The Credit Crisis and the Spent Demographic Dividend

March 26, 2009

We need to grow out of a 30-year habit of borrowing money irresponsibly. Developing a more mature character may be economically painful, but it's crucial to our children's future.


We are living through the biggest financial calamity since the Great Depression of the 1930s. The credit crisis that began in the sub-prime mortgage market in the United States in the summer of 2007 gathered strength for more than 12 months and, by the fall of 2008, had spread to almost every area of global debt markets. More than US$720 billion of bad debt was written off the balance sheets of financial institutions around the world in 2008.

Experts today predict that the total write-off of loans across the developed world could reach as much as US$3 trillion. Powerful financial institutions have been humbled and many have either collapsed or had to be rescued by taxpayers.

As the conduits of credit were quickly constricted by financial institutions, consumers and businesses both large and small quickly felt the squeeze. The previously rosy prospects for the world's economies deteriorated at astonishing speed, in a matter of weeks, showing just how interconnected the global economy is.

This freezing of credit affected every country in the world. The symptoms were obvious: troubled financial institutions, falling real estate prices and slowing consumption and investment. Consider this evidence: in 2008 a staggering US$30.1 trillion in market value was wiped off the global stock markets. Approximately US$7 trillion was taken off the U.S. market alone, the worst drop in the U.S. stock markets since 1937.

The response of governments around the world is unprecedented: mammoth bailouts of financial institutions, nationalizing of corporations, aggressive reductions in interest rates and unequalled increases in money supply.

The major concern we should have with all this government involvement is the massive budget deficits that have emerged. We should all know that rolling debt from the consumer to the government is not a long-term solution. The last thing we need is bigger and larger governments around the world.

How did we get here?

What is the root of the problem? In a nutshell we got to this point as a result of three decades of baby boomers, those of us born between 1946 and 1964, living far beyond our means. This privileged generation that began with so much promise is now embroiled in a financial crisis due largely to irresponsible and materialistic lifestyles, most of it purchased on a line of credit.

Sure, boomers were assisted by financial institutions willing to lend money without proper underwriting standards. And, yes, the regulatory oversight was exceptionally poor. But in the end, who signed up for all this debt? Who bought the larger and larger homes despite declining family sizes? Who turned over the car leases every 24 to 36 months on cars they could not afford to purchase? Who took the cruises and bought vacation properties based upon future earnings and stock market returns that were unsustainable? Who used the little equity they did have in their homes as a source of funds to buy more and more consumer products of little or no lasting value?

One statistic alone drives this point home: in the United States during the past ten years, each $100 growth in total debt was supported by only a $19 growth in GDP (the total value of goods and services produced)! So what next? We need to look this problem straight on and respond by reducing our debt levels and strengthening our own personal balance sheets. The problem is this will be painful for us as individuals and for our economy despite the fact it is the right way forward. By pain, I mean that industrial production will continue to fall, retail sales will be weak, consumer confidence will remain low and the value of our homes will not be going up any time soon.

In the end we will be better off when we right-size the economy but, in the interim, we are in for some tough medicine.

Advice for investors

What does this tough medicine mean for those of us with investments such as mutual funds, pensions and RRSP accounts? Many investors are asking: How do we get asset values to go back up? How do we get out of the grip of this nasty bear market (when the value of stocks is decreasing) and back into the arms of a bull market (when stocks are increasing in value)?

The bottom line is we have much work ahead of us before we see a substantive bull market. Bull markets do not materialize out of thin air and they do not have to appear automatically after a downward move in the markets.

Powerful bull markets are the result of strong pro-growth economic policies, stable to declining tax rates, minimal government intervention, principled capitalism, vibrant and growing populations, innovations, protection of private property and access to capital from real savings.

Prudent investors should be very concerned that many of these important elements of a strong and prosperous economy are not clearly evident.

Restoring lost trust and confidence in our institutions also requires something else that is not clearly evident: the moral authority to inculcate in younger generations the necessary virtues such as hard work and delayed gratification. Will the younger generations in our postmodern culture willingly adopt such values when their model generation, the baby boomers, spent most of their lives shirking such values, only recognizing the need for them late in life? Without a strong ethical and moral base (which for Christians is rooted in the truth of God's Word), we will not have the necessary foundation upon which to build a strong and enduring economy for our children.

