Let me explain. Most European countries have pension systems based on the "pay as you go" principle. When the percentage of retirees suddenly rises and the active population percentage therefore drops, the ratio "working population/retirees" – a measure for the pension system's "cash in/cash out" – becomes unsustainable.
Anyone can see the danger, so there comes the expert wisely advising governments that individuals or governments (on their behalf) start saving money in order to produce the required extra for the rainy day. Actually it does not matter whether the saving is done individually or collectively: the point is that people will systematically put some money aside for the future.
But what to do with it? Stacking up cash under a mattress is not recommendable, as inflation makes this a purchasing power-losing proposition. So people (or their mutual funds or their pension fund managers) will put it in stocks and bonds.
If the demographic "pyramid" were just a "skyscraper" (or even a geometrically true pyramid) that would not be a problem and under such a scenario, a "pay as you go" system would survive. The problem, however, will be brought about by an aging baby-boom generation. What will happen is that when this large group all of a sudden starts saving, so much money pours into the markets that it drives up valuations.
So far so good but when they gradually start retiring, the inflow of fresh money dries up. When most members of the group will have retired the time will come to cash out and live from the nest egg. This massive group causes so much selling pressure that it makes markets tumble.
Even if the economy keeps doing fine and corporate profits rise, stocks will fall if there is more selling than buying. All it means is that valuations get more attractive (and revert to their longer term averages – not of the past 20 years, but of the past 100), but stocks can indeed fall despite higher corporate profits.
In my view the bull market in the West since the early eighties, which saw P/E values rise from under 10 to above 20 is nothing but the result of US (and European) baby-boomers in the glorious period of their lives (student loans paid off, first kid born, moving up the career ladder) pouring money into the stock market, saving for retirement.
But with the prospect of retiring, some started to withdraw funds in and following 2000. And the masses still have to divest! Since 2000, the markets have fallen spectacularly. Sure, from their lowest point we've had a bounce-back, but in my view this is nothing more than a "suckers rally" in a long-term bear market. Why? Simply demographics.
Want another example? Japan peaked 10 years earlier. Now take a look at their demographics and you will see that they are 10 years ahead in that respect as well.
And China? The government may decide to create a system where people save for their retirement through compulsory contributions plus a third pillar, meaning that money will flow into the markets and give them a boost ("Great, we're doing well, we gained so much last year, we're ahead of schedule, let's take a pension holiday this year.") and when the money is finally needed, stocks will gradually be sold – at ever lowering prices ("Damn, we're under-funded; how come the actuaries never saw this?" Sounds familiar?).
But on any market, prices are set at the margin as any economics student learns in his first semester in college, though few seem to remember this later on in their lives. So when massive buying or selling takes place, this inevitably influences the returns on stocks. And based on the "long term" past (of only 20-30 years), actuaries may be convinced that stocks always go up "over the long haul," and that the average return is x% above inflation and that, with 95% certainty, it will be between x1% and x2% (both positive of course). But what they fail to understand is that this only took place under certain unchanged external (demographic) conditions and when these change, so will change (future) expected returns.
So what to do? If only I knew. What to expect? Well, I have a scenario.
Governments (in America, Europe, China, doesn't matter basically) will see the system collapse and pensioners impoverished. Unfortunately though, the retirees will by then constitute a very large share of the population. So the governments (even in countries where no state pension exists) will "want" to do something about it if they wish to get reelected or avoid social unrest.
But what are their options? Raise taxes? No. Well, not in the West at least as that would only make labor more expensive, which would mean pushing more jobs overseas. Borrow more money? From whom? From the investors who are already net sellers of stocks and bonds? I fear they'll have no option other than printing money the way [Fed Chairman Alan] Greenspan and [Fed Governor Ben] Bernanke are already doing it (and I expect them to get "better and better" at it).
Basically this only creates inflation and erodes the value of the dollar, the euro, the RMB, or any other printable and massively printed fiat currency. Under such circumstances, the only thing I feel comfortable holding is money that no Bernanke (wannabe) can print: gold or silver. It has been money for 5,000 years and it is programmed to make a spectacular comeback.
Economic Advisory Panelist
Asia Business & Investing
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