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.