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Whither Europe and the Euro?By John Mauldin
What if the Malthusian doom and gloom crowd is wrong? What if the trend of lower population growth clearly evident in the developed world is echoed in the rest of the world? This week we look at a remarkable book by Ben Wattenberg called simply "Fewer." It is about "How the New Demography of the Population Will Shape Our Future." His thesis has implications for currency valuations, public pensions and the future of Europe, among many other things. The book has given me a great deal of food for thought, and I share some of those deliberations with you. Not all of my speculation is pretty, but these are topics which will be addressed, because the markets will not allow them to be ignored. "Fewer" is an amiable book of some 220 pages. It is extremely well written and easy to read. For an investment of a few enjoyable hours you will be given a considerable grasp of the demographic issues facing the world. I highly recommend you buy the book. But before we get started, let me warn you. Some of you may not like my thoughts on immigration. I should note that much of my view is tailored by my personal experience. As a few of you know, I have seven kids, five of which are adopted. Three are from outside the US and thus immigrants. I have two Korean daughters and two black sons (one from the Virgin Islands), along with a blond, a brunette and a red-head. We are not very tolerant of racist attitudes in the Mauldin household. That being said, let's jump right in. The book is based upon the implications of a new UN projection of future population growth. Prior to 2002 the UN assumed that worldwide population growth would slow to about 2.1 children per woman. Now it is assumed that worldwide population growth will be 1.85. (2.1 is the replacement level, by the way.) In the book and this letter that number will be referred to as the "Total Fertility Rate" or TFR. The TFR of what the UN considers the More Developed Countries (basically the countries thought of as the "West" and Japan) is 1.6, well below replacement rate. The US has the highest rate among all these countries at 2.0, while Europe as a whole is only 1.38. Using a slightly higher TFR for Europe, or 1.45, European population is expected decline from 728 million people today to about 632 million by 2050. I have written extensively about demographics in the past, both in this letter and in my book, basing much of my analysis on various projections by the UN, CIA and other organizations. I must admit to being surprised by a few of the facts in this book. Bottom line: the rest of the world is moving to lower fertility rates at a very rapid pace. While most everyone is aware that China has had its TFR drop to around 1.8 because of the One Child Policy, I was surprised that Iran has dropped from a TFR of 7 in 1960 two just 2.1 today! Egypt has watched its TFR drop in half in the last 40 years to slightly above 3, and it is dropping every year. Brazil is now below the replacement level of 2.1. India has seen its TFR dropped from 6 to just over 3 in only a few decades and the trend is decidedly down, especially among the new Indian middle-class. Demographers in Mexico expect the TFR of our southern neighbor to drop below replacement level this year! Think about what that means for US immigration policy in 20 years. South Korea has gone from a TFR of 6.3 in the late 1950s to only 1.17 in 2003. Russia is at 1.1. Bulgaria is at 1.1. Japan is a 1.3. Germany is a 1.35. All told, there are 63 nations whose TFR is below 2.1. I could spend two or three letters writing about all the interesting facts in the book, but I will resist. I hope you buy it. However, what I will do is to randomly select just seven points to give you a flavor for the book. No Dogs or Irish 1. The population in America today is roughly 300 million people. That is expected to grow to 400 million by the middle of the century. Yet the TFR for the United States is 2.01. How can we then grow? United States growth comes entirely from immigration. A newly released Census Bureau report reveals that Hispanics made up half the US population growth of 2.9 million over the past year, and now constitute a seventh of Americans (some 41.3 million). The Hispanic growth rate (births and immigration) for the 12 months starting July 2003 was 3.6% compared with the overall population growth of 1%. Asians were next at a 3.4% rate, compared with 1.7% for native Hawaiians and other Pacific Islanders, 1.3% for blacks, 1% for American Indians and Alaska natives, and 0.8% for whites. Some, like Pat Buchanan, decry the increased participation of Latin Americans in the United States. They worry that we will end up as a Spanish-speaking nation. There are indeed problems with US immigration policy, mostly having to do with the giving of government benefits. But all the research shows that 99% of third generation Hispanic immigrants speak English. Sadly, only 