RAOUL PAL: Why do we invest? We invest for a reason, which is to give ourselves the chance to have a better future. That's what it's all about. The problem is here, as I talked about in the first retirement video, we've got 76 million baby boomers, on average, 65 years old this year or last year, in fact. Everybody is stepping into retirement phase. They all have their dreams. You see the glossy brochures, skipping along with your wife or husband on the beach in Florida in your nice linen shirt, suntanned, and happy and gray head, but that's bullshit.
Hi, I'm Raoul Pal, the CEO, and co-founder of Real Vision. I'm here in the Cayman Islands, representing myself as Raoul Pal, CEO and co-founder of Global Macro Investor, my research business. Actually, it's more than that. I'm here to go on a personal journey with you. This whole two weeks of content, as you saw from the introduction video, is really important to me. I think it's the single most important topic that I could ever help anybody with.
Sure, I can help people in investing, trying to make more money. The reality is, there's something more basic, why do we invest? We invest for a reason, which is to give ourselves the chance to have a better future. That's what it's all about. Saving for retirement, or for a different life. You see, I've been passionate about this story of demographics, and the effects that it's had on everything that we understand to be the financial markets, and the potential effects as that demographic wave of baby boomers starts leaving the workforce.
I'm also worried about how people allocate money when they're getting too close to retirement age. You see, I think I explained in the first video I ever did on this two years ago, the one that reached, I don't know, 2 million people, the most shared video in the history of Real Vision, and the most commented on, was the fact that I saw it firsthand with my father, and some friends of mine who were a bit older, who had retired young. You see, my father retired basically at the 2000 recession, and wiped out a whole bunch of his pension assets. He has mis-sold complex products that he lost fortunes on. He then hit out in the bond market where possible, and I tried to help him through.
As you got into the unexpected consequences of the second wave of financial defaults that came in 2008, it became even more sinister. You see his bonds, which were 10-year bonds, had essentially rolled over in 2010, the ones that I've put him into. Great, he had bund yields at 4.6% and everything was fine, but they were 10-year bunds, then it came to roll them over and the interest rate was essentially zero. That meant he had no income left, that he had to eat into his capital.
The shock that that had to him was huge. He was a man of great pride, an Indian with a lot of pride and for him, to have to face the consequences of your savings, he had a very good career. Not being enough was something he didn't really want to face. One of the things, obviously, he did as almost every person who goes in retirement is they stop crimping expenditure, and he must have lowered his expenditure by 60% or 70% over the years. He passed away last year, my mom's still alive, still living in Spain, and it's easier for one person to manage and there's enough assets for her to go on through, and I'm obviously there to help out.
Just seeing it firsthand, another friend of mine retired young. He got hit by 2000. He lost 50% of his retirement savings, never recovered. That's been the story that I've seen time and time again. The problem is here, as I talked about in the first retirement video, we've got 76 million baby boomers, on average, 65 years old this year or last year, in fact. Everybody is stepping into retirement phase. They all have their dreams. You see the glossy brochures, skipping along with your wife or husband on the beach in Florida in your nice linen shirts, suntanned and happy and gray head, but that's bullshit. It's never going to happen. Not for most people, maybe for the 1%.
You see, the baby boomers created their wealth, the most disproportionate wealth in all recorded history, and they're probably going to destroy it too. It's not their fault. They didn't know. They're just doing what they were trying to do. They were trying to save for retirement and then they were trying to cash in for their retirement.
You see, here is the problem. There was 76 million people born between-- that's in the US alone, born between 1946 and 1964. The fabled baby boom generation. Didn't really matter in those first years, but by 1979, the first of them started getting through into the workforce. When the maximum number of baby boomers were jamming into the workforce at the same time, those very people were the first buyers of tables, chairs, suits, ties, cars, houses, lamps, everything. They bought everything from scratch. There was no offsetting generation to sell them to, because so many people had died from the two world wars.
They were it. They were everything. They were the saviors of our world, that special generation, the baby boomers, and that behavior pattern of spending was normal. They were all coming into their 20s and 30s, getting their first job, they drove up inflation.
If you look at this chart, you can see where the boomers first started coming to work, and the dramatic inflation that they created. Then after that, inflation started falling. Part of that was the Federal Reserve, part of it was just a natural, less of initial purchasing that these people went through. Yes, included in that was coming off the gold standard and the implication from that. Yes, included in that was a bunch of other factors like the oil crisis, but at core, it was a demographic issue.
If you think to yourself, what do you do when you're in your 30s? You start thinking, oh, shit, I better start planning for retirement. I start to need to think about my pension. This was the rise of the pension system. From that moment, from about the 1980s, the pension system started to really take hold. Corporations were giving out big pension benefits with defined benefits, too. Meaning they promised you 60% of your final retirement income at retirement age. That seemed an amazing thing. I could pretty much have the same lifestyle I have now and never work again. That was the promise.
