I am sitting here in Casa Interloper relying on the fact that influidity’s Steve Randy Waldman is orders of magnitude brighter than I am because I really, really hope I have this wrong. Because, if I don’t, the medium term for assets markets looks far more depressing than I thought when I woke up this morning.
Today’s influidity post, a discussion on whether the “natural” level of real interests rates can be negative, could be interpreted as academic esoterica at first glance. But it’s not, or at least might not be. Mr Waldman writes:
it is the marginal productivity of investment to existing lenders [ie investors] that sets the floor beneath market rates.
By this, he stakes the position that real rates are in no way limited by 0% at the lower end and could theoretically fall to -100% if the investing public determined that there was no use in investing for the future. Indeed, Mr. Waldman makes the argument that only the desperate shenanigans of Wall Street financial engineers has prevented real rates from averaging below 0% since 2007, and that the engineering process has proven a failure anyway.
To understand why this concerns me so much, refer to the chart below from the Federal Reserve Bank of San Francisco, showing the historical effects of demographics on S&P 500 price/earnings ratios (Using M/O (red line): ratio 18-34 group/60-69) . Yes, that looks to be a seven or eight handle predicted for the average bottoming of multiples, after a steady decline until 2020. And, unfortunately this makes intuitive sense – retired Boomers will inevitably consume less in almost every area beyond health care and vacation cruises, dramatically downsizing the world’s largest market for goods. Perhaps more importantly for our purposes, the aging Boomers will also invest less, becoming a net drain on investable assets as retirement continues. Following investment theory, what they do remain invested in will be fixed income or fixed income-like investments and this in turn will support the trend of negative real interests by assuring steady demand for savings.
In looking at Waldman’s argument and the market effects of demographics in tandem, the financial crisis can be seen as just the tip of a miserable iceberg. Demographics, not just in the United States but also Western Europe (particularly Italy, just in case you were not worried enough), insures high enough demand for savings to keep real rates negative. At the same time, declining aggregate consumption levels will negatively affect “the marginal productivity of investment to existing lenders”, the younger population, who will increasingly see fewer and fewer investment opportunities likely to generate returns.
The Keynesian interpretation of the current economic malaise is lack of aggregate demand and I suspect they are correct. The means by which this drag can be sustainably addressed in the face of demographic factors escapes me. It may just be one more area of dependence on the Chinese, with the hope that the rise of the Sinoconsumer can help offset this western structural drag. In the shorter and mid-term, however, the export-dependent Chinese economy is going to have to figure out somewhere to sell their goods.
This is a pretty dire macro picture and, as I said, I’m hoping I have this wrong in some fundamental way. As always, sane comments and feedback are more than welcome.