Is Inflation Dying of Old Age?

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Simplegift
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Is Inflation Dying of Old Age?

Post by Simplegift » Fri Jun 09, 2017 7:13 pm

For those of us saving and investing in the 1970s, the loss of our financial assets to high inflation (5%-12% annually) made a strong impression. In his 2013 e-book, Deep Risk, William Bernstein identifies inflation as one of the most important threats of permanent capital loss (along with deflation, confiscation and devastation). Many of our portfolios today are designed to protect against future inflation, with diversified stocks, REITs, commodities and TIPS.

This post reports on a growing body of research indicating that inflation may be waning as a global risk, due to aging populations and shrinking work forces, especially in developed countries. This is not just futuristic research — 7 countries today are already considered “super-aged,” with over 20% of their population 65 and older (Japan, Italy, Greece, Portugal, Finland, Bulgaria, and Sweden). By 2020, this group will have 13 countries, and will grow to 34 nations by 2030, including the United States.

The charts below show inflation and declining working age populations, first in the G7 countries and then for the U.S.:

Why the suspected correlation? Besides the reduced availability of labor, aging countries suffer lower economic growth, lower productivity, higher savings and lower investment rates, and low or even negative equilibrium interest rates. Even correcting for the effects of monetary policy in recent decades, aging populations appear to be a significant factor in falling inflation rates.

Portfolio Implications: If inflation and economic growth stay low for years, it wouldn't be great news for bond investors, especially those looking for retirement income. Like most retirees though, after years of low rates already, I’ve personally adapted to them. Stocks and REITs have historically done well in low-inflation, low-growth environments. However, in a wholesale structural shift to a low inflation future, portfolio allocations to commodities and TIPS might be reconsidered. Your thoughts?
Last edited by Simplegift on Fri Jun 09, 2017 8:51 pm, edited 2 times in total.
Cordially, Todd

Good Listener
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Re: Is Inflation Dying of Old Age?

Post by Good Listener » Fri Jun 09, 2017 7:19 pm

Correlations aren't indicative of causality necessarily. Can you explain why a tightening labor force would lead to a decline in inflation as opposed to the opposite?

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Re: Is Inflation Dying of Old Age?

Post by grok87 » Fri Jun 09, 2017 7:24 pm

Simplegift wrote:For those of us saving and investing in the 1970s, the loss of our financial assets to high inflation (5%-12% annually) made a strong impression. In his 2013 e-book, Deep Risk, William Bernstein identifies inflation as one of the most important threats of permanent capital loss (along with deflation, confiscation and devastation). Many of our portfolios today are designed to protect against future inflation, with diversified stocks, REITs, commodities and TIPS.

This post reports on a growing body of research indicating that inflation may be waning as a global risk, due to aging populations and shrinking work forces, especially in developed countries. This is not just futuristic research — 7 countries today are already considered “super-aged,” with over 20% of their population 65 and older (Japan, Italy, Greece, Portugal, Finland, Bulgaria, and Sweden). By 2020, this group will have 13 countries, and will grow to 34 nations by 2030, including the United States.

The charts below show inflation and declining working age populations, first in the G7 countries and then for the U.S.:

Why the suspected correlation? Besides reducing the availability of labor, aging countries suffer lower economic productivity, higher savings and lower investment rates, and low or even negative equilibrium interest rates. Even correcting for the effects of monetary policy in recent decades, aging populations appear to be a significant factor in falling inflation rates.

Portfolio Implications: If inflation and economic growth stay low for years, it wouldn't be great news for bond investors, especially those looking for retirement income. Like most retirees though, after years of low rates already, I’ve personally adapted to them. Stocks and REITs have historically done well in low-inflation, low-growth environments. However, in a wholesale structural shift to a low inflation future, portfolio allocations to commodities and TIPS might be reconsidered. Your thoughts?

it's an interesting theory.

here's another one. bouts of higher unexpected inflation tend to be associated with major wars. this link makes the point

https://inflationdata.com/Inflation/Inf ... Decade.asp
1913-1919 figures were driven by World War 1.

1940-1949 was driven by World War II

1970-1979 was driven by Vietnam.

i don't think we will be waiting tooo long.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Fri Jun 09, 2017 7:45 pm

Good Listener wrote:Correlations aren't indicative of causality necessarily. Can you explain why a tightening labor force would lead to a decline in inflation as opposed to the opposite?

Most economic research historically has considered inflation to be purely a monetary phenomenon. But with real live aging countries to study now (most notably Japan and Germany), aging populations have recently become the focus of research on persistent low inflation rates. So there is not a lot of long-term data.

My sense is that the impact of shrinking work forces is most directly related to lower demand, lower investment rates, and reduced productivity in the overall economy — in other words, the whole secular stagnation theme. In this era of modern monetary policy, It’s pretty hard to have high inflation when economic growth and demand are low and/or declining steadily.
Last edited by Simplegift on Fri Jun 09, 2017 7:55 pm, edited 1 time in total.
Cordially, Todd

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Re: Is Inflation Dying of Old Age?

