European Demographic Time Bomb

Another old post from 2006 - I have to admit this is a pretty darn good call re: the Republican party. The party has imploded since 2006 and immigration helped split the party in two (admittedly the economy was the bigger issue in 2008).

This week's commentary comes to you on a night that I should be finishingmy tax return. It reminds me a little bit of college when I would use anyexcuse to procrastinate from finishing one of my papers or study for an exam. I've always done my best work late at night – that is how I always justified wasting time.

Last week's political work aroused some emotional responses. I really doappreciate people writing me back even if they don't agree with my views andwant to tell me about it. A couple things I want to clarify from lastweek's article:

1) Last week's article was supposed to be about the rift in theRepublican party – with immigration just being the tipping point, not thewhole point of the article. I wanted to emphasize that the old GOPbusiness wing really messed up when they went to bed with the Christian right back in the 70s. It is now going to blow up in their face.

2) Since the article – and certainly the responses that I got – turned outto be about immigration, I would like to emphasize that I do not believethat people should just ignore the problem of illegal immigration (althoughthat is still better than mass deportation), I certainly hope that I didn'timply that I did. I simply would like to see legal immigration expanded to the point that only criminals and terrorists would not be allowed in.

3) I should have taken care to be more balanced in my commentary andincluded more of the "other" side of the argument. The financial andsocial strain that is placed on the host community – especially whereillegals are large in numbers. While these costs are real and need to beaddressed – regardless of how new legislation progresses – the pale incomparison to the benefits to American society and the economy as a whole.This is not even close – especially when you consider that our whole entitlement system (primarily Social Security and Medicare) will collapsewithout huge numbers of young immigrant families.

Ok, enough about last week and on to this week.

*EUROPEAN DEMOGRAPHIC TIME BOMB*

My wife and I have visited various parts of Europe three times over thepast 4 years and have each time asked each other the questions: "Where are all the kids?" (by the way, this excludes London where you see babystrollers everywhere).

It's almost as if sometime in the 1970s and 1980s, that European couples have simply decided to stop having children en masse. The numbers area stounding, here are the statistics from the CIA World Factbook.

*European Union*<http://www.cia.gov/cia/publications/factbook/geos/ee.html>
1.47 July 2005 est.

And European Union (EU) 25 members make up 14 of the bottom 25 countries andthe EU average places it in the bottom 15 of non-EU countries. Outside of Japan, South Korea and the Northern Mariana Islands, all of lowest reproductive countries are European, if not in the EU.

It is common sense that for a country's population to remain stable, the number of children per woman needs to be at least 2.0 (the actual numberis around 2.2 dependent on various other societal factors). So the EU average of 1.47 and countries with numbers around 1.2 is nowhere near thenumber to maintain 0% population growth (without significant immigration flows) over the medium-to-longer term. But even the numbers above aremasked by the fact that immigrant families still average 3-5 children which brings the overall national figures higher than they would otherwise be(more on this later).

By the way, the U.S. figures are somwhat better (2.08) but remain below thecrucial 2.2 mark – despite the influx of immigrant families with larger numbers of children. Slower immigration would bring eventually bring thenumbers down to more European-type levels.

So what is causing this phenomenon and what are the implications of thistrend if it is not reversed in the immediate-term (once the median womanhits the age of 45 or so, the trend becomes virtually irreversible – at the current time, the median age per woman is around 40 years old).
*Reasons*

In my years of exploration and research around this topic, I have put together the following list of reasons for the current European Baby Bust(by no means do I think this list is comprehensive, if anyone has different or better ideas – I would love to hear them):

1) Taxes are too high/wages are too low – the argument that it is simply too expensive and not economically possible for the average European couple to bear the expense of raising multiple children.

There is some merit to this theory as the European families that live here in Cayman – where there are no direct taxes – seem to be having plenty of babies.

2) Young Europeans are simply too selfish and don't want the commitment of marriage and the burden of families.

