Written by: Thomas Signer, Member of the Advisory Board of ELIA Investment Advisors Ltd.
When we first meet a child, one of our initial questions is “how old are you?” No other piece of information gives us as many clues to the child’s likely desires, interests, knowledge and activities. For similar reasons we are equally keen to learn an adult’s age. Usually, we act more subtly in obtaining it.
However, we generally don’t have a similar interest in the development of the average age of a country’s population. There has been tremendous change in this dimension. With a median age of 38 years in 2020, Americans are clearly a very different citizenry from who they were with a median age of 25 years in 1920, and just 17 years in 1820.
The table below highlights the enormous “ageing” underway – with the exception of Africa.
Median Age in Selected Countries & Regions
Source: UN Population Prospects 2019 revision; Estimates for 1950 to 2000;
UN’s low variant projections are used for 2025 E (Expected) and 2050 E. Own table.
Age not only reveals a lot about a person’s consumption but also their savings habit. Intuitively, the aggregate development of consumption and savings trends should impact the price level in a FIAT monetary system, i.e. determining whether inflationary or deflationary forces have the upper hand. After all, the price level is the resultant of demand meeting supply. Babies and youngsters only consume, as do folks in their retirement ages.
On balance, an increasing proportion of “consumers” in society would favor inflationary trends. Only working people contribute to the supply of goods and services and in aggregate don’t consume the equivalent value of what they produce (in order to generate savings). Their activities have deflationary character. Correspondingly, looking at the developments of “dependents” (consumers) vs “independents” (producers) is worthwhile.
The below graph shows that the size of cohorts of people in the non-working ages vs those of working ages. The resulting Total Dependency Ratio, which is simply the quotient of “consumers” divided by “producers” has, and will, continue to materially change from 1950 to 2050 (the data does not incorporate the fact that a large number of people in the working ages are not working; particularly in the US the “participation rate” has dropped in recent years):
The dependency ratio captures the relationship between “consuming” and “producing” groups. Adding the cohort of 0-19 years olds to that of over 65 year olds and dividing the sum by the size of the cohort in between (assumed to be all working) yields the above dependency ratio.
Source data: United Nations Population Prospects 2019 revision; for the expected development of the ratios from 2025 to 2050, data from the UN’s low variant are used. Own graph.
In short, it would seem odd to discuss inflationary or deflationary developments fully detached from demography. But that has been the case over decades now. Statements of key central banks generally have made no mention of demographic developments. Instead, central bankers have sought to “manage inflationary expectations”. As if an individual’s consumption or savings habits could be managed by decree. An exercise detached from real life experience.
The conclusion from the above thought experiment is stark: The pursuit of the “golden” two percent inflation target, a mantra restated by all key central banks over the years, may amount to nothing less than an attempt to fight changing demography, i.e. to impose rigidity onto a slowly but powerfully moving force. A fight monetary policy is unlikely to win in the long run.
The disinflationary trend starting in the early 1980s may have been less the result of FED chairman Volcker “breaking” inflation expectations and activist central bank policies since, as the common narrative holds, than simply the price cycle adjusting to changing demographics. However, the trend of an increasing proportion of society in the producing group has now been broken in all major Developed Economies, with only the cohort of elderly growing very rapidly.
The strongest argument for a demographically driven view of financial markets may come from the study of Japan. Since humans are not “economic utility maximizing agents” but rather “bias driven animals” – a view now broadly undisputed – theorizing about human behavior yields little insight. Observing behavior, however, does. So, to study the impact of ageing in empirical fashion is best done by looking to Japan.
The Japanese form the ideal “control group”. The island nation has autonomously undergone distinct boom and bust cycles, preceding other developed countries not only in their economic and financial but also demographic cycles. The baby bust hit Japan in the early 1950s vs the US and Europe in the 1960s. Japan experienced disinflation a decade earlier. It also witnessed a giant equity and real estate bubble in the 1980s vs the US and Europe in the 1990s. Since the bust of the bubbles in both stocks and real estate in the early 1990s Japan has experienced increasingly strong deflationary pressures. Those the Japanese central bank (BOJ) fought with ever more extreme monetary policies. Particularly with Abenomics and a new central bank governor in 2012, Japan went into monetary overdrive. Higher stock and real estate prices since then must be credited to BOJ’s hyper-aggressive policies. Particularly higher real estate prices since 2012 are entirely detached from underlying demand trends, with a record 8 million homes vacant in 2021.
Indeed, it may be argued that the “successful” monetary policies which have prevented declines in asset prices in stock and real estate markets both in Japan and Western countries have accelerated demographic decline. Household formation remains low not least due to the high cost of housing and education. Birth rates in key economies have hit new lows during the pandemic. In 2021, Japan recorded a record low 0.805 million births (with a population of 127 million), China 10.6 million (with a population of 1.41 billion) and for 2021 the US may record a similar new lowly number of 3.6 million as in 2020 (for a population of 332 million).
Doubtlessly, the growth of debt and asset values is on collision course with a decline in births and working-age populations. Disruption is programmed.
Five key takeaways emerge from this first cursory review of Demography & Financial Markets:
- Demographic cycles may be at the root of economic and financial cycles. The study of demography may help forecast future developments in asset markets. Fortunately, demographic developments are highly predictable.
- The giant growth in asset and debt aggregates since the early 1980s may be substantially the result of ageing societies, which are disinflationary at core – up to a point. However, corresponding deflationary outcomes in stock and real estate markets have been “successfully” averted by central banks, foremost the US FED. They intervened more forcefully in each new financial crisis and so prevented deflation from materializing. Proper price discovery has been suppressed in financial markets for decades.
- With financial markets not being allowed to impose financial discipline, power has shifted into the hands of governments and central banks. Governments have been enabled to finance any size of deficit and make costly promises to large groups of (elderly) voters.
- The deflationary trends set in motion by ageing societies may still not have run their course. Japan, as the furthest ahead country in this process, still enjoys a strong currency, low inflation and solid asset prices. This would imply that deflation and a deflationary financial bust, rather than inflation, is still the bigger challenge for all developed countries for the foreseeable future.
- A point will come when demographic changes favor inflationary developments, rendering government deficits unfinanceable. History teaches that, at that point, governments will resort to drastic confiscatory measures. Wealth planning must take such a potential sharp paradigm shift into account.
Thomas Signer, Zurich, Switzerland (Biography)
Thomas has been passionate about finance and economics for all his adult life. After working at Nomura Securities and Morgan Stanley in Zurich, New York and London, Thomas started his own financial consultancy in 1998. He teaches MBA courses in finance at a SBS Swiss Business School and hugely enjoys delivering tailor-made finance education programs to the Next Gen. He has published two books on the parallels between the United States and Japan in the spheres of economics and finance. He sees demographic change as the key force shaping societies and financial markets and conducts his own research in this field.
Thomas lives in his native country Switzerland. He concluded his studies in the US with a MBA from Tepper School of Business at Carnegie Mellon University.
More information on his thoughts and insights can be found at: https://www.signer.swiss/