Post by Bastiat » Fri Jun 09, 2017 7:54 pm

I view this question akin to asking the same thing about market corrections. If human history is any indication, particularly given the debt levels carried by most nations, I'd say inflation is not yet a thing of the past.

This chart omits the past 5 or 6 years, but it conveys the point.

Image

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Fri Jun 09, 2017 8:05 pm

Just a general caution: If this discussion wanders into the weeds of central bank monetary policies and general theories of inflation — rather than the portfolio implications of inflation — the moderators will understandably lock the thread. So let's attempt to stay focused on the investment aspects. Thank you!
Cordially, Todd

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Re: Is Inflation Dying of Old Age?

Post by Dominic » Fri Jun 09, 2017 8:23 pm

I think the rationale for inflation being negatively correlated with population age makes sense. Retirees live off of the resources they have, and a younger workforce will generally be lower paid than a more experienced one. That would imply a tightening of monetary velocity, and as a result, decreased inflation.

Is it also possible that inflation has less to do with the supply of money and more to do with the supply of products? The availability of cheap imported goods may have contributed to decreased inflation in the developed world throughout this period. Developed countries also tend to age as a result of declining birth rates, so the original correlation makes sense.

This line of reasoning behind low inflation makes sense, and it can be reasonably expected to persist. If that's wrong, equities will appreciate in an inflationary environment, and eventually, bond yields will catch up. As a young investor, I see no reason to hold inflation-linked bonds at this point.

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Re: Is Inflation Dying of Old Age?

Post by dsp » Fri Jun 09, 2017 8:36 pm

Bastiat wrote:This chart omits the past 5 or 6 years, but it conveys the point.

Image


That chart is misleading. It needs to be on a log scale to be of any utility.
dsp

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Re: Is Inflation Dying of Old Age?

Post by grok87 » Fri Jun 09, 2017 8:44 pm

Simplegift wrote:
Good Listener wrote:Correlations aren't indicative of causality necessarily. Can you explain why a tightening labor force would lead to a decline in inflation as opposed to the opposite?

Most economic research historically has considered inflation to be purely a monetary phenomenon. But with real live aging countries to study now (most notably Japan and Germany), aging populations have recently become the focus of research on persistent low inflation rates. So there is not a lot of long-term data.

My sense is that the impact of shrinking work forces is most directly related to lower demand, lower investment rates, and reduced productivity in the overall economy — in other words, the whole secular stagnation theme. In this era of modern monetary policy, It’s pretty hard to have high inflation when economic growth and demand are low and/or declining steadily.


with regard to "reduced productivity" i think the standard theory is that, all things being equal, it would lead to HIGHER inflation.

http://www.econmentor.com/college-macro ... 0inflation

"If nominal wages increase faster than increase in labor productivity, we will have inflation in the economy, equal to that differential. "

the trouble is everything is inter-related, so it is hard to hold things equal.

Year over year house price appreciation for the 12 months ending 3/1/17 is 6%. My guess is that eventually housing costs are going to spark inflation.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Re: Is Inflation Dying of Old Age?

Post by Spirit Rider » Fri Jun 09, 2017 8:47 pm

I am always skeptical of any one suggesting "this time its different" no matter why.

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Fri Jun 09, 2017 8:48 pm

Checking to see how stocks and REITs have actually performed historically in low-inflation, low-growth environments, this chart surfaced (since 1972):

According to the article, when U.S. economic growth was less than 5% and inflation less than 3% historically, stocks and REITs had their best performances (on right in the chart above).
Last edited by Simplegift on Fri Jun 09, 2017 8:54 pm, edited 1 time in total.
Cordially, Todd

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Re: Is Inflation Dying of Old Age?

Post by letsgobobby » Fri Jun 09, 2017 8:53 pm

Simplegift wrote:

Portfolio Implications: If inflation and economic growth stay low for years, it wouldn't be great news for bond investors, especially those looking for retirement income. Like most retirees though, after years of low rates already, I’ve personally adapted to them. Stocks and REITs have historically done well in low-inflation, low-growth environments. However, in a wholesale structural shift to a low inflation future, portfolio allocations to commodities and TIPS might be reconsidered. Your thoughts?

EE bonds would do very well in this scenario.

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Re: Is Inflation Dying of Old Age?

Post by runner540 » Fri Jun 09, 2017 9:02 pm

grok87 wrote:
Simplegift wrote:
Good Listener wrote:Correlations aren't indicative of causality necessarily. Can you explain why a tightening labor force would lead to a decline in inflation as opposed to the opposite?

Most economic research historically has considered inflation to be purely a monetary phenomenon. But with real live aging countries to study now (most notably Japan and Germany), aging populations have recently become the focus of research on persistent low inflation rates. So there is not a lot of long-term data.

