A lid on interest rates
12 November 2021
Demographic forces combined with the increased use of technology across all businesses put downward pressure on yields. Current supply-side inflation cannot fight these strong structural forces over the long term.
To fight the Covid-19 pandemic, governments imposed measures that rattled the global economy. Following the release of the vaccines and the reopening after that, demand increased above expectations. As the supply could not keep up, there has been high inflation on some goods and services. Adding to this supply-demand imbalance the unprecedented fiscal and monetary policies of the various governments and central banks, fears of inflation seem justified.
Inflation and interest rates are rising, and the Fed is slowly starting a tightening cycle, which is a concern for many investors. However, investors with a long-term view should always consider the long-term driving forces of the economy.
Demography is one – if not the most – important of these factors. It affects not only all macro factors such as growth, inflation, monetary policies, and fiscal policies but also geopolitical tensions, globalization, urbanization, etc. For the years to come, current demographic trends in all major economies suggest lower growth and lower inflation, i.e., structurally low-interest rates.
Besides, we are entering into a new technological revolution, driven mainly by Artificial Intelligence and Robotics, which will massively increase productivity, scale efficiently, cut costs and drive down the output prices, also known as technological deflation.
How is Demography linked to Global Macro Factors?
Demography is the study of the measurement (graph) of the people (demo) and aims to examine changes in societies throughout space and time. It is a powerful but slow force at the root of many transitions in history and plays thus a central role in macroeconomics.
Historically, new technologies, global economic expansion, and population outbreaks have tended to occur together. Lately, the technology and healthcare revolutions have been accompanied by the fastest rise ever seen in the global population, increasing by 400% since 1950, along with an unprecedented economic expansion in duration and scale.
Demography is intimately linked to macro factors because workers create the GDP, and consumers consume the GDP. Thus, any change or imbalance between workers and consumers affects macro factors.
More precisely, the working-age population (25–54) is the cohort that will produce most of the GDP and consume most of it, given their relatively high income. They create the demand, buy houses, cars, and other durable goods, generating higher growth (more production to meet the demand) and inflation (demand shock). Conversely, the older population (65+) is out of the workforce and consumes less, thus decreasing growth and demand-side inflation. Therefore, when the share of the older population is increasing, both real growth and inflation would structurally be trending down.
Moreover, over the life cycle, financial decisions, risk aversion, and utility function change. Borrowing happens mostly at a young age, asset accumulation at middle age, and spending at old age. These behaviors have a substantial effect on growth and inflation as well as on asset allocation and asset prices. Thus, demographic changes are having a significant impact on how people work, consume and save.
In conclusion, growth and inflation follow the growth of the proportion of workers to the total population, as shown on the graphs below, plotting 10y annualized growth and inflation rates vs. the Age Dependency Ratio (i.e., the ratio between young and old over the working-age population).
How is technology linked to inflation?
Using various forms, technology allows businesses to scale efficiently, cut production costs, and expand to new markets. Lower costs imply a balance between higher margins and lower output prices. Global competition tends to boost the latter.
Moreover, the scaling capacity enabled via technology implies that virtually any change in demand could be met with an adequate supply, making it impossible for the prices to rise. Demand-side inflation will be non-existent. In other words, the advance in Artificial Intelligence, especially in forecasting capacities, allows the suppliers to predict future demand and act accordingly. Robotics will enable the resulting scaling and, except from supply shocks similar to those of the Covid-19 pandemic, consumer prices across all sectors could not go up.
Starting within its own sector, technology’s inflation has been trending down, with consumer prices losing more than 93% since 1988. The chart below shows a simple measure of inflation, also known as the consumer price index (CPI), for IT, Hardware, and Services.
Technology, Artificial Intelligence, and Robotics adoption are accelerating along the whole value chain and across sectors, helping to lower consumer prices similarly to what already happened in the Information Technology sector.
Besides, the use of automation and robots to replace human workers will put downward pressure on wages, avoiding salary Inflation, and simultaneously prevent more demand for goods and services.
In other words, the use of technology in any business generates a deflationary trend.
Technology and demographic trends are suggesting yields shall remain low for years to come. Both are stable, robust, and structural forces that pressure yields down. While inflation can increase for the next few months considering the current demand/supply imbalances, yields face headwinds that are almost impossible to fight. This should support assets and, in particular, the equity sector.
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