The Economics of the Boomers

America is getting older, indebtedness is rising, and economic recoveries keep taking longer. This is not a coincidence.

Credit: Mael BALLAND/Unsplash

We’re now in the longest economic expansion in U.S. history, so it’s as good a time as any to think about how the next recession will play out.

In theory, recessions should be getting some combination of rarer and milder over time. We have better data (thanks to the work of an army of technocrats starting in the 30s), and we have better theories (every recession refutes at least one theory of recession prevention). It’s possible to imagine shifting to a regime where economic growth oscillates in a tighter range and never goes below zero.

This, of course, doesn’t happen. There are partisan theories as to why — the evil Republican theory of unrestrained speculative excess, the evil Democratic theory of excessive regulatory meddling — but the more interesting ones are politically agnostic. I’m partial to Hyman Minsky’s argument that the process goes as follows. In good times, few loans default and credit spreads narrow; investors’ return expectations are sticky, so they respond to lower spreads by levering up; at some point, what would be a minor speedbump at low leverage turns into a crisis with higher leverage, leading to a funding crisis and a deflationary unwinding.

What’s convenient about this theory is that it embodies enough human wisdom to explain that we’ll never fully solve the recession problem. As another expert on the human condition might have put it, the poorly-calibrated risk models you will always have with you.

But Minsky runs into the same problem as every other economic theory: If it’s universal, it’s also smug. Minsky doesn’t tell you what will go wrong. He doesn’t say, “That’s why you’ll have a maturity mismatch between commercial paper funding and illiquid structured credit in 2008.” Just that something, someday, will go wrong. That’s frustrating because it’s not action-guiding, and the whole point of understanding recessions is knowing when to short equities in size.

Predicting recessions while policymakers are trying to prevent them is a metagame: You’re trying to figure out what the Fed, Congress, and the president either can’t or won’t stop. That’s a two-step problem. You need to enumerate forces that governments can’t control, and you need to figure out which tools will become surprisingly ineffective.

The irresistible force of demographics

There’s one phenomenon too big for any American political party to stop: the boomers. They’re an immense generation, and they’ve been distorting the economy for decades. From 1950 to 1970, college enrollment rose from 2.2 million to 6.7 million. In the 70s, we had high inflation — oil was a factor, but a bigger factor was the biggest generation in history buying homes, cars, and appliances. In the 80s, the boomers already owned houses, and they started buying stocks. In the 90s, more stocks. In the 2000s — panic! They’d overinvested in equities to compensate for undersaving, so they switched to an investment category that offered more leverage: housing. We know how that turned out.

And now, they’re retiring. Retirees do two things with assets: They sell them down, and they rotate from risky products like equities and mortgaged-to-the-hilt houses to safer stuff like T-bills and annuities.

The boomers are an important phenomenon, and no generation has so assiduously tried to understand itself. It’s always best to get an outsider’s perspective, so I picked up a copy of the definitive opus on the generation.

Harsh!

Gibney’s book is informative and quite entertaining. If you want to argue with him, I recommend reading it. If you read the title and decided to hate him, I’ll help you out there: Check out this interview he did with his tailor, featuring a photo where he poses with a Juul.

A Generation of Sociopaths is thorough and well-researched. But it’s part of a long literary tradition in which mild misanthropy gets applied to particular anthropes. A few other titles that might work just as well:

Protocols of the Elders of Woodstock

The Eternal Boomer

The Rising Tide of Boomerdom Against Below-Retirement-Age World Supremacy

The Camp of Saints (Who Were Born Between 1945 and 1964)

Seriously, he does not like the boomers. But there’s always the question of whether they’re special because they’re bad or special because they’re numerous. Any demographic bulge causes problems — there’s a lot more civil unrest in South Sudan (average age: 17) than in Japan (average age: 47). Meanwhile, Japan suffers from a capital surplus and slow economic growth. As the boomers shifted the average U.S. age lower, we faced young-country problems like unrest and inflation; now that the boomers are making the United States older, we have old-country problems.

