Demographics - The Central Bankers' Nightmare

Updated January 2018

In 2017, former Federal Reserve Chairman, Ben Bernanke, gave a pep talk to the Bank of Japan, discussing the nation's monetary woes.  As those of us that have been paying attention know, Japan's economy has suffered from a multi-decade period of mediocrity with deflationary pressures present despite the Bank of Japan's best efforts to stimulate inflation and reverse low economic growth rates.  In this posting, I want to look at some of his key points and explain why I think that the Bank of Japan, like the Federal Reserve, is doomed to monetary policy failure.  

Let's open by looking at two graphics; one showing the population pyramid for Japan, a graphic which shows the age distribution issues facing Japan:

As you can see, there is clearly a dearth of younger Japanese supporting an aging population, an issue that is causing significant problems for the nation's economy.

Here is a current population pyramid for the United States:

While that doesn't look particularly threatening, here is a projected population pyramid for the United States in 2056:

As you can see, in four decades, the situation has changed significantly with the U.S. pyramid starting to resemble the bottom-light pyramid of Japan, although, not quite as bad thanks to a higher birthrate among some people groups in the United States.  The further out that we go, the worse the situation looks with fewer and fewer young Americans supporting more and more older Americans, in large part because of the dropping birth rate as shown here:

Now, let's start the main part of this posting by looking at what the Bank of Japan has done to stimulate its economy:

As you can see, the Bank of Japan has had an extended period of near-zero interest rates going all the way back to  the mid 1990s.

Now, let's look at what Ben Bernanke recommended for the Bank of Japan in the early years of the new millennium, prior to his term at the helm of the Federal Reserve and while he was still an academic:

"I argued that central bank purchase programs should focus on longer-term assets and not be concentrated on bills (i.e shorter term government securities), as had been Japanese practice in earlier forays into quantitative easing.  I made the point, associated with Reifschneider and Williams (2000), that in the face of deflation risks it was important not to try to conserve policy ammunition but to move “decisively and preemptively” (Bernanke, 2002). I emphasized the need to set an inflation target high enough to provide some buffer against deflation, and I noted that temporary overshoots of the target to compensate for prior inflation shortfalls could be warranted following a period in which rates are constrained by the effective lower bound.  I frequently acknowledged the need to complement monetary policy with fiscal and structural measures and cited the critical importance of assuring financial stability through lender-of-last resort actions, financial regulatory reform, and bank recapitalization."

Here's what he had to say in hindsight about his recommendations:

"However, I certainly did not get it all right. In particular, in earlier writings I was too optimistic and too certain about the ease with which a determined central bank could conquer deflation, and I had little patience with the alternative view. For example, in a 2000 paper written while I was still an academic, I criticized the Bank of Japan for its “self-induced paralysis” and for showing insufficient “Rooseveltian resolve.” I asserted that more-aggressive policies would certainly yield better results, as Franklin Roosevelt’s unorthodox strategies seemed to do in 1933, and, indeed, as Minister Takahashi Korekiyo’s policies did in Japan during the same period. But when I found myself in the role of Fed chairman, confronted by the heavy responsibilities and uncertainties that came with that office, I regretted the tone of some of my earlier comments. Central banks do have viable options at the effective lower bound, but the problem has proved less tractable, in both the United States and Japan, than I had suggested. In particular, in some of my early writings, I did not always demarcate sharply enough between what monetary policy can achieve on its own, and what requires some degree of coordination with fiscal policy (i.e government-led stimulus spending).  At a 2011 press conference, in response to a question from a Japanese reporter about my earlier views, I responded, “I’m a little bit more sympathetic to central bankers now than I was ten years ago.” Why ending deflation and escaping the effective lower bound has proved tougher than I once expected will be one of the themes of my talk today."

His conclusions about the Bank of Japan and what should happen on a going-forward basis?

1.) The Bank of Japan should continue to pursue its goal of 2 percent inflation because it will restore economic stability in the future by restoring the ability of monetary policy to respond to future economic contractions.

2.) Since 2013 and the election of Shinzo Abe, the Bank of Japan's policy of quantitative and qualitative easing (QQE) has been implemented policies which, interestingly, included purchases of exchange-traded funds (i.e. the stock market) and private assets, the Bank of Japan's balance sheet has grown to about 88 percent of Japan's GDP at the end of 2016 compared to 24 percent for the Federal Reserve and 34 percent for Europe's ECB.  While this has had some benefits to the Japanese economy, it is unclear whether the Bank of Japan will actually be able to meet its objectives since much of the economic response "...depends in part on factors outside of the central bank's controls".

3.) If (and it appears that the Bank of Japan has already passed the point of no return on their policies) current policies are insufficient, Japan needs a program of both fiscal and monetary co-operation in which the Bank agrees to increase its inflation target temporarily to offset increased government spending or tax cuts to prevent the nation's debt-to-GDP from rising any further.  Since Japan's debt to GDP is already well passed the danger zone at more than 200 percent of GDP, this could prove to be problematic.

