The Most Important Paper Of The Next Decade

Authored by Kevin Muir via The Macro Tourist blog,

Whenever I tell people the next big crisis will come from inflation, not deflation, the looks of disgust are worse than when someone says Justin Bieber’s music is not that bad. And when I try to tell them that the true bubble is in fixed income, not stocks, they look at me as if I just slipped the Biebs into the next-up slot on the Spotify playlist.

“Where will the growth come from?” they often ask or, “demographics will keep inflation subdued for another generation,” they retort.

And I must admit, I have always had difficulty articulating how inflation would manifest. Usually, I would go with the classic, “throughout the millennia, governments have always resorted to inflating their way out of debt, and this time will prove no exception.”

But that has always left a sour taste in the mouths of the deflationistas who cannot imagine anything but falling prices and moribund growth. These investors need a theory why the trend will change. And it has always been difficult to slap any research in front of them as the Lacy Hunt deflation crowd seems to have the market cornered with their articulate forecasts that the trends of the last 30 years will continue ad infimum, and that interest rates are going to zero throughout the entire developed world.

Until now…

In a Bank of International Settlements paper from this summer, Charles Goodhart and Manoj Pradhan present a powerful argument that demographics are about to usher in a sea change. I am surprised the paper is not receiving more attention, but I guess with everyone so focused on the supposed coming deflation, this sort of research is not all that popular.

But you should go read the paper titled “Demographics will reverse three multi-decade global trends“ today. I suspect it will be one of the BIS papers of the next decade.

Here is the abstract:

Between the 1980s and the 2000s, the largest ever positive labour supply shock occurred, resulting from demographic trends and from the inclusion of China and eastern Europe into the World Trade Organization. This led to a shift in manufacturing to Asia, especially China; a stagnation in real wages; a collapse in the power of private sector trade unions; increasing inequality within countries, but less inequality between countries; deflationary pressures; and falling interest rates.


This shock is now reversing. As the world ages, real interest rates will rise, inflation and wage growth will pick up and inequality will fall. What is the biggest challenge to our thesis? The hardest prior trend to reverse will be that of low interest rates, which have resulted in a huge and persistent debt overhang, apart from some deleveraging in advanced economy banks. Future problems may now intensify as the demographic structure worsens, growth slows, and there is little stomach for major inflation. Are we in a trap where the debt overhang enforces continuing low interest rates, and those low interest rates encourage yet more debt finance?


There is no silver bullet, but we recommend policy measures to switch from debt to equity finance.

Higher real rates, inflation and wage growth to pick up, and inequality going down.

This is the opposite conclusion that almost all economists are subscribing to. And the paper’s authors are keenly aware of their unorthodox position:

We argue that ageing will lower both desired savings and desired investment, but desired savings will fall by more. The resulting imbalance will require the real interest rate to rise for the market to clear. Just as the real interest rate has fallen since the 1980s thanks to a decline in desired investment borne out of the demographic sweet spot we described above, real interest rates will reverse course along with demographic trends and the resulting changes in savings and investment dynamics.


This is clearly our most controversial proposition, and much of the pushback we receive is based on the argument that demographics will lower potential output growth, and hence real interest rates. We agree wholeheartedly with the first argument regarding output growth. But we disagree that it will also lower real interest rates. Indeed, there is much less reason to believe the two are connected than many believe. We discuss first the path to determining the equilibrium real interest rate and then delve into some of the dynamics that will drive savings lower but keep investment from falling by as much or more.

This paper will not help us decide where inflation and interest rates are headed next week. Nor will it even matter next month. But in the coming years, it will prove unbelievably important. The arguments that deflationistas are using to justify their bullish views on fixed income might the very reasons why you should be short! Take the time to read the paper, file it away, and keep it in the back of your mind when the pundits tell you that bonds have only one way to go - they are right, they have just picked the wrong direction.

*  *  *

Speaking of bonds, often people tell me that investors are not overweight fixed income. Instead they argue the speculation is all in the stock market. I call bullshit on that one.

