Spend, Spend, Baby: Are Boomers defying monetary policy?

A couple of weeks ago, I was having lunch with one of our board members, and the conversation turned to the weird economic phenomena we have both noticed. Higher interest rates and inflationary conditions do not seem to be impacting discretionary spending. Instead, we have labor shortages in travel, leisure, restaurants and hotels, and Europe was completely overrun with tourists from the U.S. all summer. Are Americans simply much less impacted by monetary policy than in past cycles, we wondered together, or is there perhaps something else going on that is muting the rate hikes???

I thought aloud if perhaps our unusual economic trends have something to do with the rapidly retiring baby boom generation. This prompted my lunch companion to blurt out, “Shannon, you should see my friends – they are spending like there’s no tomorrow!” As a card-carrying member of the Boomer generation, she has a front row seat to the retirement wave of 76 million people (about twice the population of California) who are presently between the ages of 59 and 77. And she’s watching as her retired friends and neighbors exhibit a degree of profligacy previously unheard of as they buy exotic vacation experiences, second homes, and new luxury cars. Inflation and higher interest rates be damned!?

According to Federal Reserve estimates, the Boomer generation owned half of U.S. assets, about $78 trillion, as of the end of June of this year. Here’s a quick visual of wealth breakdown by generation:??

Within the Boomer generation this wealth is not distributed evenly. Approximately 10% of adults 65 and older live below the poverty line, per the most recent U.S. census data. About 42% of this generation have no retirement savings at all. 10,000 Boomers hit retirement age every single day, and an estimated 45% or so are considered retired. There are a lot of moving parts to consider when contemplating how this wave of folks exiting the job market and making different spending decisions will wash through our economy. Today, let’s narrow our focus to how and why the Boomer generation may be impacting monetary policy.???

According to the U.S. Bureau of Economic Analysis, personal consumption expenditures account for 68% of GDP in the U.S. We are a consumption driven economy, so the prevailing economic wisdom has historically been that when inflation goes up, the Fed raises interest rates to tighten financial conditions. The increased cost of tight financial conditions should force consumers to spend less on goods and services, and more on debt servicing and basic needs. Yes, I am aware that there is quite a bit of arguing among economists about how well or how equitably this framework has worked in the past, but let’s leave that to the side for the purpose of this newsletter.??

The Fed has rapidly raised interest rates, and the pace at which prices are increasing has modified, per the chart below:?

Notably, a slowing in the rate of inflationary increases is not a decrease in prices from elevated levels. So, prices remain far above the absolute levels consumers were accustomed to while the cost of debt service has exploded.??

Take a 30-year fixed rate mortgage of $350,000. The cost to service the principal and interest on this loan at a 3% interest rate is under $1,500/month for a loan taken out in 2021. At current mortgage rates (over 8%), the debt service cost for the same loan has nearly doubled, to $2,800/month. Weave in student debt, car and credit card payments at these rates, while everything else you are buying is still getting more expensive, and it sure seems like we should have a massive economic headwind. Except we don’t, at least not yet, and the retired Boomers may be part of the explanation why.??

There appear to me to be two major factors that support a case that wealthy Boomers may be short-circuiting the impact of restrictive monetary policy: they are 1) less sensitive to the increase in interest rates and 2) they have become a very large percentage of total consumer spending.??

Millions of financially secure adults in their retirement years have limited exposure to higher debt servicing costs. While approximately 10 million people over 65 have a mortgage, most are locked in at very low interest rates, and are scheduled to fully pay off these loans within 10 years. Borrowers over 62 hold the least amount of outstanding student debt, representing only 6% of total student loan borrowing. And while most Boomers have a few thousand dollars of outstanding credit card debt, they tend to pay off balances quickly, avoiding the interest penalty. On the asset side of the ledger, financially secure retirees are receiving more interest on fixed income, money market and savings accounts as a direct benefit from the Fed’s tighter monetary policy.??

This combination of little to no debt plus a historic 40-year rally in stock prices during peak investing years and becoming direct beneficiaries of higher interest rates into retirement is unique to the Boomers. An additional shift is that they are moving from being primarily tax payors to recipients of tax-related benefits in the form of Social Security and Medicare payments. The result is that the Baby Boom generation has accumulated wealth unlike any previous generation and is now in the process of spending it.?

The share of consumer spending by adults 65 and older has marched steadily higher over the last two decades. As you can see in the chart below, the 65+ population is now the largest share of consumer spending , at 22% of the total, of all age groups. This is pretty incredible when you recall that peak spending years are generally considered to be 35-64, when most of us have family and education-related expenses.??

Further evidence of just how weird this situation seems to be is evidenced by how insensitive the 65+ cohort currently is to inflation. This chart shows reported changes in household spending by age group. We expect that the inflationary conditions + increased cost of borrowing should result in a material dip in household spending. This thesis clearly holds true in the sharp drop off in spend for every age group except the Boomers.??

Anecdotal evidence, like my board member observing significant spending among her peers, provides further data on Boomer spending trends. I’m writing this newsletter on a flight to Raleigh, and easily ? of the plane is over 50. This is the 5th flight in a row where I’m chatting with row mates who are a retired couple traveling for fun to a destination vacation. We are sunsetting the “revenge travel” of 2022 and business travel remains below 2019 levels by 10-20%, yet every flight I’m on is oversold. The biggest jumps in retail sales this year are in the food, beverage, travel and entertainment categories. Consumer spending in these “fun” categories remains the #1 driver of GDP growth and fueled the recent September print of +4.9%.??

One item that has received little attention in the press is that the Boomers are the first generation with significant wealth who manage their own retirement account investments and distributions. Their parents had defined benefit pensions in retirement, where companies, actuaries and professional investors work to determine benefit amounts. The current generation of retirees have predominantly defined contribution plans, like 401ks and self-funded IRAs. For the most part, they are selecting their own investments and deciding how much to distribute to themselves in retirement.??

Only about 30% of workers and retirees surveyed by the Employee Benefit Research Institute work with a professional financial advisor. As my board member noted at lunch, “I think I have a lot of friends who don’t realize they need to save part of their RMDs” to maintain their lifestyle over time. RMDs, or required minimum distributions, are the amount the IRS says retirees need to withdraw from retirement accounts after a certain age. The Boomers are just starting to hit this age category and may assume they should add the full amount to their annual budget. With many folks living well into their 90s, the lack of professional advice may result in a material financial shortfall as healthcare related costs drain budgets late in life.??

In the meantime, younger Gen-Xers and the Millennial generation, who are in their highest spending years, are essentially experiencing a double whammy on their ability to generate both consumption dollars and accumulate wealth at the same time. With high expenditures, these groups are forced to absorb the inflationary shock in full. Higher expenses result in lower cash balances, so they are largely missing out on higher interest on savings. Higher mortgage rates limit home purchase options and discourage geographic movement, and the resumption of student loan payments is just beginning to be felt.?

What if the framework for monetary policy we’ve become accustomed to over the last 45 years no longer works? What happens if the Fed keeps tightening, and the Boomers keep spending anyway? Will the Fed smashing the younger generations’ financial situation eventually cause a correction big enough to kill inflation, or is the wave of retirement spending simply too large for the rest of us to offset???

We are just at the beginning of a very strange economic journey. I look forward to reader thoughts in the comments!?