My sense is that the impact of shrinking work forces is most directly related to lower demand, lower investment rates, and reduced productivity in the overall economy — in other words, the whole secular stagnation theme. In this era of modern monetary policy, It’s pretty hard to have high inflation when economic growth and demand are low and/or declining steadily.


with regard to "reduced productivity" i think the standard theory is that, all things being equal, it would lead to HIGHER inflation.

http://www.econmentor.com/college-macro ... 0inflation

"If nominal wages increase faster than increase in labor productivity, we will have inflation in the economy, equal to that differential. "

the trouble is everything is inter-related, so it is hard to hold things equal.

Year over year house price appreciation for the 12 months ending 3/1/17 is 6%. My guess is that eventually housing costs are going to spark inflation.


Bingo. Rents have also increased fast. The survey method where owners estimate the rental valuen of their dwelling doesn't seem that reliable to me.

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Re: Is Inflation Dying of Old Age?

Post by NibbanaBanana » Fri Jun 09, 2017 9:09 pm

Referring to 20 year treasuries; "Beginning with the decade ending in 1985, the average annual return was +9% or higher. This sea change in the level of interest rates, driven in part by changes in expectations about the level of inflation, is one of the more remarkable events of modern financial theory." - John Bogle, "Bogle on Mutual Funds"

It can't be the case that the Arab oil embargo didn't play a huge role in this. Remember the gas lines of the 1970's and spike in oil prices. The more energy you consume, the higher your standard of living. Energy prices effect everything. From what they say, the world is awash in fossil fuel with no end insight. Low inflation.

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Re: Is Inflation Dying of Old Age?

Post by rgs92 » Fri Jun 09, 2017 9:17 pm

Thanks to the OP for this very good post.
I've always felt that inflation was a self-fulfilling prophecy, where optimism about widespread growth and prosperity led businesses to invest in plant/equipment/labor for future gains.
I haven't sensed that kind of attitude since 1999.
I don't see this returning anytime soon.
No more moon shots or Worlds Fairs.

Oil shortage? People will just Skype to work. No need to travel with 100+ Mbps at your fingertips.

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Re: Is Inflation Dying of Old Age?

Post by Bastiat » Fri Jun 09, 2017 9:30 pm

dsp wrote:
Bastiat wrote:This chart omits the past 5 or 6 years, but it conveys the point.

Image


That chart is misleading. It needs to be on a log scale to be of any utility.


The chart is only misleading if you don't understand what a dollar is. And in fact, if the goal is to understand the absolute supply of money, the chart has utility, because that's what it shows.

If we are speaking of inflation, the absolute money supply matters, and the dollar is the unit of measure. This is why the Fed itself publishes the money supply numbers on linear graphs. It's also the reason your personal performance graphs on vanguard are on a linear scale; it would be silly if $100,000 looked different depending on where on the scale you were because it is still $100,000 regardless of how much money you have.

It took some digging, but I was able to find a graph of M1 on a logarithmic scale so as not to mislead you:

Image
Last edited by Bastiat on Fri Jun 09, 2017 9:32 pm, edited 1 time in total.

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Re: Is Inflation Dying of Old Age?

Post by Nearing_Destination » Fri Jun 09, 2017 9:31 pm

Looking at the OP's figure 7, there is no correlation and certainly nothing that attempts to drive the OP 's hypothesis, not even a correlation like "compared to the cost of butter in Mongolia ".

As another poster has noted, the conventional "wisdom " is that as the workforce ages, the number of employable workers decreases which drives up wages and products associated with the requirement for labor and thus an increasing inflation.

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Re: Is Inflation Dying of Old Age?

Post by grok87 » Fri Jun 09, 2017 9:44 pm

Dominic wrote:I think the rationale for inflation being negatively correlated with population age makes sense. Retirees live off of the resources they have, and a younger workforce will generally be lower paid than a more experienced one. That would imply a tightening of monetary velocity, and as a result, decreased inflation.

Is it also possible that inflation has less to do with the supply of money and more to do with the supply of products? The availability of cheap imported goods may have contributed to decreased inflation in the developed world throughout this period. Developed countries also tend to age as a result of declining birth rates, so the original correlation makes sense.

This line of reasoning behind low inflation makes sense, and it can be reasonably expected to persist. If that's wrong, equities will appreciate in an inflationary environment, and eventually, bond yields will catch up. As a young investor, I see no reason to hold inflation-linked bonds at this point.

equities don't always do well in an inflationary enviroment. in the stagflation of the 70s and 80s stocks did poorly

http://ritholtz.com/1979/08/the-death-of-equities/
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Fri Jun 09, 2017 9:51 pm

Nearing_Destination wrote:As another poster has noted, the conventional "wisdom " is that as the workforce ages, the number of employable workers decreases which drives up wages and products associated with the requirement for labor and thus an increasing inflation.