3) Years of warning about the threat of world overpopulation finally sunk in and changed societal behavior. My father told me that in the 60sand the 70s, people were warned about the dangers of overpopulation and theEarth's ability to maintain such population growth.

4) The problem of the "Mama's Boys", don't laugh – this is actually a big problem in Italy (less so in other parts of Europe – but not nonexistent), many men simply refuse to leave their parents' home. Theylike the lifestyle of being pampered by their mother's and do not want to go it alone – or even with a wife who may not be as pampering as Mommy. Even worse, many of these men don't even work full-time and live off the pensions of their parents.

My personal theory is a longer term view which deals with two broad changes in society over the past 50-100 years. The rise of pension plans and a shift away from an agrarian workforce. This is another topic I would eventually like to more fully explore, perhaps as a PhD thesis. But in a nutshell it goes like this, the main reason that people had largefamilies in past generations is that (1) children/relatives represented your pension plan and medical care – if you didn't have enough children to support you in your old age, you simply died once you were too old to work or if you got sick. (2) Agrarian society requires large amounts of labor to work the fields, etc. As people were much less mobile and could not import labor from other areas, you had to have children for the system to work.

This also helps explains why the former communist countries, many of which remain poor, have the lowest birthrates. The governments in those countries provided for 100% of retirement needs. I know there is more to it than just this, so given time and resources I think I could put together a more complete theory for this trend.

*Implications*

Most people will think this is another doom and gloom prediction, but my honest opinion is that this demographic crisis equals the threats from communism and fascism as the biggest threat to face Europe since the Plague from the 1300s. The populations of many European countries are projected to decline by 25% over the next 50 years. In some regions, the numbers look even worse.

The most recent forecasts that I have seen predict that Germany's population could fall from around 82 million to around 65 million by 2030 and to under 60 million by 2050. On a more local scale, the population of Sicily is projected to fall from the current level of 5 million to 3 million by 2030 – some of this due to migration as well, another by-product of population shrinkage due to the reduction of economic opportunities in hard hit areas.

As I said earlier, the numbers above do not reflect the whole story. The population numbers would look worse if not for the large numbers of immigrants currently flowing into Europe, mainly from North Africa and the Middle East. In addition, these immigrant groups are having a greatly disproportionate number of the children being born in Europe.

In some countries, by 2030 the Arab and Muslim population of the younger age segments (ages 30 and under) will outnumber people of European descent. I don't want this to come off as anti-Arab or anti-Muslim in any way, shape or form. The problem is NOT where these people are from, but how they fit into their new countries. In Europe, unlike the U.S. and Canada, immigrant communities have not – in the past - been well-integrated into society.

While in North America, the children and most-definitely the grand-children of immigrants are considered to be fully American or Canadian. People of different backgrounds are rarely ever accepted as fully German or Italian, for example. This is not to blame only the host countries, resistance from the immigrant communities themselves have played a large factor in this. I will say that this is changing (at least among younger people in the larger cities) but it will be a while before this change is complete.
Therefore, you end up with a situation where large, and growing, segments of the community feel as though they are second-class citizens. You do not have to look any further than the recent riots in France and the murder of filmmaker Theo Van Gough in the Netherlands as examples of this. Even in Britain, which has been the most successful European country in assimilating immigrants, there were riots from South Asian youths a few years back.

The implications of this growing problem are many and are very serious, both from a political and economic standpoint. I will get more specific in later paragraphs.

Economic Implications

European countries tend to have very generous pension, health care and welfare states. Most Europeans are very proud of these programs as they contrast them with the less civilized "Anglo-Saxon (meaning the U.S. and Britain) economic model".

Well, this is just common sense, but with a declining population base and less children to work, I have one question: Who is going to pay for these programs in the future? You need young workers if you want to have a pension plan, there is just no other way. The Europeans use mainly pay-as-you-go financing for their entitlement programs – just like in the U.S. (think of Social Security). This is nothing more than a fancy name for a Ponzi scheme – except that instead of needing new investors to pump in capital, new workers are needed to pay in contributions.