When we entered the new millennium, US 10-year rates were 5.5%. Since then they have fallen to today’s 2.08% rate. Given the significantly lower rates, it makes sense to believe that investors have shunned fixed income.

But have a look at this chart of the total amount of US Treasuries held in stripped form.

Wall Street only strips bonds when there is demand for zero coupon instruments. The total amount of stripped bonds gives a good measure of fixed income demand.

In the aftermath of the Great Financial Crisis, the total amount of stripped bonds fell. That makes sense. Clients throughout the world suddenly found themselves short on capital and extremely scared, so I wouldn’t expect anything else. As quantitative easing was instituted, clients rushed to buy more stripped bonds, and by 2011, the total amount was back to pre-crisis highs (even though rates were significantly lower).

The total amount of stripped bonds went sideways from 2011 and 2012, but then in 2013, they started rising again. But the really amazing action happened in 2016 and 2017. It went parabolic!

The notion that clients are not leaning heavily long fixed income is crap. They are stuffed to the gills as the whole world can only imagine rates and inflation going one way - lower.

Keep this in mind when you are thinking about where the next crisis will come from…

*  *  *

Moving our trading to an even shorter time frame, this weekend I came across this terrific chart from Nordea’s Mikael Sarwe.

Mikael notes that the small open Swedish economy reacts to global economic momentum earlier than the rest of the world. By advancing the Swedish manufacturing PMI a couple of months, we get a sense where European PMI is headed.

In the twitter discussion that followed, m4crotrader had an explanation of why the Swedish economy was such a great indicator.

I have been worried that China’s reflation run is waning, and this Swedish PMI rollover might be another signal. At the very least, I think it might be a sign that the EUR’s run might be getting long in the tooth.


Cognitive Dissonance Mon, 09/11/2017 - 12:10 Permalink

It's all they have left in their bag of tricks....massive and sustained inflation.And make no mistake about it, common everyday 'inflation' can be created at any time by turning up the printing presses to 15 on a scale of 1-10 and feeding it directly to "We the People".

onthedeschutes Cognitive Dissonance Mon, 09/11/2017 - 12:27 Permalink

Real inflation is already here...across a lot of important categories needed for everyday, housing, healthcare, autos, food.  Trouble is with these bankers, among other things, is their dogged determination to exclude anything inflationary from the actual inflation calculations.  So, no need to print at level 15 when their printing thus far has already done quite the fuckover on the average saver, living off fixed income.  All bankers are parasites.

In reply to by Cognitive Dissonance

fx onthedeschutes Mon, 09/11/2017 - 12:42 Permalink

Apart from their flawed inflation measurements: how on earth is rising inflation going to soften inequality? Inflation is ALWAYS a major drag on the lowest and middle income groups and affects the richest way below average. Nominal wages may sluggishly start to respond, with a considerable time lag, but that doesn't alter the overall picture.

In reply to by onthedeschutes

mtl4 fx Mon, 09/11/2017 - 13:21 Permalink

Its folks discretionary income that is deflationary because even if .gov hand feeds the public with direct QE they will take it right back via taxes.  QE was supposed to be massively inflationary (and it was for assets and investments) but for main st times are still tough and inflation is only making the divide larger.  The next damaging aspect will be continual interest rate increases for which gov't will need even more taxes to kick the can down the road (servicing debt we know they can't pay back) or if they decide to stay the course on rates the states with their pensions will go bankrupt one by one not to mention the problem of who will buy the gov't debt when rates rise.....this is why behind the scenes they are dreaming up ever more draconian capital controls in the hopes it will buy them enough time to pass the buck to the next round of politicians.  