Aging populations

Besides the morals and ethics of the people in our economy, the age and productivity of the population are also crucial. Unfortunately, we are also facing an aging crisis as well.

In fact, the severe problem of the world's aging population is one of the most significant and misunderstood challenges facing global capital markets over the next two decades. This problem is not restricted to rich western countries.

Contrary to the uninformed consensus, countries such as China and India will be the most affected by the economic results of huge drops in the number of children per family. Thus it's a mistake to look to them for our long-term growth.

Statistics can help explain the problem. Over the past three decades, the average number of children born per woman has dropped from more than four to fewer than 1.5 on average throughout the largest economies in the world. Given that the sustainable level is 2.1 children per woman, we will soon be losing from 30 to 50 percent of our population with each passing generation. In Europe the average number of children per woman is hovering around 1.3 and in Canada we are currently at 1.7. Philip Longman's book The Empty Cradle (Basic Books, 2004) explains these issues in greater detail.

The fact that this change will not cause an absolute drop in the number of people in the world for another 30 years does not mean we can continue to ignore the impact this will begin to have on the world's economy. Russia and Japan are already experiencing more deaths than births and this can be seen in their dismal economic numbers. Over the next 30 years this death spiral will begin to hit country after country within the developed world.

Yet many economists refer to the drop in family size as a wonderfully positive trend providing a "demographic dividend." They point to how families with fewer children consume more goods today and can leverage themselves up quite nicely on a double income. Because of the way economists tabulate our GDP, it appears we are better off in the short run if we reduce the number of children per family.

The problem is that the baby boomers, products of large families themselves, have not only reduced family size, they have also dramatically increased consumption of goods and services. In short, the demographic dividend has been spent and we have a pile of debt to show for it!

Why is this so serious? The global fall in fertility is creating a new world that few individuals, companies or nations are prepared for. We are unprepared because modern economies, including modern welfare states, are basically founded on the assumption of population growth and the human capital it creates. Our global financial system has become capitalized for prosperity and growth alone. It is not prepared for a shrinking working population!

Who will service all the debt that has been created, and is now being created, by governments around the world?

What price will the boomers' children pay for our assets as the boomers retire? Who will pay for the escalating medical bills? Instead of using credit to pay for winter vacations in Florida or cosmetic surgery, we will need to save up for these expenses the old-fashioned way or forgo them altogether.

And what about all those underfunded private and public pension plans around the world after the 2008 financial markets carnage? Let's face it: they will stay underfunded until they renege on many of their current promises and redefine their future obligations in light of the new reality and not the reality that existed 20 years ago.

The reality is we are facing years of slowing global GDP growth, higher taxes, increased government intervention and fewer young people who are so integral to a vibrant economy.

Discipline and leadership

Now that the panic button has been pushed it's time for leaders to take an honest look at the problems. We face unprecedented challenges around the globe as we try to bring stability in the midst of a world swimming in debt and unsustainable promises.

All of us need to realize that growth in capital is a long-term process underpinned by discipline, hard work and self-sacrifice.

Christians in particular should be part of the solution because we can provide the necessary spiritual anchors in a postmodern culture plagued by short-term thinking. We need true leaders who will balance the needs of this generation with future generations and build a strong economy rooted in such enduring biblical principles as honesty, hard work and generosity.

Leadership means standing on fixed principles and never wavering from these principles. We need leaders with character, vision, integrity, courage and understanding. We need leaders with the power to articulate solutions and a strong sense of Providence because they see themselves as part of a higher purpose and meaning that transcends the temporal. If the Christian community cannot step up to the leadership plate, who will?

In practical terms this means we are to invest for the future, spending only what we have and avoiding the awful trap of consumerism and materialism even if this means fewer 'things' in the days ahead. We must also be those who remember that God is sovereign. Despite all the challenges we face, Jesus the Christ is on the throne and He is moving history forward to its appointed end.