by Peter Zeihan
Before industrialization, most people farmed. Preindustrial agriculture is backbreaking work. Land has to be tilled, planted, weeded, irrigated, and harvested. Animals have to be fed, tended, guarded, and slaughtered. Grain has to be gathered, threshed, bagged, dragged, stored, and sold. There is always something to be done and never enough time or workers. No wonder that for most of human history oxen and horses were indicators of wealth, because their labor could be used to produce it. And for those who were not wealthy, there were children. Children are free labor. Luckily for farmers, they know the secret of how to make children, and so they made a lot of them.
Industrialized agriculture, however, operates at higher levels of productivity—it takes (far) fewer man-hours to bring a bushel of produce in than before. The higher productivity creates a surplus labor force that gravitates to industrial centers—cities—in search of higher-paying manufacturing and industrial jobs. Over time, mass urbanization results, and as the population density of cities increases, the demand for living space outstrips the supply and rents go up. Children are no longer a necessary pool of free labor in the cramped, expensive confines of the city, but rather a luxury reserved for those who can afford them.
Put more simply, industrialization leads to plummeting birth rates. The depth and speed of this shift varies greatly based on any number of factors—the ability of agriculture to mechanize, the ability of locally supplied capital to support local industrialized development, the ability of people from the countryside to easily integrate to urban areas, and so on. As such, hyperorganized, hypercapitalized, webwork-infrastructured, small-footprint Germany became the first country to majority urbanize in 1890, and today what is left of the German countryside feels like an open-air museum being preserved for posterity. The sprawled-out Americans didn’t hit majority urbanization until about 1920, and even today the United States remains the least urbanized of the major nations.
The (post)industrial map of finance doesn’t so much follow river systems as it did in the preindustrial past (although to this day most major cities remain on excellent transport nodes, the most excellent of which remain rivers) as it follows the demography of workers. While workers’ spending determines economic growth, and workers’ savings determine financial strength, not all workers are created equal. Once your country industrializes, the difference that matters isn’t race or ethnicity or (gasp) even geography, but rather age.
From a financial perspective the population can be split into four groups. The first are the children. They’re not working but they are eating, wearing clothes, requiring shelter, and needing education. They are expensive and they give nothing back whatsoever. They are an absolute drain on both the system and maybe their parents’ sanity. They have but one redeeming feature: In time they will grow up to be the workers and taxpayers of the future.
In the second group are young workers. This age group—roughly from eighteen to forty-five—are massive consumers. They are buying homes and cars for the first time. They are raising children, with all of the attendant—and rising—expenses that come from keeping growing kids fed, clothed, housed, and educated. Sometimes they are going to school themselves. They don’t have that many years of expertise under their collective belts and they have the (lack of) paycheck to prove it. They are at the nadir of their earning potential but they are saddled with more expenses than they are likely to know at any time in their lives. They carry balances on their credit cards. They have home loans, car loans, college loans—both theirs and their children’s. They are massive consumers, massive borrowers, and anemic savers. As a society, most of our economic growth comes from their debt-driven consumption.
The third group are the mature workers. For this group the hard stuff is behind them. The kids have moved out. The house is largely paid for. They are far more likely to own their vehicles outright. They have bills—who doesn’t?—but those debts and bills tend to occupy a far lower percentage of their income than is the case for their kids. That’s not simply because their debts are relatively lower, but also because their incomes are relatively higher. People in their fifties and sixties are at the height of their earning potential as well as the low end of their borrowing needs. Low debts and high incomes also mean they are at the height of their taxpaying existence. Governments love their mature workers.
These mature workers are as capital-rich as the younger generation are capital-poor. A very large chunk of this extra capital ends up being invested for various purposes, most notably to prepare for retirement. They are attempting to grow their money, so their investments tend to go into a wide range of stocks, bonds, and mutual funds, both domestic and foreign. Volatility is fine because they are taking the long view, and their continual savings mean that most market crashes are simply opportunities to buy up cheap assets that will later rise in value. They are massive providers of capital to the system at large, the government included, and their choice of investments is heavily skewed toward vehicles that promote rapid economic growth since those are the investments that tend to generate higher returns.
