The Economic 'Skeleton Key' Is Flashing Red for the U.S. Today

The factors that make a country succeed or fail... From 'pioneering reformers' to 'stale leaders'... Wealth inequality is bad for growth... Treating hype with care... Inflation and debt – a one-two punch... The economic 'skeleton key' is flashing red for the U.S. today... Why this indicator matters so much... It's time to redefine 'success'...

In a world drowning in data, it's not hard to get bogged down and overanalyze things...

It's great to have so much information at our fingertips these days, but too many facts and figures can be a bad thing, too... It can play against us, making it hard to come to valuable conclusions.

But as I (Kim Iskyan) will explain in today's Digest, when it comes to analyzing countries and their futures, it's easier than you think to boil all of this data down in a useful way...

You see, one single figure stands out as the economic "skeleton key" for a country... its Rosetta Stone... its secret decoder ring... its key performance indicator... or whatever you want to call it.

It's the data point that, more so than any other, indicates whether a country is moving toward greater prosperity... or set for a slow, steady decline in the coming decades. It's about as important as every other indicator combined – from politics to geography to inequality and more.

And the important point I want to make today... right now, this figure is flashing red for the U.S.

In the coming years, this indicator and its implications will change the way we think about economic growth, immigration, and what type of stocks we'll buy. And it's not just the U.S., either... The economic "skeleton key" holds critical lessons for much of the world right now.

It's easy to overcomplicate the factors that make a country succeed or fail...

Economies are monstrously complex. They're the result of millions of independent decisions by individuals, companies, and governments... each with often conflicting motivations and objectives.

So-called economic research institutes develop sprawling, multifaceted models of economic growth... These models bring together enough data to choke a hippo. Ultimately, it's too much to handle.

But like a lot of things in life, the best approach is often much simpler.

Ruchir Sharma is a longtime emerging-markets fund manager at Morgan Stanley Investment Management. And in his 2020 book, The 10 Rules of Successful Nations, he finds that a middle ground between too much data and one tell-all indicator usually works best...

Some of the most important factors that contribute to growth, according to Sharma, include politics, geography, macroeconomic issues (like inflation and debt), inequality, and most importantly, the economic "skeleton key."

Let's start with politics...

Whether you like them or not, politicians play a pivotal role in driving a country's success...

Sharma places a lot of weight on political leaders...

For example, he applauds former British Prime Minister Margaret Thatcher and former U.S. President Ronald Reagan as "pioneering reformers"... They both worked hard throughout the 1980s, boosting their respective economies and strengthening their militaries.

And at the same time, Sharma warns of "stale leaders" who lose the impetus to change and grow content with the status quo. One of the best examples of this, in my mind, is Vladimir Putin...

When Putin became Russia's president in 1999, he introduced reforms to the country's tax system, government bureaucracy, land ownership, and bankruptcy legislation. I was a stock market analyst in Moscow at the time, and it felt like Russia was on the cusp of dramatic, generational change that would lay the groundwork for the former superpower to become an economic heavyweight once again.

But Putin's reform push ran out of gas after a few years, and nothing much happened.

Today, Russia is an investment backwater... The country's stock market accounts for just 3.2% of the MSCI Emerging Markets Index (a key stock market index benchmark), compared with around 10% in 2008. And economic output per person has barely changed over the past 12 years.

On the flip side, political leadership was critical to success in South Korea and Singapore...

Sharma points to Kim Dae-jung, who was South Korea's president from 1998 to 2003, as "arguably the most impressive change agent" for one of the most impressive success stories of the past century. He fundamentally changed the structure of South Korea's economy, dramatically improving the quality of life of the country's roughly 50 million people.

Sharma also commends Singapore's founding father Lee Kuan Yew, who was selflessly focused on the long-term success of his country while in power from 1959 to 1990. He's revered in Singapore for creating one of the world's greatest economic success stories – and one of the world's richest countries – out of a sweaty, Chicago-sized swampland. And he did it within just a bit more than a generation, through smart policy, political dexterity, and force of personality.

Like stale leadership, inequality also stifles success...

Basic math shows that wealth inequality is bad for growth.

Rich people tend to spend less and save more – as a percentage of their total wealth – simply because they run out of stuff to buy. A billionaire who owns 10 mansions will buy fewer washing machines, lawn mowers, and power drills than, say, 1,000 families who spend that same $1 billion in aggregate.