That may the conventional wisdom, but a simple regression of the median age of a country’s population and its inflation rate shows differently (chart below). This analysis looks at the twenty largest developed and twenty largest emerging markets (40 countries in all), averaged over a 5-year period from 2000-2014. This sample represents a fairly good cross-section of economic growth rates, central bank monetary policies, and demographic characteristics, I believe.

This analysis appears to confirm a fairly strong inverse relationship between population age and inflation rates (R2 = 0.51). For the countries bunched on the left side of the chart, think about their reduced economic growth due to lower demand and investment in older populations — the secular stagnation theme.
Last edited by Simplegift on Fri Jun 09, 2017 9:55 pm, edited 2 times in total.
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Re: Is Inflation Dying of Old Age?

Post by in_reality » Fri Jun 09, 2017 9:53 pm

In America's inflation heyday, didn't salaries keep up? I think they pretty much did and that extra cost kept pushed up prices more.

In today's globalized times, even a country like Japan which has a shortage of labor with more openings than applicants doesn't get inflation because they can push more and more work overseas.
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Re: Is Inflation Dying of Old Age?

Post by TD2626 » Fri Jun 09, 2017 9:55 pm

It seems like there is a large focus on inflation protection on the part of those old enough to have lived through the most recent period of high inflation.

It seems like there is a large focus on stock investing (with some suggesting excessive equity allocations) on the part of those young enough to have not been invested during the most recent market crash.

I feel that a middle ground can be found. Allocations of 100% stocks or 100% tips/ibonds are unreasonable for most. Inflation protection is important, and inflation should always be considered in portfolio design. However, protection from inflation can't be the only goal - other things (risk vs return) are generally more important.

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Re: Is Inflation Dying of Old Age?

Post by Nearing_Destination » Fri Jun 09, 2017 9:57 pm

I'm sorry, but an R^2 of 0.51 and "fairly strong" correlation is not consistent-- rather it is a fairly weak correlation.


(If I had posited that in any of my papers when I was w@rking, the reviewers would have rejected them )

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Re: Is Inflation Dying of Old Age?

Post by HomerJ » Fri Jun 09, 2017 9:59 pm

All I know is...

The absolute easiest way for any government to handle national debt is to inflate it away.

Just saying.

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Re: Is Inflation Dying of Old Age?

Post by Nearing_Destination » Fri Jun 09, 2017 10:06 pm

HomerJ wrote:All I know is...

The absolute easiest way for any government to handle national debt is to inflate it away.

Just saying.


You mean like the Weimar Republic? ...and the like

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Fri Jun 09, 2017 11:01 pm

Nearing_Destination wrote:I'm sorry, but an R^2 of 0.51 and "fairly strong" correlation is not consistent-- rather it is a fairly weak correlation.

For economic and financial data the correlation isn't bad. The more important point is that the regression line is sloping in the right direction (the older the median age of a country, the lower its inflation rate) — refuting the “conventional wisdom” that the post and chart was responding to.
Cordially, Todd

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Re: Is Inflation Dying of Old Age?

Post by jalbert » Sat Jun 10, 2017 12:10 am

Expected inflation should priced in to most stocks and bonds whether it is expected to be 1.5% or 10%. Protecting against inflation risk is protecting against unexpected inflation regardless of where inflation expectations land. Projections about inflation being low mean expected inflation is low. In that scenario, inflation unexpectedly rising even only to moderate levels would be a significant issue.
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Re: Is Inflation Dying of Old Age?

Post by Stormbringer » Sat Jun 10, 2017 12:25 am

Simplegift wrote:This post reports on a growing body of research indicating that inflation may be waning as a global risk, due to aging populations and shrinking work forces, especially in developed countries.

It seems to me that there is a mathematical near-certainty lurking somewhere out there on the horizon of widespread, government-induced inflation. Governments around the world continue to accumulate staggering levels of debt and pension obligations, and with shrinking work forces to tax, eventually something has to give.

Outright default would have horrific economic consequences, and draconian levels of austerity are politically unsustainable and perhaps self-defeating. This leaves some form of financial repression (long-term negative real interest rates) or currency debasement as the path of least resistance.

That said, Japan has shown us that these things can go on for a long, long time, but ultimately the math is what it is, and that which cannot go on forever, won't.

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Re: Is Inflation Dying of Old Age?

Post by mega317 » Sat Jun 10, 2017 12:59 am

Does this imply that as that generation passes on and the median age decreases we can expect inflation? Is it that predictable and straightforward?

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Re: Is Inflation Dying of Old Age?

Post by in_reality » Sat Jun 10, 2017 1:15 am

mega317 wrote:Does this imply that as that generation passes on and the median age decreases we can expect inflation? Is it that predictable and straightforward?


I don't think so but rather that globalization has reduced it beyond what age demographics might.
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Re: Is Inflation Dying of Old Age?

