The IEA made its damming assessment of UK debt after the ONS revealed the latest figures on public debt.

Mark Littlewood, the IEA’s director-general, said: “The latest official national debt figure is seriously misleading. Looming in the background are pension liabilities. These should be moved to the forefront.

“The ONS should include these liabilities in their calculations. It is shocking enough to see official figures revealing a jump in national debt over the last year from the equivalent of 48pc of GDP to 56pc, but the grave reality is that our real national debt stands at 333pc of GDP.”

Nick Silver, an IEA research fellow, said the full figure, including the £1.2 trillion public sector pension liability and £2.7 trillion state pension liability, should be published either monthly or annually alongside the net debt data for reasons of transparency.

At first glance it seems a bit confusing to see public sector pension and state pension liability treated separately. But the difference is that one relates to pension liability for state employees, such as staff at the state-owned banks, the other relates to the liability which relates to all of us, state and private employees alike, but who will all enjoy a state pension.

The question is, is the IEA right?

There are a few points here worth considering. Firstly, banks are not going to remain under state ownership indefinitely. It is absurd to include pension liabilities arising from these companies in the figures for total state debt.

Secondly, pension liability is a function of two variables. How long we live after we retire, and how well the stock market performs.

As for longevity, maybe it is time we stopped bemoaning the fact we are living longer. George Burns once said: “Old age isn’t so bad when you consider the alternatives.”

According to research from The Pensions Policy Institute (PPI) the retirement age will need to rise to 72 within 20 years. Apparently, in 1981 people typically enjoyed a state pension for 25 per cent of their lives. From this year that figure is likely to be around 33 per cent.

So yes, it is possible, nay likely, that the state pension age will rise, but then when you consider the alternative, maybe this is not so bad. To expect a better standard of living, and improved health, and an early retirement age, is expecting too much. And if we work to an older age, the pension liability will fall.

The other variable is stock market performance. The fact is, since 2000 the European, US and Japanese stock markets have seen an appalling performance. Actually, for Japan, the appalling performance goes back 20 years.

And here there is a real dilemma. If the government starts including the pension liability within its debt calculation, and cuts spending even more than it is planning, and maybe even saves as common sense dictates, the result will be a dramatic slowdown in growth, corporate profits will fall, and stock market valuations will fall further.

On the other hand, should equities start to rise again, like they did in the 1990s, the pension liability will soon be eradicated.

We have two ways of dealing with the pension deficit. One method sees the economy as a fixed entity, and concludes we have to cut back on spending and save more. The other sees the economy as something that has the potential to grow, and furthermore sees a relationship between saving and growth.

The last couple of days have seen a plethora of articles suggesting the US really is deep in it. There is this one: U.S. Is Bankrupt and We Don’t Even Know It: Laurence Kotlikoff ; or there is this one: Is this finally the economic collapse? . Or, if that is not enough to make the hairs stand up on your neck, take a look at this video on the FT site comparing the US today with Japan twenty or so years ago.

Recently we published an article here referring to a report from Capital Economics predicting that US public debt will hit 350 per cent of GDP by the midpoint of this decade: Will the US government inflate its way out of debt hell?

In the short term Uncle Sam’s problem relates to a combination of factors. The inventory cycle seems to have turned, meaning the US can no longer rely on companies topping up their stock. US consumer confidence has crashed. And, judging by the inventory of properties for sale, US house prices are set to fall, even though relative to average incomes they are now quite cheap.

The Fed’s recent decision to engage in a certain amount of quantitative easing (QE) has spooked the markets. Although, in the press conference held for the release of the Bank of England’s inflation report, Mervyn King seemed quite relaxed about the Fed move. Dr King suggested that the Fed was merely taking action to renew maturing bonds.

Meanwhile, others are now drawing some nasty parallels with Japan 20 years ago. Back then, markets seemed to be in denial. And yet the Nikkei is currently around one-third of its all-time high set in the late 1980s. The markets didn’t crash overnight; it was a plummet in slow motion. Yields on Japanese government ten-year bonds fell from 7 to 1 per cent, but the collapse took around eight years. The collapse in Japan’s property prices was like a slow motion car crash.

Markets are anticipating more QE, not just from the Fed, but also from the ECB and maybe our very own Bank of England too. And for that reason the yield on ten-year German bonds – or bunds – is currently at an all-time low. The yield on five-year UK gilts has fallen to below 2 per cent for the first time ever.

Quantitative easing is hugely unpopular. We are told that the lesson of history is that it never works, although, actually, it has never really been tried in circumstances like the ones we have now. Japan tried it, but economists have argued it left it too late.

A part of the problem with QE is that it entails creating money by creating new debt. The Fed lends money to the US government. So QE effectively entails fighting a debt crisis with more debt.

But in the longer term the problem in the US relates to the ageing of its population. The bill for this will be huge. The charge that the US government is using Enron-style accounting is that it is simply not allowing for this future cost.

The news from Europe, by contrast, is much more hopeful. Data out this morning showed that the Eurozone expanded by around 0.9 per cent in Q2, with Germany expanding by a stunning 2.2 per cent. France and Italy expanded by 0.6 per cent and 0.4 per cent respectively.

And so, while the US exports woe, Germany exports goods and the Eurozone exports one big sigh of relief.

But it is all fuzzy logic. The US economic cycle is more advanced than the European one. What Germany experienced in Q2, the US experienced in Q4 last year. On an annualised basis US growth in Q4 2009 was 5 per cent.

