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This is why Japan will never recover

Here’s a cheery headline to start the week: Japan 2014 births fall to lowest on record but deaths rise.

From the FT:

Deaths outnumbered births in Japan last year by the widest margin on record, underscoring the scale of the challenge facing the government as it tries to ensure a dwindling pool of workers can support growing ranks of pensioners.

The urgency of getting the country’s finances in order was highlighted this week as preliminary figures indicated that Japan’s population fell by a record 268,000 in 2014.

According to the data published by the ministry of health, labour and welfare, births slipped by 2.8 per cent to a low of 1m, while deaths rose fractionally to a high of 1.27m…

If the current nationwide fertility rate of 1.4 stays unchanged, a task force warned in November, then Japan’s population of 127m would drop by almost a third by 2060 and by two-thirds by 2110.

Even if the fertility rate were to rapidly rise to the replacement level of 2.07 by 2030 and then stay there, the population would keep falling for another 50 years before stabilising at a little less than 100m.

I tip my hat to Japanese Prime Minister Shinzo Abe for at least making the effort to shake up Japan’s sluggish economy with his Abenomics reforms. But it won’t matter. Japan will never recover.

Try as he might, Abe can never be Japan’s Reagan or Thatcher. As sick as Britain and America were before the Reagan and Thatcher revolutions, the problems facing both countries were political. A politician with sufficient charisma–Reagan–or cojones–Thatcher–could have fixed them. But you can’t “fix” demographics with politics.

In a modern economy, consumer spending is the dominant contributor to GDP. But consumer spending requires consumers, and Japan has fewer of them every year. And the ones they do have are older and more inclined to save than spend.


China’s Mother Shortage
Shinzo Abe’s Win Doesn’t Mean Much for Japanese Stocks
Japan’s ‘Surprise’ Recession and How You Should Trade It
Japan: Apocalypse Now or Apocalypse Later?
Thinking About Buying Japanese Stocks? Let Me Get You a Duffel Bag, Some Gasoline, and a Lighter

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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Milton Friedman was Wrong. Inflation is Not Always a Monetary Phenomenon

I have a lot of respect for the late Milton Friedman. I really do. His unapologetic defense of the free market was–and still is–a breath of fresh air amidst the constant drone of calls for the government to “do something” to fix all of our problems, real or imagined.

But on the subject of inflation–the subject on which Friedman is most often quoted–he was dead wrong. Inflation is not “always and everywhere a monetary phenomenon.” Other factors–such as demographic change–can and do overwhelm central bank monetary policy when they reach extremes. I tackled this subject two years ago in a piece that tied Japan’s chronic deflation to its aging and shrinking population.

I’m not the only voice in the wilderness. Harry Dent has made the same basic demographic arguments for over twenty years, and his views have gone a long way to shaping my own here. And now, the Fed appears to be coming around. Earlier this year, the Richmond Fed published a piece that asks: Will the Graying of America Change Monetary Policy?

Here is an excerpt:

Despite the certainty of the oncoming demographic change, little is known about how it is likely to affect the Fed’s policy tools. Some policymakers and observers have expressed concern, however, that the Fed’s ability to stimulate the economy may decline for demographic reasons, if it hasn’t already done so. For example, New York Fed President William Dudley suggested in a 2012 speech that “demographic factors have played a role in restraining the recovery,” [emphasis mine] in part because spending by older Americans is “less likely to be easily stimulated by monetary policy.”

It’s called “pushing on a string,” and it’s something I addressed recently in an article on secular stagnation. Keeping interest rates artificially suppressed will not encourage older Americans to buy more on credit. In retirement, most of us trade down to smaller homes rather than trade up. We also drive less and thus replace our cars less often. And we already own all of the big-ticket items that consumers generally buy on credit, such as furniture and appliances. So, the older a society becomes, the less effective monetary policy is in spurring consumption.

Need evidence? Look east to Japan. The Bank of Japan has had some of the loosest monetary policy in the world for the better part of two decades, and they stepped it up several notches recently with an expansion of their quantitative easing program in October. A program which was, by the way, already the largest in the world. Thus far, it’s all been for naught. Japan is officially in recession again.

So, what does the Richmond Fed see going forward? In short, the Fed will get a lot less bang for its buck with traditional monetary policy. The Fed may be forced to make “bigger interest rate changes for the same amount of stimulus or tightening it wishes to apply to the economy.”  Or it could be forced to revisit large-scale bond-buying (i.e. “quantitative easing”) programs again. The Fed wrapped up “QE Infinity” in October.