Many of the trends we’re dealing with today — financialization, globalization, inequality, cultural stasis — can be chalked up to a combination of two factors. First, things the baby boomers have in common with anybody else who grows up in a time of comfort and abundance. And second, the impact of sheer numbers.

🎵 You will get a gloomy sinking feeling when you see, retirees per worker soar and wreck the whole economy 🎵

In my capsule summary of the late 20th century above, every decade was defined by the boomers’ demographic bulge; we’re still a few decades away from that bulge ending, but if boomers are the swing factor, the 2020s and 2030s will be defined by rising health care expenses, selling pressure on equities and residential real estate, demand for treasury bonds and other safe assets, and a political bidding war for the elderly vote. The political dimension is especially important because while boomers will not be the largest generational cohort much longer, they’ll be the largest voting cohort for a while yet. Presidential election turnout was 70% for people over 60, compared to 46% for people under 30. And in off-year elections, it’s more extreme: 65% versus 36%.

So in 2020, baby boomers will be around 21% of the population and will represent around 39% of the votes cast. They will probably vote more or less like everyone else: They’ll vote for their own interests within an Overton Window defined by their principles. Voters in most countries are uncomfortable with pure giveaways; nobody is going to run on a platform of “raise taxes in states that voted for my opponent, use those to fund basic income for my supporters.” But within the range of acceptable outcomes, people like to vote for what they want to get. This is dangerous because in the U.S. the Overton Window doesn’t set many limits on how much we can tax workers and investors to transfer wealth to retirees.

Big generations and the savings problem

Whenever a country suddenly has a lot of young people, the clock starts ticking. They’re about 60 years away from having a lot of old people. Broadly speaking, there are two solutions to this problem:

Grow the population so the pyramid remains balanced. Defer more consumption than usual so you have assets to live off of when you’re older.

Unfortunately, the U.S. has collectively chosen option three, which is to do neither of these things and then see what happens.

To be fair, it’s a new problem. For most of human history, life expectancy was under 40, mostly driven by high infant mortality. There’s an annoying paucity of data, leading to all sorts of contradictory claims here — hunter-gatherers got lots of exercise and had great diets, so maybe they all died old. On the other hand, modern hunter-gatherers have ridiculously high homicide rates, so it might be a moot point.[1]

We start to get better data from a few countries over the last 200 years. In England and Wales, 50-year-olds had a life expectancy of around 70 from 1850 to 1900, which steadily rose to 75 by 1950, and is now in the mid-eighties. Or, to put it in starker terms, if you expected to stop working at 65, your years in retirement have risen from five to 17 in the past century. These work as a proxy for life expectancy trends in countries that have access to modern medical technology and are mostly unconstrained by costs.

Given the rise in rich-world life expectancies over time — which has only slowed in the last few years — you’d expect a meaningful rise in savings rates over the same period. That’s not what we see, though. U.S. savings rates peaked around 1975, dropped steadily until the mid-2000s, and recovered slightly following the Great Recession.

Savings rates trended down as boomers became a larger proportion of earners, but young people generally save less, and their savings rates trended down further in the 2000s, only turning around post-recession:

The worrisome possibility is not that the boomers are uniquely bad, but that they’re not especially bad but very numerous.

“Savings” can somewhat obfuscate what’s going on, though. Someone burying coffee cans full of cash in the backyard is saving, but so is someone who buys equities.

We can break the options down like this. If your expected future expenses rise, you can either:

Save more and consume less. Save the same amount but take higher risks. And you can do that by either A) Taking discrete, tangible risks; switching careers, starting a company, making yourself an expert in a field that you think will pay well in a decade, or B) By looking at a menu of investing decisions with consistent risk/reward payoffs, and choosing the one with the highest risk and reward, perhaps levering up to do so.

Baby boomers took advantage of both options. Microsoft and Apple, for example, were both founded by boomers, and both had distinctive and unconventional visions. But it’s hard to take unusual risks like this, especially if you’re thinking about risks only when you start calculating how much money you need for retirement (Gates founded Microsoft at 19; Jobs founded Apple at 20).