But, in one key respect, Europe’s troubles are far more serious than Uncle Sam’s.

It boils down to demographics. Economists can talk about QE and fiscal policy, and asset prices, and stimulus this and boost that, but in one all important way they are impotent.

Japan’s fundamental problem is that right now for every person who is retired, there are just three people working. By 2050, the ratio is expected to be one to one. For its ageing population, saving more is the only logical answer. And it was surely this surging saving ratio in Japan that created all of its problems.

The US and the UK have each got their own demographic crisis – which is why they both have serious long-term problems to grapple with. But these problems are as nothing compared to the ageing of the population across the Eurozone. By 2050, the elderly support ratio in the UK and the US is expected to be three. By contrast, in Germany, Italy and France the ratio is expected to be two. Over the next 40 years the populations of the UK and the US are likely to rise; the population of Europe is set to fall.

To say the US is bust because of the burgeoning pension crisis, and then to talk about Europe being the land of opportunity, when its potential pension crisis is much, much worse, is the stuff of mythology.

As for inflation/deflation, at the moment the spread between US ten-year bonds and 30-year bonds is the highest on record. This rather suggests markets expect deflation in the medium term, but inflation in the longer term. This view may well be right. This is how it should pan out: as the baby boomers approach retirement, savings should rise, bringing deflation pressures. But once the baby boomers are all retired the problem may be the precise opposite as the retired population draw on their savings, and yet the working population is not large enough to produce sufficient goods and services to meet demand.

According to the Population Reference Bureau, the UK will be the most populous country in Europe by the midpoint of this century. And while Britain’s population surges, the European population is expected to fall from 739 million to 720 million. But globally, the population is expected to rise from 6.89 billion to 9.49 billion.

The latest population bulletin from the Population Reference Bureau makes good reading. In fact, it is hard to think of more important topics than those raised in the report. For the report’s key findings click here:

But here are some highlights.

When you are looking at population, the numbers involved are so large that it can be hard to comprehend. So let’s simplify. Right now, there are 4.4 births per second across the world. And yet in the developed world there are just 0.5 births per second. See it in these terms. The population of the developed world is around 1.2 billion; the developing world’s population is around 4.6 times bigger than that, and yet the birth rate is 8 times greater.

Worldwide in 1950, there were 12 persons of working age for every person age 65 or older. By 2010, that number had shrunk to 9. By 2050, this elderly support ratio is projected to drop to 4.

Japan has a total fertility rate of 1.4 children per woman, and an elderly support ratio of 3 – the lowest in the world, along with Germany and Italy. By 2050, Japan will have only one working-age adult for every elderly person; Germany and Italy will each have two. Meanwhile Africa’s population is projected to double to two billion by 2050, although this growth could be greater if birth rates do not decrease faster than currently. Africa’s total fertility rate is 4.7 children per woman.

In the US, as the population ages, spending on entitlement programmes such as Social Security and Medicare will rise sharply. Total spending on these two programmes is projected to increase from today’s level of 8.4 per cent of GDP to 12.5 per cent in 2030.

An interesting phenomenon is the relationship between fertility and economic growth. Economies that have a high ratio of youth to older citizens clearly have good potential for growth. If there is also an abrupt fall in the fertility rate, then there can be a spurt in wealth creation. So in the West, economies boomed as baby boomers entered the work force, while at the same time they had fewer children than the previous generation. It is called the demographic dividend. Much the same thing happened in Asia. The Population Bureau says: “the accelerated economic prosperity of East Asia over the past few decades is often attributed to this demographic dividend.”

And looking forward it seems Bangladesh and Brazil are likely to benefit from this dividend. Between the 1970s and 1990s, fertility fell from 6.9 to 3.3 births per woman in Bangladesh, and from 4.7 to 2.5 births per woman in Brazil. Conversely, in Uganda and Mali, where fertility remains persistently high – women in Mali have an average of 5.5 births each, and women in Uganda have an average of 6.4 – the number of working-age adults for each child will likely increase only slightly.

As for the UK, in 2006 there were 11.7 million youths between 10 And 24. By 2025 there are expected to be 10 .6 million. So we will see a slight decline.

The birth rate is 13 per thousand a year (the world average is 20, and the European average is 11). The population in 2009 was 61.9 million. By 2025 it is expected to have increased to 68.4 million, and by 2050 to 76.9 million. This means the population is expected to increase by 24 per cent.

Today, the world’s most populous countries, in order, are: China, India, US, Indonesia, Brazil, Pakistan, Bangladesh, Nigeria, Russia and Japan. By 2050 India is expected to be number one. Pakistan will be number 4, Nigeria number 5 and Ethiopia and the Congo Republic will join the top ten. Japan and Russia will leave the top ten.

The oldest country in the world today is Japan, followed by Germany, then Italy, Sweden, Greece, Portugal, Bulgaria, Austria, Latvia and Belgium.

In 2050, the number of working adults to support older people is expected to be 19 in Nigeria, 5 in India and 3 in China, but just 2 in France and I in Japan. For the UK, the elderly support ratio is expected to be 3. Currently the ratio in the UK is 4.  Click here for more data

Give credit where it is due, Vince Cable has been brave. He couldn’t have chosen a stronger tide of public opinion to swim against. If the Lib Dems had adopted a tougher policy on immigration during the election campaign, they would have won more seats. And since we live in a democracy, and since the UK public clearly want less immigration, then less immigration is what we should get.

