Merryn Somerset Webb talks to Paul Hodges about how the current wave of refugees could be the answer to Britain’s demographic time bomb.
• To listen to the audio only, click here.
• If you missed any of Merryn’s past interviews, you can see them all here.
Merryn: Hi, I’m Merryn Somerset Webb, editor-in-chief of MoneyWeek magazine, and I’m here today with Paul Hodges. A lot of you watched my previous interview with Paul, so we’re just going to update a bit on that. Paul is the author of the PH report and also the chairman of International eChem. Now, Paul, things have been going your way. Last time we met we talked about the slowing of China’s economy and we wondered when other people would begin to notice that China wasn’t growing at the speed it was before now. I think they’ve noticed.
Paul: They seem to have woken up, don’t they, in the last year or so.
Merryn: And so, has anything changed to bring that to people’s attention? Anything changed in the Chinese economy, or is this just a manifestation of what we were talking about before?
Paul: I think when we first talked, what we were discussing was this great unwinding of policymaker stimulus, and if you go back to the post 2008 period what you saw was that all the major economies were doing stimulus in one way or another. And so that was mutually reinforcing. Now, of course in the west and in Japan central banks are still doing stimulus, but once one major government starts to go in the other direction the weakest chain, if you like, in that stimulus programme starts to unwind.
Merryn: OK, so is this possibly connected to a rise in US rates, which would signal perhaps the beginning of the end of stimulus?
If you go back to 2007, every dollar of lending gave you about 83 cents of GDP growth. You are destroying value, but you can probably live with it. By 2013 that dollar is only getting you 17 cents of GDP growth
Paul: Well, you can’t ignore the concept of them rising, but I think what one has to do is look more at the fundamentals of what’s happening in China’s economy. If you go back to 2007, for example, every dollar of lending gave you about 83 cents of GDP growth. So, not great. You are destroying value, but, you know, you can probably live with it. By 2013 that dollar is only getting you 17 cents of GDP growth.
Merryn: OK, so that’s very intense value destruction.
Paul: Very intense. And you can do a chart like that, and you can say, if you carry on, this isn’t going to work. Secondly – and I think people are starting to pay attention to this as well now – if you look at China’s foreign reserves, they have peaked. So what you’ve got… we’ve had 400 billion taken out of them. That’s only 10%, if you like, but 10% is 10%, and more importantly what it is, is it’s unwinding the system. If you’ve got an asset bubble, which is what we’ve seen created by the stimulus programmes, you have to keep blowing more air into the balloon. Once somebody, somewhere starts to say, “no, I want to take air out of the balloon”, which is China, then of course the whole thing starts to ricochet around. So, that’s why I think a year later people are now becoming much more focused on this. And the other thing which I’m sure we need to talk about a bit is the commodities position, because this is where it’s really starting to connect across to the rest of the world.
Merryn: OK, so it’s the fall off and demand for commodities from China that’s really sending the domino effect around the world. What you call the ring of fire, right?
Paul: Exactly, and if you look at it this is the third great bubble of our lifetimes, if you like. We had the dotcom bubble, which you can kind of say was an accident that the central banks were very worried that the computers wouldn’t recognise the year 2000 when we switched from 1999 to 2000, so they pumped money into the system in order to make sure everything was okay.
Merryn: Which was a perfectly reasonable idea maybe.
Paul: Exactly. You know, that was an insurance policy, but it obviously did push Nasdaq up to 5,000 and then of course Nasdaq fell 80%. So, it was a kind of warning really. We shouldn’t do this again. Probably a good idea to have done it, but not…
Merryn: And one that went entirely unheeded.
Paul: Well, the wrong message was taken, so you went into the subprime bubble, and the subprime bubble took us to near collapse of the Western financial system, which was really not a very good idea altogether. But it was exactly the same principle of pumping up… well, we had Eddie George, you know, telling the House of Commons select committee in I think it was 2007 that when he’d been Bank of England governor, he felt he had no choice but to pump up property prices because otherwise we would’ve had a recession. Excuse me, is the job of a central bank to prevent recessions? I hadn’t thought that was their job, but that was where we were.
