Stephen King: Who will pay for our retirement coach tours?

Countries that have too many obligations to foreigners can always choose to default
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The Independent Online

If the population of Cardiff is ageing more swiftly than the population of Birmingham, no one is going to complain too much. Cardiff's pensioners may exert a greater burden on the rest of the British population than Birmingham's pensioners, but we have a combination of the tax system, corporate pension schemes and individual savings plans that should alleviate some of the potential pressures. And, if all else fails, we should be able to come up with a national solution through the democratic process.

It's all a bit more complicated, however, if the population of Japan, for example, is ageing more quickly than the population of the US. And it gets even more complicated if the population of the US is ageing more quickly than the population of India. Assuming that retirement ages don't change a lot - admittedly a rather heroic assumption - differing rates of ageing imply that countries become dependent on each other in ways that go beyond - possibly subvert - the democratic process.

Countries are ageing at remarkably different rates. The figures show that Japan's population of working age is already shrinking at quite a pace - as is Italy's, and, on the cusp, the UK's and Germany's.

The US and China are also ageing, but at a slower rate. Their demographic profiles are surprisingly similar given their differing stages of economic development: they're both in the middle of the ageing "league table". Unlike other industrialised economies, the US has been helped out by a wave of Hispanic immigration over the past 15 years (Hispanics typically have more children than other ethnic groups in the US). Unlike other fast-developing economies, China has been rather hindered by the so-called one child policy (leading to the 4-2-1 rule, whereby one working person may eventually have to look after two parents and four grandparents). Meanwhile, there are plenty of countries with an abundance of young working potential: India, Saudi Arabia and Egypt spring to mind.

If you live in the rich and perhaps rather corpulent west, you might look upon these young workers as potential saviours. Those countries with ageing populations are fast running out of workers. Yet the expectations of the generation approaching retirement are high: so much so that a wealthy life of leisure in retirement is often seen as an inalienable human right. So the obvious solution is to invest abroad in countries where younger workers are in bountiful supply. Companies and investors are doing just that: capital flows around the world have increased enormously over the past decade or so. And this, in turn, means that westerners who hit retirement suddenly switch from being members of the domestic proletariat to being members of the international bourgeoisie.

These capital flows carry implications for balance of payments positions. Those countries that will run out of workers in just a few years' time - Japan, for example - should be looking to invest abroad. In balance of payments terms, that implies running a capital account deficit - with savings flowing to foreign climes where the younger workers live - and, therefore, a large current account surplus. Countries in the middle of the demographic league table - the US and China, let's say - should be running neither surpluses nor deficits. Countries that have unusually young populations should be encouraging inflows of capital - in other words, they should be running current account deficits.

Of course, the real world is always going to be a lot more complicated than this simple categorisation suggests. The biggest borrower globally - the US - is not the country with the youngest population but rather the country with the most profligate population. Emerging market economies - typically those with younger populations - for the most part tend to be lenders. In other words, they run current account surpluses. These surpluses are partly voluntary: emerging markets are terrified of a repeat performance of the 1997-98 Asian crisis, when access to global capital markets collapsed and, domestically, all hell broke loose. In part, though, these surpluses are involuntary: many short-sighted investors think that their money is a lot safer deposited in the US than in seemingly "higher risk" emerging markets.

The biggest savers, though, are precisely those countries that should be the biggest savers. You'll hear plenty of complaints about the size of the Japanese and German current account surpluses - "they're not buying enough American goods, no wonder we're in such big deficit" - but, given their collective "greying", they have no option other than to build up reserves of capital elsewhere in the world. This is their nest egg, the pool of savings that they can eventually live off when they're heading through Italy on their "renaissance experience" coach tours.

Or at least that's what they'd like to think. The problem with sending savings abroad is that you can never be too sure that you'll get your money back. This is not just a case of worrying about regime change (although the 1979 Iranian revolution, for example, left a lot of investors with their fingers burnt): instead, there is no process that will definitely safeguard the value of the foreign assets. There is no global system of fiscal safeguards. The rule of law varies from country to country. And countries that have too many obligations to foreigners can always choose to default.

These differences imply that today's savings are not guaranteed to exert a command over tomorrow's resources. Go back to the Japanese situation. Yes, it makes sense for the Japanese to invest abroad. But can the Japanese really be sure that they will eventually have access to the output of foreign workers when they shut up shop and settle down to a leisurely game of pachinko? Unfortunately, no.

The Japanese are building up plenty of assets abroad, but their particular predilection is for US fixed income instruments, notably Treasuries. Of course, 10-year Treasuries offer a yield at the moment of around 4 per cent, a lot higher than the paltry 1.5 per cent yield on Japanese government bonds (JGBs). So there's nothing obviously irrational about Japan's acquisition of US Treasuries.

There is, though, a problem. Japan's acquisition of US government paper implies that Japan is building up claims on America's future economic output or, more precisely, claims on America's future taxpayers. This is no more than an international version of continental Europe's pay-as-you-go pension systems that are often regarded as giant Ponzi schemes. And for Japan and America, the moment of truth is likely to emerge in 10 or 20 years' time. By then, the US population will also be greying but, at the same time, discovering that its workers have an obligation not only to feed its own pensioners but, in addition, to feed Mr and Mrs Yamamoto who are still enjoying their years of dotage. It's the Chinese 4-2-1 story on an international scale.

Who will be able to exert the stronger claim on limited American resources? Luckily for older Americans, they're part of the American democratic process and will be able to exert their influence. Unluckily for the Japanese, they're not. So how would America be able to shrink its overseas obligations? The answer is simple. The dollar will have to come down a very long way. A dollar decline would, at a stroke, reduce the value of Japan's US-held savings in yen terms. For the Japanese, this would feel like a default. For the Americans, it would be an escape from demographic bondage. For the rest of us, it would look like theft on a grand scale.

International capital flows make a lot of sense. But the internationalisation of capital flows to deal with demographic challenges alone is not guaranteed to be successful. Ageing populations tend to make excessive claims on only limited output and this is no less true on the international scale than on the national scale. The people of Cardiff might be happy to invest in Birmingham's economy, but they might not be any better off were they to choose Birmingham, Alabama, than Birmingham, England, even if it's not greying at the same rate.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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