US Demographics - Glass Half Full or Half Empty?

First of all, I should apologize for readers for probably the longet hiatus ever on this blog. I am still trying to balance a busy day job with having time to pen blog posts. I am sure that I will manage to get a nice rythm going at some point. 

As such, I thought that I would return to a topic that I actually do know a little about and this interesting piece in the WSJ by Carl Bialik on US fertility and the idea of a crisis driven birth collapse in the US.

A recent report said the U.S. birth rate has dipped to a record low level. But another measure of the nation's fertility remains comfortably above its historic low. The mismatch shows that even in a country with comprehensive birth statistics, summarizing population trends is far from straightforward.

The article makes no judgement either way and essentially keeps to lining up the arguments without making a statement about which measures are most correct. The main debate is driven by reports that the US birth rate has plummeted since the financial crisis and that this negative shock could have a lasting impact on US population dynamics.

However, as the article suggests, measuring fertility is not straightforward and indeed while the article builds its discussion around the notion of total births per 1000 women (crude birth rate) and the total fertility rate (average children born to women in their childrearing age), no mention is given of total cohort fertility which is the completed fertility per cohort. Arguably, this last measure is the most important one, but also the most difficult one to observe since we can only see this after the fact (although we can make qualified guesses of where this is headed for a given cohort based on the interaction between tempo and quantum effects of fertility). 

So, what is the story in the US? Well, the crude birth rate recently hit all time lows, but the total fertility rate remains stable and close to replacement levels and this latter point is, in my view, giving too little credence in relation to the most recent concerns raised on US fertility. 

However, there is no doubt that the financial crisis appears to have had a noticeable impact on US fertility patterns. In theory, an economic recession should not have a lasting impact on completed fertility. This is mainly because a normal economic recession does not have a lasting impact of families' life course trajectory and decisions to have children. It may lead to an increase in postponement, but that effect should be reversed once the recession ends.

The key question is whether this particular economic crisis is different and whether we can expect a lasting impact on fertility in the US (and perhaps elsewhere)?

I would venture a hesitant no here, but the jury is still out, and there is no doubt that the specific nature of the recent economic crisis as one of being associated with a structural level of too much debt is  a worry. A prolonged period of deleveraging which now appears to have begun the US and elsewhere in the OECD could lead to a permanent and irreversible postponement of fertility decisions in the US, but so far the fact that US fertility remains close to replacement levels (and never dipped below) is a definite positive that has, so far, received too little attention I think. 

Grantham Lays Down the Gauntlet on US Growth and Demographics

If Carl Bilak's article does little to come up with an argument for or against the notion of the sturdiness of US demographic fundamentals a recent piece from GMO by Grantham is much more vocal in its worry that the US economy may be headed for zero growth and that demographics are to blame.  

First of all, Grantham is fundamentally pointing to falling trend growth in the US. This is the case not only in the US but across the OECD. Indeed, trend growth if measured with a very broad stroke is probably falling in all major global economies, developed as well as so called emerging economies. The reasons for this are pretty simple. All the things we use to calculate or account for growth are slowing down; demographics, capital formation and technology/productivity although this last bit is surrounded by a huge uncertainty and could surge or slump. Most economists would see productivity as a part of the process (i.e. it is endogenous) and thus something we can affect, but technological progress does tend to have an unpredictable and disruptive cycle which is difficult to account for.

Still, to take such a broad sweep at growth and apply equally across global economies is too general a narrative to hold up to closer scrutiny.

Enter US population dynamics and its coming “growth” effect.

On US demographics, I think Grantham focuses on long term trends of working age population growth which are obviously down in the US. However, they are down for all countries and over such a long time frame that it becomes meaningless to discuss them without some aspect of relativity. Retiring baby boomers are a drag on US growth and the lack of rising female labour force participation (because it has already happened) is also a minus, but this is also pushing the narrative a little bit.

Surely, a boost in growth from increasing female labour force participation can only happen once and is not strictly a "drag" on growth when it ends. Crucially however, Grantham interprets exhibit 1 depicting growth in the US working age population in a "glass half empty" kind of way. We are told to focus on the declining trend, but I would note the remarkable fact that the US working age population is set to enjoy positive growth beyond 2030. That is a major relative tailwind compared to the rest of the developed world and indeed emerging markets. All countries in the world have a large challenge in the context of the compatibility between ageing and a market economy with pension schemes and health care systems, but the US seems in a relatively good position to cope with this from the point of view of demographics. 

Going back to the discussion on fertility, I am surprised that Grantham does not focus a bit more on the fact that it never slumped massively below replacement level in the US which augurs for strong tailwinds to household formation. If you combine this with intra-US labour mobility you get a strong foundation for growth I think. Or at least, you get a more nuanced view of the US compared to for example many other OECD economies (Japan and Europe) where demographics are much more decisively manifesting themselves in the form of headwinds.

Two charts from the GMO piece that should make us worry a bit though are ex 2 and 3. Working less hours and falling labour force participation (and it is falling not only for women) are poison for growth because it reduces the potential growth rate per unit rate of inflation. Popular speaking, it reduces the natural level of output before the output gap turns positive (and you get excess inflation and no real growth). This is a huge challenge in the US and the persistently falling labour force participation rate in the US in a post crisis is a worrying development which needs some sort of structural/reform response as it is completely unrealistic to expect the Fed’s quanto easing policies to lead to a structurally better labour market.  

In the end, I would say that it is difficult to disagree with the overall narrative set out by Grantham because it really sticks to the straight and narrow and basically says what we already know, name that trend growth will fall. 

