September 25, 2017 glacierinvest

As a follow up to my previous post, I wanted to highlight a BIS working paper I read recently with what I consider to be an out of consensus viewpoint.

The paper is entitled Demographics will reverse three multi-decade global trends. You can find a copy of the paper here.

The overarching position of the working paper suggests the global deflationary trends that began in the 1980s and continued through the 1990s and into the 2000s will begin to reverse in the coming years, resulting in higher wages and inflation and reduced inequality. Some of the main points of the paper that caught my attention were the following:

  • A growing proportion of net consumers (older and younger age cohorts) as a percent of the total population will lead to lower savings and investment rates. The authors believe the savings rate will fall more than the investment rate, requiring the equilibrium real interest rate to rise to achieve the necessary/expected balance.
  • Wages will increase and inequality will decrease as the massive positive labor shock of the past 35+ years reverses.
  • Demographic trends of the past 35+ years have been a direct cause of growing inequality.

I have been engrossed by this paper because of its global, long-term perspective, not to mention its non-consensus viewpoint. I wonder how many CIOs and longer-term investors have factored rising real rates into their models and expectations. Maybe more than I’m thinking, but there are certainly some major implications of such an outcome for everyone to consider:

  • How would the ability to service debt at the government and corporate levels be affected and how would that impact individuals?
  • What would the overall impact on asset valuations be and would the outcome be equal across all asset classes?
  • Would active investing become more prevalent again?
  • Would corporations be more incentivized than they appear to be now to invest in longer-term growth initiatives?

There are clearly a lot of implications to consider. The authors also highlight potential risks to their thesis. The two most probable risks to the authors’ thesis, in my opinion, are the following:

  • The current debt overhang throughout the world would make it unfeasible for interest rates to rise – this seems most likely to me;
  • The labor participation rate among the 65 and older cohort rises faster than expected – if individual savings & retirement account balances are as bleak as they are purported to be then people likely won’t have any other choice but to work;

The arguments in the paper are well presented and coherent. It’s a fairly easy read and well worth it.