But from an economic point of view, Dr Cable may well be right. The sword of Damocles, also called impending retirement of the baby boomers, hovers ominously. An interesting report in Foreign Affairs Magazine from a few months ago, said the ultimate solution to the demographic time bomb, in which the ratio of retired to working population across much of the developed world soars, lies in immigration. Or, for that matter we may also need emigration of retiring baby boomers to poorer countries where their care can be provided by a more youthful population, and provide a boost to the economy they emigrate to.

The difficulty lies in the rationale for immigration. It is clear that immigrants are often more dynamic than people who choose to work in their country of birth. Maybe this is the single biggest reason why the US has done so well; its economy is, after all, based on immigration.

The big problem with immigration into the UK lies in the benefit system. Immigrants who come to the UK with no intention of finding work, but merely to claim benefit, should be discouraged. Differentiating between immigration that adds to the economy and immigration that subtracts from it is incredibly hard.

There is a danger that in our zeal to curb immigration, some people with legitimate claims to come to the UK, or others who could bring real economic benefit, will get caught in the trap.

The gold medal won by Mo Farah in the European Championship is a high profile example of how immigration policy can be good for Britain. And yet if you read his story, it is the tale of a young man who came here when he was eight, but whose career in athletics was held back over doubts on whether he could re-enter the UK after representing us in tournaments abroad.

Of course, if we are unwilling to accept more immigration we will have to face up to the alternative, which is to work until we are much older. Now the government has revealed plans to ditch the compulsory retirement age.

It is contentious legislation. On one hand are those who say it is not fair, and that those who want to retire at 65 will be put under pressure to work longer. Others say it is hard enough to fire people in this country as it is, and now you can’t even get rid of them when they are old. Maybe next they will be banning the practice of terminating someone’s employment even after they have died. You can imagine the tribunal. “We accept that Mr Smith is now dead, Sir, but the fact is, you can’t terminate someone’s employment without giving them three written warnings first.”

In reality, there simply is only one alternative to extending the retirement age, and that is having a more accommodating immigration policy.

And yet, 77 million? That’s a lot of people. Maybe we should take a close look at what the population forecasts are saying. See: UK set for population explosion. See also: The demographic time bomb.

If it wasn’t so sad, it would be funny. Markets are outdoing themselves with their ineptitude. Politicians are, if anything, proving even better at spilling a far worse pollutant than oil, and now company directors seem to have taken up playing the fiddle while all around them the great oil slick called economic mismanagement burns.

The last few days have seen news that directors’ pay is shooting up, and US house prices are shooting down. News on UK employment was about as ambiguous as you can get.

While directors enjoy more pay, it seems wages for most of us are rising at a mere snail’s pace.

Pity the French, they have got to work until they drop, or to be more precise, their retirement age has been pushed up to the grand old age of 62. How will they manage?

Then there’s the new King. Or King King, as you could call him. The FSA is gone, and good riddance too, you might say, and the new emperor is Mervyn King.

Read on for more

Markets defy logic, and BP goes where others would tread but for the grace of God

While they have not been booming exactly, markets have being doing well over the last couple of weeks. After falling at the beginning of the month to its lowest level since autumn of last year, the Dow has since surged by 500 points, or around 5 per cent. And yesterday, news that BP would have to park a mere $20bn into escrow, that it has chosen to stop paying dividends this year and that it is to sell $10bn worth of assets, was met with glee. Shares in the company surged, although BP’s stock is still well down on where it was a few weeks ago.

It is difficult to understand why. You can accept that some might say BP is a good contrarian bet, as indeed many said Northern Rock was after its share price collapsed. But there is still enormous uncertainty over what will happen next. The $20bn the company is setting aside may not be enough. Barack Dubya Bush, sorry, Barack Hussein Obama, has warned that the money the company is putting into escrow will not be a cap on costs it will have to bear. We are ‘going to smoke those folks at BP down from the hills,’ said Mr Obama, or at least he might as well have said that, after comparing the BP oil spillage, which by the way is nowhere near the worst spillage in history, with 9/11.

Predicting where this will end is like predicting the end of the euro crisis. Barely a day goes by without some report contradicting the last one. One day Spain and/or Greece are set to go the way of Argentina, the next day they are going to be rescued. One day China is terrified of pumping more money into Western debt, the next it finds Greek bonds irresistible. And markets boom and crash like a yo-yo on speed.

BP’s catalogue of PR errors is embarrassing, from “get my life back” to yesterday’s “care about the small people”. It is enough to wish for a return of Peter Mandelson. It seems the company needs a spin doctor without peer.

But then again, paying out dividends was always a bad idea. The fact that until yesterday the company had stuck to its line that dividends would be paid as normal indicated how the company didn’t get it.

Not that Mr Obama gets it. Or maybe he does, but the political groundswell is such that he dare not own up to the truth. But, as told here earlier this week, the US House Energy Committee has slated Exxon Mobil Corp., ConocoPhillips, Chevron Corp. and Royal Dutch Shell Plc, saying their plans to deal with any future oil leak are virtually the same as those prepared at BP. See it this way, the oil industry is beset with one big problem; oil is becoming harder to get at. The new oil finds off the coast of Brazil lurk far deeper than BP’s Gulf of Mexico oil well. To put it in terms of the World Cup: the ball is odd, which is making life difficult for all teams except for Germany, where the World Cup ball was used for domestic matches during the last six months. Goalkeeper errors are inevitable, it is just that the England goalie was first. In a way, BP is like Robert Green.

