What Did We Learn This Week? (08/04)—The Enduring Link Between Demography and Inflation
Tim Pierotti, Chief Investment Strategist
The Enduring Link Between Demography and Inflation 08/04/2022
Two weeks ago, I wrote about a recent book by former Bank of England Governor Charles Goodhart and former Morgan Stanley economist Manoj Pradham “The Great Demographic Reversal”, which makes a compelling case that the declining workforce growth in the US, Europe, China and other advanced economies will prove to be meaningfully inflationary. Among the work those authors cite is a working paper written by the Bank of International Settlements or the BIS. Think of the BIS like the Atlanta or St. Louis Fed except they consult and provide research to central banks globally. In short, I was blown away by what I would argue the researchers Mikael Juselius and Elod Takats have proven, which is that the age demographics of a society has a massive impact on inflation. The authors wrote, “Inflationary pressure rises when the share of dependents increases and, conversely, subsides when the share of working age population increases. This relationship accounts for the bulk of trend inflation, for instance, about 7 percentage points of US disinflation since the 1980s. It predicts rising inflation over the coming decades.”
The analysis is beyond thorough as the authors studied, “several monetary and real variables from 22 advanced economies from 1870 to 2016.” “The relationship between inflation and the age structure is robust. It is present in pre-war (1870–1913), interwar (1922–1938) and post-war (1950–1989) samples, and it extends into the most recent years (1990–2016) as well. It does not materially change when we control for economic variables, such as the output gap, real interest rates, money aggregates, government debt, and various other factors that may drive the saving-investment equilibrium.”
The conclusions are clear and definitive. “Our findings suggest that the deflationary effect that the age structure has had on inflation for the past four decades will reverse over the coming decades and become inflationary…Over the past 50 years, the increasing share of working age population has lowered average inflationary pressures by around 3 percentage points (red dotted line below the line). Currently, the shrinking number of young cohorts largely offsets the increasing number of old ones – which holds inflation pressures steady at historically low levels. Over the next half-century, the growing share of the old will dominate and increase inflationary pressure by approximately 3 percentage points on average.”
As the above chart illustrates, the US has enjoyed above average disinflationary benefits from the baby boom generation and that tailwind is turning into a headwind in the ensuing decades.
So, let’s look at the factors that might offset this inflationary pressure. Productivity could be helpful except of course for the fact that we just put up two of the worst productivity prints in modern economic history in the first and second quarters of 2022. Globalization appears to be reversing so the ability of the US and Europe to continue to import deflation from the developing world is unfortunately another tailwind that is turning into a headwind. The US and Europe could meaningfully grow legal immigration to put downward pressure on wages and allow growth industries to efficiently expand, but unfortunately the trends on legal US immigration growth fall every year with metronomic consistency and I hardly see a political environment anytime soon that is likely to reverse that trend.
As they say, nothing is guaranteed but death and taxes and the latter is questionable with the right lobbyists. But a study spanning almost 150 years across 22 distinct economies yielding such statistically significant and consistent results is pretty close to it. Increasing dependency ratios are inflationary. Obviously, this is long term stuff and doesn’t likely inform us of what the Fed will be doing in September, but it does help inform us that disinflationary forces that engendered a forty-year bull market in US Treasuries may well have come to an abrupt end with the pandemic and its aftermath.
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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