And so here we are…
For the last few weeks, your humble author has shared relevant data regarding savings rates, pension plans, inheritances, reverse mortgages, and more in order to reach some conclusions about the future prospects for retirement in the developed world (see here and here).
What we learned is that aggregate savings rates are woefully insufficient to serve as one of the "three pillars" of a solid retirement plan. Meanwhile, pension plans are becoming less common, and the ones that do exist are of the defined contribution variety which, unlike defined benefit plans, do not offer similar security and often tend to be underfunded. Even many of those with defined benefit plans are about to experience the repercussions of those plans being underfunded, too.
Meanwhile, the bailout many citizens expect to receive in the form of inheritances comes with risks and considerations. For the bottom tier of the economy inheritances will prove to be fewer and smaller than expected, but for those of the economy's upper tier inheritances will likely provide even the most profligate with the funds needed to enjoy some kind of retirement.
Alternative investment products, like reverse mortgages, will also prove to be a potentially solid source of investment income for those of the upper tier economy, though tapping it will inevitably reduce the potential size of their children's inheritances. For those of the lower tier economy - or at least those who own their home - reverse mortgages alone will not likely provide enough income to maintain their lifestyles in retirement. Some supplementary savings, pension, or inheritance will still be needed.
The image of retirement we've grown since the World War II generation started enjoying their golden years is changing.
If this story has a familiar ring to it that's because it's nothing new. The looming retirement shortfalls will exacerbate the "two economies" divide we currently see unfolding. The swelling middle-class and great prosperity the West experienced after World War II (especially the Anglo-American world) was a very special epoch in history. It was truly a "golden age" and will likely never be repeated in our lifetimes or those of younger generations.
It is a story about the rise and decline of a broad middle-class. As both citizens and investors, we need to adjust to a new reality: The Golden Age is in its twilight, and its final expression is visible as unsustainable consumption. It's not that the middle-class is going to disappear; it won't. But it will be smaller, perhaps much smaller and more comparable to historical norms.
The looming retirement crisis (for lack of a better term) will prove to be the final act in a tale of victory, prosperity, decadence, and decline. It's a tale that has been told many times throughout history, and it's our tale, too. Turns out, we're not special after all.
The Golden Age
Those of you who are familiar with my earlier writings are familiar with what I call the "Golden Age" (see here). Strangely, it appeared in the wake of the Second World War when much of the world lay in ruin, with factories bombed and businesses devastated; crops poisoned, abandoned, or unseeded; bridges, roads, and infrastructure destroyed and unusable. This describes much of continental Europe and South-East Asia.
The exception, of course, could be found in places like North America, Australia, Sweden, and Switzerland, places that did not experience the war on their own soil, either due to geographical good fortune or neutrality. Some countries, like the UK, certainly did not escape destruction, but nevertheless fared much better than, say, France, Germany, the USSR, or Japan.
In the late 1940s - amid the rubble of this devastation - the US alone accounted for 50% of global GDP. This is astonishing. What followed was the rise of the Anglo-American middle-class, and the halcyon days of the 1950s: station wagons, white picket fences, large families, pension plans, and all of it affordable on the earnings of a sole breadwinner.
While much of the world was rebuilding, the luckier nations were exporting manufactured goods and resources. Meanwhile, governments were growing, increasing their budgets, and a steady stream of new employees was needed to populate new departments and ministries. Workers, white and blue collar alike, were enjoying a rise in prosperity like never before.
Among the symbolic boons of this era was the private sector defined benefit pension plan. A blue collar worker, for example, who loyally stayed with his employer for decades could look forward to a predictable flow of income in retirement. This, along with some modest personal savings, and a government pension plan meant retirement was all but ensured for a good portion of the private sector workforce.
To be sure there were many reasons for the post-war prosperity, but its tenuousness came to the forefront once the Continental European and Japanese economies returned to form and began to compete for their share of the global marketplace.
Those, for example, who solely blame post-1980s "neoliberalism" for the decline in US manufacturing have simply been duped by just another political meme. How quickly we forget the anti-Japanese feelings that erupted in places like Detroit in the 1970s as the globalizing economy took a big bite out the North American middle-class.
