Submitted by One River CIO Eric Peters, as excerpted from his latest Weekend Notes.
In the Extreme
I often think through economic issues by analyzing arguments in the extreme. And while in practice things don’t swing that far, the exercise can help reveal the unexpected. Take the topic of ageing and its impact on inflation. The argument is made that as societies age, the elderly consume less, demand thus declines and inflation rates fall. So I then imagine a world with just one country, ageing rapidly. At first, the old people own the assets and skew the laws to protect their rights. As they age, they gradually exchange these assets for goods and services.
The young accept the elderly’s assets in exchange for providing goods and services. As the elderly population grows relative to the young, the labor pool declines relative to demand. With fewer people producing goods and services, supply shrinks and prices rise, inexorably. So with fewer workers to supply goods and services in exchange for the elderly’s assets, these assets (stocks, bonds, cash, but mainly houses) thus become worth less. In the extreme, the centenarians exchange their homes for one last diaper change. Is that deflation?
Of course, the world has more than one country. So imagine two; one rich and ageing (described above), another young, poor. For simplicity sake, there are two possible states of this world, (1) free trade and open immigration, (2) free trade and no immigration. In #1, mass immigration to the rich country somewhat balances the economy but utterly transforms the culture. In #2, the rich country’s trade deficit explodes, its currency tanks, the prices of goods still rise, domestic service prices surge, and centenarians exchange homes for diaper changes.
“Low interest rates created an incentive for companies to create monopolies,” said the CIO, discussing the unanticipated channels through which inflation may rise. 76% of companies that went public in 2017 were unprofitable, eclipsed only by 2000 when 81% were losing money. The 40yr average is 38%. “As rates rise, many companies that have relied on cheap capital will need to figure out how to make money. They’ll raise prices.” Amazon, Uber, so many others. “And zombie companies die as rates rise, reducing supply.”
“China used to prioritize employment over profits,” continued the same CIO. “And they preferred job creation to clean air and water.” Chinese unemployment is now 3.89%, a record low. Their working age population has been in steady decline since its 2011 peak of 925mm. By 2030 it will shrink by 95mm to 830mm (US labor force is 161mm). “As Beijing’s focus on employment shifts to servicing debt and reversing environmental catastrophe, they will need to raise prices and profits. That’s inflationary, globally. The process is underway.”
“Guys who thrived in 2008 had the DNA of fighters, they were willing to lean into the wind,” said the CIO. They were skeptical of Moody’s, AAA ratings, the Fed, carry, complexity, they made a lot of money. “Now it’s the guys with risk parity DNA who have cleaned up, prospered.” There’s never been a quick dip they haven’t bought. "That’s why the market over-weights any new information that reminds it of the risk-parity paradigm.” People see what they want to see, hear what they want to hear. “Even though that paradigm is so clearly changing.”