One significant issue facing the Bank of Japan is its massive balance sheet.  Here is a table showing the massive size of the Bank's assets:

Using a conversion rate of 111 Yen to the U.S. dollar, the Bank has a balance sheet totalling $4.54 trillion (U.S. dollars) with 85.5 percent of that being Japanese government securities as shown on this graphic:

While this is only slightly higher than the Federal Reserve's current balance sheet in dollar terms, it is a far higher percentage of the entire Japanese economy as shown here:

While we (and I included Mr. Bernanke in the collective), may think that the Bank of Japan's struggle to right Japan's sinking economic ship may be a unique situation, as the population pyramids at the beginning of this posting show, the demographic changes facing the United States and the other developed economies of the world mimic (in large part) those of Japan.  While Mr. Bernanke may be full of ideas on how the Bank of Japan should handle Japan's economy on a going-forward basis, demographics are proving to be a central bankers' nightmare and no amount of monetary policy creativity will be able to reverse the structural changes in the world's developed economies that are associated with an aging population and lower birth rates.  

The Baby Bust and Its Impact on Everything

Updated December 2016

A rather fascinating article by Dr. Paul Robbins on The Breakthrough website looks at the next great global change that will have a very significant impact on the global economy, the "baby bust".

Most of my readers are well aware of the baby boom, the rapid growth in the birthrate that took place in most of the world's developed economies after the end of World War II as shown on this diagram:

Let's look at one example of the looming problem.  As you can see on this diagram, the U.S. birthrate has declined substantially since the late 1960s from just over 18 births per 1000 people to its current level of just over 12 births per thousand people:

According to the World Bank, the annual population growth rate in the United States has dropped from 1.1 percent in 1990 to 0.7 percent in 2014, a 36 percent decline.

Let's go back to Paul Robbins' article.  Dr. Robbins notes that total global fertility has dropped to 2.3 from a level of 4.95 in 1950.  It is key to keep in mind that the replacement fertility rate is approximately 2 births per woman for industrialized nations and ranges from 2.5 to 3.3 percent in developing nations, largely because of higher infant mortality rates.  Dr. Robbins also notes the following:

"More dramatically, in 2014, a majority of nations in the world reported fertility lower than the replacement rate, the tipping point between a growing and shrinking population (a fertility figure slightly more than 2.3). More countries are now shrinking than growing. In fact, national fertility rates are now at or below replacement in a huge range of countries that, until recently, were growing by leaps and bounds, including Tunisia, Iran, and Vietnam.lower than the replacement rate, the tipping point between a growing and shrinking population (a fertility figure slightly more than 2.3). More countries are now shrinking than growing. In fact, national fertility rates are now at or below replacement in a huge range of countries that, until recently, were growing by leaps and bounds, including Tunisia, Iran, and Vietnam."

Let's look at the changes in fertility rates for four nations, China, India, the United States and Canada, that represent both the developed and developing economies of the world noting that the global fertility rate is represented by the green line:

This decline in fertility rates will, from this point in time forward, result in an aging population.  Right now, the majority of the world's population is young, however, the balance is tipping with the percentage of the population over the age of 60 years rising to 25 percent globally by 2050, up from its historical average of 10 percent.  This will have a massive impact on the potential support ratio or PSR, the number of people between the ages of 15 and 64 years and those over the age of 65 as shown on this graphic:

By 2050, the PSR will fall from 12 to 4 meaning that there will be a near tripling of the economic and care burden placed on the younger generation when compared to 1950.  

The baby bust will have a significant impact on the world's developing economies that didn't experience the post-World War II baby boom as well.  India, China and other nations in the region are also facing an aging crisis as shown on these graphs from the United Nations World Population Prospects 2015 revision:

1.) China:

2.) India:

Let's look at the same data for the United States and Canada:

1.) United States:

2.) Canada:

Obviously, providing health care, economic support and other key services will prove to be increasingly difficult as fewer and fewer prime-age people are supporting more and more elderly.  The baby bust will also have much deeper implications for the world's economy.  

Given that this is the prognosis for global population growth rates:

...one has to wonder what the impact of population stasis will be on the global economy which has become completely reliant on the "growth at any cost" model of quarter-on-quarter and year-on-year profit growth.  What will be the impact on the housing markets and stock markets when it becomes apparent that demand is falling (or remaining static) and supply is rising.  In the case of the United States, some housing markets in the northeastern region are already seeing the negative impact of aging populations on housing valuations as you can see in this article.  Even more frightening is the impact on pension plans, both government and private.  With fewer people contributing and more people collecting, the pension Ponzi scheme will become readily apparent to just about everyone.

