A riveting public spat between two of the financial world's biggest heavyweights – PIMCO's Bill Gross and Princeton economist Paul Krugman – leads inexorably to the conclusion that the era of bank dominance in the global economy is coming to an end.
The debate began with Mr. Gross arguing that the Federal Reserve should tighten monetary conditions because the economy can't function unless savers and investors are compensated much better than current interest rates provide.
Mr. Krugman responded in the New York Times, writing, "When I read Gross and others, what I think is lurking underneath is a belief that capitalists are entitled to good returns on their capital, even if it's just parked in safe assets. It's about defending the privileges of the rentiers, who are assumed to be central to everything."
Mr. Krugman is suggesting that the financial system works for the good of the economy instead of the other way around. Next, the Financial Times' maddeningly brilliant Izabella Kaminska jumped in with her own explanation: Global output gaps (developed world economies are capable of producing more than is demanded) mean that new investment to expand capacity is not needed. With no investment required, the demand for savings (from corporate investors) is low and mediocre returns on savings vehicles like bonds are perfectly justified. In fact, they indicate that market forces are working as they should.
Ms. Kaminska is right – and those same market forces are about to punish savers for a long time to come. The demographic outlook features increasingly elderly populations in North America, Europe and even China and this is likely to make matters worse. The San Francisco Federal Reserve has concluded that overall consumption levels are dependent on the size of the 40- to 49-year-old age group in their peak spending and earnings years. As a percentage of the population, 40- to 49-year-olds are set to shrink in the majority of the global economy as members of the baby boomer generation move into retirement age.
We are facing a prolonged period of weaker consumption and slower growth that suggests both low interest rates and low returns on investment. The finance industry's role as an aggregator of savings for large scale investors will also decline. The elderly will go from stuffing all the savings they can into markets through RRSPs and 401Ks to drawing them down in retirement. The finance industry's share of U.S. GDP swelled from 4.9 per cent of GDP in 1980 to 7.9 per cent of GDP in 2007. With the demographic changes expected to take place in the coming decades, that trend seems almost certain to reverse.
Banks and wealth management companies will remain important but will likely shed much of their market cap corpulence, at least until high-consuming age groups once again dominate the population. And that could be a long, long time coming.