An Unpleasant Comparison: Demographics and Deflation

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.

Comments

[Tony Petroski:]

Could you not say it more simply: "Aging populations don't have as many animal spirits."

Americans (as of yet) don't have an "insatiable" appetite for saving.

Open the Southern border and youthen the population.

What happens when the population doesn't just get older but actually declines? Deflation and declining GDP, but that is a half century away.

Jul 09 01:02 PM

[Jason Rines...:]

Tony, we did open the borders for 50 years. Eisenhower stopped mass immigration for awhile in the 1950's. The hispanic people are breeders (sorry if this sound un-politically correct) and was the reason for not sealing our border. We will not have the problems of Japan in 2025, the problem and crisis is the current retiring boomer generation and withdrawal from the markets in general, although I am sure boomers will spend plenty in healthcare but downsize everything else. We will not avoid inflation in energy commodities and government legislation/taxation is reflective of this speculation. Where is government really playing in? Healthcare and energy, so your commodities dabbling is probably safe but consider the serious inflation stage in energy/agr being in 2011-2012 timetable.

Jul 09 01:16 PM

[DWStein:]

This is a very important subject that only gets attention periodically. So, thank you for brining it up.

Imigration policy is very, very important to the continued prosperity of our country. We need a comprehensive policy that deals both with security and population growth. We should be letting people emigrate to this contry, but only the people we want.

Tired, hungy and poor is a wonderful policy, but it needs to be brought into the 21st century. We need to know who is coming through our borders, we need to get them into the system properly, and we need to fully enfranchise them. Let us also not kid ourselves. Let's be transparent and agree that people with real capital (educationaly and/or monitarily) should be given priority.

There is nothing more dangerous, in the long term, than having a seperate society within a larger society. Large poplutions without a significant stake in the future of the broader society are inherantly unstable. Just look at Europe's struggles with their muslim population.

As the boomers retire, we are going to need freesh blood, period.

Any fraternaty/sorority alumni might recognize the phrase, "Give 'em a bid. We need the dues!"

Jul 09 01:52 PM

[Larry House:]

Thanks, David. I think this is a comparison and a conclusion that must be made. There IS a major change taking place with consumers. There will not be a quick bounce back to the way it was a few years ago. Few seem to get that idea or see the implications of it. Harry Dent has done some very detailed work on demographics, but because his outlook for the economy is dire (depression coming), he is largely dismissed as a false prophet. Time will tell.

Jul 09 02:10 PM

[LilBob:]

I was thinking of the topic of economic deflation earlier today and realized something pretty striking. I made a little chart of what I expect I'll spend in my lifetime compared to my parents. Given that I'm an individual comparing myself to my father and step-mother, a ratio of 50% represents spending parity.

All figures represent "real-dollar," spending, not adjusted for inflation:

Amount of health care services I expect I'll consume in my lifetime:
<25% (projected life expectancy of between 68 and 72 years)

Amount of travel I expect do do:
<10%

Amount I expect to spend on housing/square footage of my domicile.
<25%

Amount I expect to spend on motor vehicles
<20%

Amount I expect I'll spend on dining/entertainment
<15%

Amount I expect to spend on a boat
0%

Amount I expect I'll spend on clothes/televisions/ap...
<15%

I know this is idiosyncratic at best but those figures are-if anything-on the high side.

Jul 09 02:37 PM

[John Galt:]

You also forgot to mention that debt is deflationary.

A debtor is using tomorrow's dollars to buy today's goods. Well, tomorrow is here. That means we are using todays dollars to pay for yesterdays goods which don't allow you to buy more goods today ( especially when banks won't lend you money).

There is a website, I can't think of the name right now that invests based on country demographics. Older people spend less money than younger people.

They have their life cycle spending chart something like this...
- When a person is say 18-22 they pay for college
- The next phase is looking for a partner/marriage/buying a car
- Then let's say 28-32 they try and buy a home, which needs a washer, drier, furnature, etc. etc. etc.
- Then come kids
- Trade up to a bigger house, need more durable goods.
- Savings for Kids college/ retirement
- Retirement/paid off house/ Less spending.

Look at some of these countries with younger populations like Brazil and then look at their abundance of natural resources etc.

Think about when happens when baby boomers start passing away, 401k's are getting liquidated, Grandma and Grandpa's house is sold off for Husband and wife...

There really is a lot to think about.

Jul 09 03:39 PM

[jstratt:]

Gary Shilling made the same point in a book he wrote in 1999.

I will say that Japan had stocks with 200 PEs and Commercial RE at 300% of true value. It was a huge bubble that popped.

Perhaps it was similar to our CDO and structured finance bubble valuations.

Jul 09 05:30 PM

[GeminiAtlas:]

Adding more uneducated, unskilled, poor people won't help the economy. In the 19th century the skills matched the jobs (repetitive, no need to read, etc.), so it helped the economy. Just adding more unskilled folks to the melting pot will make things worse. More skilled people are needed for this economy in certain sectors.



On Jul 09 01:02 PM Tony Petroski wrote:

> Could you not say it more simply: "Aging populations don't have
> as many animal spirits."
>
> Americans (as of yet) don't have an "insatiable" appetite for saving.
>
>
> Open the Southern border and youthen the population.
>
> What happens when the population doesn't just get older but actually
> declines? Deflation and declining GDP, but that is a half century
> away.

Jul 09 05:56 PM

[Alex_G:]

Great article, but I am curious as to why you would be buying commodities, as the premise of the article points to deflation. Unless the emerging markets develop internal demand for goods and services, there will be less pricing power for commodity producers. The emerging market export model can't be changed on a dime. It will take years.