In closing, let's quote again from Dr. Robbins' article:

"And, of course, lurking behind all these smaller questions is the most interesting one of all: what will the global economy do without human demographic growth? On a planet arguably already plagued with overproduction, where will sufficient demand emerge to maintain the levels of surplus accumulation demanded by many political leaders, most investors, and every corporate CEO? Will demographic decline lead empowered laboring classes to leverage improved wages and rights or instead lead to harsher bargains for workers to squeeze still more productivity from fewer bodies? Can prosperity be decoupled from demographic growth in a way that is just, equitable, and good for the planet? Given the population luxury that capitalism has enjoyed for two centuries, this has been a question long deferred. But no longer."  (my bold)

The Impact of Longevity and Income Level on Social Security Benefits

A recent study by the Government Accountability Office (GAO) looks at how changing life expectancy is projected to have a significant impact on Social Security benefits.  Increases in life expectancy go hand-in-hand with increased lifetime benefits from Social Security, however, this study shows that there are significant differences in lifetime benefits when income level is taken into account.  In this posting, we will look at the Social Security program in two parts; first, the overall funding issues facing the Social Security Administration followed by a look at how both longevity and income level play a role in a person's lifetime Social Security benefits.   

Let's open this posting with some background information on the Social Security system and the funding problems that face it.  According to the Social Security Administration, 94 percent of American workers had jobs that would make them eligible to receive Social Security retirement benefits in the future.  In 2014, approximately 39 million retired workers were receiving Social Security benefits which are based on an individuals average indexed monthly earnings.  Retired workers with lower average career earnings receive monthly benefits that average about 50 percent of what they were earning while they were working whereas workers with higher average career earnings receive benefits that equal about 30 percent of earnings.  Social Security pays unreduced benefits ages ranging from 65 to 67 depending on one's birth year and benefits can be claimed as early as age 62 which results in a reduced monthly payment.  In 2014, 37 percent of total retired worker benefits were awarded at age 62, the most common age to collect Social Security benefits.  

Let's now look at the future funding problems for Social Security.  Under the current scenario, it is obvious that the increase in lifespan and the number of Social Security recipients is going to prove problematic.  A 2015 study by the GAO entitled Social Security's Future noted that the fraction of older Americans (65 years plus) would look like this in the coming decades:

...that labor force growth (i.e. workers that fund Social Security through payroll deductions) would look like this:

...and that Social Security spending was projected to increase from 4.9 percent of GDP to 6.1 percent of GDP over the next 25 years.  This means that roughly 33 cents of every dollar of federal tax revenue will be spent on Social Security.  

Here is a graphic showing how the revenues from the Old-Age, Survivors and Disability Trust Funds have and will continue to run deficits into the future:

As it stands now, over the next 75 years, the Social Security system funding gap is estimated to be $10.7 trillion or slightly more than half of the current federal debt.  As well, by 2035, the Old Age and Survivors Insurance (OASI) trust fund will be depleted, meaning that Social Security payments will have to rely on outside revenues to continue paying just over three-quarters of scheduled benefits.

Now, let's look at how life expectancy in the United States has changed over the past decades and how income levels will impact the lifetime level of Social Security benefits that a recipient receives.  In 1915, on average, a man who was 65 could expect to live until age 79.7 and a 65-year-old woman could expect to live until she was 83.7 years of age.  By 2015, this had changed to 86.1 years for men and 88.7 years for women, an increase of 6.4 years for men and 5 years for women.  That said, there are wide disparities in life expectancy across the nation with the lowest life expectancy being found in the South, the Mississippi basin, West Virginia, Kentucky and selected counties in the West and Midwest.  This is largely due to environmental factors including a lack of access to health care and behaviours including poor diet, a lack of exercise and smoking but is also related to income level.  On average, lower income males live between 3.6 and 12.7 fewer years (depending on their birth year) and lower income worm live between 1.5 and 13.6 fewer years than their wealthier counterparts.  This has a significant impact on the projected remaining years of life for men after age 65 as shown on this graphic:

Obviously, this is also going to have an impact on the total amount of Social Security benefits received during a recipient's lifetime.  Lower income Americans who have a shorter lifespan will receive less Social Security benefits over their lifetime than their wealthier peers as shown on this graphic:

Sadly, it is these lower income Americans who rely heavily on Social Security benefits to fund their retirement years since they are less likely to be covered by company pension plans or have any significant amount of retirement savings.  It is also this same group that is likely to take Social Security benefits early and suffer the penalty of lower monthly payments.

It is pretty obvious that the Social Security system is in trouble and that it requires significant changes if it hopes to meet its obligations in the future.  The fact that the current crop of presidential candidates is rather non-committal on the changes necessary to ensure its future and enable lower income Americans to rely on Social Security to fund their retirements should be of concern to voters of all political persuasions.