The fourth and final group within any population are the retirees. For them, large-scale participation in the financial world looks radically different from the young-worker borrowers or the mature-worker savers. These people are done. They have saved all they are going to save, and are whittling away at their accrued wealth. They live off the interest if they can get away with it, but typically the principal gets knifed far too soon.
While these retirees enjoy a strongly positive capital position, they operate radically differently from their preretirement selves. They cannot stomach reductions in principal value because they cannot make up for any losses with new income. Nearly, if not all, of their assets are domestically held. Volatility is not just the enemy of the day, but the enemy for the rest of their lives. It doesn’t matter if that volatility is in the form of currency risk, stock market gyrations, or the sex, lies, and videotapes of corporate politics. Stocks and dynamism are out. Government bonds and CDs are in.
Consequently, it isn’t simply the case that retirees don’t put new investments into the system, or that the nature of their investments aren’t the sort that generate much economic growth, but that their accrued investments also shrink as time goes on. And of course most of them will be drawing pensions as well. Unlike young workers who generate demand and growth, or mature workers who generate capital and investment, retirees as a population cohort are a net drag on the system, and that drag increases as their nest egg shrinks.
In a “normal” population there is a very straightforward distribution among these groups. Many infants followed by slightly fewer young children followed by slightly fewer children followed by slightly fewer teenagers and so on. Simple mortality steadily whittles away at the population until there are very few remaining retirees. Stack the data up in five-year blocks with young children on the bottom and the elderly at the top and you get one of demographers’ more insightful inventions: a population pyramid. Above is India’s pyramid at the time of this writing. It is a textbook example of what a normal demographic pattern looks like.
In such a system capital is somewhat hard to come by. There aren’t all that many mature workers generating capital, while a large volume of younger workers are demanding it. The result is a relatively strict capital system in which the cost of credit is fairly high, whether that credit be sought for a car loan or stealth bomber. In such systems there are constant restrictions on growth, but nearly all of them can be traced back to insufficient capital, which in turn is rooted in the demographic structure. Investments—whether financial, industrial, technological, or labor—just are not made unless a strong rate of return is expected. While this is a gross oversimplification, money is treated like, well, money. It is something that has a great deal of value and so is only doled out when the risks are deemed reasonable. In systems that have such demographic characteristics, banks and investors ask hard questions before committing funds.
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sp; Add industrialization to the mix, however, and decades of dropping birth rates generate a wildly different demographic result. The idea that children are no longer an economic necessity takes some time to sink in, and the average family size doesn’t so much shrink across the years as across the generations. In time young adults become the dominant population cohort. Individually they are spending just as much as they did before, but they are spending more on themselves and less on their children (because they have fewer of them). That means not just fewer diapers and scooters, but also lower government outlays on education—the top line item for each and every state budget in the United States.
Across most of the developed world, this bulge in the young-worker demographic hit just as the Cold War ended. As one would expect, the mass of young workers generated unprecedented levels of growth across the rich world. In the United States this group is known as the Baby Boomers;1 they are the largest ever American generation as a proportion of the total population. This demographic structure should have pushed capital costs through the roof. But it didn’t. Geopolitics intervened and the results—for the West—were magical.
First, there was the “peace dividend.” Defense cutbacks allowed for many Western budgets to move into the black for the first time in two generations, freeing up capital for more economically productive means. Gone were the days of the Reagan budget deficits that often absorbed what free capital was on order. Instead all that credit was available for the private sector. In the United States alone the net defense savings built up to over $150 billion annually (in then-current dollars) by the end of the decade.