The following chart plots the post-World War II decline of private sector employment in areas like manufacturing versus the rising services sector which has largely replaced it. Note the freakishly constant slopes in either direction over multiple decades, impervious to the whims of electoral swings:
During the ensuing years, new sources of competition would arise, too, like the so-called Asian Tigers during the 1970s, and the rise of China and numerous other emerging markets in the 1990s.
The transitoriness of our Golden Age resulted from other factors besides just foreign competition. Automation, by many estimates, has led to at least as much displacement of manufacturing jobs as foreign competition and outsourcing. Meanwhile, the steady rise in government spending post-1950 reached its structural limits by the 1990s, spelling tougher times even for educated sectors of the economy, or at least those with degrees offering little employment demand (see my article on this topic here).
Since the late 1960s, inflation-adjusted wages have been stagnant at best. Defined benefit pension plans have been abandoned by nearly all private sector employers in favour of defined contribution plans or even no plan at all. The full-time job with benefits and long-term prospects has also become less common, leading to the rise of the gig economy.
Paradoxically, in the midst of this trend, we have seen middle-class living standards steadily rise, along with the costs associated with living a "typical" middle-class lifestyle. Meanwhile, savings rates, as we know, have become steadily smaller. Even with smaller families and the influx of women into the workforce, the maintenance of a middle-class lifestyle has devoured the incomes of most households, resulting in a dearth of savings and unfunded retirements.
Twilight Of "The Economy"
Today we stare into the abyss of a retirement hell, at least for roughly half the population. Much of the wealth accumulated during our middle-class's golden age is rapidly being replaced with debt, as even seniors are now joining the consumer debt queue as I discussed in last week's article.
Harvard economist, Raj Chetty, recently reported that back in 1940 90% of those born would go on to match or exceed their parents' earnings. Fewer than half those born in 1980 would accomplish this feat (see here). Across the OECD a similar picture emerges; those belonging to the middle-class has shrunk from 68% for the Baby Boomers to 60% for Millennials (see here).
To be sure, there are myriad reasons for this. Some will point to the hyper-consumerism embraced by the "peace and love" generation and its "slacker" progeny as the cause of our current savings woes. There is doubtless some truth to this. Others will point to the abysmal hollowing out of prospects and earnings for the unskilled and blue collar portion of the population. There is some truth to this, too. Others will note the skyrocketing costs of housing, health care, and education as the cause, and there is truth here, as well.
The decline of the middle-class is actually more severe than the aforementioned numbers suggest. Note that the 68% of Baby Boomers who once counted as middle-class is a reference to earnings only. But earnings only tell part of the story. In addition to their incomes, Boomers (and to a lesser extent Gen Xers) would also look forward to inheriting the wealth of the famously stingy, and spectacularly successful, WWII generation.
As for pensions, the Boomers (and again to a lesser extent the Gen Xers) were more statistically likely to have defined benefit pension plans. For Millennials, however, such plans are very uncommon, and for Gen Z they are unheard of, at least for those working in the private sector.
And yet, frighteningly large numbers of Boomers and Gen Xers, too, are still dangerously underfunded for retirement. It is now certain that many of these retirements will be dependent upon inheritances, or made possible only by accessing wealth locked up in residential properties via reverse mortgages.
As we noted before, many middle-class lifestyles of today are being funded at the expense of retirement savings and/or by tapping wealth that would otherwise be passed down to future generations. In other words, much of the current middle-class is something of a chimera. It exists hand-to-mouth in a desperate attempt to maintain the lifestyle it was born into, even though doing so leaves them with few options in their golden years and even fewer good ones.
Wolf Richter recently published a list of countries with the highest level of "debt slavery" among consumers. The countries appearing in the top ten may shock a great many (see here), especially among those who assume this is solely a US problem. It's a developed world issue, observable from Norway to South Korea.