Over the long term, socioeconomic inequality can result in upheaval that's far more damaging than stagnant wages. History is peppered with reminders (French Revolution, anyone?) that if too few people hold too much of the wealth, eventually it will be redistributed – and both rich people and the overall economy will suffer.

Austrian historian Walter Scheidel theorizes that economic inequality has historically been addressed by one of what he calls the "Four Horsemen of Leveling" – warfare, revolution, state collapse, and plague.

Inequality can also result in revolution through the ballot box, via the election of a populist leader who delivers redistribution through asset seizures, expropriation, and loan-shark taxation levels. And that can be just as bad, if not worse... Just take a look at Argentina, Zimbabwe, Pakistan, Mexico, and Venezuela. As Sharma noted in his book...

Political revolts against inequality have often been as destructive as the inequities themselves.

In the U.S., tax-the-rich proposals in the name of income inequality are on the docket of President Joe Biden's White House. And it's not surprising... In late 2019, income equality in the U.S. jumped to its highest level ever, and the wealth gap between America's richest and poorest families more than doubled from 1989 to 2016, according to the Pew Research Center.

We've touched on this topic for years both here in the Digest and in other publications at Stansberry Research... It's a big part of why we wrote The Battle for America and have continued to update it.

The COVID-19 pandemic – and the policy response to it – has only made inequality worse...

In the Financial Times last month, Sharma estimated that the total wealth of billionaires globally increased by an incredible $5 trillion over the past year... up to $13 trillion. The U.S. alone is home to 110 more billionaires than a year ago (724 billionaires overall today).

By Sharma's model, inequality bodes ill for economic growth... And this accelerating disparity is bad news for the future success of America.

In the search for economic success, you must treat hype with care...

As investors, most of us have little direct impact on policies and macroeconomic forces... but we can make note of how these matters are perceived. And we can use these perceptions to guide our investing...

For example, if you're hearing a lot about a country's recent new success in the mainstream media... there's a good chance that the peak has already passed. Sharma explains one of the best examples of this idea in The 10 Rules of Successful Nations...

A classic case is the rise and fall of hype for Japan. Even after Tokyo markets crashed in 1990, the global media and political elite kept talking up Japan as the superpower of the future. In early 1992, Time magazine ran a cover touting predictions that Japan could overtake the United States as the world's largest economy within a decade.

Instead, Japan got sucked into an economic black hole... The economy averaged less than 1% annual economic growth for the next three decades. And today, the country's stock market is more than 25% below the December 1989 all-time highs... an entire generation later.

That sort of hype before the fall isn't unusual. In fact, it's normal...

Sharma looked at Time's economic cover stories from 1980 through 2010. He found that if the story was negative, economic growth accelerated over the following five years in 55% of the instances. And if the story was upbeat about a country, two-thirds of the time, the economy slowed over the next five years. As Sharma concluded in his book...

Economies are most likely to turn for the better... after the media have moved on.

In other words, indifference – rather than a strong feeling one way or the other – is what matters in most cases. In the media, that's reflected by an absence of coverage... And figuring out what's not being covered involves digging to see what's not there.

The best time to buy is after no one is talking about an idea anymore... You want to buy after the "blood in the streets" – to tweak the famous phrase from 18th-century nobleman Baron Rothschild – has long since been hosed away.

Our own cognitive biases can throw off our economic-forecasting game in a hurry...

"The only thing that is constant is change," Greek philosopher Heraclitus once said.

As we've seen throughout history, countries and economies that are on top now won't be there forever... And Sharma warns that it's difficult to internalize that constant impermanence.

"Anchoring bias" is the idea that we tend to think whatever is normal right now will continue to be the expectation indefinitely... whether it's good ("optimism bias") or bad ("pessimism bias").

I fell victim to this in 2001, when Russia had fallen off the radar after a brutal financial crisis...

Everything seemed hopeless. And I readily walked away from the country and my role as a stock market analyst in what turned out to be the early days of a 5,000% market rally over the next several years.

When things are going really well – or really poorly – it's important not to forget about the overwhelming force of mean reversion... That's when the pendulum swings back, when a period of unusual good luck or bad fortune comes to an end.

In his book, Sharma says to ask this question if you're struggling with this concept...

What will happen if the normal pattern holds and cycles continue to turn?... The rules are all about playing the right probabilities, based on the cyclical patterns of an impermanent world.

And that leads us to two other factors in a country's long-term success...

Inflation and debt can make or break economies, too...

