Central Bank Money Is the Only Hope
The economic fundamentals of most large economies today are bearish and point to slow growth ahead. Bond markets and indeed quite everything else hold with Central Bank Money, and that will remain the case as long as inflation will remain in check. If inflation rises significantly above 3% for some time and does not show signs of abating, watch out for the crash of a lifetime.
Now of course we could always say “well if Central Banks don’t tighten policy and just tolerate inflation, then everything will be fine.” Yes, but that will eventually cause erosion of institutional credibility and at one point you will end up with rising inflation expectations, which is catastrophic for capital markets, which would then drive a bond market panic and all hell would break loose after that… It is a very delicate dance going forward.
A decade of headwinds 2020–2030 and a cyclical peak in 2020
The USA, China, Japan, Germany, France, the UK, Italy, and Canada all have significant headwinds for the coming decade AND are all close to reaching a cyclical peak around 2019–2020.
There are only TWO variables that cause growth of total GDP in the long run:
- Number of people working.
- Average “production value” per employee (aka “productivity”).
Everything else “feeds” into these 2 variables: R&D, innovation, education, demographics and immigration, labour market policies, infrastructure, institutional quality, social and political stability, etc.
For most “ordinary folk” total GDP is not particularly important. What “really matters” is quality of living, which encompasses material standards of living such as GDP per capita, “leasure” time, security, access to important services such as quality education and health care, etc.
But for countries as a whole, total GDP growth IS important, because if the “cake” (GDP) stops growing, it causes fiscal problems for the government, pressure on workers who produce for the rest of the population, and more. It can cause social tension due to increased immigration that the population may unfortunately resist, increasing tax pressure, deteriorating infrastructure and more problems that are not welcome by the domestic population.
Looking at demographics for all major economies other than India and Africa taken as a whole, there is an obvious “dead end” on the demographic front, and it has just started to have effects — the strongest effects are coming over the next decade…
Age dependency ratio (pop 65+ as percent of 15–64):
Fertility rate (children per woman; 2,1 is required for a constant population):
Slow growth ahead
The population problems will be a challenge to social stability and government budgets. To compensate at least a bit, several avenues are undertaken:
- Allow / “encourage” people to work past age 65.
- Encourage longer working hours.
- Increase immigration.
- Increase automation.
- Policies to encourage people to have kids.
- Encourage more people to work.
ALL these have modest effects and will certainly NOT compensate the challenges coming for the decade 2020–2030, which is shaping up to be a particularly determining decade on many aspects: fiscal pressure, social and political tension and stability, MANY environmental challenges, public health, etc.
The compensation for the “demographic headwind” is limited at best, and the general macro trends WILL be felt with certainty. This means one of the 2 “motors” of growth in the long run has downward forces: the number of people working.
Most industrialized countries have low and slowing labour productivity growth, and nothing suggests any form of miracle going forward.
Adding to this problem now is the fact that most countries are at a cyclical peak. This means that there is little room for “more production” (growth) due to most countries hitting historical lows on the unemployment rates everywhere and finding it next to impossible to find workers, and some signs of rising inflation. We will thus reach a cyclical “peak” around 2019–2020, which means downside risk for real economic activity in 2020 and downside risk for stocks and long term bonds now, since financial markets are “predictors” of future real economic activity, along with a backdrop of general downside risk for a decade.
Downside risk on stocks and long run bonds means downward pressure on capital market prices, hence upward pressure on bond yields, which go in opposite direction to asset prices.
With a cyclical peak in 2019–2020 and a decade of structural headwinds for 2020–2030, the only thing holding bond and stock markets and social order in general is government spending, tax cuts, and monetary expansion / stimulus. Current debt-to-GDP ratios are very high in many countries and will have to be kept in check to avoid a future bond market crash, although this future crisis may be already inevitable…
The problem is that debt accumulation is OK when you can count on future growth and income to finance it, but with a decade or more of stagnation and a cyclical peak soon, we are looking at stagnating fiscal income going forward. The USA has record deficits with the best possible economy you can imagine. It will only get worse from here. This means that spending will have to be kept in check and/or taxes will have to increase, WITHOUT extra government services to show for the tax increase. This adds to downside risk in the long run.
Tackling structural stagnation with “short run stimulus” is NOT sustainable. You can “boost” economic activity for a few years with deficit spending and money creation, but it is a losing proposition in the long run. This seems to be precisely what all countries are doing.
Look at Japan. Japan has painted itself in the corner, with a 250%+ debt-to-GDP ratio, but “only” 125% if you only consider bonds outside the central bank and government holdings. The Bank of Japan is even boosting stock prices by large scale index purchases. This is insane. We are trying to create “wealth effects” with money creation, which works for some time, but it is obviously not a solution to structural stagnation. They simply CAN’T “exit” central bank intervention to fix bond prices, because if they did, prices would drop and cause a spike in interest rates, then spiraling into huge fiscal pressure due to exploding debt service payments and panic in the market about fiscal solvency, which then causes a feedback loop that inevitably ends up in a major crash, as I explained in my post “3 Reasons Why Japan is the Next Global Meltdown.”
Japan is simply an augmented version of the crazyness happening everywhere else: money creation is holding everything together. Remove monetary stimulus and you get a global crash of epic proportions. What currently allows relatively large money creation and prevents monetary tightening? Inflation. Inflation is currently low and not very menacing. If inflation rises “convincingly enough” to cause more serious monetary tightening, we will lose the only floor holding everything together. Since the alternative is total global meltdown, I consider any monetary tightening as not credible and quite short lived, and I expect any signs of a sluggish economy as reason for monetary expansion.
To launch crisis dynamics, you need a trigger. I see several potential triggers, the main ones being:
- The US corporate bond market.
- Japan’s federal bond market.
- Italy’s banking sector and political tension.
- Deutsche Bank.
- China’s real estate market.
- Emerging market USD-denominated debt.
- Brexit stress.
As I sift through many indicators, I see a slowdown happening everywhere now and I see most central banks soon stopping any form of “tightening talk” and switching to “neutral” at best, just to not cause widespread panic.
Add to this massive environmental problems that are accumulating at an exponential rate (even if you do not even believe in climate change), increasing demographic pressure in very poor and large regions, social tension, and high income and wealth inequality, and you have quite the explosive mix.
The end game is eternal monetary support as long as inflation remains at least somewhat in check. We are now in a “dynamic incoherence dilemma” of monetary policy. It may find it’s ultimate end in 1 or 5 or 10 years, but it is bound to have a bad ending. You simply can’t “fix” all these problems with money printing. We are simply pushing the problem further into the future, while expecting some kind of miracle. Aliens? God? I don’t know, but we are now in denial policy and politics. It looks strangely like a global ponzi scheme: as long as it continues, it works and it continues, which pushes back the “reckoning” further into the future.
What to make of all this? Simple: No inflation = no problem! As long as inflation remains, say, below 3%, money creation will act as a floor to the entire edifice, because central banks will buy any asset class that starts to crash if it poses a systemic risk, and nothing major will happen, unless a major event really rattles confidence.