Baby-boomers or bust?
One of the gloomier econometric predictions is that when the so-called ‘baby boomers’, people born in the 1970s, begin to retire over the next two decades they will go on a massive spending spree. Their savings will overwhelm the capital markets, depress asset prices and reduce the rate of return on a wide range of asset classes. This is the so-called ‘asset meltdown’ hypothesis.
Yet this may be too apocalyptic a vision. The consensus among speakers at a conference organised by the Allianz group and the Centre for Financial Studies in Frankfurt was that the effects of ‘dis-saving’ will be both less dramatic and more complex.
Professor Helmut Reisen, counsellor at the OECD development centre, argues that an efficient market will price in the savings wave. “Well-functioning asset markets would price financial assets so that their current market price would equal the expected present discounted value of future earnings and demographic developments, and their impact on future earnings should be affected in current earning once the information on demographic-induced developments become available,” he says.
Reisen also suggests that the rate of ‘dis-saving’ may be slower than expected. Many people will want to retain their capital either to pass on to children or to fund an unquantified life expectancy: “Bequest motives and lifetime uncertainty may imply that financial assets are decumulated at a less rapid rate than the standard life cycle hypotheses would suggest.”
Financial globalisation, as OECD countries invest in emerging non-OECD markets, could also slow the process - but not by much. Globalisation is estimated to slow the drop in the net saving rate in the OECD countries by only one half of one percentage point over the next 50 years, says Reisen.
“Financial globalisation can only attenuate not compensate the demographic impact of capital returns and net savings,” he concludes. “Global diversification will not be able to beat demography.”
The reform of pension systems and the move to funded pensions will have some effect. Joachim Winter, research professor at the Mannheim Research Institute for the Economics of Aging, says the savings ratio is likely to be higher as a result of pension reform. However, he adds that “fundamental pension reform has only a small effect on the rate of return, while international capital mobility affects the rate of return substantially.
“Assets won’t disappear in the future and asset meltdown when it comes won’t be that dramatic. Our model predicts a decline in the range of one percentage point.”
One effect of the move to funded pensions is to strengthen the export of capital by the EU. However, the baby boomers will reverse this situation. Dirk Krueger, professor of macroeconomics at Johann Wolfgang Goethe University in Frankfurt, says one effect of dis-saving will be to turn the EU from an exporter of capital into an importer of capital.
“When current demographic projections are fed into a simulation model it shows that up to 2020 the EU will export capital, mostly to emerging markets in Asia, Latin American and Africa, because that is when the baby boomers will be saving for retirement,” says Krueger. “But after 2020 dis-saving by baby boomers will result in capital inflows, mainly from Latin America.”
Another possible effect would be to reverse the trend of households investing in progressively riskier assets. A survey of 247 financial experts by the Centre for European Economic Research (ZEW) in Mannheim found that a clear majority believe that higher-risk products such as investment funds and occupational pensions will become more important over the next 15 years while the importance of low-risk products such as bank savings will decrease
Michael Haliassos, associate professor at the department of economics at Cyprus university, suggests that the market is sending mixed messages on this point. “Prospects for risky asset demands and for developments
of capital markets for an aging population seem to be subject to conflicting considerations. Demographers expect greater population masses of middle- and old-aged people in the years to come. Such people have shorter horizons and this should discourage them from holding risky assets. However, they will be displacing in importance cohorts of young households, which despite their longer horizons tend to hold significantly fewer assets.”
Haliassos says that demographic and household characteristics play a larger role in determining whether people invest in risky assets at all rather than whether they move from less risky to riskier assets.
“Households are more preoccupied with choosing which assets to hold in their portfolio than with changing their portfolio composition when their age or other characteristics change,” he says.
Haliassos concludes that , in the medium term, the biggest challenges facing the financial services industry “are likely to arise from managing the entry or exit of households from risky assets markets, rather than from handling portfolio rebalancing of households that already participate in risky assets.”