Second, the U.S. dollar emerged supreme among global currencies. In February 1992, the Europeans signed the Maastricht Treaty, which created the common European currency. The euro would not be introduced to the world at large until 1999, but the mere commitment to terminate all those different currencies radically decreased their attractiveness as stores of wealth. Few wanted to risk their money on Europe’s unprecedented experiment in pan-government planning. Everyone who had cash on hand, from the Japanese central bank to Samsung to the Italian mob, switched en masse from deutschmarks and francs and lire to dollars. There is no good data as to how much cash flooded into American financial markets (as a rule cocaine smugglers don’t have the best of reporting relationships with the U.S. Federal Reserve Board), but it is pretty easy to measure what the Fed needed to do to accommodate the influx. From 1994 (when the Fed realized that there was a storm surge of demand for the dollar) to 2002 (when the euro finally got some traction and the surge dialed back) the Fed had to more than double the U.S. money supply—a $2 trillion increase—to accommodate the surge in demand. Normally such a massive monetary expansion is the province of banana republics, with all the inflationary impacts one would expect from printing vast amounts of currency. But because real money was flowing into—instead of out from—the United States, the country actually enjoyed its lowest inflation rates since the 1960s.
Third, Soviet money fled to the United States. The average Russian found their savings made worthless overnight, while corrupt officials and a new breed of Russian businessmen who came to be known as the oligarchs looked for ways to profit from rapidly changing geopolitical alignments. With the demise of European currencies already announced, the U.S. dollar was the only refuge for all. Ordinary Russians took to storing dollars in their mattresses, while Russian statesmen and oligarchs alike held their gains—ill and not—in U.S. banks. The actual amount that fled remains a very hot topic in Russian circles even today, but whether it was tens of billions or hundreds of billions of dollars, the simple point is that it all flowed to the Western countries. On top of that, the Russian industrial base simply went away, but Russian commodities output did not. The excess didn’t so much creep as hurl itself upon international markets to the tune of 500,000 bpd (barrels per day) of new crude supply per year for nine straight years. Similar dumping occurred in every mineral industry in which the Russians were players.
Collectively this geopolitical change overwhelmed the normal rule that lots of twenty-and thirty-somethings makes for an expensive-capital environment. Instead, the cost of capital plunged, allowing consumption-driven growth not simply to soar, but to explode. Somewhat restrained government spending during the Clinton administration combined with rising Boomer incomes (and therefore tax payments) steadily whittled the U.S. budget deficit away, with the federal government moving into the black in the 1998–99 fiscal year, freeing up even more capital for the private sector. And just as the post-Soviet windfall was about to wind down, the East Asian financial crisis kicked in, gutting raw materials demand—oil briefly dropped below $10 a barrel—and flooding the United States with capital fleeing from the entire East Asian rim. The amount spent on energy in the United States dropped from 4 percent of GDP to under 1 percent, and at least another $1 trillion of capital flight from East Asia sought American refuge. All told (a very conservative) $5 trillion in foreign cash—foreign cash that cared nothing for a good return, only seeking safety—inundated the American system in the 1990s.
And then things got insanely good; the American capital flood turned into a global capital tsunami. This time it wasn’t geopolitics that was responsible, but instead demography. Recall that while young workers are the world’s spenders and so generate economic growth, it is mature workers who are the world’s savers and so generate credit. As the 1990s gave way to the 2000s, the American and European demographic pictures evolved.