50% of third- generation Hispanics speak Spanish. Evidently it is as tough for Hispanic parents to get their kids to take a second language as it is for me to get mine to even think about it. (Ben Franklin famously complained about German immigrants grouping together in enclaves and only speaking German. It seems that every generation of Americans complain about the new immigrant population. My Irish ancestors were once considered to be an immigrant problem. "No dogs or Irish allowed" was posted on many an establishment door. Now everyone is Irish on St. Patrick's Day.) Wattenberg makes the point that a nation whose population is not growing and is not increasing its tax base and economic base cannot continue to thrive. The United States needs its immigrants. Without them our Social Security and Medicare problems are greatly increased to the severe breaking point. We could see our problems become as large as Europe's. Forgetting the cultural implications, and from a pure economic standpoint, the US should be aggressively seeking to increase immigration of the right kind. Our policy today is haphazard and ill-informed, but at least allows for one million immigrants per year. If we were smart, we would be doing everything we could to get young educated people to come to the US. (One day I will write about the flight of the creative class. We should institute policies to reverse this damaging trend. As noted below, we will one day see that young people are the true natural and limited resource.) It is a far different world in Europe. Quoting from Wattenberg: "...consider Europe, according to [a UN publication called] "Replacement Migration." Today, Europe has more than twice as many people as the United States, but the whole continent takes in a net of 376,000 immigrants per year, about a third of the American number. In order to keep a total constant population, that European immigration number would have to rise to 1,917,000 per year, an annual increase of more than 500%. To maintain a constant age group of workers aged 15 to 64, the number of immigrants would have to rise to 3,227,000 per year, an annual increase of more than 900%. The UN also calculated what it would take to keep the dependency ratio constant, that is, the proportions of working age persons to those over age 65 and under 15. That would require an annual immigration of 27,139,000, an increase of more than 7100%. That is not likely to happen." Quite the understatement. We will visit some of the implications of that last paragraph later in the letter. 2. I suppose it intellectually follows that a low birth rate will mean that there will be a high percentage of women who have no children. I had not given thought to that. So I was rather surprised by the number of women with no children at the end of their childbearing years: Germany 26%, Finland 21%, United Kingdom 21%, Italy 19%, Netherlands 19%, and Canada 14%. The United States stand at 16%, up from 11% in the early 1970s. "In 2003, Gallup asked American respondents over age 41, who do not have children, whether they would not have children 'If you had to do over again.' Only 24% said they would have 'none,' with the remainder specifying the number of children they wish they had borne." While that is sad for this generation, it does seem to augur that there is a potential for a revival of birth rates at some point, as future generations realize the value of children. (I would tell anyone that seven kids is an insane number of kids. Total chaos. Outrageously expensive. And I would do it all over again.) 3. "Indeed, the New Demography creates an imbalance between senior citizens and the rest of the population. So many old people! New medicines, better public sanitation, and behavioral changes have added years to life and often life to years. It is happening most everywhere in the world that is not blighted by the pandemic of HIV/AIDS or collapsing health delivery systems. That is the good news. But who will pay for the public pensions of the senior citizens if there are only comparatively few worker bees in the population? And who will pay for medical care for the seniors? After all the crisis-mongering about the situation, how serious is it? "There is an irony at work: a principal cause of the aging boom is a baby bust. The median age in America in 1950 was 30. By 2000 it was 35. In 2050, it is expected to be 40. In Europe in 1950, the median age of the population was 29 years. In 2000 it was 38 years. In 2050 it is projected to be 48. Japan had a median age of 22 in 1950, 41 and 2000, and an expected 53 in 2050. Seen another way, in 1950 just 8% of Europe's population was over age 65. 