Now we have the third bubble, which has really all been focused on the idea that suddenly China and India have become middle-class by Western standards and therefore their demand for commodities – oil, copper, you know, iron ore – is going to rise exponentially forever. And the bursting of that myth is the critical one, because where has all the money come from to finance those expansions? It’s come from the West. So, we’ve put an awful lot of money in – in the States for example $1.2trn has gone into oil and shale gas exploration – probably most of it will be wasted, because we don’t need it. You look at mining, poor Glencore, major problems now. $18bn of inventory sitting there now, which it now says it’s going to start to unload.
So, these are the fault lines, if you like, which are starting to open between the realisation China is not going to be the growth engine for the next 25 years that we all thought it was going to be, and so instead we now start to wake up in the morning and we have a bit of a hangover.
Merryn: And without China as growth engine, there isn’t really another one, is there?
Paul: Well, no, because now we come back to demographics and we have the ageing of the Western populations here in the UK and right across the Western world we’ve been failing to replace our population since 1970. So, for 45 years women have not been having 2.1 children, as it were.
Merryn: I know. Guilty! Guilty!
Paul: My wife is the same. So, the problem with that of course is that now we don’t have that flood of people in the prime-spending, wealth-creation age of 25 to 50, 25 to 54.
Merryn: Now, I want to come back to demographics in a tick, but before that I want to go back to commodities. Are we now expecting a wave of bankruptcies, or… what are we expecting the result to be from here of the commodity collapse?
Paul: Well, if we look at history what we see is that the bubbles get one or two companies who become the flagship. So, if you go back to the dotcom it was Enron and Worldcom. You know, and I remember a famous interview with Bernie Ebbers at Worldcom when somebody said to him perceptively, but you’re not making any money. And he said, don’t worry about that, look at the share price. Well… and then of course we got to the subprime crash and Lehman Brothers and AIG were the flagship. So, I think one’s got to be pretty wary about the financial health of some of the companies that have led this.
And of course the other side of this is we have to look at the emerging market’s banking systems, because a lot of the finance for the commodity expansions and for the property that bubbles in China and so on, has come from the West. It’s not been local money. This is where the Fed unfortunately has had a role to play, because by driving down interest rates it’s forced asset managers to take on risks in foreign markets about which they know very little. But they say, look, I can’t possibly take in money from people and take in a fee if I’m just putting it in a bank account at 0%.
Merryn: You’ve got to go out and find somewhere to put it.
Whenever I talk to asset managers and fund managers, this is what they say, we feel trapped by the Fed and the central banks. We have to go and do these things even though in our heart of hearts that we shouldn’t be doing it
Paul: I’ve got to go, and I don’t know much about China. I know that. And I know it’s probably not transparent, but everybody else is doing it so I’d better do it too. And you see this pattern. Whenever I talk to asset managers and fund managers, this is what they say, we feel trapped by the Fed and the central banks. We have to go and do these things even though in our heart of hearts that we shouldn’t be doing it.
Merryn: Interesting, but when we talked the other day, you and I, you said you were beginning to feel a little bullish on the Chinese stock market.
Paul: I don’t think bullish on the stock market. I’m feeling bullish on China’s economy, yes. I’ve never really taken much notice of the stock market, I have to say.
Merryn: But the economy, you feel they may manage this transition?