So the default approach is to take the usual risk, only more so: In the 90s, people worried about their retirements rotated their stock portfolios from stodgy companies to tech. That didn’t work; tech outperformed from the mid-90s to the end of the decade, then collapsed. Since investors form their expectations by looking backward, expected returns for stocks declined. The UBS/Gallup survey showed that in 2000, equity investors expected one-year returns of about 16%. By 2002, expected returns were 6%. In the 2000s, the move was to lever up by buying bigger houses with lower down payments.

The two broad approaches to risk — differentiation and leverage — have distinct macro effects. Starting a new company creates exogenous upside uncertainty: The world will be different if it works, probably for the better, but it’s hard to say exactly how. Levering up, on the other hand, doesn’t directly change the state of the world, it just changes who collects which tranche of returns. If you buy the house you can afford with a 25% down payment, a 10% appreciation in its value makes your investment worth 40% more. If the same sum of money is a 5% down payment, a 10% increase in your home’s price means a 200% gain. But the larger mortgage means that a larger dollar amount of the home price appreciation accrues to your lender, not to you — they earn the first (1–down payment %) * (interest rate) of returns, every single year. You’re buying a higher-strike option on the same basic asset.

Leverage doesn’t just shift the same returns around, though. It also creates externalities. Specifically, access to capital allows businesses to grow faster than they otherwise would, which creates wealth. However, higher leverage, in general, raises the odds of financial crises, which destroy wealth. As a rough rule of thumb, for leverage to create wealth on net it’s necessary but not sufficient for it to involve production, not consumption. So giving consumers more leverage to buy bigger houses just adds to the risk of a crisis without making the world better off.

It’s instructive at this point to compare the U.S. to other countries that dealt with baby booms, especially the East Asian “miracle” economies. For much, much more, see my write-up here, but for now, what’s worth pointing out is that A) Japan, Korea, Taiwan, etc. did fuel their growth with leverage, but B) this leverage was heavily weighted towards manufacturers, not consumers. Consumers faced high implicit and explicit tariffs on consumer goods, and artificially low interest rates on savings, which allowed banks to lend money to growing companies at scandalously low yields.

The result of this is that Japan and its neighbors have a huge capital base, and hard-to-assail positions in capital- and knowledge-intensive goods. That’s a way to induce positive-sum savings, at least at the country level: Your future income comes not from selling appreciated assets, but from selling Toyotas, ships, and semiconductors to the rest of the world.

In the U.S., we didn’t exactly do this. We certainly found things to sell to the rest of the world, but many of them were claims on our future income.

Housing bubbles, just-in-time inventory, and the great working-capital shift

There are two parallel trends over the last four decades that have changed how fiscal and monetary policy work without changing what they do. First, Americans own bigger houses with bigger mortgages. Second, American companies have become allergic to holding any more inventory than they need.

These trends happened for fairly unrelated reasons, but the combination led to some interesting side effects.

Historically, the way recessions worked was that companies accumulated excess inventory, so they laid off employees to work off the overhang. When one company does this, it’s fine, but when enough companies do it at once, they reduce aggregate demand, which makes the inventory overhang bigger, leading to more layoffs. That’s a simple model that ignores financial markets, but when financial markets are small or the main source of funds is the banking system rather than capital markets, it’s pretty accurate.

In that model, governments can stimulate growth by A) raising spending to stimulate demand, B) cutting taxes to encourage investment, and C) cutting interest rates to reduce the cost of carrying excess assets on the balance sheet.

When companies are allergic to holding inventory, though, it becomes a weaker channel for stimulating growth. This clearly took policymakers by surprise; back in the 90s, Alan Greenspan once told a metals trade association “Every day, I still look for the price of #1 heavy melt steel scrap.” In his career as an economic consultant, scrap-steel prices were a great early indicator of economic health, but by the end of his Fed tenure, China was producing four times as much steel as the U.S., and container shipping had tightly linked their economy with ours. Shipping costs are a bigger share of scrap metal’s price than they are for finished goods, so the market is somewhat localized and it’s hypersensitive to local rather than global conditions.

