The attached article is relatively lengthy – I am not going to sugar coat it. With that confession out of the way, I can also say that the author (David Kelly, Chief Global Strategist for J.P. Morgan) is one of the clearest minds and grounded investment strategists on Wall Street… granted, that might be a low bar to set. The piece for this week’s “Weekly Whiteboard” is a well-written article intended to cover a handful of topics that, as an advisor, I think about and am asked about with some frequency. Also, given geopolitical events (both domestic and foreign to the United States), I think Mr. Kelly’s commentary and analysis are timely.
The article, Demographics, Debt, The Dollar and Apocalyptic Assets (Kelly, 2024), provides valuable insights into topics of interest and pressing economic concerns, and I believe you’ll find it informative.
So, sit back, fire up a pot of coffee (or something more courage-giving) and enjoy!
Demographics, Debt, The Dollar and Apocalyptic Assets
SEPTEMBER 2024 • DAVID KELLY
Recently, a financial advisor e-mailed me, asking for help in addressing some client questions.
One client had attended a financial seminar in which the speaker had argued that, with the baby boom generation dying off after2030, the economy was headed for collapse. Consequently, the speaker told the crowd, they should sell their businesses and other assets and buy gold. Other clients had asked the financial advisor whether the rising federal debt must inevitably destroy both the U.S. economy and the dollar’s position as the world’s reserve currency.
Over the years, I have been asked many times by financial advisors about these and other apocalyptic scenarios. To be clear, these questions do not spring from the genuine concerns of financial advisors or even the diligent research of their clients. Rather they arise because investors are on the receiving end of messages from prophets of doom, delivered online, via radio shows or in person. These soothsayers make a living from hoarsely barking out assertions of disaster, without any proof or even any academically sound investigation. The “tell”, of course, comes in the pitch at the end. Because of the imminent disaster, you should sell all your assets and buy gold, or bitcoin, or canned goods and ammunition….and luckily, they just happen to have gold and bitcoin and a moderate supply of canned goods and ammunition in their shed out back.
Demographics And Growth
That being said, the first and best defense against such charlatans is a basic understanding of the issues at hand.
First, demographics do not doom the United States to recession.
The U.S. working age population is growing relatively slowly. The Bureau of Labor Statistics estimates that the U.S. population aged 18 to 64 grew by less than 0.1% over the past year. In addition, long-term Census projections, released last November, projected annual growth in 18- to 64-year-olds of 0.1% for the rest of this decade and 0.2% for the next decade.
However, it should be noted that these forecasts assume annual net immigration of less than 900,000 between now and 2040.This is likely an underestimate based on recent migration trends and, while we clearly need comprehensive immigration reform, it should be recognized that over 70% of net immigrants are aged 18 to 64, and thus in their prime working years compared to less than 60% of the existing population.
It should also be noted that the labor force participation rate for the population aged 18 to 64 has actually been rising in recent years and hit a 15-year high in April.
Consequently, in contrast to nations like Germany, Japan, Italy and China, the supply of workers to the U.S. economy should continue to grow in the years ahead. In addition, the U.S. workforce continues to become more productive. While real GDP per worker increased by only 1.3% per year in the first two decades of this century it has risen at an annual pace of 1.7% since then, despite the disruption from the pandemic. With abundant investment in AI and robotic technologies, productivity growth could well accelerate from this pace in the years ahead.
In our consumer-driven economy, an economy producing more jobs, more income and more output should also continue to generate the demand for that output, allowing the economy to grow at close to a 2% pace, interrupted only intermittently by occasional recessions.
In short, while the baby boom generation will sadly fade in economic significance, there is no reason to believe that this will spell doom for the U.S. economy.
Sizing Up The Debt Threat
A second strand to the narrative of economic disaster concerns the federal debt.
Last fiscal year, which ended on September 30th, 2023, the federal government ran a deficit of almost $1.7 trillion or 6.3% of GDP with federal debt in the hands of the public rising to $26.3 trillion or 97.5% of GDP. In their June forecasts, the Congressional Budget Office projected deficits of over $2 trillion per year for most of the next decade, with the debt rising to 122.4% of GDP by2034. Moreover, these forecasts assume that the 2017 tax cuts that were set to expire in 2025 actually do so. If they were, instead, fully extended then, again using CBO numbers, the debt-to-GDP ratio would rise to 133.4% by 2034. Even this excludes the cost of further promises currently being made on the campaign trail, including eliminating taxes on social security and tips, further reductions in the corporate tax rate, and subsidies for first-time homebuyers.
It is very reasonable to worry that our democracy has degenerated to such an extent that we will to elect politicians who propose tax cuts or spending increases without any mention of how to fund them and who entirely ignore a long-term need to move the federal finances back to balance.
However, this does not mean we are on the edge of a fiscal catastrophe.
First, political promises, over and above the extension of the 2017 tax cuts, should be taken with a grain of salt. The current election campaign is very close, suggesting that whichever party wins the presidency may not also have control of both houses of Congress. Even a narrow sweep scenario would not necessarily mean significant fiscal stimulus, since Senate moderates in both parties have a history of obstructing their own president’s proposals.
Second, the world still has a huge appetite for U.S. Treasuries. In calendar 2023, in order to finance the deficit, offset quantitative tightening by the Federal Reserve and rebuild cash balances, the U.S. Treasury Department borrowed almost $2.6 trillion from global capital markets and the 10-year Treasury yield ended the year at 3.88% – exactly the same rate as at the start of the year. In the first 8 months of 2024, Treasury has raised a further $2.1 trillion and the 10-year yield stands at just 3.91%. This suggests that the world can absorb enormous Treasury issuance without a crisis.
