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Back during Japan’s lost decade of 1990-2000 (the first lost decade, that is), Japan’s population had just began to age dramatically. In 1990 the elderly dependency ratio stood at 17%, but it had risen to 25% by 2000. As the Japanese aged, their appetite for savings grew, and as their stock portfolios and home values crashed, they saved more and more. The more they saved, the worse the economy did. Interest rates of 0.25% or less and spectacular government deficits couldn’t make a dent in the vast shift towards a propensity to save. The result was deflation: falling asset values and a strong yen.

Fast forward to America in 2010, with an elderly dependency ratio of 19%, right around where Japan was in 1990. By 2020, it will rise to 25%, almost as fast as Japan’s.

Japan
Dependency Ratios
Medium variant
1970-2020

Year Total Child Old-age
1970 45 35 10
1975 47 36 12
1980 48 35 13
1985 47 32 15
1990 43 26 17
1995 44 23 21
2000 47 21 25
2005 51 21 30
2010 56 21 35
2015 63 20 43
2020 67 19 48

United States of America
Dependency Ratios
Medium variant
1970-2020

Year Total Child Old-age
1970 62 46 16
1975 55 39 16
1980 51 34 17
1985 50 32 18
1990 52 33 19
1995 53 34 19
2000 51 33 19
2005 50 31 19
2010 50 30 19
2015 52 30 22
2020 55 30 25

Americans also have seen their stock prices and home values crater, and have suddenly shown an insatiable appetite for savings.

Savings are deflationary: we don’t spend on current goods but on future goods (securities). The government may attempt to substitute for household spending but it never quite works, no matter how many public works projects the government sponsors (again, Japan poured more cement than anyone else).

There is another deflationary dimension to aging. Old people are creditors, young people are debtors. Inflation is a transfer of wealth to debtors from creditors (debtors pay back debt in cheaper dollars). A country with a preponderance of old people will show strong political pressures against inflation. As Uwe Parpart, Cantor Fitzgerald’s market strategist, pointed out to me in conversation, that’s why the Japanese never objected to deflation. As old people, they benefitted.

The fundamentals point to deflation, not inflation. There’s an old saying: take a bite, and hope you’re wrong. That’s why I’ve been buying commodity stocks in the current decline. I might be wrong. But deflation is the way to bet, which means that most of my portfolio remains in high-quality fixed income.

Source: An Unpleasant Comparison: Demographics and Deflation