Many years from now,
Will you still be sending me a valentine
Birthday greetings bottle of wine?
If I'd been out till quarter to three
Would you lock the door,
Will you still need me, will you still feed me,
When I'm sixty-four?
"When I'm Sixty-Four" by The Beatles
As many of us can readily attest, aging is a process, not always pretty, but inevitable. We often hear terms like, "act your age" or "age gracefully", and I have to be honest with you, I'm not always sure what they mean. Well economies age too, and not always that gracefully. The most common signs of an aging economy are tied to the exhaustion of factors such as labor productivity, capital, and resources. When an economy begins to develop, labor is an abundant resource (think China, & India). Hence, it makes sense to develop labor intensive industries. When labor is exhausted, it makes sense to develop capital intensive industries. When capital stock is high enough, investment can not drive growth anymore. Economists call this diminishing returns, or more of the same investment yields less output. This isn't too bad though, when consumption and investment are balanced just right a steady state of equilibrium emerges, sort of like permanent middle age.
Youthfulness can be found in a mature economy. Through innovation an economy can produce more with less. Alan Greenspan called this "the miracle of productivity". While this so called productivity miracle is real, it too has limits. In the internet era, innovations rapidly disseminate around the world, and it's not clear if innovation benefits can be contained in one country anymore. For example, even though the United States is more innovative than Europe, it hasn't outperformed by much.
Demographics are Destiny
Historically diminishing returns were the most valid method of defining an aging economy, but population aging is becoming a new and more powerful variable. Of course populations have always aged, but we are now entering a new era where the number of people retired equals the number of people working. Merely decades ago, life expectancy was not high enough for a society to have a large retired population. But because of an increased life expectancy, and a declining birth rate, Japan, Europe, and the United States, are all entering a period where their economies are aging both figuratively and literally. Initially a declining birthrate is beneficial, as fewer resources are needed to raise the young and females enter the labor force. But when a low birth rate lasts a couple of decades, it begins to reduce the labor force, which reverses the prior decades benefits.
When a society ages, its resource allocation increasingly favors the old. Healthcare costs rise exponentially. An older population also takes fewer risks, which makes social and economic change difficult. Rising social burdens of an aging society fall on the shoulders of the younger working population i.e. their tax burden rises ("will you still need me, will you still feed me"). Diminishing returns for those who are working causes them to choose more leisure, hence producing less. A society changes in many ways; it becomes more conservative, less hard-working, and less innovative. The society ages.
Is it possible to "age gracefully"? Perhaps. I've been told that visiting Japan is a story of two countries, Tokyo and everywhere else. Tokyo looks and feels like any other major global metropolis, young, vibrant, and dynamic. Everywhere else you travel in Japan you are surprised at how few young people there are in the streets, most taxi drivers are around 70. Hotels and restaurants are staffed by ladies in their 60's and 70's. Tokyo has sucked the young out of the countryside. Japan has decided to age gracefully, the young have migrated to Tokyo, and the old have accepted the fact that they will work till they no longer can.
Will the culture of Europe and the U.S. allow us to age gracefully? It's doubtful. Already the Greeks are rioting in the streets over threats to their promised benefits, and the Italians are demonstrating to defend their retirement age of 55. Will we American's peacefully accept the fact that we have to work longer to support the benefit programs promised to those no longer working?
Is it possible to prevent or reverse economic aging? It's doubtful, declining birth rates and rising life expectancy are powerful forces. But, it may be possible to slow the aging process some. Immigration is an often cited solution, as is increased incentives for innovation. Unfortunately, here in the United States we are moving in the opposite direction on both of these fronts.
Investment Considerations
Aging is supposed to be deflationary, and Japan's experience supports that theory. However, deflation is possible only when a government can borrow to cover the costs of aging. When the worlds largest economic powers are aging, and their debt levels are already monstrously high, there are fewer and fewer investors willing or capable to buy their debt...inflation becomes inevitable. Inflation is simply a form of reneging on your promises. Promises to beneficiaries as well as bond holders.
As with everything timing is crucial. I would not be at all surprised to see a fairly heated battle between the forces of deflation and inflation over the next several years, with deflation winning some early skirmishes, but inflation ultimately winning the war.
We continue to position our portfolios for all possible outcomes, we have equal amounts of U.S. and foreign equities, bonds & Treasury inflation protected securities, and REIT's; as well as commodities, gold, and Chinese Yuan.
As the graph below shows, it is usually pretty smart to bet on the countries growing versus those declining.
Chris Wiles
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
"Aging is supposed to be deflationary, and Japan's experience supports that theory" - aging just means potentially less consumption of goods (not services, e.g. intensive care!) and equally less production thus cancelling price fluctuations out in the long run. In fact, if society consumes less e.g. through aging then economies of scale in production might be reduced, thus, all other things being equal, prices could actually rise. However, that's neither here nor there: Japan has inflated not deflated, only prices haven't (yet) risen accordingly. Wait a while. This "fear of deflation" is just a ruse by central banks to keep inflating the money supply. Deflation does not keep people from spending – they always spend what's necessary. And money NOT "spent" is then saved which means it is credit to someone who invests it for capital goods etc. thus it is again being spent, only not for consumption. Money never lies completely idle to any extent whether there's inflation, deflation, stability or a solar eclipse. For deflation to seriously happen, not only the current extreme credit expansion by the central banks and states (through "quantitative easing", stimulus packages, monetising and then spending national debt etc.) but also the money that was released into the economy PRIOR to the collapse would have to be "mopped up" again. This is nowhere to be seen nor would it be technically possible (confiscation aside) so we will rather see inflation than deflation.
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