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May 07, 2005

WSJ.com - As Boomers Retire, a Debate: Will Stock Prices Get Crushed?

E.S. Browning writes about mid-century asset meltdown scenarios:

WSJ.com - As Boomers Retire, a Debate: Will Stock Prices Get Crushed?: By E.S. BROWNING: For tens of millions of baby boomers and younger workers, the basic long-range financial plan is simple: accumulate stocks and bonds while working, then slowly sell them off to keep up a comfortable lifestyle in retirement. Not so fast, says Jeremy Siegel... a flood of boomer retirees with trillions of dollars of assets to sell over the next 20 to 40 years threatens to crush stock and bond prices. He says it will take a massive investment in U.S. stocks by people in India, China and other developing countries to prevent a market meltdown.

Robin Brooks, an economist at the International Monetary Fund... thinks the wealthy individuals who own a large percentage of U.S. stock won't need to sell, and companies may boost dividends so retiree investors can hang on to their shares.... The ratio of working-age people to retirees will decline over the next 30 years to an estimated 2.6 to 1 from 4.9 to 1 today. Simple supply-and-demand economics suggests that as retirees dump their holdings into a thin market, stock prices could plummet.... "Whether we will see some sort of crash or slow crumble over the next decade or so, I don't know," says Andrew Abel, another finance professor from the Wharton School at the University of Pennsylvania. "But it is certainly likely enough that it has got to enter into people's planning."...

Prof. Siegel's model highlights a fundamental contradiction between common expectations today and reality. He starts with several reasonable-sounding assumptions: Productivity will continue to rise modestly but not leap forward. Taxes, the retirement age, immigration and life expectancy will stay broadly in line with current expectations -- as will the percentage of income that working people consume. In that case, the model suggests, retirees can't possibly maintain 90% of their preretirement standard of living, the typical level they now seek. Prof. Siegel thinks it's likely retirees would try to sell their assets -- stocks, bonds and real estate -- in a desperate effort to keep up their living standard. But in the aggregate they would fail.... The imbalance between U.S. buyers and sellers would drive stock prices downward, leaving people with far less money than their account statements today suggest they'll have.

The cumulative gap between what retirees would need to keep 90% of their standard of living and what they'll actually get -- given all those assumptions -- is about $123 trillion between now and 2050, the model suggests. That's the U.S. figure; if the same calculation includes Japan, Europe and other industrialized regions, the gap rises to $347 trillion....

When he built a model covering the entire world, he was amazed: People in countries such as China, India, Indonesia, Brazil, Mexico and even Russia were projected to increase their wealth substantially.... They could dramatically increase their purchases of U.S. stock. "By the middle of this century, I believe the Chinese, Indians and other investors from these young countries will gain majority ownership in most of the large global corporations" in the U.S., Europe and Japan.... "The whole country is going to be like Florida," he says in an interview -- meaning the U.S. will slowly sell assets to foreigners just as retirees in Florida live by selling their stocks and bonds to people in other states. But "if the Chinese and the Indians don't come in, it will be bear-market times."...

Prof. Siegel has plenty of allies, however. Yale University economist John Geanakoplos argues that baby boomers have influenced stocks for decades, contributing to a slow market in the late 1960s and the 1970s as they came of age and aiding the long post-1982 boom as they started building nest eggs. "Baby boomers are reaching the end of the line and soon are going to have to be selling," says Prof. Geanakoplos, a boomer himself. "We should not rationally expect the same rates of return on our investments that our parents did."...

I have a very hard time getting Jeremy Siegel's results out of my own favorite back-of-the-envelope models. I find that even big sell-offs of assets by the elderly have little effect on the prices of reproducible assets--the sell-off takes generations, and (mostly) has the effect of reducing corporate investment as firms decide that they can use their cash better to merge than in boosting their own capital stock and capacity. But just because my own favorite back-of-the-envelope models don't show it doesn't mean it isn't there...

Posted by DeLong at May 7, 2005 04:44 PM