Post by Oicuryy » Sat Jun 10, 2017 9:03 am

Any correlation between inflation and population age is just coincidence.

The high inflation of the 1970s was caused by the monetary policy of the time. See https://www.richmondfed.org/publication ... ter/hetzel Monetary policy changed in the early 1980's and inflation has been low since then.

Investors reading this forum will have to decide for themselves how much to hedge against possible future changes to monetary policy. Discussions of future monetary policy are forbidden here.

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Sat Jun 10, 2017 9:14 am

mega317 wrote:Does this imply that as that generation passes on and the median age decreases we can expect inflation? Is it that predictable and straightforward?

Unfortunately, the aging of the world population is not a generational phenomenon that will reverse at some point in the future. Around 2020, for the first time in human history, the global population of those over 65 will surpass those under 5 — and the growth of the world's older population will only accelerate from there (chart below).

By 2050, the number of people 65 and older will be twice that of those under age 5 — a complete reversal of the world ratio in 1950, when the older population was less than half the younger population.
Cordially, Todd

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Re: Is Inflation Dying of Old Age?

Post by BolderBoy » Sat Jun 10, 2017 9:28 am

Milton Friedman preached rather cogently that inflation is caused by government spending money it doesn't have (by merely printing more money). Is there some reason to believe that is not so?
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Re: Is Inflation Dying of Old Age?

Post by packer16 » Sat Jun 10, 2017 9:30 am

Inflation is caused by shortages. No shortages, no inflation. Technology over time is increasing production for given units of labor & other inputs. History provides some very good lessons here. The highest levels of inflation were the results of war, famine and epidemics. These events caused shortages of goods and ultimately people which fueled inflation. There is a good book on this subject "The Great Wave" by Fischer which documents price movements since 1200. An interesting counter point the inflation is caused by increasing money supply is during the 1800s the money supply of the world skyrocketed but there was deflation (see Figure 3.26 in Fischer p.170). This is caused by productivity outstripping the increase in money supply. The difference in the 20th century was that half the world was following communism a productivity destroying economic system which in the end caused shortages (in goods and the world wars caused shortages of people & thus price increases).

As long as we do not have war, famines or epidemics or increased popularity of productivity destroying systems such as communism, inflation will not be an issue but deflation may be unless the printing presses stop printing.

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Sat Jun 10, 2017 9:36 am

BolderBoy wrote:Milton Friedman preached rather cogently that inflation is caused by government spending money it doesn't have (by merely printing more money). Is there some reason to believe that is not so?

For many years, economic researchers like Friedman considered inflation to be a purely monetary phenomenon. But with real live populations in aging countries to study now (notably Japan and Germany), older populations have become the focus of research on persistent levels of low inflation.

The recent research appears to be a new way of looking at the phenomenon of inflation, beyond the classic monetary models.
Cordially, Todd

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Re: Is Inflation Dying of Old Age?

Post by FrugalInvestor » Sat Jun 10, 2017 9:39 am

Eh, I've heard it all before. "This time it's different!" Usually it isn't. Time will tell but I won't assume that inflation is gone.
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Re: Is Inflation Dying of Old Age?

Post by Snowjob » Sat Jun 10, 2017 9:52 am

Inflation is driven by a combination of the supply and velocity of money.

To many things affecting the velocity right now, some that jump out at me are
- Aging populations that consume less as discussed above
- New Technology (think efficiency, comiditizers, sharing etc) which is a deflator over time
- Higher savings rates for those who can
- Durability of assets / no more massive leaps in basic development (invention of electricity, running water, cars. do a lot more for gdp / jobs / wages / growth, than extending life for terminal diseases a few years, snap chat social media, and the deflators like Uber, Google Priceline Airb&b etc)

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Re: Is Inflation Dying of Old Age?

Post by Theoretical » Sat Jun 10, 2017 9:54 am

Inflation is more subtle. Gasoline has 10% ethanol (less energy), a half gallon of ice cream is now 1.75 quarts, orange juice containers are 59 oz not 64, etc...

Also, housing prices have been soaring for quite some time in many areas.

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Re: Is Inflation Dying of Old Age?

Post by Oicuryy » Sat Jun 10, 2017 10:01 am

Simplegift wrote:Image

What is the equation for that line?

Simplegift wrote:Source: Census Bureau

Using the equation for that line and the data in Table B-3 from that link what will the inflation rates be for those forty countries in 2050?

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Re: Is Inflation Dying of Old Age?

Post by Levett » Sat Jun 10, 2017 10:03 am

I appreciate the post, Todd. It's a subject I have thought about, but not at your level of sophistication.

Thanks.

Lev

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Sat Jun 10, 2017 10:20 am

Oicuryy wrote:What is the equation for that line?

y = -1.8926x + 43.034

Oicuryy wrote:Using the equation for that line and the data in Table B-3 from that link what will the inflation rates be for those forty countries in 2050?

