What Did We Learn This Week? (07/21)—Tim Pierotti, Chief Investment Strategist

Tim Pierotti, Chief Investment Strategist

The inflationary impact of reversing demographics -- 7/22/22

As anyone who has been a reader of our work knows, we believe that there are several distinct structural forces that will lead to higher long-term inflation. We’ve written about energy underinvestment and declining productivity as contributors to the thesis. This week, we want to throw another factor onto that list and this one is more counter-intuitive than those previously discussed: declining populations. I say counter-intuitive because, like many, I had always looked at the example of Japan as evidence that declining populations would yield declining inflation. However, a recent publication by former Bank of England Advisor and Governor Charles Goodhart and former Morgan Stanley economist Manoj Pradham “The Great Demographic Reversal” makes a compelling case that the declining workforce growth in China and other advanced economies will prove to be meaningfully inflationary. 

Goodhart and Pradham are not alone.  JPMorgan's long-term strategists Alex Wise and Jan Loeys recently wrote that the integration of China beginning in the late 1980’s to the global economy as well as global demographic tailwinds have already reversed and would now be key factors forcing yields higher over the coming decade. The JPMorgan strategists conclude, “By 2030, the effect of demographics on real interest rates will likely revert to a level last observed in the 1980s.”

In a nutshell, Goodhart and Pradham make the case that the reason why Japan has avoided inflationary pressure since their workforce population began to flatten and peak in the late 1980’s is that they simply did a better job than any other country at investing heavily in growing manufacturing in China and essentially importing wage deflation at a time when China was beginning to liberalize their economy while becoming integrated into global trade. The output of Japanese corporate affiliates coming from China nearly tripled from 15% to 40% from 1990 to 2005. Perhaps it goes without saying that they also benefited from their proximity to China. Additionally, they note that Japan has been a global leader in labor productivity growth over the last three decades.

The China of 2022 is no longer the China of the 1990’s and 2000’s.  Thirty years ago, the authors assert that the wage disparity between American and Chinese workers was more than 35 to 1, while that delta has shrunk to below 5 to 1.  Most importantly, China’s workforce growth is now peaking and set to shrink in a manner unprecedented in history as the lagged impacts of the one-child policy manifest. Lastly, geopolitically driven deglobalization, tariffs and export controls further accelerate the end of the West’s ability to import deflation from China.  

The other component that the authors believe will be inflationary is the aging demographics and shrinking working age populations in the US and Europe that beget “dependency ratios” (retirees/workers) which are “naturally inflationary”.  In other words, we are looking at a scenario where there are fewer workers supporting more retirees. As retirees live longer, more workers are required to care for the elderly further exacerbating the tight supply of labor.

I realize all of this sounds a bit esoteric, but it matters.  As investors and advisors, we have learned to be dubious of anyone telling us, “This time is different”. Well, sorry to say it, but the next decade is going to be very different than the ever-disinflationary world of the last four decades. Massive global trends like profound shifts in demographics matter and when they change, we need to pay attention. 

Tim Pierotti is WealthVest’s Chief Investment Strategist. 

Tim has over 25 years of experience in various aspects of the equities business.  Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management.  Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund.  Tim is a graduate of Boston College and lives in Summit NJ.

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