, it is a fountain of very interesting information.

Back to Governor Duke.  I'll take a few excerpts from her speech and comment as appropriate.  In the first section of the speech, Governor Duke discusses the recent changes in consumer credit:

"During the recent financial crisis, the Federal Reserve and other policymakers throughout the government took unprecedented actions to mitigate the fallout from severely distressed market conditions and support the flow of credit to consumers and businesses. Nonetheless, the level of credit outstanding for households has been very slow to rebound and remains lower than it was at the onset of the crisis. The reasons for the slow rebound are, without a doubt, complex and multidimensional. Still, it is worthwhile to examine the data and try to understand why credit growth is not more robust.

For this forum, I have chosen to focus my discussion on factors affecting the overall movements in credit card debt. The bulk of revolving credit in the United States today is held in the form of credit card debt. As the financial crisis developed in late 2008, the aggregate amount of credit card debt outstanding began to fall. Revolving credit has dropped every month since that time and is currently about 15 percent lower than it was at the time of the Lehman Brothers Holdings bankruptcy. Although our economy has experienced other long episodes in which revolving credit growth has slowed, we have never seen such a prolonged period of outright decline."

I find it most interesting that, despite the fact that much of the Crisis of 2008 - 2009 was caused by over-extended consumers who could not afford to pay their debts (including mortgages), that Governor Duke and her counterparts at the Federal Reserve did what was necessary to support the flow of credit to consumers in large part by adopting a near zero percent interest rate policy and by taking bad investments off the books of the nation's banks.  Notice that Governor Duke states that revolving credit (credit is used on an as need basis and does not have a fixed number of payments in contrast to installment credit which has a fixed number of payments) has declined 15 percent from September 2008.  She also notes that such a sustained drop in revolving credit has not previously been experienced by the American economy and that, although consumer spending has risen, revolving credit has continued to decline.  She states that this can happen for three reasons; first, consumers can simply choose to pay cash or charge less, second, consumers can pay off more of their outstanding credit debt every month and third, households can default on their credit balances.

Governor Duke addresses each of the three issues in order:

Firstly, consumers have charged 10 percent less on their credit cards between the third quarter of 2008 and the first quarter of 2010.  Not surprisingly, and much to the chagrin of central bankers who need us to spend so that the economy grows quarter-on-quarter, households have simply elected to spend less.  Having seen many of their family members, friends and neighbours lose their jobs has had a sobering impact on the spending habits of American consumers.  As well, it has had an impact on their attitude toward purchasing items on credit; somewhat more Americans now believe that buying on credit is a "bad idea".  This is in sharp contrast to the leveraging up that American consumers were used to prior to 2008.

Secondly, the decline in outstanding credit balances could also be due to households accelerating payments toward their outstanding revolving credit balances, however, Fed data shows that repayment is having a minimal effect on the drop in revolving credit.  Generally, as the economy improves, households elect to pay off more of their credit card debt; consumers often used home equity to pay off more expensive credit card debt when the economy was strong.  It's pretty hard to do that when the value of your house is dropping.

Thirdly, as the economy worsened, an increasing number of households have found it difficult to pay their credit card bills on time.  The high unemployment and underemployment rates have made it increasingly difficult for some households to avoid defaulting on their credit card balances.  The "charge-off" (the term used when a creditor assesses the balance owed as bad debt) rate stood at about 4 percent in 2007 and rose to more than 9 percent in 2009.  The charge-offs account for about one-third of the drop in credit card balances.

There are other factors involved in the drop in credit card debt.  One additional factor is the drop in the amount of credit available to consumers.  Lines of credit available to card holders have dropped from an average of $26,000 per cardholder in late 2008 to $21,000 in late 2010.  Another factor is the change in the composition of credit card holders from "if you make fog on a mirror when you breathe, you get credit" to more creditworthy clients who pay off their balances every month.  Finally, the number of new credit card solicitations have fallen dramatically to one-fifth of their count in 2006 by 2009.  On the upside, consumers are getting a whole lot less of those annoying bulk mail-outs from credit card companies cluttering their mailboxes day after day.

The upside to the drop in the use of credit cards for companies like Visa is that they work both sides of the street.  Visa also supplies debit cards whose use has not declined in either number of transactions or value of those transactions during the Great Recession.  You see, if you own a credit card company, you can make great returns for your shareholders either way!

Speaking of Visa, let's take a quick look at their Q4 2010 numbers.  Visa had net income of $774 million in the fourth quarter of 2010 and full year 2010 net income of $3.0 billion (both excluding revaluation of their Visa Europe put option).  Their fourth quarter net income number was up 51 percent over the previous year and their full year net income was up 26 percent over 2009.  Here's a quote from Visa's quarterly report:

“We are very pleased with our fourth fiscal quarter and full-year earnings results as we continue to successfully execute on our strategic initiatives while in the midst of a very challenging business environment,” said Joseph Saunders, Chairman and Chief Executive Officer. “Our continued focus, execution and resilience have enabled us to continue to generate solid returns and meaningful growth across our business, products and geographies.”

No kidding.

Back to Governor Duke for the last time.  I find it interesting to watch central bankers and their relationship to consumer credit and debt.  It appears to be a love-hate relationship.  They deliberately lower interest rates to cajole us into spending (often more than we can afford) by taking on credit (often more than we can afford) so that the world's economy will continue to grow and the dreaded spectre of deflation will not rear its particularly frightening head.  Then, when it looks like we might have had a bit too much of a good thing, they get out a stick and try to beat us back from the pile of money they've tempted us with.  It looks rather like they are suffering from a form of fiscal dissociative identity disorder.

The Next Housing Bubble - Is This the Perfect Storm?