100 years later, in 2050, the projection is 28%." The Center for Strategic and International Studies notes that "for most of human history, until about a century ago, the elderly (people aged 65 and over) never amounted to more than 2 or 3 percent of the population." (http://www.csis.org/gai/index.htm) 4. There is a stark contrast between retirement in Europe and retirement in America. Today it is traditionally 65 in the US. The retirement age (for Social Security benefits) was raised in the US in 1983 to 67, which will take full effect by 2022. The following are examples of the average retirement age for men in Europe: Belgium, 58.1; France, 58.8; Germany 61.0; Italy and the Netherlands are slightly under 60; United Kingdom, 62.9; in Switzerland, 64.5. 5. This statistic that struck me as rather interesting: Asian Indians are the second-largest legal immigrant group coming to America. There were 1.65 million of them in the 2000 census. Their household median income was $63,699 per year, the highest of any ancestral group. I had always assumed that Jewish household income would be the highest. A national study suggests that their household income is "only" 54,000. Where Did All the Immigrants Go? 6. I was struck by how few immigrants there actually are. There are only about 175 million immigrants in the entire world. The United States has 20% of those at 35 million. We live up to our reputation as a melting pot. Russia is in second place with 13 million (although many of them are Russians returning from the former Soviet Republics) and Germany is third with 7 million. This quote highlights the problem for those nations with decreasing populations: "While there more immigrants than ever, there are nowhere near enough to deal with the massive structural magnitude of the problems at hand. A total of 3% of the global population are immigrants, but that amount, sliced and diced as you please, would not come close to providing substantial help for the looming pension shortfall in Europe. And despite the fact that scores of millions of ambitious people are ready to emigrate to places with a higher standard of living, even if it involves a high degree of danger, many of those places dislike newcomers. In a tough game, I think the immigrants will win. Someone has to empty those bedpans. And sooner or later (probably later), Europeans will have to learn how to accommodate pluralism." A final thought on immigration. As a percentage, immigration in the United States is not particularly high when compared to our history. Our national culture is not endangered by one million new people a year, anymore than it was endangered by hordes of Irish or East Europeans or Italians or Greeks in the late 1800s and early 1900s. I should note that Hispanics serve in far larger proportion in the armed services than their presence in the general population, and they proportionally receive more medals for valor than other groups. 7. Many of us remember the doom and gloom projections of the 70s. We were told the world would grow to 20 billion people. We wouldn't be able to feed everyone. There would be mass starvation, and not enough resources and energy to support even a modest standard of living. It hasn't quite turned out that way. As noted above, total fertility rates have dropped dramatically not only in the more developed countries, but in the less developed countries as well. Only a decade ago, "experts" predicted that the world population would grow to 14 billion. Now, the median projection is 9.1 billion based upon a 1.85 TFR by 2100. If that TFR were to stay the same, global population would fall from a high of about 9 billion to 2.3 billion people by 2300. If, as seems likely today, TFR rates continue to fall throughout the world, it is quite possible that total world population peaks at slightly fewer than 8 billion people in the middle of the century, and drops to 5.5 billion by the end of the century. Whither Europe and the Euro? When asked why he was now holding a different opinion than he had previously expressed, Lord Keynes is quoted as saying, "When the facts change, I change my mind. What do you do, sir?" I believe it was in 2002 that I first suggested the euro would go to $1.50, and then back to parity (or $1) sometime in the next decade. I also made the same prediction in Bull's Eye Investing. There were a variety of reasons to be bullish on the euro, not the least of which was that I was bearish on the dollar for trade deficit reasons. Additionally, the world was looking for a new alternative currency to the dollar and the new European Union currency seem to fit the bill. Recognizing that the above-mentioned demographic problems would eventually come home to roost in the European Union (see more below), I also felt the euro would become a weaker currency at some point. Last April after returning from a trip to Europe, I became concerned about short term problems for the euro, primarily due to the risk that France could vote no on the proposed European Constitution. I was (and still am) long-term bearish on the dollar, but the euro was beginning to look like it was not a safe bet. I suggested to readers that they begin to move their European currency exposure to Asian currencies. I am now more concerned than ever about the future of the European