There are also parallels with the banks. They didn’t get it either, and were paying out dividends and massive salaries right in the face of public anger.

Goodbye FSA

But at least the regulator has been reformed. Well, not so much reformed as torn apart. If you are one of our IFA readers, you will no doubt agree with the sentiment that the FSA was like a Rottweiler while dealing with little companies trying their best to navigate the absurdly stormy waters of financial regulation, and yet when it came to the things that mattered it was little more than a mildly discontented puppy.

The FSA engendered paranoia with some IFAs, leaving them terrified to say anything without running it past the compliance officer first. So the statement ‘two plus two equals four’ would need to be changed to ‘some analysts believe two plus two equals four, and here is a page of disclaimers.’ Yet while it was busy snarling at the little people, banks pretty much did what they liked. So goodbye FSA, but don’t expect our thanks.

Don’t get us wrong. We are not saying tighter regulation would have stopped the financial crisis. Doctor King, the Bank of England governor, or King King, whatever you want to call him, is now one of the most powerful central bankers in the world. He did a better job than some in warning of dangers ahead, and the Bank of England even made subtle noises about mortgage securitisation posing threats, but he has no magic wand, and it seems likely that even if King had ruled the roost throughout the noughties, we would still have suffered the deep sea banking spillage.

Osborne’s idea to have mortgages capped to a certain ratio of a property’s value is good, and it is most gladdening to see the new government trying to introduce ideas for ensuring we don’t get another property bubble. You may recall, Boy George has already asked Mervyn King to look at including house prices within his inflation target.

Hello bonuses for directors – goodbye wage inflation for the rest

But what is not a good idea is big pay rises for bosses while the small people down the pay ladder have to make do with a good deal less. According to the ONS, average earnings growth including bonuses decreased in the year to April 2010, from the March rate of 4.3 per cent to 4.2. Growth in average earnings excluding bonuses (regular pay) also decreased from the March 2010 rate of 2.0 per cent to 1.9 per cent in April 2010.

With wage inflation that low, it really is difficult to see how price inflation will take off as some fear. You need to bear in mind that interest rates as a tool for fighting inflation are meant to tweak demand. Right now, with wage inflation so modest, unemployment so high and taxes set to rise, there is no pressure on demand. Oil, food, VAT reversal, and the falls in the pound, that now appeared to be reversing, are what caused the recent hikes in inflation. And higher interest rates, or less quantitative easing, will have a negligible effect on these one-off factors. (The pound being a possible exception, but then the UK needs a cheap pound right now.)

As for jobs, the latest data is all over the place. The employment rate fell 0.1 per cent to 72.1 per cent,the number of full-time workers fell by 56,000 over the quarter but the number of part-time workers increased by 61,000. And while employment fell, unemployment got worse too, rising from 7.8 to 7.9 per cent.

Yet while we brace ourselves for austerity, salaries for bosses have surged. According to IDS, bonus payments to directors of FTSE 100 companies rose 22.5 per cent in the last six months, rising from an average of £456,000 to £558,000. Basic salaries increased by 7 per cent.

Forever blowing bubbles

Now, we have no philosophical problem with high wages for bosses, but we do have an economic problem with it. Surging salaries and bonuses for those at the top is a symptom of rising corporate profits. In the US during Q1, annualised profits expanded by 24 per cent.

The rise of corporate profits while wage increases remain modest is part of a worldwide problem. Okay, we accept that in some countries such as Greece and Spain there is the necessity for the agony of falling wages.

But worldwide, the real problem of the noughties was that wage growth was being outstripped by the growth in productivity for workers everywhere.

As a result, spending that was not backed by debt lagged behind production. Under different circumstances recession would have been the result. Instead, money saved bounced around the financial system, until eventually it found property. German money pumped up Greek and Spanish property prices. Chinese, Japanese and corporate savings pumped up house prices everywhere.

When that bubble finally burst, investors looked for a new home for their money, and that home was government bonds. And so the government took up the baton and maintained the economy (up to a point), because consumers could no longer afford to do so.

This is creating a new bubble, this time in government bonds.

Some say this time it is different, because the money has to go somewhere and there is nowhere safer than government bonds. To which others will reply ‘Ah ah,’ and add ‘this time it never is different, not really.’

So where will investors go if bonds crash? Gold, maybe, in turn fuelling another bubble.

The argument that governments will inflate their way out of debt has one thing going against it. At the moment debt is doing no more than ensuring aggregate demand is matching capacity.

The only way we will get inflation is if governments print money, and at the same time savers decide they have had enough of saving and start spending it.

If, instead, savers’ money was invested in business, and helped to increase productivity, or better still fund entrepreneurs, the result would be sustainable economic growth.

That is why the latest idea from Japan’s central bank to pump money into business is interesting. See Japan – central bank finds the plan that UK needs

Talking of bubbles, in the US, housing starts are down. They dropped no less than 10 per cent in May. Yes, that’s right, 10 per cent. That’s not annualised, it is month on month. Last year the US government ran a tax credit designed to boost the market. These schemes are over now, and crash, down will fall house prices. In the UK, the end of HIPs may have a similar impact.