This phenomenon presents itself in various way. The following graph, courtesy of the BBC, shows the decline in home ownership among young people aged 25-34 in the UK. This is troubling because with UK savings rates at record lows a family home might be the only real hope for many to achieve their retirement dreams via reverse mortgages or even downsizing.
Even if we accept that this generation is merely "deferring" home ownership it means that those homes will be getting paid off later in life (especially in light of skyrocketing real estate prices), leaving less time to save for retirement.
If we step back and look at the big picture, divorced from political bickering and finger-pointing, what emerges is a familiar scene. Like a family that became wealthy thanks to hard work, sacrifice, and some very good luck, the post-WWII middle-class would see its subsequent generations slowly burn through its wealth.
The family analogy is a strong one. It has been noted that 70 percent of newly wealthy families will lose their wealth by the second generation, and a whopping 90 percent by the third (see here).
Obviously, the middle-class isn't going to disappear. However, a macro view reveals that the outsized middle-class which emerged post-WWII was likely an anomaly. The proceeding generations were simply not able to maintain it or sustain it. The reasons are many and we all share some culpability on various levels.
As more Baby Boomers enter retirement, and as the first Gen Xers start reaching retirement age, we will observe that shrinking middle-class more vividly. The appearance of middle-class status will be exposed for a great many as just that: appearance, unveiled as they are forced out of necessity to work into their 70s, or are forced to depend on their already financially-squeezed adult children for care.
For many more, a comfortable retirement will be achieved, but at the cost of depleting family wealth and bequeath-able assets. Thus, those they leave behind - those infamously saddled with exploding housing, health care, and education costs, as well as a radically different job market - will have little hope of maintaining the lifestyles they've come to view as "normal" without sacrificing savings and retirement planning.
Finally, a significant minority will still be able to retire without tapping all their savings or converting housing assets into income streams, or for that matter without depending on their children. Theirs will be a familiar retirement, like those we've seen recent generations enjoy, complete with Winter pilgrimages to warmer locales and luxury automobiles. It's just that their numbers will be smaller, probably much smaller.
The middle-class that once roughly contained 70% of the population was once "the economy". It's not that there were no rich or poor people in our golden age, but the primary engine of the economy was driven by that huge segment of middle-earners, including their consumption, their savings, and their investments, and those efforts were nicely complemented by the significant contributions of the wealthy. That former portion of the economy is today much smaller. Indeed, some would say that the majority now finds itself as part of the growing lower-tier economy and a growing underclass.
Implications For A Consumer Economy
As the title of this section implies, most developed countries have consumer-led economies. This is obviously going to be a problem when a shrinking middle-class means fewer consumers, and fewer citizens with pockets flush with disposable income.
As I've tried to stress this isn't an "end of the world" thesis. The middle-class isn't going to disappear, and the retirement travails unfolding aren't likely going to produce some kind of economic collapse (though yet another in the recent series of economic crises certainly isn't out of the question). However, it does represent a change, and for the majority, not a change for the better.
A cash-strapped consumer is not good for growth, especially in developed countries where consumer spending constitutes such an outsized portion of GDP (see my article here). It's highly likely that at least part of the reason for the low-growth recovery we've seen since the great financial crisis (GFC) can be attributed to this.
Yes, some consumers are not cash-strapped and are faring quite well. However, this group no longer represents that great middle-class bulge that emerged in the 1950s, or in other words "the economy". It is now a minority of consumers, albeit a sizable minority.
Thus, a complete free-fall in consumer spending does not seem to be in the cards. As we've discussed, a large minority of people remains in the upper-tier economy and will enjoy well-funded retirements. Even before it reaches retirement this segment will continue to spend robustly.
Another, smaller, segment of society will retire but will need to depend almost exclusively on inheritances - or, either liquidating or borrowing against real estate assets. While this will doubtless affect the inheritances of their children it should keep the parents spending like typical consumers throughout retirement.
Finally, we will increasingly notice that a growing, financially-squeezed, section of the economy will be either forced to work well into old age or will retire into absolute poverty. The only saving grace for these people might come from support from adult children whose own personal consumption will be reduced in order to provide necessities for aging parents.