Good question, Ron. It may be a research project worth pursuing, but not for me this weekend. Have at it, if you like.
Cordially, Todd

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Re: Is Inflation Dying of Old Age?

Post by Valuethinker » Sat Jun 10, 2017 10:33 am

Theoretical wrote:Inflation is more subtle. Gasoline has 10% ethanol (less energy), a half gallon of ice cream is now 1.75 quarts, orange juice containers are 59 oz not 64, etc...

Also, housing prices have been soaring for quite some time in many areas.


Would you rather have leukemia treatment now or in 1970?

Would you rather research an academic paper now or in 1980? (I can answer that one, spent days, literally, chasing around libraries looking for journals)

Would you rather have the safety features (or the horsepower) of a car now, or 1970?

Would you rather have the computer you are using now, or the Fat Mac in 1986 (I had one of those)?

Assuming you live in Los Angeles, would you rather breathe the air now, or as it was in 1972? Would you rather your kids were exposed to the lead in the environment in 1973, or now?

Assuming you live near the Cayahuga River, would you rather it was as it is now, or in 1972?

Would you rather have a modern smartphone, or the cellphone you could buy in 1979?

My point:

- the "hidden inflation" figures you are talking about (smaller package sizes) is real. Incomes of the median consumer aren't rising, there is sticker price resistance, consumer product makers cut back. But, in fact, with a lag, CPI calculations adjust for that

- hedonic changes in quality are almost certainly undermeasured-- in other words, what you get for your money, now, is much more than you would have gotten 40 years ago.

Standards of living *are* rising due to changing technology. Unfortunately, median incomes have tended to be stagnant, so for many people, it doesn't feel like that. Contrast to the 1970s when wage rises were quite large, and so was inflation.

Just on gasoline that 10% is government mandate. And of course it makes the air cleaner (ethanol is an octane enhancer, so car engine runs better). And that's another standard of living increase.

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Re: Is Inflation Dying of Old Age?

Post by Valuethinker » Sat Jun 10, 2017 10:37 am

BolderBoy wrote:Milton Friedman preached rather cogently that inflation is caused by government spending money it doesn't have (by merely printing more money). Is there some reason to believe that is not so?


That's easy. It didn't work out.

Attempts to control monetary aggregates in the period of "hard monetarism" in the late 70s/ early 80s failed. It turned out that control in M1 led to a growth in M2. Control in M2 led to a growth in M3. And so on. The problems are two:

- the financial system is capable of constant innovation, so there is no monetary aggregate that you can point to and say "that is money supply, this is what we control". Friedman's whole idea of targetting a money supply number and keeping growth to a small and stable number just didn't work out

- it's the velocity of money, rather than the quantity, which is the thing which is really volatile. And for reasons above, impossible to control (remember money GDP per annum = quantity of money x velocity of money pa (GDP is a per annum number)).

Eventually Central Banks abandoned monetarism as a theory to guide policy. They moved on to Inflation Targeting. Which worked very well when the goal was to keep inflation down. Turns out it doesn't work so well when the goal is to get inflation back up.

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Re: Is Inflation Dying of Old Age?

Post by Valuethinker » Sat Jun 10, 2017 10:43 am

Snowjob wrote:Inflation is driven by a combination of the supply and velocity of money.

To many things affecting the velocity right now, some that jump out at me are
- Aging populations that consume less as discussed above


Be careful. The fastest growing piece of the US economy in the last 30 years has been healthcare expenditures.

Older people spend money differently-- does not mean that they don't spend it. Even if that spending is not voluntary, nor by them.

However they may save more, because they fear future impoverishment (spend less than their income, or don't fully deplete their stock of assets).

- New Technology (think efficiency, comiditizers, sharing etc) which is a deflator over time


Maybe. Telecoms bandwidth is certainly the one that comes to mind. Roughly speaking, cost of moving data or voice has fallen by say 99% (might be 99.9 or 99.99%) in say 30 years?

- Higher savings rates for those who can


Increased inequality of wealth and income perhaps? Those who have income and savings, save more. The rest don't matter.

- Durability of assets / no more massive leaps in basic development (invention of electricity, running water, cars. do a lot more for gdp / jobs / wages / growth, than extending life for terminal diseases a few years, snap chat social media, and the deflators like Uber, Google Priceline Airb&b etc)


See Robert Gordon. Not sure he is entirely persuasive. I look around, and see some incredible technological changes going on. e.g. electric and autonomous vehicles. Maybe the impacts just haven't hit yet.

Agree running hygenic water (ie sewers), the steam train & the telegraph are as big changes to human life as have happened since perhaps beginning of agriculture.

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Re: Is Inflation Dying of Old Age?

Post by Theoretical » Sat Jun 10, 2017 11:37 am

Oh I completely agree that there's a quality of living difference.