Critically however, Grantham notes the concept of "zero growth" and thus refers to the idea that trend growth in the US may fall to zero. I don't see that and this is an important qualifier.

I think there are a lot of economies in the OECD where "trend growth" as defined by conventional economic models and theories may be zero (Japan, Italy, Spain and some parts of Eastern Europe).  But I would not put the US in that group and demographics represent one of the main reasons for this. There may be many reasons why the US economy may slump to zero growth in the future, but demographics aren’t one of them. 

Busy!

I have a lot to say about the utterly insane world we know live in where the worse the news, the stronger the rally, but too little time to say it in at the moment. Stay tuned!

After Jackson Hole, Clear Road Ahead?

In terms of forward guidance I think the Fed Chairman's speech provided little direction, but Friday's precious metal price action into the close and the various sell side notes that I have seen suggest that this, at least initially, is too bearish a conclusion. The following excerpt from the speech, in particular, was taken as clear evidence of more and aggressive easing in the pipeline. 

As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation. The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.

Great emphasis has been attached to the chairman's use of the word "grave" as a clear tell-tell sign of more easing to come. I find this quite interesting since it is one of the first instances of such "new speak" interpretation of the Fed's statements akin to the good old days of Trichet and the utterance of (strong) vigilance. Needless to say, next week's jobs market report has suddenly been propelled to a key market event and every single US data point will now be watched with caution. On that note, the next ISM reading as well as consumption figures will be equally important to watch. 

I think Tim Duy’s interpretation is the right one then (hat tip Calculated Risk) with my emphasis.

On net, Bernanke's speech leads me to believe the odds of additional easing at the next FOMC meeting are somewhat higher (and above 50%) than I had previously believed. His defense of nontraditional action to date and focus on unemployment points in that direction. This is the bandwagon the financial press will jump on. Still, the backward looking nature of the speech and the obvious concern that the Fed has limited ability to offset the factors currently holding back more rapid improvement in labor markets, however, leave me wary that Bernanke remains hesitant to take additional action at this juncture. This suggests to me that additional easing is not a no-brainer, but perhaps that is just my internal bias talking.

On balance the main point for me is that the recent change in economic data clearly merits policy change on the basis of the Fed's reaction function. 

The unemployment rate in the US is sticky and the Fed has been persistently concerned about this which is indeed a strong signal to the policy bias especially as inflation expectations are well behaved. Inflation has come down significantly in the US running at 1.4% YoY and the Taylor Rule rate is now declining (though still in level terms way above 0 but that has more to do with the inputs than anything else). We have had two consecutive months of sub-50 ISM readings and consumption growth appears to be rolling over. My interpretation of the forward looking indicators is that they look better than the consensus suggests, but the Fed lives in the here and now and will act accordingly.

Another interesting point here is that despite the visible and strong recovery in the growth rates of US housing market indicators, Bernanke mentions the level of the housing market and not the change which suggest that the despite a good run of data with respect to the change in housing market indicators the level is still seen as depressed. 

The bottom line is that some form of easing is coming but what I find highly uncertain is the timing and aggressiveness of such easing. The August minutes had already stipulated potential moves for the Fed in the form of an extension of the low interest rate commitment, lowering interest rates on excess reserves as well as an extension of Operation Twist or outright asset purchases (probably through MBS securities). But which of these measures will be employed and in what order?

One thing for example which I find very interesting is the glaring gap between Bernanke's discussion of the effectiveness of unconventional monetary policy and its effect on the real economy (i.e. labour market). In that sense, it seems quite clear to me that quantitative easing can have a strong effect in the context of imminent deflation risks and strong downward pressures in asset prices. In such an environment the portfolio effect and, indeed, outright price effect from aggressive central bank action can be very effective. 

However, whether quantitative easing can be effective in countering a structural and sticky unemployment rate (and indeed a structurally declining labour force participation rate) seems much more uncertain to me. Obviously, this goes back to the point that the Fed is the wrong tool for the job at hand, but it also raises the issue of what kind of easing the Fed is planning here.

Of the measures mentioned above one of the only things which would have an effect on the labour market (from a theoretical point of view) is an extension of the low interest rate commitment. This would be a signal to companies that their cost of capital would remain low and incentivise investment and thus, in theory, additional labour input. But such a process is slow and arguably a weak remedy in the context of structural labour market issues.

More generally, we must ask ourselves whether an extension of the low interest rate commitment be enough for the market Clearly not and in any case, an extension much beyond Bernanke’s term would be meaningless as the looming presidential election has created uncertainty as to how strong this commitment is, if for example Bernanke is faced with a Republican president.

What about an extension of Operation Twist then? If this is combined with an expansion of the balance sheet through purchases of MBS I think this could be an effective medicine (although in general I find it hard to see how it could meaningfully affect the labour market). However, the theoretical argument here is fair. By influencing long rates the Fed is likely to stand the greatest chance of supporting the ongoing recovery in the housing market and thus, by derivative, the US economy. 

Ultimately, I see two sources of uncertainty here. Firstly, it is not clear to me that the US economy is heading into a hole in the second half of 2012 to an extent that would allow very strong Fed action. Secondly, while the Fed clearly seems committed and perhaps even pre-committed to more easing the nature of such easing and its scope is still very uncertain to me. The upside risk attached to much stronger easing is clearly there (not least because we also have the ECB coming in with policy measures soon), but the spectre of grave disappointment has not been completely extinguished in my view.