Demographics and Debt

Paul Krugman recently published an article called stay the course, which urges politicians to keep priming the stimulus, despite all the green shoots that are coming out of our eyeballs. He argues that if we do not continue to stimulate, that we run the risk of repeating the errors of 1937 in the US and 1997 in Japan. In both instances, governments took for granted that their respective economies had recovered, changed their focus from stimulus to fiscal responsibility. This shift, we now believe, led to each falling back into recession, giving up prior gains. For a fantastic in-depth analysis of this point, please read The Holy Grail of Macroeconomics by Richard Koo.


In a sense, I agree with Krugman. This economy needs constant government stimulus to replace slack private demand, or else we'll see 10-20% unemployment indefinitely. Where Krugman and I differ (or not, I've never heard him speak to this point) is in my belief that, for the foreseeable future, the US economy will always need government stimulus to replace private demand. Without the federal government pumping an extra trillion-plus into the economy per annum, the days of peak credit and peak earnings cannot and will not come back.

Chart Courtesy of CrossingWallStreet.com


The strongest data point to support this I know is in the total number of people employed as a percentage of the total population. This is in a fairly severe long-term secular downtrend.






What's more, it's hard to see this improving. In Japan, Europe, and the US, this trend will likely continue for another decade or two. For one, the working age population is only growing slightly. Meanwhile, debt as a percent of GDP is exploding.

Krugman is quick to point out that stable, industrialized nations such as the US have had higher debt as a percentage of GDP before. But that was at the end of World War II, when the demographics of this nation were very different. At the end of World War II, we had the baby boom, and the growing population help to pay off that debt. Now, we are developing a comparable debt burden being placed on an increasingly small percent of the working population.

It is possible that tremendous jumps in technology and productivity will enable us to escape this pickle. But even in a best-case scenario, I suspect this will remain a serious headwind for these economic juggernauts in the foreseeable future. There are no easy outs in this one. Either dump a larger percentage of debt onto an ever-shrinking working population, or suffer a decrease in demand, which will lead to even smaller working population, and most likely, a debt burden just as severe as the stimulative approach because of the reduced top line.

Does this mean that the Dow is going to 2,000? Or 20,000? It doesn't imply or preclude either. What it means to me is that Siegel's 7% annualized S&P growth over the past 150 years was dependent upon working population growth that was significantly above what it is today. My best guesstimates make me think that the first half of this century could see growth reduced in proportion to the size of the working population. There's too many variables (at least for me) to calculate what that might amount to with any precision. But it's scary knowing that it's there.