In fact, I recently read The Kok Report, which warned that by mid-century the ratio of pensioners to active workers will double. Broadly speaking, that means the burden on the working population of supporting those who have retired will also double. And here is where the problem of increasing numbers of disenfranchised immigrants comes in.
*[Just to reiterate, I am using the term "immigrants" as a generic term for people of non-European heritage living in Europe – even as some families have now been their for 2 or 3 generations. I do this partially to drive home my earlier point that many Europeans do not, and probably, will not see these people as European.]*

Will these young immigrant workers (whatever their ethnic background) be willing to shoulder massive tax burdens to pay for pension and health care benefits for aging Europeans – particularly the same people who made their families them feel like second class citizens? I don't know the answer – but I wouldn't want to have my future financial health be dependent on an affirmative answer to that question.

As any attempts to reform these programs are met with fierce resistance, like massive strikes and changes in government, I don't see any resolve for making the painful choices needed to save these programs. Just look at the reaction in France (as mentioned earlier) to a relatively minor change in labor law, where employers will be able to more easily fire young workers in their first two years of employment – five massive strikes and countless protests. Do you really think that there is the political will necessary to make the severe and painful restructuring of the massive entitlement programs?

This is going to be a disaster and it will bankrupt most of the governments of the E.U. successively. Non-E.U. member Norway and Switzerland are in better shape. I could actually write a whole commentary on the responsible behavior of the Norwegian government (they use their oil proceeds to set up a massive public trust – for use in a rainy day, or to pay for their pensioners in the coming decades).

There are other economic problems that will be caused by the plunging birthrate. Declining spending, increased health-care costs (whether funded by the government or individuals), labor shortages and declining tax base, political radicalization (see below) among many, many others. When you add up these problems, it is not going to be an enticing situation for the young entrepreneurs and other talented young people. Therefore, you can expect a brain-drain on top of all the other problems as many young people will move to countries where they have better opportunities awaiting them.
Keeping this brief and simplistic, the economic consequences of this trend will be devastating. This, in turn, will fuel political discourse which could boil over into something worse.

Political implications

As this has already been a long newsletter, I will keep this part short and ugly. My view is that the political spectrum of Europe is going to get much more radical than it has been in recent decades.

You will see radical parties on both the right (probably anti-immigration type platforms) and the left (anti-globalization and anti-American). Both will try to blame others for their country's ills. Be it immigrants, E.U. beaurocrats, the United States, Britain (just for old times sake), the rich capitalists, China and other Asian countries, or some combination of all.

This movement has already started in countries such as Austria, the Netherlands, and even a bit in France (where an extreme right-wing candidate finished second in the last Presidential election).

Summary

An economic meltdown, and the loss of the cherished, but no longer practical, welfare state would not help the situation and may possibly be a tipping point towards right and left-wing movements. A return to radical politics in Europe would be a destabilizing force globally – both economically and politically. I don't mean to continuously make such broad and sweeping statements and then moving on – but this is truly a whole thesis in itself – so it will have to be left for a future week.

Moving forward, this is quite obviously a long-term negative for the EUR, if it even still exists in the long-term. However, I am still quite bullish on the EUR in the short-to-medium term as it is being seen more and more as a "back-up" reserve currency for the USD.

Later in 2006, when the USD gives up the remainder of its 2005 gains and continues its freefall, the EUR should be set to benefit. Specifically, the European Central Bank looks poised to raise rates several more times in their current tightening cycle as they (unlike the Fed) seeing rising asset prices for what they are – inflation.

In addition, despite the economic malaise seen in Europe over the past 5 years (although things seem to be picking up), people still believe in saving money. Euroland savings and investment rates have remained stable, and have even increased in some countries, even as U.S. consumers have seen their savings rate plunge into the negative for the first time since the Great Depression.

To summarize, in the short-term, I will continue to buy EUR, along with a basket of other currencies. For the long-term, I will continue to accumulate commodities and resources as an inflation hedge. Anything, but the USD.