Paul: Well, you see what I think is happening in China is potentially something very positive, because I don’t like bubbles and I do like people who actually want to improve the general living standards of the people, and so I am so far – maybe naively – I am very impressed still with President Xi. I think that he grasped this nettle immediately when he came in in March 2013, his “new normal” policies came through and he did what the two previous great presidents in China post-Mao history did, Deng Xiaoping and Jiang Zemin, he brought in the World Bank and he said, look, we are in trouble, everybody can see we are in trouble, please help us to guide a route map through. And so they developed this China 2030 policy, which is a very detailed policy and what it says is, we’re not going to do more stimulus and we’re not going to do more, sort of, wealth effects of that kind, but what we are going to do is long-term development where average incomes in the rural areas – which is half of China – are around $1,500 a year.
Now, if you can increase those by 10% or 15%, you’re doing a great thing. You’re creating… I’ve got a friend in the chemical industry who is selling products into the bedding industry. Now, everybody is telling us that China is doing very badly indeed and it clearly is, but if you are getting a wage rise of $5 or $10 a month, which is what’s happening, one of the first things you’ll spend your money on is actually by having a good night’s sleep. And so his sales are actually up 12% this year.
Merryn: Interesting. So, we’re seeing this huge fall off in sales of luxury good in China, but a rise in base level goods.
Paul: Yes, and you can see this being played across other areas. I really wouldn’t want to be selling new cars in China, or supplying new cars in China for all sorts of reasons, but what you can see is that the used car market is now poised for take-off. Just to give you one number, last year sales of used cars were only half the number of new cars sold. So, used cars are half… normally in the UK you have three times the volume of used cars.
Merryn: Well, that’s because you have the legacy of used cars on the roads, apart from anything else.
Paul: That’s right, you see. And so China never had that, because, a, China in 2000 hardly had any cars… the official statistics say they only had 16 million cars in 2000. So, you know, and they were Chinese made and unfortunately they more or less fell apart.
I’m actually getting quite optimistic about the medium to long-term future for China, because you can see that these positive long-term developments are now starting to take place
Merryn: No second-hand market in those then.
Paul: Exactly, it was a good replacement market. But, you know, the average age of a car on the road was two or three years. Now, China is not going to move up to US standards of 11 and a half years overnight, but it’s already moving up to four or five years because a lot of manufacturers have gone in, improved quality and so on. So, the real money in the car market in China in the next four to five years is going to be made in servicing the older cars, in buying and selling new cars and of course doing it on the internet.
I mean, Tencent, for example, you know a very savvy wealth fund, have led a $100m investment into an online used car company, which is going to have a mix of online and offline, guarantee the quality… this is very important in China. We don’t know, you and I, if we’re buying a used car if it’s a lemon or not. But if the manufacturers come in and guarantee the quality, which is what they do here and what they’re now doing in China, well then we buy with confidence. So, you can see that these… this is why I’m saying I think that I’m actually getting quite optimistic about the medium to long-term future for China, because you can see that these positive long-term developments are now starting to take place. I’m always negative when people say, China’s doing better, house prices have gone up 20%. That’s not doing well to me. That’s not improving the average income and therefore the average development process.
Merryn: OK, so you won’t be pleased with the way house prices are going up in the UK now either?
Paul: Well, I liked your chart, I have to say, at the conference that showed that all the house prices in the UK apart from London and Brighton had actually fallen in real terms over the last ten years.
Merryn: Absolutely. People keep saying, you predicted a housing crash and it never came, and I’m tearing my hair out saying, yes, it did, it did.
Chinese people who take an option on a London apartment as a flutter on currency and on the property market are now withdrawing very fast indeed
Paul: Indeed, and you look at the influence of Chinese and foreign buyers in the London market, for example, and one of the things that we know is happening and people have reported this quite widely is that Chinese people who take an option on an apartment basically as a flutter on currency and on the property market are now withdrawing very fast indeed.
Merryn: From all the new-build blocks around London we’re seeing people pulling out from flats that they’ve paid a deposit on but never actually taken possession of.
Paul: That’s right. You know, I think you said some time ago, 54,000 apartments which are supposed to be selling at over £1m in the next few years…
Merryn: Who’s going to buy them?