So let’s put it all together

The underlying causes that led to the credit bubble of the noughties have not gone away. Overreaction has begat more overreaction, and now we are told we all need to save more. Wages must go down to improve productivity. David Cameron and Co. want to see debt levels fall.

That’s fine, providing the austerity drive is being accompanied by investment. Saving is dreadful for the economy, unless the money being saved is invested into business.

During the noughties you could borrow money to spend on a jolly, but if you wanted your bank to lend to your business, then that was a non starter. Your only hope was to lie on the application form, and instead of saying you wanted the money to create wealth, say you wanted it to boost the tourist industries of other countries. Then the bank would have given you the money.

Still, the French are worse off. Apparently they have got to get used to the idea that retirement at 60 is too young. The retirement age is being pushed all the way up to 62.

As regular readers here will know, the demographic challenge facing the developed world is enormous. Workers across the world have got to retire at an older age. Upping the retirement age from 60 to 62 its analogous to BP apologising and saying how sorry it is to have let down the “small people”. See The demographic time bomb

The truth is, the way out of economic Armageddon lies with the so-called small people becoming more engaged with wealth creation, and until the government starts introducing policies that support this, the chances become greater that the economic spill of the last couple of years will just carry on.

The good news, looking forward we are probably going to experience less bubbles.

The very bad news, well you better make sure you are sitting down, and take some deep breaths.  Hyperinflation is a real danger. Bond yields will double, possibly making interest payments on government debt unaffordable.  At least that’s the startling inference.

And what is really scary about the report, is that it may well be right.  And if it is, then we will look back on the Greek crisis, or even the Credit Crunch as the good old days.

There are no prizes for guessing why the Barclays report is so pessimistic. At least there are no prizes for regular readers of this column, we have sounded the warning bell often enough. The crisis lies with demographics.

Ask yourself this question. What do you do when you retire? Answer, you live off your savings. Presumably, for most pensioners their saving ratio is negative.  But what happens if you spend more than you produce? You get inflation of course. And when spending is greater than saving, demand for money exceeds supply of money so the rate of interest goes up.  A rising interest rate is good news when your savings are high.  It is bad news when you are in debt. And as we all know, governments across the developed world are in debt.

Tim Bond, co-author of the Barclays report said: “We are moving from a world of capital abundance to a world of capital scarcity and scarcity of savings. From here on yields should probably double over the next decade…This will happen as pensions liabilities come due and as there is decreasing savings to support the economy.”

He continued: “The financial crisis, from this point of view, happened at the worst possible time – just as this demographic change was starting to take place.”

“It is very unlikely that the excess savings of countries like India and in Africa with lower average ages will be able to compensate for the fall in savings in the West.”

But at least the fall in global savings will mean less bubbles. The report authors reckon that bubbles occur when there are excess savings.

As for hyperinflation, they are not saying it will definitely occur, just that it may. The report said “Although such an outcome is by no means a historical inevitability, it is certainly the case that high debt ratios increase the temptation for policymakers to engineer higher inflation as a soft option for containing debt/GDP ratios.Pragmatically, we can take the view that when investors focus on the near ubiquitous trend for substantial increases in debt burdens, they will demand a higher long term inflation risk premium.”

The report also said “The common assumption that future savings flows from the large developing economies will be a ready source of finance for the ageing advanced economies is most probably flawed. The projected trajectory for old age dependency ratios in countries like Brazil, China or Russia are as severe as in the US. It is highly implausible to believe that Africa, the Middle East and India will be capable of funding the rest of the world’s growing population of retirees….Because the rise in old age dependency ratios is common to virtually all significant economies, the idea that a redistribution of global savings flows from surplus to deficit nations might mitigate the impact of ageing on bond markets is a false comfort.”

The editorial stance at Investment and Business News is to put more emphasis on underlying factors than you usually see elsewhere. And there are two underlying factors that have been bubbling beneath the surface that probably explain just about every economic trend.  These two factors are innovation/technology and demographics.

And while it is true that the retirement of the baby boomers could mean less bubbles, crowd behaviour being what it is, the Internet has created a whole set of new potential reasons for bubbles. The Internet was surely a factor behind the bankiing crisis, and the panic that followed.  It will surely spark off other bubbles.

The demographic factor probably explains a lot more than it is given credit for.  It is surely the real cause of Japan’s lost decade.

It is bad luck that we enter the great demographic shift at a time when the stock market has suffered such as awful run.  Or is it bad luck? Is there a connection?  One thing we can say is that the economic muddle of today probably has its routes in the dotcom crash, when equities crashed eroding the value of people’s pensions.

But, it does seem the Barclays report is somewhat precipitate.

Yes, it is true that once the last of the baby boomers has retired the world economy will face a very different set of challenges. It is very difficult to see how countries with large government debt will manage. It’s a massive problem lurking over the horizon for the likes of Japan, Italy, Germany and France.

For the UK and US it is a slightly less serious problem.

But we are surely a decade or more from this problem. The last of the baby boomers was born in 1965. They won’t reach 65 until 2030. By then, the retirement age will probably be 70.

In the mean time, the challenge is probably the opposite.

Whilst baby boomers think about their retirement, and see how dreadful their pension performance has been, they will surely save more. This will create deflationary pressures, and push interest rates down.

So for the next decade, the pressures are likely to deflationary. The hyperinflation risk is surely the challenge of the next decade.

