How the rest of the world can avoid following Japan into economic slumber

“A thought crossed his mind: How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans.”

― Michael Lewis, The Big Short

Racism, the toxic social issue that dominated the social discourse of the ‘90s and early 2000s, is soon to be replaced by an even uglier phenomenon: Ageism - as each social group pulls towards its opposing financial incentives.

According to research by the Insured Retirement Institute (IRI), 45% of baby boomers in the US have no retirement savings at all. Only 55% of boomers have some retirement savings and, of those, 28% have less than $100,000. This means that half of American retirees are, or will be, living off Social Security benefits. The UK and Europe paint an even gloomier picture.

Several things are to blame for the reason boomers don’t have any money - the children they had to raise, being the one they often point to – but also the decline of the stock market, the digitisation of the financial sector, and the distrust created by the spectre of 2008 that still looms over the financial world.

According to Google Trends, the phrase ‘OK, boomer’ has gone up by over 1000% within the last two months. The phrase is popular on Reddit, Facebook - and particularly with younger generations in meme pages and shitposting circles. From the boomers themselves, journalists respond with a flurry of articles comparing the term ‘boomer’ to that of a racist slur.

The animosity between the two generations is clear. The older is finding itself retiring after the worst financial crash in living memory, with nowhere to invest what little savings they have – only to find a generation they helped raise blaming them for every problem in the world.

On the younger end, millennials are coming of age at a time when wages are stagnating and competition for jobs is fiercer than it was twenty years ago. Social mobility is low, and those unwilling to leave job, country and relationships for their careers are often left behind with them. Their job prospects are few, their salaries low, and their retirement age rising every year – all the while being told they need to save the world from intractable problems like climate change, racism and inequality.

The days of getting an internship with a company, staying with them for forty years and retiring with a golden watch are long gone. The current UK budget for pensions is 32% of the entire budget; that’s three times the size of the education budget and four times the size of the budget for emergency services. Once the balance slides, as it has in Japan, to a non-working population costing more than the working population can afford, the public discourse is going to take an ugly turn.

The generation born between 1946 and 1964 are now retiring at a rate of around 10,000 a day, with Generation X hot on their heels. People set to retire are locking their pensions into ‘safe’ assets. Pension funds are essential just hedge funds – they invest in whatever they think will make money – expect they have a ten year ramp down period where they invest in high-grade securities to make sure any potential losses are made up and the pensioner actually has money to retire with.

When returned, this cash is usually then locked into a retirement fund, which exclusively invests in high-grade, non-risky bonds – usually government bonds. This requires “immunising them”, whereby retirement funds use a buy and hold strategy to invest in the high grade bonds mentioned above.

The problem is that, because of monetary policy over the past ten years, governments are now charging investment funds for the privilege of lending them money. These are called negative interest rates, and they mean that the more people who retire, the more risky investments pension and retirement funds need to make in order to make the same returns.

The pensions of the younger generation are inevitably going to have to be put into securities which have a high risk of default, and therefore a high return. Once the boom and bust cycle begins to ramp up, the centre of political gravity is going to shift away from racism and towards ageism, as both sides point fingers at the other for losing the money both were promised.

This is the inevitable consequence of a world-wide Western response to the 2007 - 2009 financial crisis, the effects of which are yet to be felt. The methods used to try and save the economy led to the rise of two economic phenomena: quantitative easing (QE) and negative interest rates.

The cost of living

Negative rates are quite new. Turn to most economics text books written before 2015 and they will tell you that negative interest rates are impossible. Now, that has all changed.

One of the problems of negative interest rates and QE is that they can cause a big increase in asset prices such as housing, while not improving the broader economy. The US employed QE throughout much of the next decade to stave off economic woes post-2008 resulting in an eventual boom - after quite a significant bust under Obama - and an increase in employment.

This didn’t translate into real wage growth, though. From 1964 to 2018 in the US, average wages per hour went from $2.50 to $22.65. When accounting for inflation, as PEW research points out, real wages only went from $20.27 to $22.65. For Americans earning an average wage, that’s only a $2.38 rise in the past forty-six years, hardly an economic policy to write to the Nobel Committee about.

The European Union at first faired just as badly as the US, except that the European Central Bank (ECB) also began to dabble with negative interest rates, a way of taxing banks for holding money with the central banks, where elsewhere in the world they expect to get paid for lending the central bank money.

The result was that, following the European debt crisis, the European economy not only saw next to no growth compared with the US, but also a slump in employment, and by extension, wages - which the ECB itself says are significantly down today compared with 1999. Europe not only suffered the biggest blow from the 2008 crisis but also missed the recovery.

Those who had to live through the crisis came out with a deep distrust of the financial system in general. This led to a wave of people exiting the stock market, getting their money out of banks and people looking for other ways to hide their money.