Third, a critical factor in any fiscal crisis isn’t the debt itself – it is the interest payments on the debt. Provided inflation is low, long-term interest rates should also continue to be low, allowing the government to finance its debt cheaply. Since peaking in9.1% year-over-year in June 2022, the U.S. CPI inflation rate has fallen to 2.9% in July of this year and is on track to drop below2.0% early next year. The reality is that, despite the bout of inflation caused by the pandemic, the policy response and the Ukraine war, long-term forces such as diminished union power, greater inequality and increased use of information technology tend to depress U.S. inflation. And if inflation and interest rates remain low, the federal government can likely continue to run massive deficits in the years ahead without precipitating a crisis.
The Role Of The Dollar
And then there is the issue of the dollar.
The U.S. dollar continues to play a preeminent role as the currency of global trade, an asset on the balance sheet of the world’s central banks and the alternative currency of choice in countries around the world where governments allow their domestic currency to be ravaged by inflation.
The dollar’s role has significant advantages for the United States. It has funneled global savings into U.S. capital markets, boosting asset prices and allowing the federal government to finance its debt more cheaply. It has allowed the Federal Reserve on many occasions to coordinate a global response to regional financial crises. And it gives the U.S. government some ability to impose financial punishment on countries as an alternative to the horrible extreme of war.
However, it has also had its downside. Partly because of its preeminent position in world financial markets, the U.S. dollar has traded at too high a level from an economic perspective for many years. In raw numbers, this can be seen in a trade deficit that
will likely top $800 billion this year. In the real world, decades of a too-high dollar have decimated American manufacturing, contributing to economic decline in many communities across the nation.
With inflation retreating, a steady decline in the dollar to more appropriate levels would likely be a good thing. However, despite efforts by some nations to undermine it, the dollar is likely to retain its role in the global economy. The reason is simple—there is no better alternative.
There are some countries, such as Russia and Iran, who resent the dollar’s position. However, they are in no position whatsoever to challenge it. Relative to the United States, their economies are small and weak and, given their arbitrary and corrupt authoritarian rule, are likely to stay that way. Nor has either government given the global public any reason to trust the Rial or the Ruble relative to the U.S. dollar.
China clearly has a much bigger and stronger economy than those of Russia and Iran and has greater hopes for the international use of the Yuan. However, China currently faces major economic, fiscal and demographic challenges, making it unlikely to challenge the dollar any time soon. It should also be noted that any sharp appreciation in the yuan due to its greater use in the global economy would only compound some of China’s economic problems.
The euro is probably the most respectable long-term challenger to the dollar. However, Europe has its own problems of slow growth and federal cohesion. Moreover, the European economy would also likely be hurt by any appreciation in the euro from its greater use as a global currency.
In short, despite occasional alarming headlines, there is no evidence that the dollar is about to plunge or lose its role in the global economy.
Apocalyptic Assets
Finally, while reasonable analysis can address many of these apocalyptic scenarios, should investors consider buying gold or cryptocurrencies anyway?
These two assets should probably be considered separately.
Gold does have some positive characteristics. It has been a form of money for millennia, it is used as an asset by central banks, it has some industrial uses and does, of course, make beautiful jewelry. In addition, short of nuclear fusion, it is in genuinely limited supply.
However, this limited supply ultimately means that it cannot be used as a modern currency. In a global economy with positive real economic growth, a gold-standard economy would be doomed to a either perpetual mild deflation or require some artificial mechanism to increase the velocity of transactions at a steady pace. Moreover, while gold has been seen as a hedge against inflation in the past, this has not worked out recently. Since January 1991, the correlation between gold and inflation has barely been positive and over the past decade it has actually been negative.
The price of gold has risen by over 20% so far this year. However, it is fundamentally a speculative asset, and, as such, should only merit a very small allocation, if any, in a diversified portfolio.
That being said, the fundamentals of gold positively glisten relative to cryptocurrencies. Cryptocurrencies have gained new interest this year as the industry has invested heavily in advertising and political contributions. However, it needs to be emphasized that an “asset” such as bitcoin can never really be used as a currency since the primary requirement of a currency is stability and that those buying and holding bitcoin are only doing so on the conviction that it will go up. Needless to say, bitcoin is not used as a reserve asset of global central banks, has no assets or taxing authority backing it and is not used in any extensive way in transactions. Nor is it really in limited supply. While the algorithms upon which bitcoin is based allow for a maximum of 21 million coins, there is absolutely nothing to stop an enterprising young crypto enthusiast from setting up “mitcoin,” “zitcoin” (or my personal favorite “davecoin”).
This is not a place to review the shortcomings of crypto currencies. For any financial mania to succeed you don’t need to fool al lof the people all of the time—you only need to fool some of the people some of the time. You can even make a profit if,
according to the greater fool theory of finance, you can find some greater fool to take it off your hands at a higher price.
However, for serious long-term investors, there is really no reason to dabble in speculation or the hunt for greater fools. The reality is that, while the U.S. economy faces plenty of risks, the noisiest alarm bells are mostly false alarms. As we enter the fall of 2024, global financial markets still offer plenty of opportunity to those willing to invest in a diversified way with one eye on valuations and the other on their own return goals and risk tolerance.
David Kelly is chief global strategist at J.P. Morgan Asset Management.