Consumption will not be a dependable engine of robust GDP growth for developed economies for decades to come.
If nations are to continue their obsession with growing GDP then it will have to come from increased investment or from increased government spending, both of which have problems. Investment requires precious savings and capital and can take years or even decades to bear fruit. Meanwhile, government spending has limits and most governments are already heavily in the red (as are consumers and corporations).
Another possible source of GDP growth could come from increased exports, but there's a potential problem here, too.
So why is pension underfunding a global problem, rather than one faced by individual providers or countries? The simple answer is the unprecedented scale of the deficits and the number of economically important countries caught up in the problem... [emphasis mine].
Source: The Conversation
This is the crux of it. We have a problem that will not only affect each of our individual countries but those of our major trading partners as well. As we can see, combined government, consumer, and corporate debt has doubled in the last 20 years, while growth in the developed world shows little sign of reaching the heady 3+% levels of old (the recent US is an outlier here, but time will how long that lasts).
Source: Financial Times
Debt accumulation on this scale is not necessarily a bad thing if economic growth can keep pace with it, or better yet exceed it. But that's not what's happening (see here). Throughout much of the developed world, combined debt is growing faster than GDP.
With the developed world essentially ensconced in consumer consumption economies, the prospects for rapid growth appears increasingly slim, unfortunately, as the population ages. Meanwhile, national governments and major corporations don't appear to have much room to vastly expand their already heavy debt-loads in the absence of said growth.
In short, our consumer economies just aren't going to produce the kind of growth needed to maintain a broad middle-class like it once did. The upper-tier earners will do just fine and will continue to spend, but they will constitute an increasingly smaller segment of society.
Conclusion: A Gold Watch For The Golden Age
This consumption angle explains why the retirement situation is so symbolic of the twilight of our middle-class "golden age":
The broad post-50s middle-class laid the foundation for the West's consumer culture and consumer-led economies. Macro pressures on that middle-class accumulated in the ensuing years in the form of foreign competition, automation, dramatic changes in the nature of employment (pensions, benefits, full-time hours, etc.), as well as living standards and living costs which rose (and continue to rise) faster than incomes.
Perpetuating a middle-class lifestyle became increasingly more difficult post-60s, exacerbated by the fact that a "typical middle-class lifestyle" is itself a moving target. A "normal" standard of living today is a far different animal from that of previous generations.
Families of the 50s typically had one breadwinner and needed only one automobile. A single landline served the entire family, unlike today, where every family member - including even the youngest of children - has a personal phone. Houses have gotten bigger (even as families got smaller), along with the additions of countless new appliances and conveniences within; video gaming consoles were unheard of, as were botox injections, iPads, quartz countertops (granite is SO last year), and trendy upscale markets, like Whole Foods; etc., etc., etc.
Rapidly rising living standards kept GDP growth mostly positive (in the 3% annual growth range) for decades as most consumers tried to maintain the ever-expanding living standards which they perceived as normal.
Problem is, the maintenance of countless middle-class lifestyles has largely come at the expense of savings, especially for retirement. The segment of the middle-class least capable of keeping up has gradually watched its savings rates drop to zero, or even go negative.
Currently, 25% of Americans are using credit cards to pay for necessities, like food (see here). This dis-savings and/or debt-accumulation has concealed the shrinkage of the middle-class through the steady but unsustainable maintenance of consumer spending.
The dearth of retirement savings is already beginning to expose the implausibility of many Baby Boomers' middle-class lifestyles (see here), and this is only going to worsen once large segments of this cohort burn through their inheritances and real estate equity. In other words, their children and grandchildren are less likely to benefit from similar retirement bailouts from these sources. Increasing numbers of Millennials and Gen-Zers will have to choose between either keeping up with unsustainable living standards or having any hope for a retirement.
It's a two economies world now. Are you one of those who can afford your lifestyle and still look forward to a retirement? If you're not sure, then you're probably not. Now is the time to figure it out.
Good luck, dear readers.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.