And that means it is not too late.

In order to stop the detonation of this demographic time bomb creating economic ruin we have got ten years to start making technological innovation count.

The needs of the retired baby boomers can be met via increasing productivity. But that means, for the time being, we need more risk not less, and it means more flexible labour, and more willingness to let the creative destruction that comes from capitalism do its thing.

For other articles covering a complementary theme see:

The demographic time bomb

Did the economic crisis begin in 1997?

The demographic punch

But it may be changing. Recently two books have been published looking at this deeper threat.

A fascinating article in “Foreign Affairs” magazine came up with a radical solution.

And in its latest quarterly report, The National Institute of Economic and Social Research touched on this all important issue.

It is not all bad. There is a positive twist you can make can make. Actually, it is a very positive twist. There’s another book that has been published recently that makes that point, and that’s called Bubbles and Wisdom, by yours truly.

Right now the world is going through two contradictory changes. In half the world the population is rising at an extraordinary and quite frightening pace.  And in the other half of the world, the population is declining at a pace which is just as terrifying.

How can one possibly find good news in that?

The surge in population will bring with it pressure on raw materials. Food will be pushed up in price, so too will oil, but most serious of all, water will become an ever more vital commodity.

The balance of power will shift. According to Jack A Goldstone in his piece for Foreign Affairs – The New Population Bomb -  “At the beginning of the eighteenth century, approximately 20 per cent of the world’s inhabitants lived in Europe (including Russia)…In 1913, Europe had more people than China, and the proportion of the world’s population living in Europe and the former European colonies of North America had risen to over 33 per cent.”  And yet, “by 2003, the combined populations of Europe, the United States, and Canada accounted for just 17 per cent of the global population. In 2050, this figure is expected to be just 12 per cent – far less than it was in 1700.”

As you know, the developing world is seeing GDP per capita rise at a breathless pace.  So not only is the population of the developing world growing while the developed world’s population stagnates, but GDP per head is rising in the developing world too while in the developed world it seems pretty static.

The Foreign Affairs piece suggested that we may want to ditch the old way of breaking the world into First, Second and Third World, into three new groups. Mr Goldstone says we will have  a “new First World of the aging industrialized nations of North America, Europe, and Asia’s Pacific Rim (including Japan, Singapore, South Korea, and Taiwan, as well as China after 2030, by which point the one-child policy will have produced significant aging); a Second World comprising fast-growing and economically dynamic countries with a healthy mix of young and old inhabitants (such as Brazil, Iran, Mexico, Thailand, Turkey, and Vietnam, as well as China until 2030); and a Third World of fast-growing, very young, and increasingly urbanized countries with poorer economies and often weak governments. “

Much of the increase in the world’s population will be in countries with a large Muslim population. Take Afghanistan, as an example. Its population is projected to rise from 28 million today, to 45 million by 2025 and 75 million by 2050. Now see that particular demographic shift in light of the current war.

If the current divisions between the West and Islam grow, then see how this could become more serious as the Islam world sees its population explode while the western world sees stagnation.

But the conflict points won’t just be between new and old powers.  Conflict between burgeoning powers will be a danger too. Take as an example China’s policy in Tibet. In all the criticism laid at China an important point is forgotten. Arguably, Tibet possesses the most valuable natural resource of all: fresh water.  The rivers that flow from this region irrigate much of China and India. These are the world’s two most populous countries. At some point during this century they will probably be the world’s two biggest economies. How the dynamics of water will pan out, when these two powerful nations find they have a common source of water is a tad scary.

But, at the same time, in Europe, And much of Asia, including Japan, South Korea and eventually China, the problem is a declining population.

According to the Foreign Affairs piece, by 2050 the entire working population of South Korea will barely exceed the number of people over 65.

There’s a new book by Tory MP David Willets: “the Pinch: How the Baby Boomers stole their Children’s future and how they will give it back.”   To be honest you know what the book is about form its title. The Baby Boomers have run up huge debt. They have pushed up house prices making them unaffordable for the youngsters. They went to University and came out without debts. Now to fund  the baby boomers’ lifestyle, kids need student loans. The baby boomers will retire with inadequate savings leaving the diminished population of the young, who after repaying their student debt, have to find a way of caring for the elderly.  And to cap it all, the baby boomers have left this legacy we know as Climate Change.

The truth is the retirement of the baby boomers is a massive problem in the making.  And the aging of the Japanese populace is surely a forgotten cause of Japan’s lost decade – which still hasn’t ended.

In another book the problem is also described in the title:

Fred Pearce has penned “Peoplequake: Mass Migration, Ageing Nations, and the coming of the Population Crash.

Mind you, the problem will be worse in some countries. As NIESR pointed out recently at least in the UK the government has woken up to reality and is extending the retirement age.

NIESR has divided the developed Western World into three groups. “The first group includes countries where both the total and working-age populations are projected to decline. These countries include Japan, Germany, the Baltic economies, Poland, Hungary, Bulgaria and Romania. Economic growth in these countries over the medium term relies on strong productivity growth, or on a rise in the labour force participation rate.

“The second group consists of countries where total population is expected to rise, while the working age population is expected to decline. This group includes the Czech Republic, Finland, Italy, Greece, France, Portugal, Belgium, the Netherlands, Slovenia, Slovak Republic, Denmark and Sweden. Again potential growth in these economies depends on the prospects for productivity growth and on the potential to increase labour force participation, either by raising the retirement age or encouraging non-participants to join or rejoin the workforce. Fiscal pressures may be particularly high.