In reply to by fx

OverTheHedge mtl4 Mon, 09/11/2017 - 14:34 Permalink

Interesting, because this article confirms my thinking, which is always a worry. My theory is that the only possible way to keep the system running is to inflate away the debt, because the other option, default, is a disaster for the banks. However, inflation has been hard to come by, but this article seems to make some sense, as fewer workers means more pay for each worker, even if productivity drops and overall output is reduced. If interest rates rise, then inflation will need to rise even more, putting even more strain on the system. I have been thinking deflation first, followed by inflation, but this could be the secret sauce that makes everything better, without any evil deflation.Regarding your comment specifically, inflation benefits asset owners over wage earners, as assets rise in "price" faster than wages rise, thereby giving a boost to assets over wages. Deflation does the opposite, as asset prices fall quickly, but wages are always slow to respond. However, this article suggests that wage inflation will be the front runner, rather than assets. Not sure I have ever seen that, in my lifetime, at least. Maybe this time IS different....  

In reply to by mtl4

strannick OverTheHedge Mon, 09/11/2017 - 18:58 Permalink

Higher interest rates for the market to clear because desired savings  will fall more than desired investment. What a pretty ivory tower egghead fantasy. As though interest rates were a real relationship and not a financial derivative gargoyle contruct.There are almost a Quadrillion $ in interest rate derivatives. That's what keeps rates low. Let THAT clear the market and stand in front of Irma with an umbrella.

In reply to by OverTheHedge

ElTerco mtl4 Tue, 09/12/2017 - 07:50 Permalink

Irving Fisher probably would have correctly predicted where the inflation would land with his MV = PQ formula and a few seconds worth of thought. Since the Fed is the gatekeeper, the Price of the bank sanctioned investments (and only the bank sanctioned investments) will rise as Money supply rises, with Quantity remaining more or less constant. Well, the banks sanction loans for homes, cars, school loans, stock buybacks... but not so much for general general expenditures other than through a HELOC. So where did the inflation get concentrated? Homes, cars, school loans, stock buybacks...

Wages or employment? Not so much. The general economy expenditures were minuscule compared to overall loan volume, so there was no mechanism for wage or employment growth in the overall economy. Now, credit cards should have had some impact, but revolving credit has already been around a long time, and expenditures there have stabilized (or contracted) at this point. Debt load has maxed out, and there is nowhere to go but down for run-of-the-mill citizens that need wage or employment growth. The well connected bank welfare recipients (real estate, stocks, possibly government employees) will continue to party as we dig a deeper hole for the rest of us.

The Fed is fulfilling its charter in Letter of the law (through contrived government statistical formulas for CPI and employment), but is in no way fulfilling its charter in Spirit of the law anymore:

"The Congress established the statutory objectives for monetary policy--maximum employment, stable prices, and moderate long-term interest rates--in the Federal Reserve Act."

In reply to by mtl4

TeethVillage88s fx Mon, 09/11/2017 - 16:36 Permalink

Under-Rated post.

Boskin Commission, they reformed CPI, like 20 years back or whatever... 1995-1996.

- Social Security is Dead in Policy Planned Inflation Govt/Central Bank Ideology...
- Medicare/Medicaid Planned Subsidies to Corporate Health Care System is also "Dead" in Policy Planned Inflation Model
- Affordable Housing is Dead in Hedge Fund, Mutual Fund, Venture Capitalist, Asset Management ... investments in Real Estate & Housing... like Federal Reserve being Largest RE Holder... Housing Prices/Rents can't Deflate for kids, Fixed Income people, Elderly, Diseased...

- Repost my list of issue to work never took off:

So could Harvey and Irma be used to highlight statistical bull shit and financial weakness in our cities/states and federal govt? Short Financials, force Interest rate hikes for Bonds, Treasuries, Pensions, Savers, Fixed Income people, Social Security, Force Interest Bearing on Trust for Social Security...