On the macro scale, I think the heavy use of derivatives makes "what's out there" a murky concept.

When you had trillions of dollars in leverage collapse followed by trillions in worldwide QE, I think there's a real risk that someone will miscalculate badly in either a deflationary or inflationary way. The latter I think especially possible because inflation has been tamed so long.

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Re: Is Inflation Dying of Old Age?

Post by stlutz » Sat Jun 10, 2017 11:42 am

However, in a wholesale structural shift to a low inflation future, portfolio allocations to commodities and TIPS might be reconsidered. Your thoughts?


To step away from the theory and back to the practical, I think think allocations to TIPS should be reconsidered, but not in the way I think you were thinking. :happy

When 10 year treasuries yielded 6 or 7% not all *that* long ago, you had quite a bit of inflation protection built into that rate to start with. The inflation risk of such an instrument was actually rather low--if inflation averaged 5% over those 10 years, you still come out positive. The inflation "risk" was actually to the down side--inflation has been lower than expected, which meant among other things that longer term debt was a big winner over shorter term debt. The risk showed up for the person who opted for shorter-term debt.

Today, the 10 year yields 2.2%. That has baked in most of the logic which you've discussed in this thread and others about secular stagnation, demographics etc. However, that means that the risk is actually to the high side. Something my change to actually cause inflation to go higher again. Perhaps central bankers will figure out how to better "stimulate." Perhaps households will start taking on more debt than they have been in this recovery. Perhaps there will be a lot of war. The main downside risks (adopting the gold standard?) seem extremely unlikely.

So, even though there may be a probability of continued low inflation, there is a real risk of higher inflation. That would seem to suggest that it would be wise to use a higher allocation to TIPS than one might have 10 years ago to protect oneself from those risks. Relatively low real returns from bonds are near certainty--TIPS will protect you from the risk of significantly negative real returns.

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Re: Is Inflation Dying of Old Age?

Post by Theoretical » Sat Jun 10, 2017 11:53 am

So, even though there may be a probability of continued low inflation, there is a real risk of higher inflation. That would seem to suggest that it would be wise to use a higher allocation to TIPS than one might have 10 years ago to protect oneself from those risks.


Interesting point. TIPS in deferred and 3-6 month T-bills in taxable are my inflation plans.

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Re: Is Inflation Dying of Old Age?

Post by Simplegift » Sat Jun 10, 2017 12:16 pm

stlutz wrote:So, even though there may be a probability of continued low inflation, there is a real risk of higher inflation. That would seem to suggest that it would be wise to use a higher allocation to TIPS than one might have 10 years ago to protect oneself from those risks. Relatively low real returns from bonds are near certainty--TIPS will protect you from the risk of significantly negative real returns.

A persuasive point, which I largely agree with. Personally, my portfolio allocation to TIPS is still intact and is not likely to change in the future. I view it as a modest insurance policy against the very inflation dynamic you suggest.

Musing about real returns over on the stock side: In a low inflation future, it could be that real equity returns would not suffer all that much. In decades past when nominal stock returns were high historically (8%-10% on average), inflation was also high (4%-5%, or in the 1970s, 10%+). Thus, the positive effects of high returns were offset by the negative effects of rising inflation and high interest rates.
Cordially, Todd

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Re: Is Inflation Dying of Old Age?

Post by Valuethinker » Sat Jun 10, 2017 12:38 pm

Theoretical wrote:Oh I completely agree that there's a quality of living difference.

On the macro scale, I think the heavy use of derivatives makes "what's out there" a murky concept.

When you had trillions of dollars in leverage collapse followed by trillions in worldwide QE, I think there's a real risk that someone will miscalculate badly in either a deflationary or inflationary way. The latter I think especially possible because inflation has been tamed so long.


It has proven to be extremely difficult to "create" inflation-- just ask Japan.

I tend to use a Keynesian model. When we are at full employment, then rises in in demand above that level tend to lead to inflation.

Problems:

- US may be close to that. However we live in a globally integrated economy, and it's easier to move factors of production around. Rise in demand may simply be met by countries with excess unemployment, rather than raising US wages. Further, companies cannot pay higher wages without higher productivity, without in turn losing market share to companies that don't have that problem (e.g. with production facilities offshore).

Also a structural point: trade unions are nowhere as powerful now as they were during the period of sustained inflation of the 1960s & 70s.

Even if the US is close to full employment, most other countries are not.

- Central Banks have hard won inflation credentials. For an increase in inflation to take place, the market has to believe CBs will be now, and *for all time in the future* irresponsible about a rise in the price level (rational expectations). In other words, the CBs have to convince the market that if monetary policy is too loose now, it will never be corrected. They won't in future try to bring down inflation.

- Derivatives - since a derivative is just a win on one side and a lose on the other, I don't see how derivatives can inherently create inflation? My purchase of an oil future is just your sale. In other words, derivatives net to zero (always).

