DECEMBER 01, 2010
'The times they are a changin'
One of the topics that greatly interests me is the change in societal attitudes and norms, and how these affect the broader economy.
Let me give you one simple example. Consider that household debt has expanded way beyond income growth and inflation over the past 10 years. It currently sits at just under 150% of disposable income. Now can that growth last forever? Clearly not. So what will that change look like? How will it affect our economy? What might trigger this secular shift? These are the questions that fascinate me.
I'm going to restate some of the major secular shifts that I think are set to reshape the economic and social landscape over the next few years and then connect them to what is happening in the news.
1) Public sector pension woes
Defined benefit pension are based on ponzi dynamics to begin with. They work brilliantly when the total returns from the fund's assets produce enough capital to pay out high entitlements in perpetuity or when demographics are on the side of the pension plan and a proportionally growing base of contributors ensures that entitlements can be met.
But when those two factors are not in play, defined benefit pension plans run into major problems.
Our current low interest rate environment puts tremendous drag on plans that typically discount future liabilities by 6-8% (meaning they expect their pension assets to return that much). Hitting these targets becomes extremely challenging when over 40% of the assets are in fixed income investments which perform well during falling rate environments, but poorly when rates rise....as they now must.
Also consider shrinking sectors like education where demographics ensure a smaller working base to support entitlements. Given the low current birth rate and immigration rate as well as higher life expectancy of retirees, it poses major problems to continued solvency of certain plans. We know the proportion of working educators to retired educators is shrinking. In the case of Ontario teachers, the ratio was 10 to 1 in 1970, 4 to 1 in 1990, and 1.5 to 1 today.
So for young Ontario teachers hoping to retire at 55 with a 65K/year indexed pension......forget about it! It's a pipe dream. Some simple common sense should tell you that a system is unsustainable when it requires that you work for 30 years and then collect generous, indexed pension benefits equal to the salary of a year 7 or 8 teacher for the next 35 years, especially when the ratio of new teachers supporting the old ones will reach 1 to 1 before too long. Come on!
It's not just Ontario teachers. It's also federal civil servant pensions and post secondary pensions, like mine. None of them are sustainable....which means that stories like these should be increasingly commonplace:
"Canadian university pension plans have fallen into a collective $2.6-billion hole, and may have no choice but to cut services to begin climbing back out of it."
"Most faculty and staff have defined benefit pensions, which promise a set retirement income based on service and salary. But those funds suddenly cratered when markets crashed in 2008, most losing 15 to 30 per cent of their value."
"...cuts are likely unavoidable....“The only place that [money] could come from is our operating budget.”
So students are set to get screwed. Lovely. As so often seems to be the case, the burden to rectify these shortfalls seems to fall squarely on the shoulders of those who stand to gain little benefit from them.
Given enough time and enough media attention, public sentiment will turn against them. It may take a full decade, but I fully expect to see every defined benefit contribution plan become defined contribution. If you're young and are part of a DB plan and are not familiar with DC plans, you may want to familiarize yourself. It will quite likely be your future.
2) Consumer frugality....less debt, more savings
It's really a no-brainer that debt has to be paid down at some point and that savings cannot sit at these absurdly low levels forever. Have a look at household debt (left) and savings rates (left).
The funny thing about sheeple is that they can be counted on to make the worst possible financial decisions until they are scared into being prudent. I'd suggest that the reality check is coming in the form of falling home prices and rising unemployment. Regardless of what causes it, these trends won't continue indefinitely. The particularly concerning part is that mass psychology ensures that most people pile onto trends en masse. This is troubling for the economy as a wholesale repudiation of credit and embracing of savings spells deflation.
Yesterday, courtesy of a TransUnion report, we found out that there the average credit-active Canadian consumer carries a debt load of $25,168, excluding mortgage debt. Yikes.
The report did highlight that while the debt loads of Canadians is still rising, it is doing so at a much slower rate that in the past few quarters. Gee, what a relief!
"Overall debt has continued to grow (4.3 percent year over year), but at a slower, single digit rate in the last three quarters."
Confirming this report, Stats Canada today released their updated bank credit stats.
While they calculated that total household credit advanced at a wholly unsustainable 7.1% year-over-year clip in November, easily outpacing inflation and income growth, there were some interesting developments in the mortgage arena.
Notice that while total consumer credit advanced during the month at a 7.2% clip, it was offset by a decline in total mortgage credit. Now one month doesn't make a trend, but it does make you take notice. Given that expanding mortgage credit and the associated wealth effect of rising home prices is what spurs consumer credit growth, a sustained drop in mortgage demand and home prices by association spells big trouble for consumer credit demand. Keep an eye on this one!
3) Renting back in style....McMansion lose their appeal
We're a long ways from experiencing this here in Canada, but it will come. As we look south of the border where the "real estate only goes up" illusion has been thoroughly thrashed, we find that indeed a mean reversal is underway:
I don't think we'll see quite this same love of renting from affluent Canadians, but it does foreshadow a coming shift in our perceptions of the merits of buying vs. renting.
Also a great read. I firmly believe that we will see a similar movement here in Canada. McMansions are finished. To quote the teeny-bopper crowd....."they are like.....so last year!"