- Unemployed & forgotten in rush for Globalism, NAFTA, CAFTA, TPP, TTIP, TAP
- Planned Inflation & bubble blowing economy harms our youth & fixed income citizens, harms social security
- High Debt Levels are unsustainable, scaling up debt & credit make our cities & states targets of BANKs
- Fake Financial rating haven't been fixed
- Mal-Investment expands with ZIRP/LIRP/NIRP
- Bond Markets No Longer Function
- GDP is fake, Inflation & Govt Spending need to be discounted
- Boskin Commission Reforms on CPI hide the real inflation rates
- We are dying in Debt from Health Care Costs, Housing Costs, Education Costs, Expensive Cars & Trucks, Transpo, Parking
- Money Stock Expansion makes the USD very vulnerable to collapse, Scaling up is unsustainable, Debt Levels too... WRC stewardship will he hammered in future G20 & IMF Agendas
- USA can not go into a World War with these Debt Levels, this Cost of Living, these price levels, this cost of Labor & MIC Contracts... This is a National Security Issue TODAY

In reply to by fx

MrSteve Cognitive Dissonance Mon, 09/11/2017 - 12:43 Permalink

If "people need more money" then governments, claiming to be democracies or republics, will give it to them. There is a logic to inflation and hyperinflation- per Zimbabwe and Venezuela for instance. Americans are currently seeing shrinkflation, downsizing of established brands and product packaging. US real household median income vs. prices shows a 45% gap to date since year 2000, also masked by CPI "adjustments".

In reply to by Cognitive Dissonance

Lumberjack Cognitive Dissonance Mon, 09/11/2017 - 13:36 Permalink

Vampire squid gives birth to a minnow.…

The so-called vampire squid of global finance will soon have a new tentacle: UK retail banking. Goldman Sachs plans to start taking British consumers’ deposits next summer, using the Marcus brand already launched in the United States.

Goldman’s main assumption is that bigger isn’t necessarily better in retail banking. That’s correct, to a point. Marcus customers will benefit from the same deposit insurance as those who trust their finances to larger rivals such as Lloyds. But provided deposits don’t exceed 25 billion pounds, onerous Bank of England rules on “ringfencing” won’t apply. Goldman can therefore in theory use cheap deposits to help fund its investment banking activities, and without the need for a pesky branch network. With around 6,000 UK staff already, adding 100 or so recruits to Marcus by next summer will barely move the dial.

Nor will the new bank be burdened by what are euphemistically known as “legacy issues”, such as decrepit computer systems, or the past mis-selling of loan insurance that has cost the four biggest UK lenders over 36 billion pounds in provisions.

In reply to by Cognitive Dissonance

1033eruth Cognitive Dissonance Mon, 09/11/2017 - 17:07 Permalink

Why do you think it would go to "We The People".  So far the printing press money has been going to the Feds proxies so they can pump up asset classes.  The printing press money is going to go to bail out states that fail and prop up the PBGC as well as ALL union pension funds if they have been given enough money in bribes to certain politicians.  

In reply to by Cognitive Dissonance

JoJo Kracko Mon, 09/11/2017 - 12:15 Permalink

Just no.   If cheap labour created the deflationary argument, as they propose, then what do you think robots are going to do?(besides take over the world or kill all humans)

small axe Mon, 09/11/2017 - 12:18 Permalink

so instead of our dollars losing half their value in 20 years with 2% inflation a year, we can look forward to a much quicker loss of purchasing that's what I call progress...stagnant wages will be the frosting on the cake for John Q Average.  

taketheredpill Mon, 09/11/2017 - 12:19 Permalink

 1. Are rates as low as they are BECAUSE of the Fed or DESPITE the Fed.  In other words, without ZIRP+QE where would stocks be, and then where would long rates be??2. Instead of arguing for mean reversion and looking for theories to support some future mean reversion, why not look at theories that support actual current events (low long term rates), and explain why the factors in those theories (ex. Too much debt year after year after year)?3. Japan 

Leafy Greens taketheredpill Mon, 09/11/2017 - 12:50 Permalink

Well said. Who knows where rates would be were it not for the activities of the Fed.As the BIS article abstract surmises, the debt overhang may keep us in a long-term position where interest rates remain low. The author of this article/blog, The Macro Tourist also goes into describing cryptocurrencies as a bubble on his website. Granted, I think the whole ICO thing is bubbly, but with low interest rates, I think some people are diversifying their savings and chasing yield. Normally, one would think that a lack of demand for savings would force interest rates higher. Who knows when/how it will all change?