Watch any hastily thrown together documentary on the stock market you can find - such as Netflix’s The Stock Market Explained - and you’ll hear a confident narrator telling you that the stock market is “bigger than it’s ever been.''

But talk to anyone who tries to make money there and you’ll soon find that the amount of publicly listed companies on the US stock market has declined by nearly 50% over the past twenty years. One of the great financial institutions, birthed from the Dutch stock exchange in 1603 - the place where financial entrepreneurs took their first on to global markets - is now dying, and may not survive past 2050.

Enter the boomers, who missed out of easy stock market investments in the US recovery, who are now dumping what little savings they have on retirement funds who have nowhere to put them that can actually make money.

The fool in the market

On the other side of the world, the One Child Policy in China means that the country with the world’s biggest population is about to run head first into a hurdle that Europe and the US have already run headlong into; an ageing population whose healthcare and pension costs rise above those of the working population. In other words, the US and China are about to have very similar problems, only China is likely to feel the squeeze sooner as it actively curtailed its working age population.

China has of course reversed its policy once the consequences of population restriction became known, with a two-child policy being allow in cities and no restrictions enforced in rural areas. This has only mitigated the affects of an otherwise disastrous policy, though, whereby the working city-dwelling population is scheduled to shrink and be outpaced by a growing rural-living population who will require more retraining and government investment to be able to keep up with the modern world, should the demand for high-end jobs suck them into the cities.

Japan was ahead of the world in many ways following its surrender in World War II, but more so perhaps than many 20th century commentators realised. With the highest life expectancy in the world - soon to be overtaken by Spain - the country was the first to plunge head first into negative interest rates which saw its economy stuck in permanent limbo. Now, the economic no man’s land between deflation and wage growth has arrived at Europe’s shores, and is soon to come to America.

US President Donald Trump has repeatedly expressed a preference for negative interest rates. American economists said that the Federal Reserve was more likely to pursue a policy of quantitative easing rather than sending rates negative, but the central bank’s decision to cut interest rates already shows the institution is not immune from political pressure.

The central policy of the United Nations to deal with the declining population problem in Europe was to import young working-age migrants from developing nations in order to make up the deficit caused by low fertility rates. Immigrants get old too, however, and might be as displeased as the native population when their pensions are nowhere to be found after years of investment in securities yielding a negative return.

China is about to face the same dilemma, and time will tell if the upcoming economic slowdown tilts the country towards Japan’s approach of investing in workplace automation and welfare spending, or opt for the European solution of inviting a new workforce from around the world. Its investments in Africa, Latin America and Eastern Europe give it no shortage of options there.

This will be mitigated by the fact that Chinese parents often rely on their children to support them, but with live expect enact rising as it has in Japan, the financial press on the younger generation will continue to grow.

Faith in finance

Central banks usually lower interest rate as a way of stimulating the economy during a slowdown. E.g. if the government gives away money to the banks, it is cheaper for banks to lend money to people, so people are more easily able to borrow money and spend it on things, making the economy grow. Before 2015, central banks did not think that negative interest rates were an option in times of crisis. Now they do.

The next financial crisis will not be a sudden high-impact crash like the last one was, but a deep and eternal slumber, from which the world’s economies might never awaken.

The real challenge for the west - Japan included - will be to take the economic plunge away from negative interest and quantitative easing and towards a policy of bank digitisation, creating an area of competition from challenger banks and online lenders who do not benefit from a government guarantee.

Saving the economy from another Great Depression was always going to need some kind of QE involvement, and regulators should be applauded for not making the same mistakes that were made in 1929. But what was used as an emergency measure is now becoming a first response. Sometimes, the stitches need to be ripped out in order for the wound to fully heal

The largest economic default in history occurred when Iceland racked up a debt of 32 times the size of its GDP. For a country of just over 300,000, there was no “bailing out the banks” - default was the only option.

The result, at first, was turmoil, as the country saw every investment bank collapse like a domino stack falling before completion. Twenty-seven bankers were sent to jail, and the country crashed harder than any economy relative to its size ever had before. The UK even declared that Icelandic money invested in the UK was suspected of “terrorism funding” using the lie as a way of stopping Iceland from defaulting on its loans. The small, Nordic country seemed powerless on the world stage and destined for economic woe.

But fast forward ten years, and the country saw the largest recovery in economic history. The boom rivals that of even the US, and the country's real wages vastly outpace the European economic area by miles.

The upcoming recession will force every country in the world to take a hard look at the Lost Decade of Japan and decide for themselves if this is something they want for their own economy, of if they want to take the risks that Iceland did, and bloom from the ashes of the coming economic storm.

Francis Kett