Paul: Exactly. This doesn’t fill me with joy, of course. I mean, I’d much rather we hadn’t got into this situation, but, you know, I thought your point last week about the change in attitude among the population to say, look, there would really be positive benefits from having lower house prices. Is it right that our children cannot possibly afford to buy even a one bedroom flat in London? If they want to work there, it’s costing them £300,000 or something.
Merryn: At least. You can’t get a one bedroom flat for £300,000 in central London anymore.
Immigration is a very positive thing. But we’re seeing it as a problem.
Paul: Well, you can in certain parts. I have a close eye on this through my sons, but probably not in places that are very attractive.
Merryn: Maybe not. Speaking of your sons, let’s go back to demographics. One of the interesting things about the refugee crisis at the moment, leaving aside all the general misery, is the arrival of a very large group of educated migrants into central Europe and particularly into Germany, and we’ve talked before about the demographic problems in Germany where certainly they’re not replacing their population. So, as I say, general misery aside this could actually be a great long-term boost for the European economy.
Paul: Well, yes, this is one of the windfalls that comes along. Here in the UK, you know, we’ve had waves of immigration like this. After the war, from the West Indies, from Cyprus, from Hungary, Czechoslovakia. So, there’s been a long-term… and of course Asians from Uganda, and so on. This has all been very positive, because you are bringing in more people, and particularly as far as one can see with these poor Syrians you’re bringing in people who are relatively well-educated. OK, they’re going to have to learn the language, they’re going to have to learn a different way of living, and so on, and they’re clearly going to be very homesick from where fled, for Syria, understandably. But this is a very positive thing. Now, the problem is we’re not seeing it that way, we’re seeing it as a problem. We’re trying to put up walls and we’re forgetting the basic problem, and I think…
Merryn: I suppose the UK doesn’t have quite the same demographic problem as Germany. I mean, our population is still growing at a reasonable speed.
Paul: It’s not as extreme as Germany. I mean, Germany and Italy are like Japan, they’ve got a median age of 46, 47. You know, we’re a bit less than that, but we’re not in the clear. I mean, our birth statistics, for example, are still in decline. So, we’ve had the numbers for 2014 now and they were a bit below 780,000. Now, you compare that with the baby boom and you were averaging 900,000. So, you’re a long way down and let’s face it this has been going on now for 45 years. So, you’ve got a medium-term problem here, and I suppose that what’s happening really is that the idea of quantitative easing has neglected this demographic shift.
You know, you and I have talked about this in the past, but I looked in vain at Jackson Hole, in the meeting of the world central bankers and so on in August, I looked in vain for references to demographics and there were almost none. They are still stuck on the idea that there is an average person in the economy and if you just get the tax and spending policies right for that average person, everything will be all right. And they haven’t caught up with what the biologists would tell us, which is the concept of competing populations. Modern biology – which is moving ahead in leaps and bounds, as we know – has taken on board now the concept that animals of different species actually compete with each other and that is how we get, through Darwin and everything else, the survival of the fittest.
Now, if you like it’s understandable that the central banks got this wrong in the 1970s and 1980s, because pretty clearly the UK population, like the UK, was homogenous. It was white, male and female, not so many women working, in a certain age-group, earning certain amounts of money and all having children. So, if you pushed interest rates up for a bit, you stopped having larger houses and then the kids have grown up so then after that you had to get your larger house and your new car and so on. But that pattern doesn’t exist anymore. One fact which really seems to have been completely ignored in this whole debate now, is that we have more households headed by someone over 50 in the UK than headed by under 50. And we know, because the data is there, that spending peaks in that 25 to 50 age group.
Merryn: So, these households behave differently, they react differently to interest rate changes than in the past.
Merryn: So there’s… I mean, I was discussing this with Richard Thaler who I interviewed the other day, and we were talking about how extraordinary it is that macroeconomic policy doesn’t take any behavioural economics into account at all. You know, there’s been a big shift in finance to looking at behavioural issues etc, but when it comes to macroeconomic policy, we’re just not looking at it at all, and this feeds into that very idea, right?
