Tuesday, May 26, 2009

Peak Earnings and Demographics

To get a feel for what is going on in the economy you have to look at a few really big trends. The two most important are the total amount of debt and the demographic trends. This data was taken from the census bureau and translated to % of population in certain age categories. I broke them down into 20 year increments to roughly translate them into generations. The data is quite interesting and tells us the broad direction that we are heading and we can draw a few conclusions about the way these generations will act in the future.

The U20 line shows the boom of post war youth in the 1950s through the 1970s. Over time, this has progressed forward in the 20-40 and 40-60 generations. We are in the beginning stages of the baby boomers moving into the 60-80 generation. Our population is getting older very quickly, with relatively few chances for a country that is getting younger. People in my generation, the 20-40 are smart enough to know that it costs too much to have a lot of kids, so our birthrate is low. We are struggling by on two incomes whereas a family could make a decent living on one wage earner in the 50s-70s.

Today we have an aging population that has saved all of their lives (some of them) and put their wealth in 401(k)s which have been destroyed twice in the last ten years. Those that have not saved are totally dependent on Social Security and Medicare benefits. These entities are all but bankrupt along with the government that funds these entitlements.

This older generation is also coming off of “peak earnings” and heading into retirement. They worked their 40 years and have made it to the 6 figure income bracket and saved mightily in the last 10 years to live a comfortable and somewhat frugal retirement. The problem is they accumulated large debts in housing and consumption which is about to wipe out much of the country’s financial system and their retirement nest egg.

Peak Earnings:
I would define the Peak Earning generation as that generation that is on the cusp of retirement within 10 years. These are the people that are not quite terrified they have enough money to retire. They are making good money and are saving a little bit, but their earnings power is allowing them to buy nice things like McMansions and Mercedes.

The real coincidence in Peak Earnings is how well the stock market has tracked the peak earning generation through their earnings years, no matter which generation they came from. The graphs below show the 45-49 year old demographic as a percentage of the population and the S&P 500 index since 1900 on a log scale. The 45-49 year old demographic is currently in their peak earnings years and we are starting to see the effects of their cut back in spending right now.

The last time we saw a decline in the peak earnings generation as a % of population, there was stagnation in corporate earnings growth. This happened in the 1960s and 1970s. It was a high price inflation and rising interest rate environment. We are going to see this type of environment again, except as a whole, the country is more indebted and has a competitive environment with many educated people in foreign countries that can perform much of the engineering and science work at attractive prices. This combination is likely to be fairly catastrophic for the dollar currency as policy makers have only two choices:

1. Face the debt deflation music now as the baby boomer generation retires, spends less money, and does everything they can to pay off any debt. This leads to falling prices and an appreciating currency. Or…
2. Inflate the currency into oblivion, to transfer the debt burden off of individuals to the government, which will then raise taxes to pay the interest on an ever rising deficit. This leads to an eventual sovereign default and a currency implosion much like what happened in Asia in the late 90s, Argentina, Russia, etc.

Option 1, in my opinion, is the better option. Debt deflation reduces our “slavery” to debt and debt fueled consumption. Too much leverage in the system make prices of everyday goods rise, case in point oil prices in the last 6 years. Leverage only works in the favor of those who have money. Those people who complain about rich people getting ahead can look simply at the leverage in the system. Credit creates an abundant supply of money which leads to price inflation. Those on relatively fixed wages are made poorer by price inflation. The person who uses the leverage is made richer by taking variable income. It is a double edged sword, however because leverage enhances the risk inherent in an investment.

Option 2, is catastrophic and is based on the “free lunch” theory surmised by Harvard graduates who concoct schemes that are based on theft from the socially unfit low and middle classes. They sell to these classes, schemes that they say will benefit these classes, knowing fully that it is crap, and that the classes are too stupid and lazy to realize it. Unfortunately, this is all going to come to a very abrupt end. It will almost be like today we were the wealthiest country in the world and the next day we will be a bankrupt nation with a worthless currency. I expect it will be swift and terrible. Afterwards, however, the Harvard graduates will simply blame it on the government, install a new government of tyrants and misfits and repeat the process of bleeding the lower classes of their labor. This is of course, unless the lower classes wise up and remove all of the Social Darwinists from the government and require a law abiding constitutional form government that is strictly limited by the 10th amendment.

Overall, the scenario is ugly as we have a whole class of retirees who have not saved for retirement and are totally dependent on the labor of others for their livelihood. This will create a lot of resentment by those who labor for others. I would classify these people as the earners and the looters (popularized by Ayn Rand’s Atlas Shrugged). The earners will eventually stop earning to end the subsidization of the looters. This is not a theory, it is what happened in Russia, China, Vietnam, etc. when the loss of incentive to earn was taken away. It is human nature for people to not want to subsidize the bad decisions made by others. We are in for a rough 10 years no matter what option the government fools take. It’s just that option 1 will lead to more freedom, more jobs, and more incentive for people to earn their way out of the mess that has been created.

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