Sharma noted that you want to look for countries with low inflation and manageable debt.

Moderation is key. And as we all know, the U.S. has been anything but that in recent years...

A successful, developed economy should aim for 2% inflation, according to Sharma. But remember, last August, the Federal Reserve announced that it was abandoning its longtime 2% inflation target – in favor of "average inflation targeting." In other words, the Fed will allow inflation to spike before it raises interest rates to counteract rising inflation.

We've warned about rising inflation a lot recently in the Digest... And sure enough, year-over-year inflation for April equaled 4.2% – the highest monthly reading since 2008.

It's a sure sign that inflation is here.

Concerns about rising debt will also sound familiar to regular Digest readers, too. So far, the U.S. government has distributed about $5.3 trillion in COVID-19 aid. And as of March 1, roughly 77% of all dollars that have ever been made were created over the previous 12-month period.

Plus, the federal deficit is forecast to hit 15% of U.S. gross domestic product ("GDP") this year, according to credit-rating agency Fitch Ratings. That's the biggest deficit since World War II. And when compared with 2.4% as recently as 2015 and 9.7% in 2009, you can see that it's out of control.

By Sharma's figuring – as well as that of pretty much everyone else – the U.S. is moving in the wrong direction on this front.

Still, this land is our land – and it's pretty good...

Some countries are blessed with good geography, which can allow them to fuel economic growth through trade.

The U.S., of course, has massive coastlines. When combined with well-developed ports and other needed infrastructure, it's a recipe for shipping success. And two important trading partners (Canada and Mexico) are our next-door neighbors, on long and easily accessible borders.

The land serves as an advantage in other ways, too... The U.S. is an ocean (or more) away from serious military competitors.

By investing in ports, a country can maximize its natural geographic advantage... One of the underappreciated reasons for Singapore's success is how it has maximized its position at a maritime bottleneck (the Strait of Malacca) through which 27% of the global oil trade and 18% of the global grain trade flows, according to geopolitical-risk consultant Eurasia Group.

Geography isn't destiny, of course... North Korea, for example, hasn't done much to capitalize on being situated at a prime global intersection of South Korea, China, Japan, and Russia.

A country can also be disadvantaged by geography...

The Central Asian country of Kyrgyzstan is trying hard to be open to trade. It's ranked above South Africa, China, and India on the Heritage Foundation's Index of Economic Freedom.

But at 1,620 miles, no country is farther from an ocean. So the chances that landlocked Kyrgyzstan is able to drive economic growth through trade are virtually zero... It's too remote to use trade to its advantage.

Underpinning it all, these are the two ingredients to growth...

Productivity – the structures and incentives in an economy to increase production per hour worked – is a key driver of economic growth. One way or another, nearly all of Sharma's 10 rules of successful countries all touch on productivity.

But the other key ingredient of an expanding economy (and Sharma's first rule of success) is population growth. Again, it's simple math...

If more people in a country are doing economically productive things like building houses, flipping burgers, or selling widgets – and they're doing it more efficiently than they did in the past – the overall economy will grow. As Sharma explained...

Throughout recorded economic history... population has accounted for half of all GDP growth... In a way, this is half the story.

Of course, a fast-growing population alone doesn't guarantee economic growth...

If it did, Djibouti and Uganda – population growth-leaders over the past 60 years – would be economic powerhouses. Elements of Sharma's nine other successful-country ingredients also must fall into place to drive productivity and create a successful economy.

However, population growth still stands above the others because no economy has ever been able to succeed without a sustained level of it... even if it can do everything else right. Eventually, a country needs more people to generate substantiable economic growth.

But where do more people come from?

That leads us to the economic 'skeleton key'...

The most important indicator of population growth is the fertility rate. If the fertility rate in a country is moving in the wrong direction, almost nothing else matters.

This number is the most important indicator of the future size of the working-age population (ages 15 to 64). It's a longer-term predictor of what you can expect from a country's workers.

And fertility has been falling worldwide for decades... The average number of births per woman has declined from 5 in 1960 to 2.4 in 2019, according to the World Bank. That's barely above the "replacement rate" of 2.1 children per woman (to "replace" those kids' parents).

In much of Europe and Asia – including Germany (1.57), China (1.69), and South Korea (0.98) – the birth rate is already below the replacement level. And here in the U.S., it's a similar story...

The fertility rate in the U.S. hit a 35-year high in 2007 at 2.12 births per woman. But since then, it has fallen steadily... dropping to a record low of 1.64 in 2020. To make things worse, there were more deaths than births in half of all 50 states last year.