I’ve been talking in generalities. Let’s drill down to some real numbers. The Richmond Fed continues,

It’s challenging to reach firm empirical conclusions in this area because demographic change is slow. One such effort, by Imam of the IMF, studied the effect of monetary policy shocks on inflation and unemployment in the United States, Canada, Japan, the United Kingdom, and Germany and found that their effect has decreased over time. Imam further looked at whether this effect was associated with the timing of the aging of those societies and found “quite a strong negative long-run effect of the aging of the population on the effectiveness of monetary policy…” He determined that a 1 percentage point increase in the old-age dependency ratio reduces the effect of such an interest-rate change on inflation by 0.1 percentage point and its effect on the unemployment rate by 0.35 percentage point.

The Census Bureau estimates that the old-age dependency ratio in the United States will rise by 14 percentage points from 2010 to 2030. If Imam’s estimates and the Census Bureau’s estimates were to hold, they would imply a 1.4 percentage point drop in the Fed’s ability to affect inflation and a 4.9 percentage point drop in its ability to affect unemployment. Over the course of a 20-year period, such a change might be perceived as modest from one year to another, but cumulatively it would amount to a strong negative effect indeed.

I should also point out that all of this assumes we’re in a “normal” interest rate environment. The target Fed funds rate is still at 0%, and the 10-year Treasury yields 2.2%. If we were to follow Europe and Japan into another recession–even a mild one–the Fed has almost nothing in the way of policy tools to draw on. Pushing longer term yields from 2.2% to, say, 1.0% just isn’t going to make that big of a difference.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

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Want an Explanation for Secular Stagnation? Try Demographics.

The Federal Reserve can lower interest rates to zero, or even–as the European Central Bank has done–into negative territory. But it can’t make lenders lend or would-be borrowers borrow if they don’t want to. And it certainly can’t make a shopper open their wallet and spend if they’re more inclined to save.

Economist John Maynard Keynes is often credited for comparing these limits of monetary policy to “pushing on a string,” but the term actually predates him. Congressman T. Alan Goldsborough used the term during the congressional hearings on the Banking Act of 1935.

At any rate, it is a good metaphor. And it’s the problem facing the United States, Europe, Japan and even China. The Fed’s quantitative easing (“QE”) programs have run their course–at least for now–and America is slowly moving towards more “normal” monetary policy. Whether or not QE worked in the U.S. is a matter of debate. My view is that is was wildly successful is stoking a bubble in the stock market and in giving homeowners a refinancing windfall, but not much else. Credit growth is still very weak, and consumers are not as eager as to spend as they were before the 2008 meltdown. But while the U.S. has pulled back from its QE excesses, Japan and Europe are just getting started, and China is getting more creative as well. Thus far, none of this has amounted to much more than pushing on a string.

The Economist recently suggested that demographics were the cause of this secular stagnation.

I agree. Years of  working with Harry Dent taught me that a person’s age is the single biggest contributing factor in their spending decisions. Advertizers have understood this since the dawn of mass consumerism. You’re a lot more likely to see commercials for Viagra or life insurance during a baseball game than you are during a Twilight movie. But economists tend to ignore the role of demographics, focusing instead on big “macro levers” like interest rates and government spending.

Or at least they do today.  But during the Great Depression, the role of demographics was taken seriously. As The Economist writes,

In the facing recession and a possible drift into deflation,late 1930s economists trying to explain how a depression could drag on for nearly a decade wondered if the problem was a shortage of people. “A change-over from an increasing to a declining population may be very disastrous,” said John Maynard Keynes in 1937. The following year another prominent economist, Alvin Hansen, fretted that America was running out of people, territory and new ideas. The result, he said, was “secular stagnation—sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment.”

Sound familiar? It should. Japan has been living this nightmare scenario for the past two decades. As its population has aged and shrunk, its economy has stagnated. And the aging of America’s baby boomers means that we’re facing a lesser decree of Japan’s experience here.

So, how do demographic trends affect growth? As The Economist continues, “An aging population could hold down growth and interest rates through several channels. The most direct is through the supply of labour. An economy’s potential output depends on the number of workers and their productivity.”

Economists tend to put the most weight on this first factor, though it is the one I find the least important. Labor can be replaced with technology. This has been the case since the Industrial Revolution, but information technology and robotics are making it ever more true with every passing day. Labor shortages simply spur more automation as businesses look to cut costs.

Our jobs can be replaced, in some way or another, by robots or computers.  But our consumer spending can’t. And that brings us to the second point. As The Economist continues, “The size and age of the population also influences how many customers and workers businesses can tap, and so how much they will invest. Keynes and Hansen worried that a falling population would need fewer of the products American factories made.”

This is where modern economics really misses the point. Sure, you can boost output by boosting the labor supply. Put every man, woman and child to work on 18 hour shifts, and you can send production through the roof. But if underlying demand is not sufficient to absorb the new supply, prices fall and eliminate profits.  Keynes and Hansen pointing this out when mulling over population size. Harry Dent took it a major step further by considering the age of the population. But the key takeaway here is that an aging an shrinking population will consume less…which means that boosting production will only cause price deflation.

