Demography and debt revisited

Clients worry – understandably – that a greying, indebted world bodes badly for portfolios. The issues may be more nuanced than they seem, however, and other things matter more to living standards and investment returns. Here is a recap of our take:

• We can afford to grow old… Funding our collective pensions conjures up a picture of warehouses full of food, clothes and the other stuff we'll need when we retire. In reality, the things pensioners consume are produced effectively on a pay-as-you-go basis, by people still at work. A greyer economy, then, needs to be more redistributive, and/or more productive. The former is a political issue, but the latter is an economic one: can we grow? The answer is a clear "yes".
•  … and the world cannot be insolvent Globally, gross debt is huge, but net debt is always zero. Ultimately, we own the institutions from which we borrow; and when governments borrow, they borrow from us. We cannot borrow from other planets, or from generations which are not here; nor can we collectively spend more than we make. Like pensions, the aggregate effect of debt is to transfer spending power – in this case, from people with more assets to those with fewer.

Let's unpack these assertions a little…!

• Demography is not dependency An aging population need not run out of labour. Participation and unemployment rates can vary; so too can retirement ages and working hours. Dependency – the ratio of people not working to those who are – is what matters, and moving even small numbers from the numerator to the denominator can make a difference. For most big economies (including the US, UK and EU, but maybe not China and Japan), there has been (and still is) enough wiggle-room to avoid big labour shortages. This assumes sensible policies (such as flexible labour markets), of course.
• Growth is not driven by labour alone Even if we were maxed out on labour supply, most economic growth, most of the time, comes from rising productivity, not more inputs.
• Productivity pessimism is premature It certainly slowed – or seems to have – since 2008's global financial crisis (GFC), but it did not stop, and it seems to be stabilising of late. Innovation helps here – and while we are a little sceptical that AI will deliver, we expect other new technologies to come along (perhaps in the energy transition). Specifically, we disagree with US economist Robert Gordon's assertion that the great inventions must all be behind us. Of course, new technology initially replaces some/many workers, but in the long term, it creates more jobs, not fewer. Meanwhile, "the learning curve" is still a thing.
• People say the strangest things… Debt is blamed for a lot, even the fall of civilizations. But its macro significance is often overstated: since 1971, and the end of the "gold standard" (see below), only around a twentieth of the increase in US consumer spending can plausibly be attributed to credit, judging from the fall in the savings ratio over the period. A bigger global balance sheet which reflected the financialisation of (say) Indian and Chinese economies – with more assets and liabilities simply reflecting a wealthier world – would be a positive development, not a worrying one.
• Public debt is not exploding… Nobody wants reckless government borrowing, but we need to keep things in perspective. Public debt ratios even at 100% need not be on an explosive path. Small changes in revenue and spending growth rates can make the difference, on a multi-decade view, between a doubling of debt or its disappearance (politics permitting of course). Meanwhile, there are few visible links between the amount of borrowing and the level of bond yields.
• … and credit spreads have rarely been lower A rout in corporate bonds has been predicted by some since before the pandemic. In the event, aggregate (US) leverage has fallen, and yield spreads have tightened steadily. This could change, admittedly: AI-related capex in particular is increasingly debt-financed, and these are now arguably nosebleed valuations.
• Financial crises are usually about liquidity… The system cannot be insolvent, but individual institutions can – and when they collapse, and their counterparties are hit, liquidity may evaporate, as in 2008. Something similar will doubtless happen again – it always could, even if we didn't think it would. But the solution need not be a drastically reduced global balance sheet.
• … money doesn't "run out"… In emergencies, the authorities have been able (so far) to create more liquidity, and may be able to continue to do so as long as they retain that elusive thing, "monetary credibility".
• … and a gold standard wouldn't work Until late 1971, monetary credibility relied largely on currencies being convertible into gold, restraining money creation. Today, credibility rests with institutions – governments and central banks – and money and credit are routinely created on demand by banking systems, often as two sides of the same coin, as it were. If that power is misused, debasement and runaway inflation could follow. But the excesses of the 'noughties; the 2008 crisis; and measures taken to tackle that crisis, didn't lead to inflation. Nor did the eurozone sovereign debt scare. The inflation we did get, after the pandemic, was predictable, and (so far) manageable. A return to the gold standard (is this what is implicitly driving the metal's current surge?) is highly unlikely, and wouldn't work anyway. Textbooks refer to the US "leaving" gold, as if there was an alternative. The likely reality is that the peg couldn't cope with a multipolar, rapidly-growing global economy, and effectively fell apart. Living standards currently are materially higher than they were on gold.

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