Union and the euro. It is not altogether clear what is going to happen, and such confusion brings contempt in the currency markets. I readily admit to not being a European expert, but some things seem clear even from Texas. First, the proposed European Constitution is on life support. Two of the original six members, France and Netherlands, have clearly rejected the Constitution. Britain has declared it will not even hold a vote. It will only take a few more members rejecting the Constitution in one manner or another to pull the plug. Many European leaders are pulling their hair out. What seemed like such a certainty only a few years ago is now destined to be a footnote in history. It will take more than a few years to negotiate a new constitution and bring it back to the people for a vote. But that presents a problem. There was an interesting fact that emerged from the exit polling: the lower your income, the more likely you were to vote no. This vote was as much about a referendum on the European economy as it was about the Constitution. Especially in France, those who are against the Constitution argued that it would destroy the basis of French socialism and would mean the diminishing of state subsidies. France, voters were told, did not need a subject itself to Anglo-Saxon free- market economics. Oddly enough, Chirac argued that a yes vote would be a rejection of Anglo-Saxon free-market economics. About the only thing the two sides could agree on was that Anglo-Saxon free-market economics, whatever that means, is a bad thing. (How the Swiss Calvin and the Austrian von Mises became Anglo-Saxon is another story.) Martin Wolf recently noted in the Financial Times: "poor economic performance was or the principal reasons for the No votes. But in France the vote was also one against openness to market forces and in favor of onerous taxes and regulation. It was, therefore, a vote against political integration and economic flexibility... if the members of the euro zone -- above all, the big countries - - are unwilling to promote reform, their project may yet founder, however great the costs they would suffer. No currency union is likely to survive without either the economic or the political conditions of success. The struggle for constitutional treaty is over. The battle for a successful currency union has begun." Let's examine a few facts. The European economy is growing very slowly, probably not much more than 1% a year. Unemployment in Germany is 10% and is almost as high in the rest of much of Europe. France, Germany and Italy are all running significantly higher deficits than the original stabilization treaty authorized. It is clear they are intending to run even greater deficits in an effort to stimulate their economies. This is in spite of the protest of many of their European neighbors. The European Central Bank seems to be stuck in time. There is a clear demand by slow growth states for lower interest rates. Yet the ECB continues to worry about an inflation that doesn't seem to exist anywhere but in their theories. However, even if they did drop rates to Japanese levels, I wonder how much actual stimulation that would be. If a project is not profitable at 2% interest rates, would lower rates make that much a difference? It seemed to help in the United States, but that was because it stimulated a housing boom and refinancing of mortgages. US businesses were already on the road to recovery at 2% rates. It seems likely that there will be either a new center-right German government or a much weaker socialist government. Either case would not make it easy for a German government to feel comfortable in negotiating a new constitution. They will have enough problems getting the Germans to accept even modest social reforms without the added burden caused by a constitutional vote. The Italian Finance Minister recently suggested that Italy might be better off if they abandon the euro and went back to the lira. My belief is that this was simply a way to put pressure on the ECB to lower rates. Italy could not afford to bring back the lira. If they brought back the lira, all their debt would still be denominated in euros. One assumes the reason to bring back the lira would be so they could stimulate their economy, which would of course weaken the lira. This means they would have a great deal more trouble paying their debts and that would be a drag on the economy. The easy analogy is Asia in 1998 or Latin America in the 80s. Their debt was denominated in dollars but their (weakening) currencies did not allow for enough exchange to make their payments. The irony is that it is not the economically weak states that could afford to leave the European Economic Union, but the strong ones. Further, the New European countries have got to be having a gut check. Maybe they would be better off forming their own union and not having to deal with Old Europe. I bet the phones are hot and heavy discussing options. The political leaders of the various (Old) European countries are not blind. They recognize that serious economic and social reforms are required in order for Europe and its citizens to survive, let alone prosper. Up to now, they have been trying to get those reforms on the political cheap. They were hoping to foist reforms upon their citizens through the backdoor of a European Union, and then blame Brussels for the resulting problems. Now, politicians are going to be forced to do something that is against their nature: they're going to have to tell their citizens the stone cold truth. Quite simply, you can't fight demographics. Strikes against demographics have no effect. The European nations have promised hundreds of trillions of dollars in social benefits over the coming decades. They simply do not have the money. There are a very limited number of things they can do, none of them easy. They can cut the subsidies. They can raise taxes. They can promote aggressive immigration (but from where would be the issue). They can leave the currency union and inflate their way out of the debt problem, which of course would destroy their currency. As I have noted before, farm subsidies are dead in a few years. There will be vastly more retirees who want their checks than farmers. Politicians can count votes, if nothing else. Any mention of a cut in subsidies brings significant backlash in France, accompanied by strikes and riots. As I have outlined in prior letters, raising taxes to meet the cost will require roughly a doubling of the payroll tax, taking taxes to over two thirds of GDP. It is not much different in Germany or Italy. Of course that will only make the situation worse. Higher taxes at such a confiscatory level would be economically disastrous, resulting in lower tax revenues. Further, you would see a significant number of young Europeans voting with their feet, leaving even fewer workers to pay taxes. One meaning of the New Demographics is clear: in many countries the most precious resource will be young, educated, motivated workers. Europe will have to compete to hold their own, and a high tax environment will present a considerable disadvantage. Right now it does not look likely that we will see a European political union in the near future. Within five to 10 years, the reality of the pension problems in Europe will begin to create massive pressures in their societies. It is not altogether clear what will happen. The one thing that seems certain is that it will be chaotic and messy. Right now, central banks all over the world have to be reconsidering whether they want to own the Euro in any significant amount in their portfolios. Only a few years ago Europhiles were promoting the euro as the next world reserve currency. Now the question is whether it will survive. Let me be quite clear. I think it is in the best interest of the United States and of the world for there to be a European political union. I hope they can figure it out. I sincerely do. But given the potential chaos facing Europe, I no longer see the euro as something in which I want to invest. I hope that within a few years, I can write that the facts have again changed and it is time to invest in the euro. But right now, I think the best policy is caution. There are other currencies against which we can hedge our dollar exposure. Friends, Surf and Family Again, let me suggest you go to Amazon and get Wattenberg's book. It will make for great summer reading. Next week my good friend Chip Wood comes to town to watch his Atlanta Braves play the Texas Rangers. While I will show him a very good time, I hope the Rangers are not as hospitable. The next night we have a bunch of local hedge fund managers out for an evening of baseball, and then I jump on a plane with my youngest son to La Jolla to meet with clients and my partners at Altegris while Trey surfs, coming back on Saturday so I can be with all seven kids on Father's Day. I will hopefully get my letter done early so I can have my Friday off. I intend to write on US pension fund (both public and private) problems. No surprise, things are getting worse. While it is not as bad as the European problems, it has all the makings of another Savings and Loan crisis. This was a hard letter to write. There was just so much to say. A lot of thoughts got left on the cutting board. Thus, it is once again late and I need to hit the send button so the person in charge of sending you the letter at my publisher, Doug Harrison, can get to bed. Poor Doug often gets my letter between ten and midnight, and yet he always seems to get the letter on the website and out the door on Friday night/Saturday morning. That does indeed take some time. Sending a million-plus emails requires some work. Thank goodness all I have to do is write it. And thank you, Doug. I hope you enjoy your week. I know I will have a good one. And my family's European vacation this summer gets cheaper every week. Your 'wishing he had a better
solution' analyst, Jun 11, 2005 321gold Inc |