The Boomers had grown up. Most of their kids had left home. Most of their houses were paid for. Most Boomers were saving up for retirement. Their consumption slimmed and their net assets ballooned. If the 1990s were the decade of growth, the 2000s were the decade of investment. Traditional demography finally pushed through the (admittedly happy) geopolitical noise and flooded the system with credit anew. This time, however, the credit wasn’t the result of a bunch of spurious, one-time events, but was core to the population structure of the entire Western world. The average American 401(k) balance in 2014 hit $90,000. That might not sound like enough to fund your retirement, but that single source of retirement money amounts to over $4 trillion. Without even beginning to count the country’s various pension plans (which have nothing to do with Social Security) or other personal assets like homes, you get a nest egg worth some $17 trillion, making the heady 1990s seem a mere warm-up.2
The Americans (and Northern Europeans, who had a similar demography) simply couldn’t metabolize all this money. Not only were the Boomers no longer at the height of their spending, but their successors—Generation X—couldn’t hold a candle to Boomer consumption. While the Boomers were the largest generation in American history as a proportion of the population, Gen X was the smallest. Consumption and growth—obviously—slowed. Credit—obviously—soared. The cost of credit plummeted to levels never before experienced. If you were ever going to purchase a house or have a credit card, the 2000s were the time to do it. But even then the Americans and Northern Europeans just couldn’t absorb all of the credit windfall, and their surplus money spilled out everywhere. To Southern Europe. To Latin America. To undeveloped Asia. To the former Soviet Union. Everywhere.
But it was temporary. And soon, very soon, it will all be over.
In a few short years the mass of mature workers—first and foremost the American Baby Boomers—will shift from the “mature worker” into the “retired” category. As that happens, instead of having new infusions into their savings every month that go into a mix of high-growth credit instruments like stocks and corporate bonds, they soon will be withdrawing money from a static investment pool populated with low-risk assets that include a lot of cash. The party will be over. It will then be up to Gen X to fund the massive geriatric social programs that the Baby Boomers’ superior voting numbers ensured for themselves while they at the same time replace the Baby Boomers as the world’s primary source of capital. As there are one-quarter more Boomers than Xers, there just won’t be eno
ugh capital to go around.
There are any number of outcomes from this demographic and financial wibble-wobble that will haunt us for quite some time:
• The Boomer-driven capital bonanza inflated bubbles in dozens of sectors. As in any system in which something exists in extreme excess, inefficient use becomes the order of the day. Too much oil in Venezuela? Gasoline sells for pennies a liter and you don’t see many hybrids on the road. Too much labor in Bangladesh? The minimum wage is pennies per hour and the population lives in de facto slavery. Remember the 2000 dot-com bust? Same basic concept. Too many people thought the opportunity was too good and put too many resources behind the Internet explosion. Depending upon how big bubbles get and how they pop, the sector can take months to years to recover. Financial bubbles, however, are a class apart. When there is too much money, the financial world shoves that money everywhere, and any investment fad can get funding and the entire economy gets decidedly frothy. The dot-com bubble didn’t spread much beyond the world of the Internet and so the ensuing recession was the country’s second shortest and second shallowest. But the financial bubble caused by the Boomers’ investment savings has flooded the system—hell, the world—with excess cash. One outcome of this was of course the 2007 subprime real estate bubble and crash. But there isn’t a sector large or small, at home or abroad, that hasn’t benefited from the wash of Boomer money. And so there won’t be a sector large or small, at home or abroad, that will not be hurt when that money retreats.
• The developing world had a great surge of energy thanks to the money flow. Countries that could never generate their own excess capital—Brazil, Russia, and India come to mind—could access international markets to finance whatever they wanted. These countries exploded onto the scene. Chinese demand, fueled by absurdly cheap money abroad and at home, rose through and past ludicrously unsustainable levels. The resulting high commodity prices only further inflated the apparent success of developing states dependent upon raw commodity exports. Again, Brazil and Russia looked particularly good, and even Africa looked significantly less crappy than history had gotten used to recording. While many developing countries did use the credit more wisely than the Europeans—investing in infrastructure, for example—the same problem exists. When the credit tap is turned off the growth will stop. The portions of the world that are the developed world are the developed world because they can self-fund. The portions of the world that are not the developed world are not the developed world because they cannot. Every generation or four a constellation of factors—like the Boomers—allows these countries to surmount their geography for a time. But only for a time. That time is now. But it is also almost past.