“If you know the way broadly, you will see it in everything.”
Miyamoto Musashi
As our national debt continues to balloon, now growing at a clip of about a trillion dollars every 100 days, we find ourselves standing on the threshold. The challenge of dealing with the gigantic baby-boom generation is upon us.
As we all know, there was an enormous surge in births across the Western world after the second World War. By 1964, individuals born after the war accounted for 41% of the total population. The Baby-Boom Generation, large enough to exert its own political and economic gravitational forces, was formed.
The impact of baby-boomers’ needs on investing is difficult to overstate. Just think about what your parents were doing during certain decades. Best stock of the 1950’s? Wham-O. (Think Hula Hoop.) Fastest growing industry of the 1960’s? Private education. Best stocks of the 1970’s? Auto makers and home builders. 1980’s? Banks.
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These baby-boomers have lived a pretty charmed life. As young people, they enjoyed rock ‘n’ roll, recreational drug use, free love, single breadwinner families and the increased availability of higher education. (In contrast, today’s youth have a Drake v. Kendrick Lamar feud, fentanyl-laced everything, herpes, two breadwinner families that have 25% less disposable income than the households they grew up in, and enormously overpriced colleges.) Perhaps more significantly, boomers have easily topped previous generations in income earned at every stage of life; American baby boomers today make up 20% of the country’s population but own 52% of its net wealth.
The sheer heft of the generation created a demographic dividend in the form of an increased labor supply. Based on demographics alone, that would have already been significant, but it was made even more profound by a surge in the number of working women. This manufactured social change contributed to smaller households populated by more earners and fewer children.
However, these gains were generational one-offs, and we’ve known it all along. Baby-boomer retirements will reverse the surge in labor-force participants, and at this point, boomers’ offspring can’t really benefit from more women working. (Maybe Joe Biden is importing illegal immigrants in order to offset that?) As for changes in higher education, it seems entirely possible that we could raise educational levels when we consider the petulant anti-Semitic children currently on parade at places like Columbia and Harvard who could so clearly benefit from an upgrade in their world history lessons, but the fact is that it’s harder and more expensive to improve the lot of disadvantaged students than to establish a university degree as the norm for good ones, which is what our country did after WWII.
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What’s most perplexing to the Generation Xers, Yers and Millenials who I talk to is that the baby-boom generation seems to be able to leverage its size into policies that are favorable to them but awful for the rest of us. Erick Eschker, an economist at Humboldt State University, reckons that each American born in 1945 can expect nearly $2.2 million in lifetime net transfers from the state— more than any previous demographic cohort-- apparently while expecting their children to pay for it.
A study by the International Monetary Fund (IMF) in 2011 compared the tax bills of a generation’s members over their lifetimes with the value of the benefits that they are forecast to receive, and it should come as no surprise that their data shows that boomers are leaving us all a huge bill. Those aged 65 in 2010 may receive $333 billion more in benefits than they pay in taxes, an obligation a full 17X larger than that likely to be left by today’s 25 year olds.
Unfortunately, the math doesn’t leave a lot of options for getting out of this mess. Faster economic growth would certainly help, but the debt left by boomers adds to the drag of already slowing labor-force growth. It has been estimated that public debt above 90% of GDP reduces average growth rates by more than 1%. Meanwhile, we’ve experienced falling levels of public investment in America over the course of baby-boomers’ adult lives-- annual spending on infrastructure as a share of GDP dropped from more than 3% in the early 1960s to just 0.5% in 2021.
Austerity is another option, but it would have to be severe. The IMF estimates that fixing America’s fiscal imbalance would require a 35% cut in all transfer payments and a 35% rise in all taxes— neither of these things will ever happen. Fiscal imbalances rise with the share of population over 65 and also with partisan gridlock, which is bad news for America because the over-65 share of the voting-age population will rise from 17% now to 26% in 2030.
A third possibility is inflation. Post-war inflation helped shrink America’s debt:GDP ratio by 35%. The Penn Wharton Budget Model projects that permanently increasing the current 2 percent annual inflation target to 3% would reduce the real obligation of current federal debt by 7% over 30 years.
The generational divide makes the inflation option a hard sell. Younger workers are typically debtors and benefit from inflation reducing real interest rates, yet retirees with large savings dislike inflation for the very same reason. A 2018 paper by the Federal Reserve Bank of St Louis suggests that as a country ages, its tolerance for inflation decreases, and the authors even posit that a central bank could use inflation to achieve some generational redistribution.
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Here at RG, we believe that the long-term trend will be for higher interest rates and inflation to remain prevalent as boomers continue to retire. A growing number of wealthy boomers will demand goods and services from a shrinking pool of workers, leading to wage inflation. And as boomers shift from accumulating wealth to spending it, the global balance between savings and investment will shift, leading to higher interest rates. …Because boomers historically get what they want.
In equities, we believe higher rates call for more idiosyncratic positioning and less reliance on macro inputs to generate alpha. In fixed income, we suspect current levels represent a timely opportunity to relinquish tactical overweights to cash equivalents in favor of more neutral duration allocations.
While higher interest rates near-term would apply pressure to many banks’ reserves-- implying that the trend to higher rates and inflation could move in fits and starts due to the regulatory environment-- we believe equity and bond investors should be generally prepared for a higher rate world.
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Here’s an intergenerational performance from last week’s Bottle Rock Festival in Napa:
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