In reply to by taketheredpill

Pumpkin Mon, 09/11/2017 - 12:29 Permalink

They can turn up the printing presses all they want, but it hasn't and won't get into the pockets of the masses.  The .01% can only buy so much stuff, wear so many clothes and eat so much food.  Prices don't stay high when people aren't buying.

Blue Dog Mon, 09/11/2017 - 12:35 Permalink

We'll have inflation because the trillion dollar deficit is funded by creating money out of thin air. We don't have it now because money velocity is near historic lows. Money velocity will increase as more and more foreigners dump their dollars.

CRM114 Mon, 09/11/2017 - 12:37 Permalink

There already is real inflation on domestic necessities, has been for 8 years.The problem with this kind of analysis is that it's based on the official data, which anyone with half a brain knows is crap.So, either the author is an idiot, or he's a lickspittle, or he's got something dodgy to sell.

TuPhat CRM114 Mon, 09/11/2017 - 12:53 Permalink

This article is based on a BIS article.  The BIS will never tell the truth and  the author of the article based on BIS bull is very naive.  There is no real market in bonds or stocks and all official statistics are made up.  I have seen nothing but inflation since I retired in 2012 and it will get worse.  The author claims that we are experiencing deflation but there will be inflation sometime down the road.  That is nothing but disinformation or propaganda but I am not fooled.

In reply to by CRM114

CRM114 TuPhat Mon, 09/11/2017 - 13:04 Permalink

Agreed, re BIS.I have found that there is deflation on some items, especially those which the average Joe can now not afford. Examples from stuff I have bought recently would be quality cookware and tools. These products are actually cheaper in the long run in many cases than the chinese crap, but average Joe cannot afford the initial outlay.I take this as further proof that there is both real wage drops and inflation on the necessities (which is being hidden in official stats).

In reply to by TuPhat

War Machine Mon, 09/11/2017 - 12:40 Permalink

The artificial migrant crisis, and the efforts to flood the US with immigrants beyond legal quotas (yes even under Trump) are in large part to add more human batteries to the debt matrix although money isnt everything and some simply seek to destroy European nation-states and White majorities - as should be clear.

(The Kalergi Plan, based on the book by the father of the EU, is absolutely what the EU is about - people like Juncker and Merkel are quite open about this, and "Practical Idealism" explicitly calls for replacing native Europeans)

Indian programmers and Chinese small business owners are one thing, but uneducated, unskilled, culturally hostile, mostly young male migrants firehosed into Europe, are not an economic solution, quite the opposite. They are an economic drain, and a nascent guerilla force that can be used against ethnic Europeans, against Russia, and a problem requiring the solution of an EU army and further centralization.

Bad times ahead without revolutions and military coups throughout the West. There are no political solutions - elections are nearly meaningless.

Imagine the, say, 300 most powerful bankers, think tankers, business leaders working against the interests of Americans and Europeans.

What should happen is such a list is generated and revised and shared and the people on such a list be understood as legitimate targets in a war of humanity against the bankers and their allies.

This is a fight to the death.

The next major stage is the Anglo-Zionist war on Iran on the nukes pretext. The time for Western popular and military coups will be during the opening gambits... which are stalled by the Syria situation, which imo is unpredictable.

Vladislav Surkov (not verified) War Machine Mon, 09/11/2017 - 12:57 Permalink

youre a complete pathetic fucking waste of life please kill yourself post-haste lil scared ratfuck whitey youre so fucking confused youre all over the place, and listen shithead syria and iran do not need your bloviating idiocy now stfu and gfto here and go back to watching infowars 

In reply to by War Machine

Fireman Vladislav Surkov (not verified) Mon, 09/11/2017 - 13:11 Permalink

"youre a complete pathetic fucking waste of life please kill yourself post-haste lil scared ratfuck whiteyyoure so fucking confused youre all over the place, and listen shithead syria and iran do not need your bloviating idiocy   now stfu and gfto here and go back to watching infowars" Charming and such a way with the language. Now wise up you retard and get over it.

In reply to by Vladislav Surkov (not verified)