All this sets up a situation in which central-bank models are tuned to an economy that no longer functions the way they expect it to, which means they get the wrong signals. In a manufacturing-heavy economy, interest rate cuts quickly flow through to manufacturing employment by way of inventory.

Actual changes in inventory still show a lag, because a reduction in demand coupled with continued production increases both how much inventory a company has and how long it takes to sell it (e.g. if you assume that demand is $1 million/month and have three months of inventory, and then demand drops to $800,000/month but it takes you three months to react, your inventory has risen to $3.6 million, or 20%, but your inventory-months have risen from three to (3.6/0.8 = 4.5 months, or 50%).

This is easiest to see with a long-term chart. From the 50s through the mid-60s, inventory’s contribution to GDP volatility was in-line with its contribution to GDP. As inflation picked up in the late 60s and through the 70s, inventory contributed to GDP volatility than to GDP growth (i.e. manufacturers tended to overreact to inventory changes — a Fed that’s constrained by inflation risks can’t seamlessly react to drops in demand). Starting in the 80s, inventory volatility and inventory contribution to GDP growth became deeply decoupled, as companies shifted inventory risk off their balance sheets and on to those of consumers and offshore suppliers. And in the 2000s, we reached the natural endpoint of this trend: Inventory’s contribution to GDP growth turned somewhat negative — GDP growth was slightly positive from the 2006 peak through 2011, but real inventories had a net decline over this period.

Also included in the chart is the steady decline in total inventory as a percentage of total GDP, from around a quarter at the start to roughly 15% today.

Dangerously for economic policymakers, monetary policy continued to work, just through a different channel. Instead of encouraging companies to produce more, it increasingly encouraged consumers to spend more. In the aggregate, this is not necessarily a problem; whether production leads to wage growth and spending growth, or spending growth leads to production and wage growth, the net effect is the same.

The problem is the side effects. Lower rates increase the value of real assets and increase the consumer’s ability to turn asset appreciation into spending. This can happen through liquidating assets, or, in the case of mortgages, taking advantage of the cheap option to refinance them.

And the side effect of this ties back to demographics. If you bought a big house to raise a family, and your kids have moved out, your surplus residential real estate is basically a speculative asset. You own more housing than you need, but when home prices rise, that just makes you financially better-off. A house that’s bigger than you need is not just an investment, though; it’s a warehouse. To someone who owns more real estate than they need, housing price appreciation gives them more money to spend and means they have somewhere to put all the stuff they want to buy.

The reductio ad absurdum of this is using a home equity loan, or a mortgage refinancing cash-out, to fuel spending. Total mortgage cash-outs were over 1% of GDP from 2001 through 2007, and over 2% at the peak of the housing bubble in 2005–2006. Growth in home equity cash-outs was around 8% of GDP growth during the bubble, and a drop in home equity cash-outs accounted for over 100% of 2008’s year-over-year decline in GDP. Earlier in the bubble, we can see cash-outs as a lever for improving GDP growth. In 2001, as the tech bubble rapidly popped and the Fed cut rates from 6% in January to under 2% by year-end, home equity cash-out growth accounted for $75 billion of the economy’s $220 billion GDP increase.

But to the younger generation, housing is not just a retirement plan with an early-cashout option. It’s mostly an expense — and, crucially, it’s the expense that determines when they will have kids.

The aggregates only tell an accurate story when you fail to account for demographics. Once you know demographics are a factor, monetary stimulus imposes negative externalities: it makes older asset-owners better off at the cost of preventing younger people from accumulating assets. As inventories have declined and total consumer debt has risen, monetary stimulus has subtly flipped from being pro- to anti-family formation.

You can imagine a fix for this: Give the Fed a triple mandate. Instead of stable prices and high employment, require them to aim for stable prices, high employment, and stable fertility rates. And if you really want to get clever, consider this: Price stability matters less when population growth and GDP per capita growth are high, because you can devalue older savers’ assets today and compensate with higher absolute transfer payments backed by your larger economy in the future. This is not just theoretical. Japan and Korea both tolerated high inflation early in their growth cycles because it paid for the infrastructure that gave them a better safety net later on.

