This episode comes from conversations I’ve had recently concerning interest rates, inflation, economic growth and why they are all relatively low in historical terms. We dig into how the global financial paradigm has changed and why the basic principles of investing can no longer be taken for granted in today’s world.
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The Realities of Aging Populations
In recent conversations, I’ve generally noted that the cause of low interest rates, inflation and economic growth may be demographics (aging populations) and technology (think Amazon and other tech companies driving prices down for many consumer goods).
In an August, New York Times opinion article from Ruchir Sharma called: Our Irrational Anxiety About ‘Slow’ Growth, the author explains how demographics are affecting growth, or actually, the lack of growth.
Here are some highlights from his article:
- Global markets have been under pressure these past few weeks because of fear that trade wars are "slowing growth in Germany, China and the United States. But the story here is bigger than President Trump and his tariffs."
- "Since the financial crisis of 2008, the world economy has been struggling against four headwinds: deglobalization of trade, depopulation as labor forces shrink, declining productivity and a debt burden as high now as it was right before the crisis."
- "Forty-six countries around the world — including major powers like Japan, Russia and China — now have shrinking populations."
- "Demographics are usually the main driver of economic growth, so it is basically inevitable that these countries will now grow at a much slower pace."
This isn’t all doom and gloom, however.
A Better Measure of Economic Growth
Sharma recommends shifting to measures that better capture satisfaction and contentment, like per capita income growth. In countries with shrinking populations, per capita incomes can continue to grow so long as the economy is shrinking less rapidly than the population.
This helps explain why, for example, Japan isn’t facing more social unrest. Its economy has grown much more slowly than that of the United States in this decade, but because the population is shrinking, its per capita income has grown just as fast as America’s — around 1.5 percent per year.
Shrinking populations also help explain why unemployment is at or near multi-decade lows, even in countries with serious growth worries, like Germany and Japan. Gainfully employed Germans and Japanese won’t really feel as if their countries are in a slump until per capita GDP growth turns negative — which may prove to be a more useful way to think about recessions in this new era.
The number of countries with shrinking populations is expected to rise to 67 from 46 by 2040, and the decline in productivity growth is in many ways reinforced by heavy debt burdens and rising trade barriers. Redefining the standard of economic success could help cure many countries of irrational anxieties about “slow” growth and make the world a calmer place.
So, to recap, developed countries around the world are experiencing population declines which will probably lead to slow or negative total GDP growth in these countries. Moving forward, looking at per capita income will probably be a better statistic to use to gauge the well-being of the populations.
Negative Interest Rates on Debt
Continuing with this same theme of relatively low interest rates, low inflation and low economic growth, a crazy fact today is that around 25% of global debt yields negative interest rates. To go deeper, let's consider 5 questions.
1. Why invest in a bond that will lose you money?
Typically, bonds are considered the safest assets on the market, so investors invest in them during times of volatility and market stress, which is what the world is experiencing at the moment.
A negative yield means the owner will lose money.
2. Why are negative interest rates reason for worry?
Negative rates are at odds with the basic principles of the global finance system. According to Marcus Ashworth, a Bloomberg opinion columnist covering European markets: “An important law of financial logic has been broken –- that law being that if you lend money for longer, you should see a higher return.”
This is no longer the case. “The time value of money has essentially disappeared.” All this can push investors into riskier bets in the hunt for returns, raising the chances of bubbles in financial markets and real estate.
3. How did we get here?
Several of Europe’s central banks, otherwise unable to spur growth in the aftermath of the 2008-2009 financial crisis, cut interest rates below zero in 2014. Japan soon followed. The idea was to spur lending by charging financial institutions, rather than rewarding them, for parking money that otherwise could be put to use in the real economy.
Since 2016, the European Central Bank's (ECB) benchmark rate has been -0.4%, meaning investors lose 4 euros to store 1,000 euros there. The sub-zero rates were supposed to be temporary but have endured. Traders are betting that the ECB will push its deposit rate even more negative this year, driving record levels of bond yields below zero.
4. Why have negative rates lasted so long?
More than a decade on from the credit crisis, inflation is still scarce, with wages increasing only modestly despite large drops in unemployment. The ECB, for example, isn’t expected to get to its close-to-2% inflation target over the next decade.
5. Where’s all this heading?
In Europe, there are fears that the continent is following the path of Japan's so-called lost decade, where policy makers struggled to revive anemic growth and inflation. This is probably caused by the lack of population growth discussed earlier.
Geopolitical tensions over trade, and Britain’s exit from the European Union will keep driving investors into the safest assets, meaning demand will remain high for negative-yielding debt.
In this new paradigm, advisors, clients and investors in general need to keep a very open mind on how things have changed and that “the old-school basic principles” can no longer be taken for granted in today’s world.
Be mindful of advisors and/or pundits still playing the game with outdated rules.