This marks the end of what had been an advantage for the U.S... It had enjoyed higher fertility than much of the rest of the developed world into the 21st century, meaning it had the economic "skeleton key" in its favor.

But now, as we've shown, this pivotal indicator is flashing a warning sign for the U.S.

Here's why fertility rates really matter...

As the Financial Times explains...

For decades, the U.S. birth rate helped buoy growth, which is a function of people and productivity, and global status... but... all the factors that have propelled America's outlier fertility... are now in decline.

And it has made a huge difference for the American economy...

The U.S. currently accounts for roughly 25% of the global economy. But over the past few decades, if the population of the U.S. had been rising as slowly as Japan's (1.41 births per woman from 1988 to 2018), the growth of the U.S. economy would've been crippled... Sharma estimated that the U.S. would account for just 17% of the global economy in that scenario.

Of course, there's a lag between lower fertility rates and lower economic growth... But as we wrote in the Digest last September, the U.S. working-age population is already falling, too.

Immigration can fill the fertility gap to help power economic growth – but there's a catch...

Today, the U.S. has more foreign-born residents than any another other country. A total of roughly 45 million immigrants live in the country today, making up about 14% of the overall population.

And as fertility in the U.S. has declined, the immigrant work force has been the critical difference for the American economy... From 2010 to 2019, the U.S. economy grew at an average of 2.3% per year, compared with the European Union's 1.6% and 1.3% in Japan.

But from 2014 to 2019, the net number of new immigrants to the U.S. per year fell 80%, to just more than 200,000, according to the Migration Policy Institute. President Biden has since lifted some restrictions on immigration from his predecessor, Donald Trump – but it might be too little too late to make up for the drop in the working-age population.

And that's bad news for economic growth... A 1% decline in the working-age population will cut economic growth by 1%, according to Sharma.

With declining fertility, immigration is the only escape hatch for the American economy. And if that piece of the working-age population isn't what it used to be either, the U.S. could be in trouble...

As growth becomes more difficult, it's time to redefine 'success'...

Right now, in the U.S., the growth drivers of demographics and productivity are slowing. As they continue to slow, economic growth will decelerate.

And what's happening now in the U.S. and most of the rest of the world is just the beginning...

According to a widely discussed July 2020 article in medical journal The Lancet, by the end of the century, 183 of the 195 countries in the world won't be able to maintain their current population levels without immigration. That's less than 80 years from now, and of course, not every country can grow through immigration at the same time...

Sure, it's likely beyond when you or I will live, so it doesn't matter to us directly. But it certainly matters for our kids and grandkids... The world is headed for a much different future.

And by then, the population of 23 countries – including Italy, Spain, Japan, and Thailand – are forecast to see their respective populations shrink by more than half. In another 34 countries – including China (down 48%) – the population is likely to drop by between a quarter and a half.

One of the very few bright spots, population-wise, is Sub-Saharan Africa... In that region, according to the Lancet article, the population is expected to triple by 2100 – to more than 3 billion. That would be slightly more than one-third of total global population at that point.

With all that in mind, here's what the mindset shift means for stocks...

Put into stock terms... the U.S. economy is shifting from being a growth stock to a cash-flow and dividend story. That's a difficult – and if you're a shareholder, costly – process...

Growth stocks are characterized by strong revenue growth and (usually) high earnings growth. Think of video streamer Netflix (NFLX) in its boom days... As an investor, you buy a growth stock because its share price might double, triple, or more as the business keeps growing beyond expectations.

In contrast, dividend stocks have steady cash flow – and they earn a solid profit – but they don't grow much... Think of a real-estate investment trust in which shareholders collect rent on properties that don't change much in overall value. You might receive a 3% or 5% dividend, but the share price (usually) won't rise or fall much... The value is in the steady income it generates.

The problem with growth stocks is that eventually, their growth curve flattens. Revenues can only double... and then double again... for so long before the growth slows. Competitors see the opportunity in whatever arena it is, and they cut into the company's market... Margins decline, and growth falls.

The best companies – and stocks – in growing sectors can deliver growth for decades. But of course, the reality is that the vast majority cannot... And if you're a shareholder of a stock when it suffers slowing growth, you're going to see a sharp fall in its share price as investors adjust for lower expectations of future growth.

Right now in the U.S., the growth drivers of demographics and productivity growth are slowing. As they continue to slow, economic growth will decelerate.

