If you were born between 1946 and 1964, in a developed economy, you are part of the most impactful demographic segment of the last thousand years – the baby boomers. Your age group is responsible for the quantum leap experienced in technology and medical advancements over the last 20 years. You fought for freedom, and have advanced such things as human rights, liberties and quality of life like never before. All of those accomplishments you should be proud of.
However, I sadly believe your generation will also be remembered as the most immature and selfish ever to have walked the face of this earth. As we all know there is force in numbers and you have used the fact that you had more votes than any other group, to consume like never before, to pollute like never before and, most of all, to get into debt like never before. Never in history, during peacetime, have nations such as Japan, the UK or the US accumulated so much debt; debt that will have to be repaid by future generations. But don’t worry my aging friends, as you still have the numbers on your side, present and future governments will continue to bend backwards to please you and push their responsibilities forward.
Just so that you understand the state of the balance sheet that your children and grand children will inherit from you, I’d like to explain in simple terms the financial conditions the world will face over the next 30 years.
Understanding the actual debt
We usually measure debt in relation to the GDP of a country. Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. The equation is simple, how much is borrowed (the debt) against what is earned (the GDP); the higher the GDP, the higher the capacity to repay the debts. The following graph illustrates the Debt to GDP of the major world economies for 2012. As we can see the country with the most debt, when considering its capacity to repay, is Japan. The USA situation is not as bad, however they are one of the nations that presents the least conviction when it comes to reducing its deficit. This is why the credit rating agency Standard & Poor’s announced last year that they had downgraded the US debt.
So as you can see, years of uncontrolled spending have been taking its toll on public finances. The solution seems obvious, we just need to cut expenses, increase tax and “voilà” we are back to a healthy financial situation. Not so fast, remember there are two components to our chart, the debt and the GDP. When an individual is in debt, he cuts his expenses and sometimes finds another job to increase his revenue. On the other hand, when a government reduces its expenses less money is spent in the economy, “de facto” reducing the GDP. Even more negative is the impact of raising taxes. Some economists have established that one percentage increase in taxes translates to up to three times the same percentage of decline in GDP. A government that cut expenses and increase taxes may well make the situation worse for the short term and as governments are always elected for a short term….
Understanding the future debt
Enough about where we are today instead lets see where we will be tomorrow. 2011 marked the year that the first wave of the 76 million “baby boomers” reached age 65 and became entitled to Medicare and Social Security benefits.
The above chart, provided to us by The Heritage Foundation, illustrates the projected trajectory of the US National debt over the next 40 years. The picture is clear, an anaemic economy, an exploding debt situation and an ageing population that continues to control governments. The situation is similar in Europe and worse in Japan. Developed countries will either address the situation in the coming months or the financial markets will force them to do so by demanding higher interest on their debts as it is presently happening in Europe.
How to fix it
Sorry, no easy fix here, whatever way governments handle the problem, it will be painful.
As I mentioned before, there are two parts to our equation, the debt and the GDP. John Mauldin in a recent newsletter said: “There are only two ways to grow an economy. Just two; you can increase the working-age population or you can increase productivity. That’s it. No secret sauce.” Expect the retirement age to be pushed to 70, expect an increase in immigration and most of all expect a global fight for investment dollars, as they are the drivers of productivity: more foreign investments, more business, more jobs and better productivity.
As for the debt situation there is no doubt in my mind that we will see tax increases in the US, and many other countries, going forward. Canada, which today presents the best financial health of the G8, has been taxing its citizens at up to 50 per cent for years, the same will become the norm throughout the world. Forget about the simplistic approach of taxing the rich only, in the US the top 10 per cent of earners already pays 70 per cent of Federal Income taxes.
More difficult to determine will be the budget cuts. In other words whom do you hurt? We are not talking here of some drastic cut in the military, NASA or foreign aid. It is deeper than that. To address their debt situation developed countries will have to cut into entitlements. It is expected that by 2049, as the baby boomers age, entitlements will consume 100 per cent of all tax revenues. Just to pay for these entitlements the US would have to double today’s tax rates for individuals and corporations. To fix the budget going forward developed countries will have to cut Medicare and Social Security. If you reside in a developed country, expect to pay more tax for much fewer services.
How to profit from the situation
Favour equity, fixed income and currency of countries presenting low debt to GDP, avoid or short the ones with the higher debt ratio. Invest in health care services as demand will skyrocket and look at the funeral industry, there is increased demand ahead.