Unfortunately for central banks, it’s hard to raise household-formation rates through monetary policy alone. One option might be for Congress to set an annual maximum earned income tax credit (EITC) or basic income, but to let the Fed choose the actual level. This way, the Fed could combine monetary tightening with a higher EITC to redistribute money to wage earners, or raise and lower both in tandem to achieve traditional policy goals.

There is roughly zero chance that it was intentional, but economic policy in the Trump administration has, ironically, improved this situation relative to Obama, Bush, and Clinton. By ramping up deficit spending in a strong economy, Trump makes a tighter monetary policy relatively more feasible and redistributes some of the benefits of economic growth from owners to earners. It isn’t what a utilitarian technocrat would have wanted, since it’s so skewed to the biggest earners who are already pretty big asset owners, but giving a tax cut to almost two-thirds of households does have an impact on the economy, even if most people don’t realize they got it.[3]

The implicit and explicit balance sheet of retirees

My broad thesis is that a shift in how monetary policy stimulates the U.S. economy has led to wealth redistribution to older people, whose high propensity to vote means their interests are entrenched. But this doesn’t address the narrower question of what investment decisions they’ll make and under what constraints. Specifically, we should ask what effect growth in the retiree population has on economic growth and price levels.

Obviously, retirees slow economic growth because they don’t work. In a closed economy, retirees would also be inflationary because while they stop earning, they keep spending at roughly two-thirds of their previous rate. But in a more open economy with levered balance sheets, mass retirement can be deflationary instead, as they de-lever and sell risk assets to buy safer stuff. If you’re 55 and thinking about retirement, you might be tempted to map out the options this way: “If I take lots of financial risks right now, I can quit working in five years if those risks pay off; if they don’t, I’ll have to work a bit longer, but I can still retire at 65 with the same standard of living.”

As you get older, though, either this happens, or you realize it won’t. So, either you quit working, shift your portfolio from stocks to bonds, and move to a smaller house, or you make those shifts, sell those assets, and cut your expenses sooner.

This means that an economy weighted toward services has a natural level of cruise control. People don’t have to stop working, but they can slow down. A manual laborer has to save a lot because one back injury can mean retiring at 45 instead of 65, but office workers don’t have this concern. However, this countercyclical tendency has a major drawback: The output of service jobs harder to measure, so employers weigh experience more.

We know these jobs have hard-to-measure outputs both intuitively (it’s easier to see where the assembly line is backed up than to figure out who in HR or accounting messed up) and through appeals to authority. Greenspan is one of history’s great economic-data nerds, and his single most famous speech includes an extended riff on how hard it is to measure the value of things like software, legal opinions, and medical operations.

Greenspan ultimately concluded that we’d probably underestimated productivity growth in the services sector, but this was a sort of arbitrary decision. It also was a way to justify not raising rates in the late 90s, which was followed by a collapse in equity prices, so maybe we shouldn’t take it too seriously.

Greenspan is not the only economist to muse about how hard it is to measure service sector productivity. William Baumol had some thoughts there, too. Specifically, Baumol noted that the productivity of members of a string quartet hasn’t risen at all since the 19th century; they still produce the same number of minutes of live performance per minute of work. And yet, we can’t pay them 19-century wages, or they’ll get 2,000% raises by working in fast food. Per Baumol, as productivity in manufacturing and agriculture rises, more people end up working in services, but any service job involving one-to-one in-person interaction has no meaningful way to increase productivity. So, over time, economies suffer a sort of heat-death, where the sectors that can grow output per hour become a smaller and smaller fraction of hours worked until the main constraint is the cost of finite raw materials.

Service-based economies tend to have milder swings. Even the heat-death thesis assumes a slow glide path to stasis. We see this in the data already. The Great Recession, the most severe postwar economic contraction, led to a 5% drop in GDP. The mildest recession in the period from 1880–1945, the period for which we have good comparable data, involved a decline of over 8%.

Meanwhile, let’s consider the balance sheets of our services-heavy economy. The Fed offers a triennial Survey of Consumer Finances, and the New York Fed offers quarterly data on consumer credit. Between these two, we can get some rough estimates.

