Friday, September 29, 2006

Will Retiring Baby Boomers Cause an Economic Collapse?

*Articles on Economics and Finance are especially perishable. Change is continuous and fast and what you say one day may be irrelevant the next. Putting my thoughts down on this 29th day of September 2006, I will come back and read it one year from now and see how relevant it will be then.

As the first baby boomer turns 60 this year, and 78 million more in America born between 1946 and 1964 do so in the next 25 years, will this have an earth-shaking effect on the U.S. economy? As the baby boomers sell their stock market holdings or downgrade to smaller homes to free up cash, investors all the over the world shudder at the possible consequences on the stock market and the real estate market. There is no consensus on how serious this impact will be. Professor Jeremy Siegel of the Wharton School of Business and author of the best seller " The Future for Investors" certainly thinks that we will all suffer a lowering in our standard of living, but street-smart reformed junk bond king Michael Milken does not. But there is no doubt that pension and healthcare systems in America will be put under great strain to meet with the coming demands of baby boomers.

Fortunately, something is also happening now that will make the picture less gloomy and pull us in the other direction. The so-called emerging economies, which is a catch-all phrase for all countries outside the club of old rich countries [The OECD which includes all old Europe, USA, Australia, New Zealand and Canada] are growing much faster. Besides the giants like China and India, oil-rich Middle-East countries, Asian countries like Singapore, Malaysia, Taiwan, Korea and even Russia and Brazil are all growing much faster than the Western economies. Their growth has already effected major changes in the world economy.Their cheap labor has had a good as well as damaging impact on Western countries. On the one hand, this increasingly skilled and mobile labor has lowered wages across the board in Western countries [except at the very high end] and put it under constant downward pressure. On the other hand, cheap labor has also meant that these countries are capable of producing cheap goods for export [not to be confused with lousy goods although garbage bags that tear and frying pan handles that come off may make you think otherwise] and this has single-handedly lowered the inflation rate in developed countries as any visit to a Wal-Mart will attest to. In aggregate, these countries have doubled the world labor supply and made possible an increase in world output while keeping inflation low. Low wages have enabled Companies to have greater profits and to reinvest in their business for the future. In the past few years, Profits as a % of GDP has increased tremendously in the U.S. while wages have remained static, due to the global impact of foreign labor. Together with Information technology, low wages has been responsible for the great increase in the productivity of U.S. businesses and helped sustain their earnings. Which translates into robust stock prices for these Companies.

What makes the availability of cheap skilled labor an even more ominous force to be reckoned with, is that many jobs, especially of the white collar, skilled type can now be performed on the computer from any point in the world, and the output delivered thousands of miles away in a few seconds. Thus, not only can foreign labor perform call-center jobs, they can also do computer programming, financial research, draft legal documentation, analyze medical scans etc. The latest news is that mortgage loan Companies are outsourcing their work to India too, so the next time you call up your mortgage Company you may speaking to someone with an American accent that is a little exaggerated.

By buying U.S. Treasury Bonds and other dollar denominated assets with the vast amount of foreign exchange they earn from exports, [they hold 70 % of the world’s foreign exchange reserves] and the high savings rate of both governments and individuals, emerging economies allow America to spend beyond her means and yet pay a very low rate of interest for her borrowing. [China's reserves has reached $1 trillion and grows at a pace of $20 billion a month]. This is because the emerging economies currently have very few opportunities for investment at home. Also, as export-oriented economies they have to buy U.S. Treasuries to keep the Dollar from ever-sinking lower [resulting in their own currencies becoming expensive] and making their exports expensive. Another factor is that the US$ is the major currency that much of world trade from oil, to shipping rates to orange juice is quoted in, so it behooves everybody to ensure that it doesn’t collapse. But even a small change in the amount or the mix of currencies or gold held by these countries will have a great impact on American interest rates. This becomes more of a possibility if for example these countries spend more at home to build up their economic and social infrastructure.

On the other side of the coin, as they grow rich and create a strong middle-class, they have begun to import more and more goods from the developed economies. The first stage of growth meant that they imported capital goods to lay the infrastructure of their economy. Goods such as commercial airplanes from Boeing, construction machines from Caterpillar, power generation systems from General Electric, or Internet hardware from CISCO. But now they are generating income for developed countries by buying wine, Gucci shoes, attending Australian universities, traveling to Europe for holidays, etc. The insatiable appetite of the growing economies for Energy and raw materials has also created a global boom for oil, steel, copper, cement and many other raw materials. The next step of investing directly in Western economies has already begun, albeit with some resistance such as in the case of CNOOC's intended purchase of Unocal and Dubai’s acquisition of U.S. ports. The listing of foreign Companies on U.S. Exchanges also means that it is easier for Americans to participate in global growth. Unfortunately, the current Sarbanes-Oxley regulations on listed Companies has made NYSE and NASDAQ less attractive places to list a Company. Last year, out of 25 wolrd major listings, the U.S. only managed to garner two, with the rest going to London and Hong Kong. In the long run, it is also good for the developing countries to share in world economic growth and take away some of the volatility in world economic growth that happens when America is the main engine of growth. A resurgent Japan, a hopefully resurgent Europe, plus China, India, Brazil etc will make the world less susceptible to boom and bust cycles.The movement of young, and skilled workers to Europe and America will help to revitalize these older economies too. In America a significant proportion of scientists and engineers employed each year is of foreign origin, since there is a shortage of science and engineering graduates from our Universities. The output of scientists and engineers from China and India already total 1.2 million a year as compared to 400,000 for the U.S. The more open the economies, the more it will benefit. Excluding U.K., Ireland and Sweden, the less open European economies like Germany, Italy and France will find that aging populations and inflexible labor laws will lead to their decline in the world economic ladder. And they will become dinosaurs on the world stage. China has already surpassed Italy, and France in GDP. America with its more liberal economic and labor environment continues to benefit from the talents of immigrants, not to mention continuing to have a younger and more fertile population * Note: Unskilled labor even helps to keep costs down in places like New York and California, by taking on the lower-paying, menial jobs that are usually shunned by Americans. Garbage collectors, waiters, construction workers, fruit pickers, hospital orderlies play a role in making our economy function smoothly too.

Because of all these factors above the Gloom and Doom picture of the Financial markets that was forecasted to accompany the retirement of baby boomers is not inevitable. The housing slowdown in the U.S. will retard growth for several months or 1-2 years, but with it’s free and less-friction economy, the U.S. economy will restructure itself in a process of creative destruction as it has always done. Added to this is the fact that the baby boomer generation is vastly different in attitude from pre-World War II generation before it. Many baby boomers are computer-literate, mentally active and eager to keep on working and the advent of the Internet has meant many will be able to do their own small business or work from home for a Company. Health-wise, advances in medical sciences have helped them to remain physically fit to work until their 70’s at least. Last but not least, while baby boomers may be retiring, America is still the country with the best demographics of a young, vibrant and constantly growing population. Russia, Japan and most of the European countries are aging and not replacing their population. So is China [the unfortunate effect of a past one-child policy] .Only India and the Latin American countries buck the trend. America will continue to attract the greatest global talent and be the leader in innovation and entrepreneurship for many decades to come. You, as a stock market investor, and quite possibly a Baby Boomer too, will need to think global to benefit from these two mega-trends.

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