The reality, we'll talk about later, was nothing like that. You see, what that did, all of those savings from those people who've now had their kids, bought their old first stuff, they had excess savings. That excess savings started dwindling and the savings rates of America started to decline. Those savings went into the stock market, first by the corporate pension plans, and then the advent of the 401k and the rise of indexation.
What that did was create one of the largest equity booms the world has ever seen. By the time we got to 2000, we're in the midst of a huge bubble. As all the baby boomers hopes and dreams of future retirement and all the wealth they could create was in that stock market bubble, the future of technology and the amazingness of it all. Everything got dashed on the rocks as the markets collapsed, and those valuations stood not to test the time and many stocks never recovered and went to the wall, many frauds were uncovered. People lost a lot of money.
Now, anybody I know who was very well invested in then generally started to get a little bit cynical about equity market investing. You see, the media have been cheering them on, buy this, buy this, you've got to do everything. The banking industry cheering them on, more, more, more. They were taking risks they didn't understand.
Then the stock market collapsed. These baby boomers now, and this was some 20 years ago, were average age of 45. The first of them started retire at the age of 55, the early retirees, and that was I think one of the factors that spilled over into the equity market crash of 2000. Collectively, they thought, huh, we need to do something else with our retirement savings. We need to do something that's a bit more secure, something I can't lose money in, something that will protect me to retirement. Property.
Bit by bit, after the Federal Reserve had cut interest rates massively to offset the equity bust, and considering the wave of demographics, it meant that deflation as debts was still piling up, deflation was coming as a persistent force and lowering interest rates over time due to these retirees, but the property market took off massively. This was now everybody's hopes and dreams. The stories of the stripper in Vegas with five houses as told in The Big Short, that was real. These are real people, real things happen.
We all know somebody who eventually succumbed to the greed of the housing market and then the Federal Reserve started raising rates and slowing things down, as they always have to. The party must end at some point. When it does, the housing market collapsed and destroyed the entire world's banking system with it.
The orgy of household debt was almost unprecedented. It wasn't just household debt, it was everything. The government was piling on debt, the corporations were piling on debt. Everybody in the financial system obviously have piled on debt. Everybody had debts upon debt upon debts. That is what started rocking the financial system, and is still rocking the financial system across the world, particularly in Europe, where those debts are dwelling and lingering and festering, those debts are still real.
The household balance sheet improved somewhat, but not entirely. Now, the baby boomers in their second half of life, had had two crises. Two crises start to really affect you. They start to affect your behavior and then started the bubble of central banking. You see, the central banks have become omnipotent, they think they can solve everything by pumping liquidity into the system and cutting rates. Even though rates across the world is zero and even negative, they still think they can use the same medicine to continue. Maybe they can for now, but the point being is that bubble in central banking has left other issues behind.
One of the key issues is the velocity of money has collapsed. Money's stuck in the banking system, it's hoarded, it's not spent. It's used as reserves because the banking system is scarred and regulated. There's no way for it to solve its problems. It is going to keep all the cash it can. That means money doesn't move around. That's lowered the rate of GDP growth. GDP growth in this, we can't call it a boom, but this upcycle since the previous recession is the lowest in all recorded history.
The Federal Reserve used the one trick it really had, its newly learned trick from 2008, the balance sheet. The bubble in the balance sheet exploded, and the Fed became the liquidity provided to everybody. That balance sheet grew at ridiculous levels. The reality of it, it was there to offset the baby boomers. That's the little understood part. It may be not explicit by the Federal Reserve, but it is implicit.
If you look at the chart of the Fed balance sheet, inverted here, versus the labor force participation rate, either the number of people in the labor force, the percentage of people in the labor force, you can see that they're very, very correlated. As you know, that labor force participation rate is forecastable in the future. We're talking demographics here. If that's the case, then it looks like the Fed's balance sheet is going to go to $8 trillion. It's a chart that shocked many people when I showed it before, we're now exactly at the point that the balance sheet should be expanding. Lo and behold, it's playing out perfectly to plan.
The next part of this bubble phase driven by the baby boomers is, oh shit, we can't save enough money so what we must do is take as much equity risk is possible again, because we're in our retirement years, we must go, go, go, go. That's the message that's come from the asset management industry, from the banks, from the brokerage houses, from the media. What happened was another neat little trick, Wall Street said with a little sleight of hand is we'll just cut your fees. Now, it's almost free to buy equities.
Well, A, there's no such thing as a free lunch. Secondly, that passive indexation cause another bubble. Everybody pulled their money into the lowest cost thing to hopefully increase their returns in the end. They were in a race against time. They've got 10 years, 15 years to retirement, they've got to find the best return so they pulled back into equities again, generally not at household level, but by pension fund level. Your pension fund took this risk for you. Most of you guys didn't want to take that risk, but your pensions did. They went into passive strategies.