And finally, “The third means by which demography can influence growth and interest rates is through saving. Individuals typically borrow heavily in early adulthood to pay for education, a house and babies, save heavily from middle age onwards, and spend those savings in retirement.”

Want an explanation for the low bond yields on offer across the globe? A fair bit of it can be explained by baby boomers aggressively saving and hunting for yield. As boomers pile into income-focused investments, they push yields down.

How does this end?

Watch Japan to find out. As Japan’s elderly start to spend down the colossal savings they’ve accumulated, it will eventually push up bond yields. Of course, the Bank of Japan is aggressively suppressing yields with the biggest QE program in history. But this has caused the value of the yen to plummet, which in turn has caused the prices of imports to rise. None of us can say with certainty how this will end because it’s never been seen before. But my bet is that Japan’s chronic deflation reverses into outright hyperinflationary collapse.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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What’s Driving the Boom in 1980s Classic Cars? The Male Midlife Crisis

The Financial Times published a good piece this week on the boom in 1980s “classic cars.”  Yes, I put “classic cars” in quotation marks because, frankly, everything to come out of that decade is horrendously ugly and best forgotten.

The FT writes:

The 1980s, often recalled as fashion’s ugliest decade, is back in favour when it comes to sports cars.

Collectables such as the Ferrari 308, driven by Tom Selleck in the Magnum PI television crime drama, are rapidly rising in value as a new generation of buyers enters the classic car market to purchase the cult supercars of their youth.

Average prices for signature wedge-shaped models including the Lamborghini Countach have doubled or tripled in the past year on both sides of the Atlantic. Even the cost of a humble Ford Capri Mk 3 has risen more than 80 per cent…

A Lotus Esprit car converted into a submarine and taken underwater by James Bond in The Spy Who Loved Me in 1977, was listed on eBay this week for $1m – in the region of the price Tesla chief Elon Musk paid for a similar model last year.

What’s driving the boom?  Ian Fletcher of IHS Automotive calls it “bedroom wall syndrome.”  The boys that used to hang posters of these cars on their bedroom walls are now middle-aged men with the disposable income to buy them.

Doc's time machine would be worth a lot of money today.

Doc’s time machine would be worth a lot of money today.

Men are predictable.  Most of us, while we age physically, never really mature much beyond our teenage years.  So might buying broken-down old sports cars be a viable investment strategy?

Yes, but pay attention to demographic trends.  A man who is 50 today was born in 1964, just a couple years past the peak of the post-war baby boom. He would have been sixteen years old–and fantasizing about exotic sports cars as much as exotic women–in 1980.  The demand you see today for early 1980s cars are from men born at the very end of the baby boom.

But think about what came next.  After 1961, U.S. births went into a long decline that didn’t bottom out until the late 1970s.  It wasn’t until the late 1980s that Americans really starting having babies at anything close to the levels of the 1950s and 1960s baby boom.

What does this mean?

It means that we shouldn’t expect a repeat of this next decade with 1990s classic cars.

Why?  There will be a shortage of middle aged men buying 1990s cars next decade because there was a shortage of teenage boys in the early to mid 1990s to lust after them.

If you want to play the long game here, start shopping for hot cars from the mid-to-late 2000s in another 10-15 years.  The boys born in the “mini baby boom” that peaked in the early 1990s were car-crazed teenagers circa 2006.  They will be 40-something professionals with disposable income to burn by the early 2030s.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

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Maybe Germany’s Stodgy Conservatism Isn’t So Bad After All…

The Economist ran a piece over the weekend prodding German Chancellor Angela Merkel to “Build Some Bridges and Roads” as a way of jolting Germany’s slowing economy back into growth.

My response:  Who’s going to be driving on them in another 10 years?

Take a look at the following chart, which comes from the United Nation’s Population Division.  All estimates are using demographic data as of 2012.


Germany is in the midst of a multi-decade baby bust.  Its population peaked in the mid 2000s and has been in decline ever since.  The average estimates (i.e. “medium variant”) shows Germany losing nearly 10 million people by 2050, or roughly 12% of the population.  Another 10.4 million Germans–or nearly 14% of the then-living population–will be aged 80 or over.  So roughly a quarter of Germany’s current population will be either dead or too old to do a lot of driving in another 35 years.

So I repeat the question: Who’s going to be driving on all of the roads and bridges The Economist is prodding Germany to build?

Germany has consistently resisted looser monetary policy by the European Central Bank and calls from the rest of Europe for Germany to spend more as a way of keeping the Eurozone economy afloat.  On the first count, I’d say Germany is dead wrong.  The German obsession with inflation looks more ridiculous every day as the Eurozone inches closer and closer to outright deflation.  But on the resistance to run government budget deficit, the Germans are taking the only course of action that makes sense.  Running up debts today to build infrastructure that no one will be around to use makes no sense, particularly when you figure that there will also be no one around to pay it back.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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