Global Economic Forces Building to Create a Sticky Outcome

Powerful forces produce powerful outcomes.

Oil is the result of forces millions of years in the making.

Over time, the build-up of microscopic plants and animals on the ocean floor created sufficient pressure and heat to produce oil and natural gas.

Nature’s forces produced an energy outcome that, when tapped, transformed the world…in so many ways.

This process has led to many positive improvements to our everyday lives.

But, of course, demand for the ‘sticky stuff’ has also caused many unintended negative consequences. The Middle East is in perpetual unrest. The potent combination of power and money has led to war, toppled numerous regimes, and killed millions.

When the combustion engine was invented, the knock-on effect to the Middle East couldn’t have been imagined.

Indeed, the forces put in place by nature millions of years ago have produced powerful and unexpected outcomes.

Likewise, the forces at play within the global economy will be disruptive and transformational.

Although these forces have been just decades in the making, rather than millions of years, they are every bit as powerful and combustible.

A post-WWII Western world had access to cheap oil, a baby boom, and — with the removal of the gold standard in 1971 — the capacity to create money out of thin air.

The impact of these forces is evident in US GDP growth during the 20th century.

In the first half of the 20th century, there was a four-fold increase in US GDP.

The second half saw an explosive 30-fold increase. The world’s largest economy was on steroids.

Growth and prosperity on this scale had never occurred at any other time in history.

Governments rich with tax bounties and freed from the pesky restraint of the gold standard embarked on an entitlement free-for-all that has produced generational social security dependency.

For example, according to the Congressional Budget Office, over 60% of the US population receives more in government benefits than they pay in taxes. Welfare entitlement is a common affliction in the Western world. That’s true here in Australia, but especially so in Europe.

The economic benefits created by tens of millions of ‘never-had-it-so-good’ consumers (baby boomers) accessing a world awash with easier credit standards is well documented. We have lived in a world far removed from the hardships of the first half of the 20th century.

Wealth and welfare have raised our standard of living…and complacency.

The forces that created this ‘economic prosperity’ are under pressure — and a different energy threatens to be unleashed.

The following chart shows the impact retiring boomers are going to have on the workforce dynamics of major Western countries.

The seismic shift from ‘tax payer to tax receiver’ over the coming decades is going to be a complete reversal of the prosperity driver of the previous decades.

The slow release of this negative energy into the economy is bound to create budgetary headaches for Western governments.

The other major energy force in the past two decades has been the rise, rise and rise of China. Nothing before and probably nothing again will ever rival the power of the Middle Kingdom’s determination to lessen the disparity between their world and ours.

The transformation in major and not so major cities is the stuff of legends. Before and after pictures of Shanghai, for instance, leave you in awe of what can be done with single minded focus (and several trillion yuan).

China’s rise coincided with the final phase in the Western world’s economic ascendency.

Heavily indebted Western consumers discovered the ‘have-it-all’ party could continue with lower priced Chinese imports. Both worlds benefited from this alignment of Western buyers and Chinese suppliers. Australia’s economy reflected the dynamics created by this situation.

The following chart from the Department of Foreign Affairs and Trade (DFAT) shows how, over a twenty year period, the supply of raw materials to create cheap imports altered the composition of the Aussie export pie – resources grew while our manufacturing sector shrank.

The Australian mining sector (and government revenues) benefited greatly from China’s two decade long boom, but it’s also made us very vulnerable to China’s economic fortunes.

And that brings me to the other negative force starting to press against the negative economic energy created by retiring boomers.

The following is an extract from a Financial Times article published on 27 November 2014, titled ‘China has ‘wasted’ $6.8tn in investment, warn Beijing researchers’:

“Ghost cities” lined with empty apartment blocks, abandoned highways and mothballed steel mills sprawl across China’s landscape – the outcome of government stimulus measures and hyperactive construction that have generated $6.8tn in wasted investment since 2009, according to a report by government researchers.

In 2009 and 2013 alone, “ineffective investment” came to nearly half the total invested in the Chinese economy in those years, according to research by Xu Ce of the National Development and Reform Commission, the state planning agency, and Wang Yuan from the Academy of Macroeconomic Research, a former arm of the NDRC.

…The bulk of wasted investment went directly into industries such as steel and automobile production that received the most support from the government following the 2008 global crisis, according to the report.

…Misallocation of capital and poor investment decisions are not the only explanation for the enormous waste in China’s economy. A significant portion of China’s post-crisis stimulus binge was simply stolen by Communist Party officials with direct responsibility for boosting growth through investment, according to separate estimates by Chinese and overseas economists.

This assessment of waste on a truly monumental scale is provided by none other than the State Planning Agency – National Development and Reform Commission (NDRC).

In four years, US$6.8 trillion has been poured down the drain.

Not even China can afford to tear up this sort of money. Corrections to compensate for this waste and over-capacity will need to be made. This is an irrefutable law.

This is why Morgan Stanley has projected Chinese economic growth slowing to 5% or lessin the coming years.

My guess is these estimates are too optimistic. Rarely do economies go on a glide path.

The power created by the collision of the gathering negative forces in the East and West is likely to create a level of turbulence so severe that neither world is prepared for it. The hoped for glide path could end up in a free fall.

If we look back to when these forces first started, there would’ve been little or no thought of the unintended consequences of a world dependent on ‘growth at all costs’.

The economic pressure created by these forces is placing enormous heat on politicians and central bankers to find a fix.

It can’t be found. The forces are too powerful — you cannot change global demographics overnight and you cannot ‘unspend’ $6.8 trillion of waste.

These slow moving forces are in play, and they are destined to collide. The negative energy forces have the potential to create financial destruction on a historic scale.

The obvious outcome of this collision will be felt in share, property and precious metal markets. The unintended consequences will be far reaching — higher unemployment levels, the elimination of welfare entitlements, etc.

Now is the time to review your financial situation and ensure you and your family won’t be caught in a sticky situation when this gusher blows.

Vern Gowdie
for Markets and Money

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Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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