Noise, Demographics & Why We Need Lower Rates
My one-word summary of the week: NOISE.
The U.S. is banning visas on certain Chinese officials? Risk-off! The Chinese are open to a partial deal? Risk-on! Having been a professional money manager for most of my career, volatility-inducing headlines like these used to make me lose sleep – literally. Now that I’m mostly managing my own money and not overly concerned about monthly mark-to-market performance, I find it somewhat easier to cut through the noise and focus on what I consider to be bigger picture trends.
What I heard this week through all the noise was that the Fed has turned decidedly dovish and is expanding its balance sheet once again – just don’t call it QE! Okey dokey, Jerome. In the same interview, he also echoed some of my own musings that while there may be “bubblets” here and there, there simply is no evidence of an all-encompassing “irrational exuberance,” and therefore the economy “still has significant room to run” (paraphrasing here).
Regardless of whether you agree with this or not (I agree), I think this is significant coming from the Fed Chair. The primary argument I hear from bears is essentially this: “the Fed is pushing on a string,” “companies aren’t going to hire/spend more just because interest rates are 0.50% lower,” etc. Respectfully, I think this argument misses the crux of the issue – the USD is just too strong vis-à-vis most world currencies and will continue to strengthen if the Fed does nothing. Why? Because at least 20 central banks around the world are easing to combat their own fiscal/structural issues.
Quick digression on these structural issues – I think the big albatross around everyone’s necks is demographics. Why on earth are central banks around the world continuing to ease when the world is already awash in $17 trillion of negative-yielding debt? Again, zooming way out from the day-to-day minutia, I think the primary issue the developed countries are facing is an aging population, and this factor more than anything else is going to drive the global economy in next several decades.
Barron’s ran an excellent cover story several weeks ago about this demographic time bomb, and I’m going to borrow 2 of their exhibits (see below).
The first exhibit on the left is pretty self-explanatory – the world’s population mix is getting older. Japan’s post-WWII Baby Bust shows exactly what happens economically as a result of this effect – tepid growth for decades despite perennially low rates.
The exhibit on the right really startled me. The caption is hard to read, so I repeat it here: “The time it takes for people over 60 to grow from 10% to 20% of the population.” The U.S., with a population of around 330 mm, takes 75 years to reach this milestone – although we have a looming Social Security problem, we’ve arguably had enough time to build the societal infrastructure required to handle this shift. China (population: 1.4 bn) and India (population: 1.3 bn) have far shorter timeframes to deal with a much more massive population shift. While we here in the U.S. face structural issues of our own, there is far more slack in the system -- we have far more land and resources with a quarter of the population, and we have a far higher rate of immigration (although it’s debatable whether this helps or hinders our structural issues).
China and India are going to face huge structural headwinds on this front. Not only are they far more populous, they are also short the resources that we are naturally long: food, water, and oil. In this context, it makes sense that the Chinese Communist Party is hell-bent on stimulating its economy through urbanization and the creation of a viable middle class – they are truly racing against the clock. The adage that “China is going to grow old before it grows rich” rings somewhat true to me, and this further bolsters my case (see Kaoboy Musings 5) that China has the much weaker hand in this trade war. End of digression.
So now that we’ve established a potential why for the seeming nonsensicality of negative yields around the world, I go back to why an accommodative Fed is important. If we do nothing, and the rest of the world continues to ease, we are actually tightening economic conditions through the strengthening USD, which will effectively import economic weakness from abroad. I believe this is why the Administration has been lambasting the previously hawkish Fed – I agree with the call for lower rates, but I don’t condone the lambasting.
In short, this is why I’m still sanguine on the U.S. economy. Now that we’ve had a whiff of economic slowdown in the numbers, the Fed has morphed from hawk to dove, and now that the Fed is no longer “in the way,” we are no longer boxing China with one hand tied behind our back. This strengthens our hand in the negotiations, and with an upcoming Presidential Election in 2020, I predict that the Administration will incentivize China to do a deal sooner than later.
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Kaoboy Musings is a private distribution list/blog that I created to encourage dialogue regarding the economy & markets, geopolitics, investment ideas, and life in general. I have a passion for the markets and investing, and even though I no longer accept investor capital, I try to keep current on global events and opportunities and remain active in the markets. I’ve always found that writing my ideas down, sharing them with smart people, and encouraging two-way discourse and devil’s advocacy is often the best way to validate or invalidate a thesis and stay mentally flexible.
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