‘It is good to rub, and polish our brain against that of others.’
Michel Eyquem de Montaigne (1533–1592,
French Renaissance philosopher and writer)
There’s nothing like a bit of market action to get the juices flowing. The behind the scenes editorial discussions have ramped up in recent weeks.
Plenty of free-flowing ideas, opinions and educated guesswork have been shared between local and international editors.
These email exchanges could be a publication in their own right. Really good stuff. Different angles to consider.
One of the email chains was started by former Port Phillip Publisher Editor-in-Chief Dan Denning.
If you’re not familiar with Dan’s impressive resume, click on this link.
Dan is currently the co-author of The Bonner-Denning Letter.
Dan sent an email to Bill Bonner, Greg Canavan, me and a few other US editors about:
‘Richard Duncan (@PaperMoneyEcon) tweeted at 11:45 PM on Mon, Feb 24, 2020:
#China has overtaken the US in R&D investment. America needs to wake up to the national emergency confronting it; and immediately set in motion a multi-trillion-dollar government-funded investment program in new industries and technologies.’
Dan’s email sparked a flurry of responses on the potential inflationary or deflationary impact of Richard Duncan’s tweet.
I must confess, some of the responses that delved into economic theory went over my head.
My contribution to the email thread was a little more basic…which can be a tad daunting when participating in a group of this quality.
And it’s that response I’m sharing with you today…
While we’re all hypothesising on a possible outcome from a probable pandemic, my money is on deflation.
The chain started with Richard Duncan’s call to spend trillions on new industries and technologies.
I’m looking at this from the end user perspective.
We know pension funds (corporate and public) are somewhere between ‘somewhat to woefully’ underfunded…and this is after an extended bull markets in bonds and shares.
These returns still haven’t been enough to offset the outgoings resulting from more boomers (with gold watches) putting their hands out.
Pension funds are climbing further out on the risk limb and increasing exposure to highly leveraged private equity. What could possibly go wrong with illiquid funds that are geared to the eyeballs?
When the proverbial hits the fan (whether it’s COVID-19 or another ‘unknown unknown’) pension funds are cooked.
For example, CalPERS is only 70% funded at present and is on a projected glide path to 100% based on…
- 7% per annum return and
- b) higher taxes.
Again, what could possibly go wrong with this beautifully presented spreadsheet scenario?
One by one pension funds are going to fess up and say ‘we can’t pay the amounts we promised’.
Some monthly income haircuts will be more severe than others.
The spread of the pension virus will be like COVID-19…at first it’ll it be isolated to the weakest funds.
Then when the pension fund body count starts to mount up, it’ll gain momentum.
I saw this in late 2006/early 2007. There was a website that kept a daily tally on the closure of US banks.
Initially, the numbers were small and confined to local banks. However, the continual loss of this ‘plankton’ eventually impacted the ‘whales’.
I expect the same principle will apply to the coming pension fund crisis.
Those pensioners immediately affected will be forced into spending contraction. Those next at risk will start exercising restraint.
And, those who think their fund might be a bit ‘iffy’ may also act with a little prudence.
Little by little, the margin shrinks. And deflation/depression happens at the margin.
Even at its worst in 1932, the US economy only contracted 13%…which means 87% of the economy was still functioning.
You can create all the new industry and technology ‘waterholes’ you like, but if the retiree ‘horses can’t/won’t/don’t drink, then the trillions have been allocated to the wrong place.
The World Economic Forum (WEF) published a chart estimating back in 2015 the global pension shortfall was US$70 trillion…and projected to grow like a pressurised puss-filled boil to US$400 trillion in 2050.
The WEF modelling was based on the status quo…no accounting for a pesky bear market or two.
The pension boil will be lanced well before 2050.
The difference between now and 2008/09 is that boomers are 11–12 years older.
They have crossed over the retirement threshold in greater numbers.
And those numbers — there’s around 200 million people aged over 65 in the developed world — are big enough to really matter.
Let’s not forget those who aren’t members of pension funds.
Retirees relying (in full or in part) to fund their lifestyles from their superannuation or 401(k) capital.
If they’ve bought into the industry BS about diversification, they too will be cooked in a market rout.
You can only have genuine diversification when assets are not correlated with each other.
But the sea of central bank liquidity has floated all asset boats higher…with one exception…cash.
Shares, bonds and property are tethered together.
Investors in these asset classes have all done well — on paper — from central bank stimulus.
What happens to those poor schmucks in their (un)diversified or (un)balanced funds when they start receiving statements awash with red ink? What will that do to their psyche?
They too, on balance (unlike the funds they were in), will pare back spending to a more modest level…especially if they still have 20 years or more (thanks to the marvels of medical science) above ground.
Life is full of irony.
The boomers kick started this credit-fuelled consumption growth model…riding a four-decade long wave of rising asset prices.
Now, as boomers move into retirement (based on those elevated asset values), it’ll be the ‘income deprived contraction model’ that brings the wave crashing down.
Newton’s Third Law will be satisfied…every action, equal and opposite reaction.
The problem I see coming is three-fold.
Firstly, the sheer volume of money needed to make good on pension promises (and annual indexation) is beyond a trillion or three or five. It’s in the ten of trillions…does the Fed, ECB et al have that quantity of ink and paper?
Secondly, what about those who are say 5–10 years away from retirement? After watching this train wreck from the vantage point of employment (provided they haven’t been made redundant in the next recession), do they rein in their spending and squirrel away some savings as a buffer?
Thirdly, if you are a 65-, 70- or 75-year-old retiree living — in part or fully — from your retirement capital, how many years have to pass by before your dollar is whole again?
In the interim, do you ‘cut your cloth’ or keep spending in the hope/belief central bankers can manufacture another rapid recovery? But what if they can’t? When does hope turn to despair and finally resignation?
My theory is that pending and current retirees — in growing numbers — are going to significantly shrink the economic pie.
The boomer spending contraction will be the yin to the debt-fuelled consumption yang.
When the anaemic numbers start coming through, my expectation is for MMT — helicopter money — to be the programmed response.
The problem is, those helicopters can’t just do a once-over fly by. The helicopter fleet has to take to the skies each and every week, year after year,
Ultimately that could create the inflation the Feds so desperately crave.
However, that 3, 4 or 6% inflation will be coming from a base that was pushed much lower — in the first instance — by some very powerful deflationary forces.
Deflation first and then inflation later.
The Royal Robes are being dry-cleaned. The sceptre is getting polished. The bejewelled crown undergoing a minor adjustment.
All in preparation for the coronation of cash…as king.