What you did was create this enormous bubble in these momentum stocks. If you think of value versus growth, this chart here shows us the most extreme levels in all recorded history. That, again, is the baby boomer capital sloshing around through very small doors into places it should never be.
Another bubble happened at the same time. After the 2008, the next bubble took off. That was the bubble of corporate debt. You see, corporates had cashflow, unlike households that were nervous about it, corporate said retire, they didn't need the money for now. Then there was this nice neat little tax trick, which was I can issue myself stock options. Then issue a bunch of debt, record low interest rates. I'm borrowing money, and I'm going to buy back my shares. What that did was drove up the share prices, because there was less shares available and there's a big bar in town, made the management super rich because they had stock options, but it created the largest corporate debt bubble in all of history.
US corporate debts are now all-time highs as a percentage of GDP. I've discussed this before, how this doom loop of corporate debt could get ignited, and it's probably the end of this next cycle. It's something that everybody is invested in. Your pension fund basically has two core assets here. You have equities at all-time record valuations ported into this small sector of indexation and passive flows, where valuation doesn't count, and credit at all-time record lows where valuation doesn't count.
It's all herd mentality. It's the same as the property market in 2008 and it's the same as the stock market in 2000. This time, you're not making that choice or your parents aren't making that choice. It's being made for you by somebody else, being irresponsible with your capital and your future retirement.
That combination of those passive flows and those corporate buybacks were interesting, because everybody else, scarred and disenchanted, has left the market. Baby boomers have been selling as they should do as they go to retirement. Households have been divesting themselves of assets, but pretty much everybody. Even the pension system has been dubbed by divesting of assets, but buying a lot of corporate credits at ridiculous levels, but the equity markets still took off.
It was not on rampant speculation. It was on rampant pension flows, driven by the baby boomers in the index funds, skewing the returns of the S&P and largest stocks like never before, but also those corporate buybacks, that Pavlovian issue shares, make myself money, buy back my debt, looks good on my earnings numbers. That ridiculous situation pushed up equities further and further into that spectacular bubble we're seeing now.
How can it not be a bubble when Apple, truly great company, tax on $350 billion in market share in two months? This is simply ludicrous. The ludicrousness of Apple, Amazon, Microsoft and Google being larger than the stock market of Germany, second or third only to the US, Japan. This is madness. These are great companies but at what price? That's your retirement savings, or your parents' retirement savings that is creating that price. It's a false price.
Again, that's not a judgment on the companies. They're all amazing, but they are cyclical. Microsoft, it's a business services provider and software provider. Google, it's basically advertising. Amazon, purchases consumer goods. These things are really important to understand. They're not bulletproof, but the market and the pensions industry is doing it because it's given all responsibility to the index.
It is now not my choice. The index drives these, not me. I didn't buy them. I bought the index. This is the dangerous territory, the one that Mike Green has been warning and warning about saying that this is ridiculous. It can go on further, but what is going on is something truly concerning for all. Even worse, is this a bubble in volatility selling of all things?
We didn't learn the lesson when volatility blew up in February 2018, on my birthday, in fact, two years ago today is it blew up because the pension system, still not getting enough yield for those promises, there's broken dreams that they've given everybody, starts selling volatility as an asset class because they can pick up excess returns. Well, that's all well and good, but anybody who's traded volatility for as long as I have, knows that it completely can fuck you up if it goes wrong.
Being short volatility was being like short Tesla stock in the last few weeks. When it goes vertical, it's unviable, it becomes a huge structural problem. It also dampen the volatility of markets and I've been saying for a very long time, and maybe who knows me from Real Vision or Global Macro Investor is that suppressed volatility always and every time eventually leads to hyper volatility. That's the potential outcome for this volatility short selling bubble.
As I've mentioned before when I talked about corporate debt, we've got the corporate bond bubble. Junk bond yields are at all-time record lows. There's in fact, no risk offset in the margin for junk bonds. There is literally no action excess premium in the BBB market that is on a precipice of being downgraded. There is no margin to account for any rising defaults when they arise, and they will arise. They always arise in the next recession.
It's priced to perfection with your retirement income. You're hiding out in the lowest available yield, because you're desperate to get the returns or your pension manager's desperate to get the returns that they promised you in those shiny newspaper articles. Those ones that are elusive and never exist. You can be on that white sand beach in Florida, skipping along in your pink linen shirt. That's not the reality of the situation at all, and people need to come clean about it.
You see I caught the real issue here is that bond yields are driven by population. If you look at this chart, this chart is the color chart of truth that shows you the effect of demographic on the 10-year bond yield. It pushes it lower and lower and lower as you get older. As you get older, you save more, you spend less. Your marginal spending is non-inflationary, it becomes disinflationary, and bond yields go lower.