Baby Boomers: It's All Your Fault

There is no shortage of scapegoats to finger in the credit boom and bust. Exotic derivatives, overcompensated executives, Alan Greenspan, the SEC, reckless borrowers -- all have worn the scarlet letter at one point or another. But the list has not yet been exhausted. Baby boomers, it's your turn.

The Baby Boom lasted from 1946 to 1964, and some 78 million American children were born during that time. As this cohort ages, its sheer size overshadows the rest of society. If you look at an "age pyramid" for the U.S. (shown below), the baby boomers are the metaphorical bulge in the python's throat.

As this bulge moves from bottom to top, it is having a dramatic impact on the economy. Indeed, the impact is so large that there are hedge fund managers that specialize in picking stocks that will benefit from boomers' buying habits ("Go long on denture manufacturers!").

The big question, of course, is what happens when boomers start to retire. The oldest of them became eligible for Social Security in 2008, and as we move forward in time, more and more of the bulge will switch from middle age -- when they're busy earning and spending -- to retirement, when they start to draw down on their savings. According to the "age wave theory," popularized by money manager Harry Dent in the late 1990s, when the boomers hit this transition point, the U.S. will enter a long bear market, as new retirees start tapping into their pension funds and 401(k)'s, selling their stocks and bonds to pay for their golden years.

Seen in this light, the credit boom and bust was almost an inevitable byproduct of demographics. As the boomers hit their peak spending and borrowing years in the late 1990s and 2000s, they splurged on second homes, SUVs, and went crazy on credit. At the same time, pension funds and retirement accounts peaked in size. There was more money than ever, since boomers had entered their final decade before retirement, and fund managers grew desperate to find attractive returns for the huge piles of cash they managed. Hence, when charming bank salesmen came bearing AAA-rated CDOs backed by subprime mortgages, it was an offer they couldn't refuse. The subsequent crash marked the turning point, after which the boomers will buckle down, try to rebuild their nest eggs in the final years before retirement, and soon thereafter start to draw down on the assets they've accumulated over a lifespan.

This is basically what happened to Japan, which experienced an enormous asset boom in the 1980s -- at one point the land around Tokyo's Imperial Palace was worth more than the entire state of California -- and then a crash in 1990. In the subsequent two decades, the country has grown very little or not at all. The investment managers at Sitka Pacific Capital chalk it up to the factors described above. In the company's most recent investor newsletter, they write:

What happened in Japan in the 1990s was a demographic shift into retirement, where a large portion of the population went from a lifestyle of earning, saving and spending to a lifestyle of not earning, living off assets and spending less. This resulted in less demand for investments like stocks, less demand for housing, and less demand for material 'things' -- and the prices of all these fell.

Today the Nikkei is about 75 percent below its 1989 high. Sitka thinks that the U.S. is "now starting a similar demographic shift into retirement, and that has coincided with what appears to be a peak in spending and debt." If they're right, the current bear market isn't a mere hiccup or even an indicator of a particularly nasty recession -- it's the start of a decades-long slide. (See Sitka advisor Mike Shedlock's blog for more background.)

Is the U.S. really at the same point? One piece of evidence suggests that it is: in 1990, near the start of Japan's woes, the median age was 37.4 years, meaning half the population was older than that. The U.S. today has a median age of 38 years. We're at roughly the same demographic place that Japan was at 20 years ago. Will we face the same future?