Friday, February 7, 2014

The Avaricious Baby Boomers, a Failure to Reproduce, and Deflation

I said in the comments that,

"I've become very bullish on long bonds after realizing that the natural owners of them (older baby boomers, retirees) have been scared into buying much riskier stuff (SPY index, tech stocks, MLPs) with the mantra about how interest rates are going to go up real soon now."
Commenter Nathan pointed out that,
"It seems like prices in many markets are driven by what present holders of those assets need to rationalize their decisions, not any rational expectations of the future. In particular, baby boomers keep holding their equities and real estate, hoping for greater fools and 'household formation'. It never occurs to them that what they're proposing to younger generations is such a bad deal that many will simply refuse to play along, as they have in Japan."
Which led me to reflect more on Japan and deflation. His comparison to Japan is apt. What happened the U.S. early 2000s bust is that we hit the same worker/retiree inflection point that Japan hit in 1990.

Basically we are on course to follow their trajectory with about a 20 year lag, except that our elites are doing selected things to make the problem worse like spending 5% of GDP on warmongering, and importing hostile illiterates in a misguided attempt to fix the R/W ratio.

Money printing makes no difference. The BOJ has printed oodles of yen since their demographic collapse started - 4x increase in monetary base since 1990.

As Cornelius Vanderbilt would say, "that amounts to nothing." The Nikkei fell 65% anyway during the same time period (75% peak to trough), and - best part - their 10 year bond yield has fallen to 60 bps. Their 30 year yields 1.6%.

Further, the Japanese price index has not changed in 20 years. On a long term view, Japanese CPI increases seem to have stopped right around the time that serious yen printing started.

The "increased monetary base causes increased CPI" thesis has sprung a leak, and the inflationists are out of buckets. Clearly there is a different, lurking variable. In fact, an increase in monetary base and a fall in the inflation rate both look like dependent variables of population!


Stagflationary Mark said...

The Future of American Baby Manufacturing (Musical Tribute)

Check out that parabolic trend channel. It's not good for US baby production in the slightest.

Stagflationary Mark said...

From the previous thread:

Mark, you should do a chart on your blog of Japanese monetary base versus consumer price index (not rate of change).

For what it is worth, I am living the Japanese "dream."

I am a retired saver. I never had kids. I don't plan to own stocks again.

I don't make spending decisions based on how big the monetary base is. I make spending decisions based on how long my nest egg will last relative to my life expectancy.

The key factors are:

1. Net worth.
2. Current real interest rates after taxes.
3. Expected future real interest rates after taxes.

As real interest rates fall, I *need* to spend less to compensate. That's deflationary. Fortunately, I locked in real yields long-term (so I'm not hurting as bad as I could be). Unfortunately, many like me did not.

#3 is the tough one. I tend to be a "bad case" planner (not worst case but close). When I turned permabearish in 2004, I spent based on a real nest egg growth rate of -2% per year (after taxes) over the long-term. It seemed wildly pessimistic to some back then but times have changed.

The 5-year TIPS yield is decidedly negative. Inflation's running at about 2%. Three month treasury bills are paying 0%. That's a real growth rate of -2% after taxes (no taxes on 0%).

If inflation falls the real rate will rise of course. -2% was never my average case prediction. It was my bad case planning (and still is).

Stagflationary Mark said...

With 0% inflation, buried cash yields 0% after taxes.

Wouldn't that be something!

How could we get there? What if our debt was so big that interest on the debt needed to be kept low lest the financial markets collapse?

What are the odds that the deflation rate in Japan averaged almost exactly 0% over the past 20 years? Why not -1%? Why not 1%?

Perhaps it was managed more than most think? Or perhaps endless 0% interest rate policies did it? Is it just a coincidence? Who can really say for sure!

Taylor Conant said...

I wish you guys would just say what you actually think on this subject and drop the snarky "Who can say!" and "It looks like X". So are you saying there is a universal cause-effect relationship, or it just LOOKS that way?

I am ready to give up on these discussions because I can't make sense of your reasoning.

Stagflationary Mark said...

