Monday, January 23, 2012

Why Isn't Central Bank Reflation Working This Time?

Although I have given Paulson quite a hard time, there was a plausible argument that 2008 would be followed by a normal cyclical recovery to new highs, i.e. the post-WWII experience. The Federal Reserve facilitated these recoveries by turning a blind eye to insolvent banks, lowering short term interest rates, and allowing the insolvent banks to borrow freely at low rates; then lending at a higher rate, and using the interest margin to earn their way back to solvency. This has never failed to work during the lifetimes of investors alive today.

The inability to lever up and rally to new highs should remind us of Japan. Why has their stock market been falling for decades? Don't central banks have the ability to target whatever nominal price they desire for a stock market index?

Could it be the aging population of Japan? By aging population, we mean a falling worker/retiree ratio. Among other outcomes, more people consuming and fewer people working means less investment and therefore slower growth. Because falling populations have not happened in recent history, almost no one sees the economic and social threat that this poses.

The aging populations are a result of falling fertility in wealthy nations. It is unclear what causes this, because the strongest correlation is simply with prosperity itself, as measured by GDP/capita. There is something about success that leads to demographic collapse. It could be that the social security safety nets in rich countries allow individuals to selfishly consume instead of reproducing. Or perhaps rich societies suffer from Geoffrey Miller's theory regarding Fermi's Paradox.

Whatever the ultimate explanation for aging populations, this trend is already in place and nothing can be done about it because everyone involved has already been born. Yet, strangely, U.S. investors continue in blissful ignorance of this underlying demographic reality.

Falling populations will of course decrease the demand for capital goods like new houses and cars. The housing market in particular faces three threats: aging population, excess supply and supply of the wrong type, and U.S. wage convergence with emerging market countries.

One structural problem with the U.S. economy is how leveraged it is to growth: the financial services sector needs positive first and even second derivatives of economic activity in order to prosper. Without a long term trend of rising population as a tailwind, investors will be less sheltered from malinvestments and problems of excess capacity.

These problems are obvious yet ignored because the consequences are grim and also because they involve concerns that are many years away. The phrase "I'll be gone, you'll be gone" applies here.


Taylor Conant said...


We aren't big on demographic trends. It's difficult to translate that information into profitable decisions. It is hard to figure out what businesses will prosper in the future, based on macro trends. See's candy is for anyone and Fruit of the Loom is for people who need underwear today. We want to be right on something that will work right now, not something that might work in the future. I doubt that Wal-Mart spends a lot of time on demographics. They instead focus on where to put the store and what to put on the shelves. I've never found those kinds of stats useful. People were all excited to go into stocks 6 years ago, but it wasn't because of demographic trends.

CP said...

Amazing find! That is from a talk at University of Kansas?

Of course, U.S. demographics were a steady tailwind during his lifetime, so he is conditioned not to pay attention to them.

By the way, I'm noticing a lot of commentary on the Federal Reserve where people are honestly searching for that elusive "monetary policy" that will result in prosperity.

Which completely devalues the thrift, industry, and inventiveness of millions of individual economic actors! Who even thinks about that anymore?

Taylor Conant said...

Lots more at

The intelligentsia have suffered the same conditioning-- there are increasing numbers of them who have never worked a day in their life and have been so sheltered from the productive part of the economy that it's a true mystery to them how wealth is created. They have never experienced the process of creating wealth, only of consuming it. End result is they believe their own intelligence can be of use in summoning wealth into existence through thoughtful policy manipulation.

CP said...

WB: "I don't see how the age distribution of a country, or whether the population is rising or falling, could be of relevance to any business."

CP said...

This is at once a blessing and a curse for us.

By paying attention to demographics, we are looking at a metric that is orthogonal to what everyone else is following.

So, there needs to be some kind of theory about when other investors will include this data in their thinking.

Until then, it can inform our trading but we can't bet on it directly.

Taylor Conant said...