Theoretical economics? You've got to be kidding...


ref :- "Demographics will not reverse interest rate fall" by Robin Harding in the Financial Times, Economics

Generally speaking, theoretical economics is an area we are only too happy to steer clear of, and confess to enjoying the many quotes made at economists' expense. Those offered by J.K. Galbraith, who as well as being an advisor to J.F.K. and Ambassador to India was primarily an economist himself, could fill a small book on their own ("Economics is extremely useful as a form of employment for economists"). Perhaps that's one reason many subsequent economists over the years have been happy to criticise Mr Galbraith's own theories, though in fairness his post-Keynesian , interventionist approach to capitalism would find few high-profile adherents in the modern era... at least not in the US and other mature economies.

Our excuse for not getting over-involved in this area is that by definition it is theoretical and usually long-term in nature, and only rarely has any great practical relevance to what we're focusing on... that, and the fact that we're not bright enough to follow most of the ideas being advanced. We're only highlighting this piece because the subject matter is getting a fair bit of space in a number of financial news outlets, and because it might just be more relevant to those making investment decisions over a shorter timeframe.

So, in our very simplistic fashion (we know no other way) and very briefly, here goes:

Last year economists Goodhart and Pradhan published their theory (The Great Demographic Reversal) that ageing populations ultimately are a driver of inflation, which will induce a higher interest rate response. The idea is that an increasingly significant portion of the population, after spending years saving for retirement, eventually reaches the stage where they start to spend on whatever retirees like to spend their money on and subsequently on the inevitable and onerous costs of healthcare. This spending translates into demand for the services of a shrinking workforce, which pushes wages higher which in turn then drives prices up. Result: higher inflation, and consequently higher interest rates.

It all seems perfectly logical, but how then does one account for the experience of Japan, which has the fastest-ageing population of all and despite the added huge stimulus of Abenomics has spectacularly failed to kick-start any upticks in inflation?

Messrs Auclert, Malmberg, Martenet and Rognlie think they know the answer. In a new paper they argue that Goodhart and Pradhan's theory is incorrect. Yes, an ageing population will spend its savings but that is more than compensated for by the fact that ageing populations reduce growth, which lowers demand for investment. That being the case, there is little chance of a new era of higher rates. In fact, ageing populations will have the opposite net effect and the downward trend in rates that has already been going on for so long is set to continue. That, needless to say, has "profound implications for investors and central banks across the world".

And there's more... at the Jackson Hole conference at the weekend (yes, we're back there again), Professor Amir Sufi presented new research that that would seem to confirm what we already assume: rising inequality also puts downward pressure on rates. The rationale behind that thinking is that wealthy households save more, and if they're getting a bigger proportion of total income then taken as a whole overall savings go up. More savings relative to investment = lower rates. The professor notes that rates of saving vary far more by income than they do by age, and thus inequality is an even bigger factor than demographics.

From an investment point of view, it all means that with continued downward pressure on rates we might expect asset prices to remain high and returns to stay low. For a fuller, and let's face it more knowledgeable briefing on what might be in store, you should have a read of this article. But in case anyone is tempted to believe that such theoretical musings have little bearing on what's going on right now, there's plain evidence that it is affecting the thinking of key players already.

Fed Chairman Powell said on Friday (again, at Jackson Hole) that these long-run factors "will continue to weigh on inflation as the pandemic passes into history". Mr Harding posits that it may be the reason why Mr Powell is so "sanguine" about the current inflationary spike, even if others are less so. It could be that Mr Powell, and other central bankers, would welcome a more prolonged bout on inflation than they currently profess to expect as it would give them an opportunity to raise rates if only because they'd have the ammunition of cutting them when the next crisis rolls along.

The article finishes where it started... in Japan, still as far from any inflationary upticks as ever. It's a prime example of lack of investment outweighing late-life spending as an effect of an ageing population. Things are still looking pretty bleak for the younger workforce, for as Mr Harding puts it: "More jobs at care homes do little good if there are fewer at factories and building sites". If the rest of the developed world follow where Japan leads, well... it's not a pretty picture.

Have a happy day!


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