“The final group is projected to have positive growth in both total and working age population. These countries include Spain, Canada, Australia, US, UK and Ireland. These countries all tend to encourage inward migration, especially of highly skilled migrants. Potential growth is generally higher in these economies, although they may still come under fiscal pressure if the non-working-age population is growing significantly faster than the working-age population.”

Thomas Malthus is the man who painted the warning of woe.

He said that the world’s population will increase faster than our ability to produce goods and services. And ever since then, economists have talked about a Malthusian nightmare. There is a very real danger that the world will see the realisation of such a nightmare. Will there be enough natural resources to meet demand?

The solution lies in innovation. Not everyone is going to like this next statement. Genetically Modified crops are just going to have to be developed.

As for energy, there is plenty of energy beaming down on this planet from the Sun to provide all we need. But we are going to have invest a fortune in renewables. Regardless of whether you agree or disagree with the man made climate change hypothesis, it is clear that fossil fuels just don’t do it. We have got to learn how to harness the energy from the Sun, either indirectly via wind tide and wave power, or directly via solar power.

Apparently, 5.8 per cent of the people who have ever lived are alive today.

This is what the book Bubbles and Wisdom co written by the author of this article has to say on the subjects of our population challenge:

“If 5.8 per cent of all people who have ever lived are alive today, then presumably 5.8 per cent of all geniuses who have ever lived are alive today.

“Since the birth of Sir Isaac Newton, around 20 billion people have been born. Around one-third of that number are alive today. Think of all the geniuses who have lived since that time – scientists such as Einstein, musicians such as Mozart and Beethoven, artists, authors, great leaders. It seems reasonable to assume that no less than one-third of all geniuses who have been born since the birth of Newton are alive today.

“Take an even more recent date, 1850, and we find that less than half of all people who have been born since 1850 are alive today.”

In other words we can meet the needs of this growing populace and we can innovate by using all that new brain power that the population explosion has created.

And as for the dynamics between the population explosion and the population decline, Bubbles and Wisdom  said:

“In the West and in other developed countries, we have discovered a new reality. Once economic wealth reaches a certain level, and once a society has learnt of the benefits of liberated women, we have discovered that the population no longer keeps rising. Instead, we opt for smaller families. It seems that, in part, this is down to women finding they no longer want to spend their lives as a form of baby factory, churning out newborns for as long as they are able.

“It is also down to another factor. In the past our children were our welfare. The bigger our families, the more likely we were to enjoy security when we grew old and were no longer able to provide for ourselves.

“These days in advanced economies, welfare is often provided by the state. We put our money into pensions and, depending on where we live, healthcare packages also, meaning we don’t need such large families. It seems these days that children provide negative economic benefit. We have kids because we want them, not because our kids provide our future pension.

“And as this reality bites, we discover the flaw in the theories of Thomas Malthus. Our ability to produce may increase arithmetically, but there can come a point when the population moves from geometrical increases to more gradual rises, and then turns negative.

“It is clear that there is a limit to how many humans this planet can sustain. It is uncertain what this limit is, but it seems we can have reasonable confidence we are not there yet. This means we enter a kind of race, a race where the finishing line is not clearly defined. We know that as the world gets richer, the population will rise until we reach a level where the secondary effects of the greater wealth we have already discovered in the West set in, and the change in population goes into reverse. It all boils down to hoping we can reach that point when economic development is sufficient to ensure the global population falls, before we reach that point when the population is too great for the earth to sustain it.

“It is clear that this race will not be smooth. In lane one is racing the threat of overpopulation; in lane two are the benefits of falling population that come with rising development. There will be occasions when the competitor in lane one goes into the lead, and other occasions when the competitor in lane two leads the race.”

So the demographic story goes like this:

It seems that once an economy reaches a certain level of development, population goes into decline. We need to try and ensure the developing world reaches this stage before it is too late.

But then, once the population declines a whole new set of problems emerge, namely how does this diminishing labour pool provide for the growing number of people retired?

To end, let’s leave you with the conclusion from the Foreign Affairs piece: “One somewhat daring approach to immigration would be to encourage a reverse flow of older immigrants from developed to developing countries. If older residents of developed countries took their retirements along the southern coast of the Mediterranean or in Latin America or Africa, it would greatly reduce the strain on their home countries’ public entitlement systems. The developing countries involved, meanwhile, would benefit because caring for the elderly and providing retirement and leisure services is highly labour intensive. Relocating a portion of these activities to developing countries would provide employment and valuable training to the young, growing populations of the Second and Third Worlds. “

We all know the world has got a population problem, The number of human beings on this planet is set to grow and grow. This could create massive poverty in some countries.

But, in other parts of the world, the problem is the precise opposite.

If there is one country in the world, however, that is sitting pretty, it is the US.

The deepest of all underlying economic forces, demographic change, is likely to benefit the US, and yet we are told the US is on a collision course with disaster. This doom laden prophecy is wrong, and this is why.

There is a forgotten explanation for Japan’s malaise.

It is the great demographic shift.

The land of the rising sun also happens to be the land where the demographic shift is happening first too. In Japan, people are older.

It has been an issue now for around two decades.