In stock market terms, the American economy is going to evolve from being a growth stock to more of a dividend and cash-flow investment.

That might sound strange... just as the post-COVID-19 economy roars back to life, with U.S. GDP growing by 6.4% on an annualized basis in the first three months of the year.

The bounce-back from pandemic-related lockdowns, and mean-reversion after the 3.5% contraction in the economy last year – fueled by the Federal Reserve's money-printing mission and COVID-19 stimulus cash – will continue for a while. The International Monetary Fund forecasts still-solid economic growth of 3.5% next year.

But as French sociologist and philosopher Auguste Comte once said, "Demography is destiny."

Not even the Fed can fight the realities of the fertility rate – the economic "skeleton key"... or prevent America's economy from faltering as population growth tapers off. And we're already seeing the impact of the destiny of demographics being played out in Europe, where declining populations and weak economic growth – and poor stock returns – are increasingly the norm.

In the meantime, though, the economic "skeleton key" highlights just how little of the noise – masquerading as data – in day-to-day market talk really matters over the long term...

All of Sharma's nine other factors – including politics, debt, inflation, inequality, geography, and hype – are only about as important as demographics when put together. And right now, the big picture is saying that growth will substantially slow from here... which is bad news for stocks.

Consider this an early warning bell.

New 52-week highs (as of 6/7/21): ABB (ABB), American Homes 4 Rent (AMH), American Express (AXP), Biogen (BIIB), Blackstone Mortgage Trust (BXMT), Crown Castle (CCI), Richemont (CFRUY), Colony Capital (CLNY), Commvault Systems (CVLT), Dropbox (DBX), Facebook (FB), SPDR Euro STOXX 50 Fund (FEZ), Alphabet (GOOGL), Invitation Homes (INVH), Cheniere Energy (LNG), Nestlé (NSRGY), United States Commodity Index Fund (USCI), U.S. Concrete (USCR), Victoria Gold (VITFF), and Washington Real Estate Investment Trust (WRE).

In today's mailbag, feedback on Stansberry NewsWire editor C. Scott Garliss' recent essay honoring those who served in World War II... and a note on the origins of the term "HODL." Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Dear Scott, thank you for sharing your story about your grandfather and D-Day. Your story was so well written that my memories flooded back to the day my father returned home from WWII. He was an intelligence officer on the Block Island II, a carrier in the Pacific. He also would not talk of the war and his experiences – ever.

"As I opened the front door at age three, I saw my father standing there and ran to the kitchen to tell my mom 'there is a man at the door.' How sad my father must have been that his baby didn't know him when he returned in 1945.

"I forwarded your story to my sons and nieces because we all should never forget what that great generation gave up in order to save the world from evil." – Paid-up subscriber Betsy B.

"First, thanks to Scott Garliss for his recognition of the Greatest Generation... My father landed on the beaches of Normandy on the second day and began the long trek to liberate Europe. He is 96 and is in quite good shape. He vividly recalls many of the events of the war, especially in the episode where he earned a bronze star for the Battle of the Ardennes Forest. I agree we can't begin to fathom the life changing events of that era and will never be able to adequately express our gratitude for the freedom that we enjoy today.

"On another note, I wish to [clarify] Dan Ferris' definition of HODL. Dan incorrectly attributed the definition of HODL to the acronym 'Hold On for Dear Life.' In fact, the term HODL was first used December 18, 2013, during the first bitcoin 'crash' in a post by a member of a bitcoin bulletin board. He posted a rant against bitcoin traders and admitted he could never trade well so he was HODLING. He confessed it was a drunken rant and he had tried to spell HOLDING but he decided to just leave the misspelling.

"Since then, HODL has become the battle cry of the bitcoin community who believe in free markets, honest money, and bitcoin as a medium to free the economically oppressed. To HODL is to believe in the ultimate power of bitcoin to serve as the basis for eventual economic freedom and resist the market manipulation by traders.

"Indeed, bitcoin is the very definition of free market money as seen in the last 'crash,' where overleveraged traders, some as much as 100x, were liquidated by exchanges as the price fell. There were no exchange circuit breakers to halt trading, no bailouts by any government, nor any other resetting of the market. The market performed as intended and the price stabilized fairly quickly. So HODL and you will be rewarded." – Paid-up subscriber Sherman T.

Good investing,

Kim Iskyan
Dublin, Ireland
June 8, 2021