The exception is of course counterparty risk (think AIG). I go broke, so you lose money on the contract. That has to be inflation neutral or deflationary?

It may be that Derivatives accelerate the velocity of money in the economy. Again, I'd have to think about that pretty carefully. That could, in principle, be inflationary.

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Re: Is Inflation Dying of Old Age?

Post by Valuethinker » Sat Jun 10, 2017 12:42 pm

Simplegift wrote:Musing about real returns over on the stock side: In a low inflation future, it could be that real equity returns would not suffer all that much. In decades past when nominal stock returns were high historically (8%-10% on average), inflation was also high (4%-5%, or in the 1970s, 10%+). Thus, the positive effects of high returns were offset by the negative effects of rising inflation and high interest rates.


Rising inflation tends to be bad for stock returns, I believe:

- due to the way capital allowances (tax) are calculated companies pay too much tax when prices are rising (depreciation and tax writeoffs are understated, also companies make stock profits on goods sold from inventory which they pay tax on)

- a lot of companies get a cost squeeze, where their costs rise faster than they can pass it on to customers. Exceptions are companies at the beginning of value chains (eg raw materials producers, and many of those are state owned (oil & gas) or pay royalties based on those prices) and those with premium products where the consumers absorb price rises (are price inelastic)-- example: tobacco

- interest rate rises make stocks less attractive

Because in falling inflation often 2 or 3 of these factors are reduced, stocks may rebound.

Haven't tested this statistically, but intuitively this is what I think is going on.

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Re: Is Inflation Dying of Old Age?

Post by garlandwhizzer » Sat Jun 10, 2017 12:43 pm

Great post, Simplegift. Brings up a very interesting question that has major long term implications for DM economies and investments. I tend to agree that all DM demographics are unfavorable and getting worse, with historically low labor force participation rates, and that these changes are not temporary but rather are likely to accelerate in the future. I believe that demographics plays an important part in the low inflation/low growth macroeconomic situation that continue to confront all DMs even 8 years into a "recovery." Never before in economic history to my knowledge have central banks lowered interest rates this much for this long and still they can't produce 2% inflation which is well below historical inflation averages in the US (3%+). I believe the ultimate problem to be sluggish aggregate demand due to high levels of household debt, unfavorable demographics, and declining productivity growth, increasing longevity, and net manufacturing job destruction largely by technology, less so by globalization.

Much of what growth we have experienced in the US over the last 8 years has been debt-fueled growth, both governmental and household, rather than growth driven by ever increasing aggregate demand unrelated to increased debt. Corporations currently have many billions sitting on their balance sheets in cash and typically do not invest it in new plant, equipment, and hiring because they do not believe that aggregate demand is sufficient to absorb that increased output. The net killing of jobs by technology and globalization exacerbates this employment picture, concentrating massive wealth in the hands of highly educated and highly skilled few who typically either save that money, failing to increase demand, or buy stocks, bonds, and fixed assets, driving up the very generous valuations we see today. Increasing longevity also exacerbates this picture, more years spent in asset-consuming retirement, relatively fewer in asset-producing employment.

There is in my mind no doubt that clouds are on our intermediate/long term macroeconomic horizon. However, in spite of all this, we have had a fantastic bull market run in stocks for 8 years. In short, there is has been a growing disconnect between investment markets which are driven by the wealthy looking for places to park their money, and main street where job insecurity is high and real wages have been stagnant for 25 years. In the face of ever appreciating home prices and college educational costs, driven up largely by demand from the wealthy, it is quite difficult now for a couple, even with both working, to afford a home and to send their kids to college without talking on massive levels of new debt. Currently student loan debt in the US is $1.4 trillion and the loan delinquency rate is 11.2%. This merely digs the debt hole deeper and makes it harder for young workers to save anything after graduating from college. 30 or 40 years ago, one worker alone could afford a home and send his kids to college without resorting to debt while the spouse could stay at home. Those days of defined benefit pensions, secure well paying jobs, and low priced houses and college tuitions are gone, likely for good.

All this sounds gloomy but there is hope. In my recollection there has never been a time over the past 4 decades when threatening clouds weren't on the economic horizon for those who looked for it. How all this will play out in the end is not known. It doesn't really change investment plans. A widely-diversified low-cost portfolio of stocks and bonds is still the best way to go IMHO. I do believe that for the foreseeable future DM inflation will continue to be persistently low and economic growth will continue to be muted in spite of the massive efforts of central banks. Central banks have succeeded in fueling a great stock market rally and in inflating fixed asset prices but they have not been able for the above reasons to create robust and growing end demand. These macroeconomic imbalances in DMs are either nonexistent or not as severe in EMs where populations are younger, economic growth and final end demand are robust and growing, household savings are higher and household debt is lower. Increasing aggregate demand is not a problem there. I believe this in addition to relative valuations argue for inclusion of EM into current investment portfolios.

Garland Whizzer

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