What happens if you are approaching retirement, and asset prices have just crashed in price? Answer, you surely first panic, and then cut back and save. This is what happened in Japan 20 years ago. She has been saving ever since. This high savings rate sucked demand out of the economy, and everything the government tried to do to fix the problem failed.

In Japan, the problem is set to get more serious. The Population Reference Bureau reckons the country’s population will decline by around 25 per cent over the next 42 years. Only a handful of countries mainly in the former Soviet Union are expected to see an even bigger decline. (Incidentally Bulgaria is expected to see the biggest fall.) Russia is in it deep, too. Its population is expected to decline by 22 per cent.

By contrast, Europe has got it easy. Its population decline is expected to be around 7 per cent.

But a 7 per cent decline in population at a time when people are living longer, is still serious.

Very soon there will be more Europeans retiring than entering the workforce. How this diminishing labour pool supplies the growing retired population is one of the great challenges of today.

What is inevitable is that we will save more. The appalling stock market performance of the last few years, coupled with worries over housing, means the savings rate is rising and it is set to stay high.

This is the single biggest reason why there is a real danger Europe could follow Japan into decades of economic malaise. It is also the single biggest reason why deflation, and not inflation, is the long-term danger.

Contrast this scenario with the US.

The Population Reference Bureau expects the US to see its population rise by 44 per cent between now and 2050.

Couple the growth in the size of Uncle Sam’s brood, with the impressive improvements seen in US productivity recently, and you see an economy that is actually in pretty good shape.

Assume US productivity rises at 3 per cent a year – which is lower than the current rate - and that in the long term per capita growth keeps pace with the rise in productivity. If this is right, and if the population increases the way it is expected to, by 2050, US GDP will be around 400 per cent greater than it is now.

Those who look at the fiscal deficit and say the long-term prognosis for the US is dreadful, are about as wrong as you can be.

This does not mean there won’t be hiccups along the way, but the underlying trend is clear, and it is up

But what about Europe, how do we deal with the demographic problem? Well we can, and to find out how, click here: The panacea to UK strength lies in banks that remember their purpose

But in making that comparison, something rather interesting comes out, something that we should all be aware of.

Writing in the Independent this morning, Stephen King suggested Japan did rather well to come out of its own economic crisis of 1989 as painlessly as it did.

Sure, Japan was slow to react; sure, it was far too conservative in dealing with the potential threat of deflation; and sure, the crisis has just gone on and on. But then again, Japan did not suffer a 1930’s-style depression. Maybe that was a real achievement. Who is to say that if she had done all the things experts say she should have done, things would have been any better.

Remember, all these ideas for dealing with this crisis are just theoretical; we don’t know they will work. We don’t have any examples to call upon to show that fiscal stimuli work.

Japan really faced two problems. First, she had seen the development of a bubble in the 1980s, as both property and shares boomed. The parallel with today is obvious.

But Japan also faced the problem of an ageing population. Again, just like us today.

If the population is ageing fast, then really those who are due to retire face only one prudent choice, and that is to save more. This means, of course, consumer spending falls, meaning job losses, deflation, etcetera.

But it is like that now in the West. The baby boomers are approaching retirement. They have discovered their home can not be their pension too. So they have to save more.

But we know that rising saving can lead to rising unemployment. And if you lose your job when really you should be saving for your impending retirement, that just makes things worse.

The ageing population may well have been a subtle but often overlooked factor behind this crisis. And it is difficult to know what the answer is.

But now KPMG have really gone along and thrown the cat amongst the pigeons.  ”The UK and other developed countries such as the US,  Western Europe,  and Australia”  says KPMG,  “face a slow-down in the supply of both skilled and unskilled labour in the next few years,  if there is not a significant increase in the immigration intake.”

It is all the fault of the baby boomers.  Our Gordon once said no more boom and bust. Well,  it appears boom and bust is not just a phenomenon of economies,  it applies to demographics too.  The babies of the 1946 to 1961 generation boomed.  And the eldest of these boomers is close to retiring now.

The bust occurred between 1976 and 2006.  The result,  as baby boomers retire,  less indigenous workers will enter the work force.

KPMG says  “in the UK,  the recent growth trajectory suggests that there will be a contraction in the growth of the working-age population in the year 2013.  In some countries,  such as France and the Netherlands,  the working-age population will shrink from around 2010 onwards.  Either participation rates must rise or the productive capacity of these nations is affected as a consequence.”

Bernard Salt,  a partner with KPMG in Australia and primary author of the report,  said:

“Without a surge in the annual intake of working-age migrants there will be a slow-down, if not a contraction,  in the pool from which the labour force is drawn at the end of this decade in the US,  and by the middle of the next decade in the UK and in many other developed markets.  This will have a number of implications for corporates.  One of these will be that,  over time,  large multi-national corporations will increasingly expand their head offices out of the traditional western headquarters and into the new territories of the developing world.  We are going to see a change in the landscape over the course of the next few decades.”

Jill Storey,  UK partner in KPMG’s International Executive Services practice, said:

“Increasing globalisation combined with the effects of demographic change will present some big challenges for businesses.  From 2011 onwards,  when the first Baby Boomer passes the age of 65,  the supply of labour in many developed nations will start to slow down.  This may be off-set to some extent by increasing the participation of older workers in the labour force as well as by changes to migration policy.  However companies that are likely to be increasing their international footprint over the next ten years need to start laying the groundwork now to ensure they are equipped for the future.”