Paul: Exactly, yes.
Merryn: These households don’t behave in the way that old fashioned economic models tell us that households will behave, because they’re older.
Paul: Yes, I mean, you’re looking at a world now where the population over 50… I mean, there are some government numbers that came out recently that said, between now and 2022 – which is only seven years – 3.7 million people are going to go into the 50 to 65 age group and we’re going to lose 0.7 million from the younger age group who contribute to wealth and so on, because their incomes are rising as they move up in their jobs and so on. And very clearly, if you are 65 and if you are on a pension, a) you haven’t got the money to spend when you were young, and, b) you don’t need to because you’ve already got most of what you need. You may well, if you’ve got good health and so on, do some foreign trips and so on, and it may therefore appear that you’ve got money, but actually you’re not paying the mortgage, you’re not paying the school fees, you’re not paying the food bills.
Merryn: And also, behaviourally, very low interests don’t stimulate you to feel wealthy and to spend money, they stimulate you to be frightened that you won’t be able to maintain your income through the next 20 to 30 years. So, they could make you spend significantly less rather than significantly more as they’re supposed to.
Paul: Anybody who reads the papers and looks at the problems of pension fund deficits, where you’ve got a number of large companies whose market capitalisation is actually less than their pension fund deficit, you would look at that and you’d say, well, I just think I might keep the money in the bank for the moment, just in case.
Merryn: Yes, because I might not get that money.
Paul: Yes. You know, how likely is it… because what we really need the central banks now to do, and the Bank of England in particularly, I would just love Mark Carney, Andy Haldane and these very bright people at the bank to say, look, let’s have an open session for a day and let’s talk about this idea that demographics could have an influence on the economy. It’s not something we understand at the moment, but, look, there are a lot of people talking about it and it’s worth spending some time just examining it. Because I think this is the key now, because this is why we’re not seeing the refugee crisis in the right way from an economic point of view, because we think, well, all we ever have to do is print more money.
Merryn: Print money, play with interest rates.
Paul: We forget that it’s actually all about people. There is no economy without people.
Merryn: OK, last question then. If you were in charge of the world – and maybe you should be – would you just open the borders?
Paul: No, I wouldn’t open borders, no. But what I would do is… this policy or this situation has been building for quite some time, and what we know from all sorts of history is that a quick gut reaction to a long-term problem, you generally do the wrong thing. So, what we’d need to do is we’d actually need somebody… this is where political leadership is required… we need somebody to come through with a thought-through strategy. How many immigrants should we now be taking? What is our policy to refugees? What is our policy to migrants? But refugees, probably one would say… I would certainly say, refugees, yes, we must have them because this is awful for them.
Migrants, they’re a different category, but not necessarily should we say, well, they’re bad news, and we certainly shouldn’t have policy dictated by fear, which is where we are today. This is my whole problem, that we are closing borders… it’s like the problem of Schengen if you like. If we close borders, then young people who on the one hand with social media have no frontiers at all, will now if we’re not careful will find themselves having to go back to the Post Office if they want to go abroad, with their passport and say, please, sir, can you give me £50 of currency, which is where we were until 1979. It’s lasted a very long time, and I don’t want that restriction of frontiers. You see, these are the things that need to be wrapped up into a strategy. Just taking a one-off decision, I think is…
Merryn: It’s not enough.
Paul: You might get it right, but chances are you actually would miss some of the critical issues.
Merryn: OK, but in a nutshell your point is that we’re looking at all this as a threat, when Europe should be seeing it as an enormous opportunity.
Paul: A) it’s an enormous opportunity, and, b) we have to do something for these poor people. It’s not their fault that this has happened to them, and, you know, whether we’re Christian or not this reaches out to our hearts and we must do something.
Merryn: Paul, thank you very much.
Paul: Thank you, Merryn.