Demographics, current accounts and the savings cycle

Here, J.P. Morgan Asset Management's Tom Elliott considers the lifecycle of savings…

"The life cycle of savings theory suggests that when we are young, and old, we dis-save (ie, borrow or wind down savings), but that this is balanced out during our lives through savings in our middle age. It might seem straightforward, but it won a man the Nobel Prize!

"If we think of a country as a person, we can also use the theory to illustrate changes in current accounts. With millions of baby boomers in the industrialised world now approaching, or entering, retirement, and being replaced by relatively fewer savers, this theory has obvious implications for the demand of financial assets. For instance, this theory would suggest that low-risk assets, such as core government bond markets, can expect a surge in investor demand over the coming decades as baby boomers steadily shift their asset mix away from equities and eventually put the bulk of their pension into annuity products.

"Or perhaps the baby boom generation will remain in equities longer than previous generations, deterred in part by rising longevity?

"We can push the demographic theme still further. A country with a low median age, such as a typical emerging economy, will be investing heavily and so borrowing more than it is saving. We can therefore expect a current account deficit. As it becomes older, and richer, savings increase and eventually it will look like a mature industrialised economy with a current account surplus as it saves for its old age.   

"At the risk of gross over simplification of the argument, Japan, Germany and the US fit the model quite nicely if we think of them as individuals. Japan (median age of 44.8 years) is seeing a downward trend in its current account surplus. Germany (median age 44.9) enjoys a strong current account surplus with no sign of it shrinking, while the U.S (median age 36.9), has seen a steady decline in its current account deficit since it peaked in 2008, with household savings rates now positive. In contrast, China (median age 35.5) has a current account surplus, which it is not supposed to have under the model, but then the model does not allow for pegged currency regimes.

"Because a current account surplus in one country means it has lent money to another, the greater one country's surplus the greater another's deficit. The model confirms what we know to be true, that older industrialised countries invest (ie lend) to younger emerging markets.

"From here we might go further and start to use demographic trends to not only anticipate asset prices and movements in current accounts, but also to help forecast long-term trends in foreign exchange and in relative interest rates.

"After all, without people there would be no economics."


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