First, the old are rich. In 2016, the median net worth for households aged 65–74 was $224,000, versus $97,000 for the country as a whole. That makes sense, of course. Your net worth should bottom out when you’re first forming a household and should peak when you retire and slowly drift down from there. But it doesn’t: Over-75s have a median net worth of $265,000. Ten years after the standard retirement age, the average family is richer. This has not always been so, and the numbers are volatile, but in general, the net worths of the very old are trending up.

What explains this? Looking at the 1989-versus-2016 breakdown by age and asset type, older families’ median ownership of retirement accounts rose $48,000 as the number of older families with retirement accounts rose from 6% to 41%. However, this wasn’t just because people shifted savings into tax-advantaged accounts; older families’ median ownership of stocks rose $9,000 ($5,000 in 1989 to $14,000 in 2016), and their mutual fund holdings also rose (from just over $3,000 to just over $24,000). Younger families’ net worths in these categories have risen, but not by nearly as much. It’s a truism, whether you read the biographies of successful investors or look at the Fed’s data on net worths by age: The most prudent financial strategy is to do as much of your asset accumulation as you can in the early 80s when everything is screamingly cheap.

Homeownership tells a similar story. The cadence of homeownership over one’s lifetime has shifted in the last three decades.

In general, older people are holding on to their homes a bit longer, and younger people are a bit less likely to own.

If we break these numbers down by median home equity by age, the reason becomes apparent:

It’s gotten expensive to own a home! Those younger savers will still buy homes — eventually. But it will take them a few more years, which means they’ll delay having kids by a few years, which means, 30 or 40 years hence, fewer workers per retiree.

On the liability side, there’s another factor besides high home prices: high student loan debt. Among adults over 40, mortgage debt is typically about 70% of total debt, but of the $970 billion in debt owed by 18- to 29-year-olds, 38% is student debt.

One way to look at this is to argue that older people are enjoying a pretty healthy economy, as their jobs and their assets are both well-defended by the government’s policy decisions. But this prosperity comes at the expense of young people, who are in a sort of balance-sheet recession. They can’t afford to invest until they’ve paid down their debts, so they delay home-buying and family formation.

(Perhaps the only upside here is that student debt, unlike mortgage debt, doesn’t force you to stay in one place if you’re financially underwater. The sunk-cost fallacy, however, does encourage you to stay in one career. The only thing more demoralizing than owing $50,000 in student debt for your masters in photography is owing that much money and not being a professional photographer.)

Explicit balance sheets are only part of the story. There’s also the implicit balance sheet: the liabilities that constitute expected future spending.

As people age, they travel less and spend less on food — calorie needs decline by 10–15% from middle age to old age, and senses of taste and smell weaken, too. This means that the elderly are less exposed to fluctuations in food and fuel prices, the two consumer price index (CPI) components that get excluded from the core metric because they’re so volatile. People over 65 have access to Medicare, have social security benefits indexed to costs of living, have a 79% homeownership rate (compared to 65% for the U.S. as a whole). They don’t have to spend money on education, either.

In short, the non-financial asset portfolios of the average retiree make them the most inflation-protected group around. Old-person CPI growth is well below the national average. This has an important implication for their financial portfolios: It means that they get a better real return on treasuries than other investors would.

For the boomers, the 20th century was awesome, but the 21st has left a lot to be desired. First, the equity bubble popped, so they had to find a new way to save. They chose housing, then that popped, too. They’re still well-off, with portfolios weighted toward both homes and equities. The only alternative is fixed-income, and with the 10-year yielding 1.78%, that’s not too attractive.

But a high homeownership rate among the old means that as people either move to retirement communities or die, they need to liquidate housing. And a drop in the labor force, coupled with continued anemic growth in productivity, puts pressure on GDP growth, which compresses equity valuations. Retirees have a long time to live, and if their assets start to depreciate, they may shift to thinking of capital preservation over capital appreciation. And that’s when their effectively lower inflation rate kicks in. The richest demographic in the U.S. — the richest group in human history, as a matter of fact — has just one asset class to rebalance into.