In surfing the tubes that make up the internet (my apologies to the late Senator from Alaska), I happened upon this article from the Journal of the American Planning Association.  The article is entitled "Aging Baby Boomers and the Generational Housing Bubble".  It is a fascinating analysis of what could bring a fatal blow to the idea that our houses will form the bulk of our assets as those of us that are baby boomers enter our retirement years.  Unlike the short-term "temporary" meltdown in house prices created by the subprime mortgage issue of the past two years, this long-term demographic price correction could have a permanent impact on the housing market.  While this study is specific to the United States, its overall conclusions apply to any country in the world where a long-term surge in births was noted immediately after the end of World War II.

Traditionally, the generation that parented baby boomers has watched house prices rise, at times seemingly exponentially, and have sold their homes at prices that are often orders of magnitude more than what they paid for them decades earlier.  In large part, the sale of these assets has provided funds for their retirement years.  As baby boomers, we have learned this lesson (perhaps a bit too well) and have patterned much of our financial planning with a similar target in mind.  Sure saving money from our weekly paycheques is a good idea but it's hard work and requires discipline and, after all, we can count on using the equity we have in our homes to make up the difference between what we save and what we need to retire with very little effort on our part.  After all, house prices have nowhere to go but up....eventually.

This study by Dowell Myers, a professor at the Univeristy of Southern California School of Policy, Planning and Development and co-authored by SungHo Ryu studied the relationship between the 78 million baby boomers and the housing market and what effects aging baby boomers will have on the housing market in the United States as they retire, relocate, downsize and eventually leave the housing market.  The large numbers of this cohort has largely driven the real estate market since they first entered it in the early 1970s; burgeoning demand for homes drove prices and inventories ever higher seemingly unendingly, especially if one listens to real estate associations.

According to the study, sales of existing homes make up 85 percent of the homes sold today.  Senior citizens are by and large the suppliers to the housing market as they downsize, move into senior's residences or pass away.  Those over 65 years are proportionately more likely to own their own homes in comparison to younger adults so they are more likely to have houses to sell.  The first baby boomers are slated to reach their retirement years at the age of 65 in 2011 and the last will pass through the "gate" to seniorhood in 2029 so it seems likely that the effects of this demographic change on the real estate market will be seen sooner rather than later.  As well, a decrease in the number of younger, first-time home buyers means that the housing market will feel additional stress from shrinking demand at the same time as it faces rapidly growing supply.  This does not bode well for prices since the supply of available housing will be increasing at the same time as the demand for that housing is decreasing.

Here is a chart from the United States Census Bureau showing the projected changes to the demography of the United States over time for the years 2010, 2030 and 2050:

  

Notice how the bulge in the population age pyramid travels upwards particularly in the 2030 projection?  This indicates an overall aging of the population as the baby boomers reach their senior years.  Also note that for the 2030 projection, the number of people in the age groups under 45 years of age increases much less in proportion to those who are over 65.  From a housing perspective, that means that there are fewer people that will be entering the housing market than those who will be leaving.

Here's another chart showing what percentage of the population will be over 65 by state comparing the year 2000 to projections for the year 2010 and 2030:

Notice that the overall nationwide over 65 population only increases from 12.4 percent to 13 percent in 2010 because the baby boomers have not yet reached that age bracket.  The big change occurs after 2010 and the U.S. Census Bureau projects that the percentage of those over 65 will rise to 19.7 percent of the total population.  Some states will be more affected than others; Florida, Maine, Wyoming, New Mexico, Montana and North Dakota will each have more than one quarter of their populations being aged 65 and over.  That will have a major impact on their local housing markets.  Data from the Centres for Disease Control puts life expectancy at birth at 77.9 years in their latest study that examines all deaths in the United States for the year 2007.  This tells us that it is most likely that the baby boomers that reach the age of 65 in 2011 will most likely not be around by 2029 when the last of the boomers reach 65 years of age.  Those senior boomers who own houses in 2011 will in all likelihood not own homes by 2029 which is part of the supply problem.

Another factor that is affecting home ownership by the generation following the boomer generation is the  lack of affordability especially when one compares median house prices to median income level.  Dr. Myers gives the example of house prices in New Jersey where the median house price to median household income multiple rose from 2.89 in 2000 to 5.00 times the income of young adult households by the year 2005.  Some states showed much greater ratios of median home values to median incomes of household heads between the ages of 30 and 34, California, Hawaii, Nevada, New Jersey, Rhode Island and Massachusetts being particularly problematic in 2005.  There is no doubt that the recent decline in housing prices has improved affordability in these markets but houses are still unaffordable for many families that are in their prime home purchasing years.  For further information on housing affordability, I highly recommend the 6th Annual Demographia International Housing Affordability Study 2010 which shows which parts of the United States have the least affordable housing as measured by a multiple of median price to median income.

What is rather critical to Dr. Myers' thesis is the crossover point where selling of homes exceeds buying.  The problem will be most severe in states where the older population is large and sells their homes at a young age and where the population of young buyers is growing slowly or is stagnant.  From the study, it appears that the northeastern states are the ones where older homeowners sell in greater numbers than younger homeowners buy as shown in this chart:

Baby boomers were born over an 18 year period of time; it is likely that the housing sell-off (and accompanying price declines) that takes place will take far longer than a normal correction in the housing market, most particularly when compared to the price decline seen in the past 2 to 3 years.  The baby boomers born in the late 1950s and early 1960s are likely to suffer the greatest price drops since, by the time they are ready to sell their homes, the supply of real estate for sale will be approaching its peak.

Home equity forms a very important part in the retirement savings of many American households and real estate is more widely held as an financial asset by Americans than other asset.  While it is comforting to think that the equity that we have built up in our homes is the key to a secure retirement, shifts in the demography of nations in Europe, the South Pacific and North America may prove that paradigm to be a fallacy.