Europe's numbers will look just as bad as ours, with worse demographics. Capacity utilization is at all-time lows, developed world credit will continue to contract, pointing to very slow growth for an extended period of time.

Owning debt, not assets, seems to be the investment choice for the foreseeable future.

Alex

Jul 09 07:35 PM

[Fighting Yoda:]

"The fundamentals point to deflation, not inflation... That’s why I’ve been buying commodity stocks in the current decline." - this seems contradictory.

In any case I am in the DEFLATION camp - all roads lead to deflation. Fed tried everything to inflate but has failed- helicopter, bazookas - cheap money, easy money, free money - Trillions of dollars - all it has gotten us is deflation.

Jul 09 08:15 PM

[John Bowman:]

If the number of aborted babies hadn't occurred over such a long period, I doubt that we would have the young/elderly ratio problem which exists today.

However, when I look at the work ethic of kids who dropout or don't go to college and the expectations of current college grads (cushy white collar job, high wage and rapid advancement), I wonder if we would have gained anything economically with their presence. And I am not trying to be cold-hearted by that statement.

Jul 09 10:29 PM

[Alex_G:]

Actually, there are millions of educated, skilled workers just dying to emigrate to the USA, but government puts limits on the number that can come.

Imagine an entire new generation (ok, part of one) that cost nothing to raise or educate, ready from day one to contribute to the economy (and pay taxes).


On Jul 09 05:56 PM GeminiAtlas wrote:

> Adding more uneducated, unskilled, poor people won't help the economy.
> In the 19th century the skills matched the jobs (repetitive, no need
> to read, etc.), so it helped the economy. Just adding more unskilled
> folks to the melting pot will make things worse. More skilled people
> are needed for this economy in certain sectors.
>

Jul 09 11:29 PM

[John Galt:]

Alex G: Exactly

A typical American is supposed to go through 18 years of publicly funded schooling and other expenses, and then College/work and pay for others.

By allowing in 18 year old + immigrants, educated, ready to work, good at things that Americans aren't good at, you basically had their home country subsidize their education/development, while America gets to reap the rewards.

Would you rather have the IT work done on American soil, or in India? The number of H1B worker Visas we have is not enough.

Bill Gates went to congress to testify that we don't have enough worker Visas and we don't even have enough Americans qualified enough to do the work.

The best and brightest in America want to go to Ivy league schools and be lawyers, politicans, or investment bankers. Show me the smartest kids that want to create, build, and produce.

Jul 10 09:26 AM

[Jaysan:]

I hold TLI for "high quality income." This closed-end fund invests globally in floating or variable rate collateralized senior loans to corporations, partnerships or other business entities operating in various industries.

Jul 10 10:16 AM

[GeminiAtlas:]

I agree. They need up the allowance for educated workers drastically, but reduce the allowances for unskilled workers (i.e. stop illegal immigration) who are depressing wages for our own unskilled workers.
I also have a theory that having too many unskilled labor depresses investment in automation technologies and impedes progress instead of enhances it. Why do you think Japan is so advanced in robotics, etc? It has an aging population, high wages, not enough immigration to sustain the size of population. This creates an environment where investing in automation technologies would make sense, and indeed, that's what many Japanese firms do. A shrinking population that is getting older creates another set of problems but that's another subject.


On Jul 09 11:29 PM Alex_G wrote:

> Actually, there are millions of educated, skilled workers just dying
> to emigrate to the USA, but government puts limits on the number
> that can come.
>
> Imagine an entire new generation (ok, part of one) that cost nothing
> to raise or educate, ready from day one to contribute to the economy
> (and pay taxes).

Jul 10 01:12 PM

[baird:]

All true from an economic point of view however the implications for environmental quality due to ever increasing numbers searching for the "good life" are sobering. And I'm not talking about the usual tree hugger issues of snail darters, etc but big time environmental degredation which will be painfully obvious to all of our children and future generations.


On Jul 09 01:52 PM DWStein wrote:

> This is a very important subject that only gets attention periodically.
> So, thank you for brining it up.
>
> Imigration policy is very, very important to the continued prosperity
> of our country. We need a comprehensive policy that deals both with
> security and population growth. We should be letting people emigrate
> to this contry, but only the people we want.
>
> Tired, hungy and poor is a wonderful policy, but it needs to be brought
> into the 21st century. We need to know who is coming through our
> borders, we need to get them into the system properly, and we need
> to fully enfranchise them. Let us also not kid ourselves. Let's
> be transparent and agree that people with real capital (educationaly
> and/or monitarily) should be given priority.
>
> There is nothing more dangerous, in the long term, than having a
> seperate society within a larger society. Large poplutions without
> a significant stake in the future of the broader society are inherantly
> unstable. Just look at Europe's struggles with their muslim population.
>
>
> As the boomers retire, we are going to need freesh blood, period.
>
>
> Any fraternaty/sorority alumni might recognize the phrase, "Give
> 'em a bid. We need the dues!"

Jul 10 07:32 PM

[TeresaE:]

The "fundamentals" may point to deflation.

And I am 100% positive that wages and tangible assets will deflate--even more dramatically than they already have.

But the inflation that will be raging as American families try to pay for more expensive Asian goods and the bills coming due from Washington will be completely silent.

And utterly devastating.

These families were once the world's best customers and if only half the regulation running through DC becomes law, they won't be able to afford anything other than the most basic necessities.

Believe it or not.

Small business and American Families are teetering on the edge of extinction.

Deflation won't matter to millions of us.

Jul 11 09:34 AM