Luis F. Dumlao, Ph.D. is an associate professor, Department of Economics, Ateneo de Manila University and a post-doctoral fellow, Department of Economics, Fordham University. This article was published in the March 16, 2009 edition of the BusinessWorld, pages S1/4 and S1/5.
On 23 October 2008, in his testimony to the United States House of Representatives Oversight Committee, Alan Greenspan called the banking and housing chaos a “once-in-a-century credit tsunami.” Interestingly and figuratively speaking, a once-in-a-century tsunami was happening in the population of those aged 60 to 65. The reason had to do with three particular birth spurts in the US. The first and second batches were born in 1942 and 1943 or during pre-deployment to Europe and Asia .(The invasion of Normandy was June 1944, and Leyte Day was October 1944.) The third was the first born “baby boomers” in 1947 immediately after World War II. (V-day in Europe was May 1945 and V-day in Japan was August 1945.)
Those born in such years are now in the early 60s or mid-60s. In other words, they are at that turning point in their lives when many stop working and retire. In finance and economics, many are in their critical stage of their life when they go through the transition from the mode of capital accumulation to the mode of withdrawal smoothing. “Capital accumulation” is defined in the sense that workers invest and accumulate wealth for retirement. “Withdrawal smoothing” is defined in the sense that retirees stop investing and slowly take out from lifetime savings.
Indeed, six batches of ages 60, 61, 62, 63, 64 and 65 go through “transition” every year. But those three of the six batches in 2007-08 represent more than the usual increase of people. Consider the National Populations Projection of the US Census Bureau released in 2008, and calculate the growth rate of population of each age. In 2007, the population growth rate of the United States was just less than one percent, but the growth rates of aged 65, 64 and 60 were 7.70 percent, 8.38 percent and 20.30 percent, respectively! (According to chi-square test of normality the distribution is normal—the standard variations from the eman are two, two and five, respectively.
The bigger picture can be seen in Figure 1. The growth rate of each age as of 2001 is shown. The spike in the growth rate of those aged 54 is noticeable. The spikes corresponding to those aged 58 and 59 are less noticeable but still unprecedented in a century’s perspective. Every year, the population ages and the line graph moves to the right. Now imagine this movement as a wave going from left to right. Then figuratively speaking, the spikes of aged 58 and 59 hit the “island of transition” in 2002. While the first two hits would not have left the “island” yet, the spike of aged 54 appears like a tsunami that approached and hit the “island” in 2007. And if one is to look at the magnitude of this wave and frequency of its occurrence, it is the only time in a hundred years it happens. Indeed, it was a once-in-a-century tsunami!
The result was a disruption of the usual flow of capital from accumulation to withdrawal smoothing. The disruption has got to be major if the people in transition are average savers. But they are more than average savers. David Weil (1994) showed the average savings rate in each age bracket. Accordingly, average savings rate was positive, starting at age bracket 25-29, increased over the years, reached its peak of over 15 percent at age bracket 55-59 and then went negative at age bracket 59-65. In other words, the transition was from peaked savings rate to negative for the first time in at least 30 years. Concomitantly, Adair Turner (2007) updated James Poterba’s data and showed how the S&P 500 Index and the ratio of aged 40-59 to the rest of the population correlate since 1970.
Here are the implications. First, if the disruption of flow was foreseen and one was to minimize its negative impact on the financial economy, the response needed would be a-once-in-a-century, drastic and un-experimented policy. If it was unforeseen, which was probably the case, a once-in-a-century tsunami had actually shaken the financial economy off-guard. The US was hit in one of the worst timings possible when it was already facing the challenges of failed real estate investments, ballooning debt and persistent BOP (balance-of-payments) deficit.
Second, the more mainstream explanation of the recent US financial crisis is that the financial institutions’ investment failure, especially in subprime mortgages, triggered an eventual vicious cycle of sell-off and decline of financial markets. Unfortunately, a-once-in-a-century tsunami resulted in an unusual outflow of wealth from the financial system that eventually added to the momentum and further aggravated the cycle.
Third, the US financial crisis is unlikely to be followed by a boom of another major market. This is in contrast to what has happened the past 10 years when collapse in one major market tended to be followed by a boom of another. For example, the 1998 Asian financial crisis was followed by the dotcom bubble. Its burst in 2001 was followed by the rise of commodities markets highlighted by oil. When the commodities markets slowed down around 2004, the proliferation of investments in subprime mortgages began. When financial institutions began to feel the lack of fundamentals because of subprime mortgages, commodities markets highlighted by oil boomed again, reaching a peak nominal price of around US $150 per barrel.
The reason why the bursting of one major market was followed by the booming of another was that there was no permanent decrease of capital in the global financial system. When the Asian financial crisis hit, offshore capital was pulled out of Asia. Since capital was still there, it had to be put somewhere. That somewhere happened to be in dotcom—hence the dotcom boom. When the dotcom burst, capital was pulled out of dotcoms. Since capital was still there, it was placed somehere; that somewhere was in commodities market—thus the oil price boom.
This time the US financial crisis is not likely to be followed by a boom of another market. This is because when the US financial crisis hit, capital was pulled out of Wall Street and then pulled out of the whole global financial system. When those in transition retire, they essentially stop pouring and start withdrawing capital from the financial system. Thus, there has been a permanent decrease of capital in the financial system. Unfortunately, in the US case it might just be the beginning. The ageing officially hits the US, Japan, Germany and the rest of the first countries in the next five years.