Taylor Conant,

So are you saying there is a universal cause-effect relationship, or it just LOOKS that way?

It would seem you want proof. Good luck on that one.

Stagflationary Mark said...

I have been predicting the death of real yields for nearly a decade.

It was my "belief" that, as more money appeared, it would become harder and harder to make money off of money.

It was my "belief" that, as more people began to retire, they would value safer investments just as I have.

It was my "belief" that, as exponential trend after exponential trend began to fail (both debt growth and employment growth), growth in this country would slow.

Could I prove any of that? No. Was hindsight kind to my predictions? Yes.

There is no absolute proof in the markets. If everyone had proof then everyone would always be on the same side of the trade.

Stagflationary Mark said...

One more thought.

I wish you guys would just say what you actually think on this subject and drop the snarky "Who can say!" and "It looks like X".

There wasn't an ounce of snark in that. I said exactly what I meant. I'm adding some snark now though.

Ever heard of brain storming? Or thought experiments?

If all you want me to do is converse when I have proof then cue the cricket noises. Seriously.

CP said...

This creates a positive feedback loop:

As real interest rates fall, I *need* to spend less to compensate. That's deflationary.

What people may not realize is that there seems to be a powerful positive feedback loop driving interest rates lower - at least in countries that are aging.

CP said...

There's a sentence like this in every single fixed income article:

"But, prices on longer-term muni bonds of 15 to 30 years can get hammered harder when interest rates rise because bonds and interest rates move in opposite directions."

The articles never say, "prices on longer-term bonds can go up a lot when interest rates fall the way the did in Japan despite the BOJ quadrupling the monetary base".

Stagflationary Mark said...

What people may not realize is that there seems to be a powerful positive feedback loop driving interest rates lower - at least in countries that are aging.

I think the key for me is just how little CD rates have risen (meaning that they have not risen at all).

As more and more money appears, why would we expect banks to pay more interest. They've already got more deposits than they know what to do with (especially with credit growth slow).

This is simple supply and demand at work. As you have pointed out, too much money doesn't necessarily mean rising interest rates.

That said, one of my bigger concerns is what would happen if inflation did pick up and I'm willing to pay for the insurance in case it happens.

Mundell-Tobin Effect Epiphany!

I hadn't really given this much thought. I just sort of assumed that the Fed was the only one driving interest rates down if inflation picked up.

Think about it though.

1. You are 50% in stocks and 50% in cash.
2. The CPI starts climbing at 1% per month pace.
3. That cash position stinks.

So there you are. You've got a problem.

What do you do next?

1. You could buy something with that cash.
2. You could buy some bonds that pay at least some interest. Something is better than nothing.

If you choose option #1 then the person you bought from will be faced with the same problem you just had. Eventually someone will choose option #2. When they do they will be driving interest rates down.

So while it is true that bonds yields would rise as inflation rose, there would be some money that was once in cash that would move into bonds. It would therefore seem likely that nominal interest rates would not rise as fast as inflation rises. That's assuming I understand this process correctly.

CP said...

Mark, that is a good point.

Increase in supply -> lower price (interest rate).

Pure microeconomic theory.

CP said...

I'm feeling very very bullish on bonds all of a sudden. Look at that Japan CPI chart!

Zeros anyone?

Sustainable Gains said...

I realize I'm late to this party but I wanted to put out a comment for Mark:

If you're 50% in stocks and 50% in cash, and then you buy some bonds with some of the cash, that doesn't necessarily imply a change in interest rates. It's one of those "that which is seen, and that which is unseen" situations: your "cash" was in reality a bank deposit, which is really a loan to a bank, and the bank didn't just leave the cash in a vault, they used it to give someone a car loan or a mortgage (i.e., they lent it out aka bought a bond with it). When you withdrew your cash they securitized their loans and sold you a bond instead.

There's no net change in interest rates just from trading existing securities (including cash). There has to be an actual change in the total amount of credit available.

Now, if you had been a BANK, you could've made a loan (bought a bond) AND pushed down interest rates at the same time, by creating credit.