Down Under Daily, 31 October 2015

The Long View

Disinflationary forces have been at work for 30 Consequently, the rising trend in real rates to 1980
years in developed economies. This followed 30 is strong prima facie evidence that investment plans
years of secular inflation. Many factors are behind tended to exceed planned saving. This was a period
this rise-and-fall, but demographics are perhaps the of secular inflation. The trend decline in rates since
most important. Interest rates can always be set 1980 suggests the reverse: investment plans were
high enough to control upward pressure on prone to fall short of planned saving hence rates
inflation, but the reverse is not true. The problem fell to ensure that actual investment and saving
on a long view is that disinflationary trends were balanced. This is secular disinflation which,
continue but monetary policy is almost exhausted. taken too far, is now rebranded secular stagnation.

The post-war period for developed economies is a Many factors contributed to these structural trends,
story of two halves: three decades of rising but demographics seem particularly important.
(nominal) growth and interest rates, followed by a Japan shows that decelerating labour force growth
matching decline (Exhibit 1 shows US data). tends to slow labour pay (Exhibit 3). The view that
at some stage demographics will boost inflation
Exhibit 1 because the scarcity of workers will increase their
The Great Rise And Great Fall bargaining power has been wrong in Japan.
US INTEREST RATES & TREND NOMINAL GDP
16 16
10 YEAR YIELD Exhibit 3
14 14

12
3M INTER-BANK
12
Running Out Of Workers Doesnt Lift Pay
5YR NOMINAL GDP
JAPAN LABOUR PAY AND LABOUR FORCE GROWTH
10 10 24 6
JAPAN RECESSIONS SHADED. BOTH SERIES 5YR CAGR %.
%

8 8
20 5
6 6
LABOUR PAY*
16 4

5 YEAR CAGR %
5 YEAR % CAGR

4 4 LABOUR FORCE (RHS)

12 3
2 2

0 0 8 2
50 55 60 65 70 75 80 85 90 95 00 05 10 15
4 1
Source: Federal Reserve, BEA, Bloomberg, NBER; Minack Advisors
0 0

In part this was because trend inflation rose then

* COMPENSATION OF LABOUR PER EMPLOYED WORKER
-4 -1
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
fell. But real rates also show a similar pattern of Source: Cabinet Office, MIAC, ESRI; Minack Advisors
trend rise then decline (Exhibit 2).
US experience shows the reverse is also wrong: the
Exhibit 2 increasingly supply of labour through the 30 years
The Rise And Fall Of Real Rates to the 1980s did not weaken labour power: wages
US REAL FED FUND RATE & 10 YEAR TREASURY YIELD
10 9.0 10 accelerated as labour force increased (Exhibit 4).
REAL FED FUND
8 6.6 8
6.1
5.5 Exhibit 4
6 6

REAL 10YR
4.0 More Workers Led To Higher Pay In The US
4 2.6 4
2.3 US LABOUR FORCE GROWTH AND TREND LABOUR PAY
%

9 3.0
2 2
8
0 0 2.5
7
LABOUR FORCE* (RHS)
5 YEAR AVERAGE %
5 YEAR AVERAGE %

10 YEAR CENTERED
-2 -2 6 2.0
AVERAGE 10YR TREASURY

-4
REAL RATES ARE NOMINAL DEFLATED BY 5YR AVERAGE HEADLINE CPI
-4 5
1.5
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 4
Source: BLS, Bloomberg, Federal Reserve, NBER; Minack Advisors 3 1.0
AVERAGE PAY (LHS)
2
0.5
In a typical economy interest rates adjust to ensure 1 BOTH SERIES SHOW 5 YEAR ANNUAL AVERAGE. * LEADING BY 3 YEARS.
COMPENSATION OF EMPLOYEES PER NON-FARM PAYROLL.
that investment and saving are brought towards 0 0.0
1955 1965 1975 1985 1995 2005 2015
balance (exactly into balance in a closed economy). Source: BLS, BEA, NBER; Minack Advisors

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Saturday, 31 October 2015
The key issue here is not how demographics affect profits and investment is corporate saving.
trend growth. The key is how demographics affect Corporates have driven the change in saving-
the balance between saving and investment. An investment balance in many developed economies.
accelerating labour force seems to lift investment
demand more than saving hence is inflationary. Second, disinflationary trends have been in place for
Labour force growth affects how fast companies some time: the gap between profits and investment
grow their capital stock and hence how much first appeared in the 1990s; it widened in the 2000s
investment is required. When labour force growth cycle; and widened again since the Great Recession.
slows, so does capital stock growth (Exhibit 5).
Third, equity investors have hugely benefitted from
Exhibit 5 these disinflationary trends. Profits are high, cash
More Workers Require More Investment flows are high, and because of the secular
6
US BUSINESS STOCK OF CAPITAL AND LABOUR FORCE
3.0 disinflation, rates have been falling for 30 years
which has lifted asset valuations. Pricing in secular
5 2.5
LABOUR FORCE (RHS) stagnation is marvellous for investors.
5 YEAR AVERAGE %
5 YEAR AVERAGE %

4 2.0

3 1.5 Interest rates have fallen for 30 years to provide a

PRIVATE CORPORATE
2
CAPITAL STOCK (LHS)
1.0
counterweight to the change in corporate saving. It
was the fall in rates that meant that aggregate
1 0.5
BOTH SERIES SHOWN AS 5 YEAR ANNUAL AVERAGE
saving and investment was balanced, despite high
CHANGE WITH TREND SERIES.
0
55 60 65 70 75 80 85 90 95 00 05 10 15
0.0 corporate saving. The forward-looking problem is
Source: BLS, Census Bureau, BEA, NBER; Minack Advisors that rates now have little room to fall further. If
rates cant continue to play that role then it suggests
US labour force growth has been slowing since the that the gap between profits and investment must,
1980s. Investment has likewise been making lower on a medium term view, stop widening. In short,
lows and lower peaks as a share of GDP in every these trends cannot get better for equity investors.
cycle since the early 1980s. At the same time
profits have done the reverse: higher peaks and One final point on demographics and labour
higher lows as a percent of GDP. Exhibit 6 shows income: China is following the pattern of Korea,
the widening gap between profits and investment. which is following Japan (Exhibit 7). However,
slowing labour force growth is disinflationary
Exhibit 6 because of its effect on investment spending. That
The Rise In Corporate Saving suggests that the disinflationary effects may be
US PROFITS AND NET INVESTMENT AS SHARE OF GDP
11 11 more pronounced in China given the higher
10 10
9
PROFITS* NET INVESTMENT
9 starting-point investment share of GDP.
8 8
7 7
6 6 Exhibit 7
% OF GDP

5
4
5
4
Following A Common Path
3 3 TREND GROWTH IN LABOUR PAY AROUND $7k/CAPITA
33 33
2 2 WAGE & SALARIES PER EMPLOYED WORKER, 5YR
30 NOMINAL GROWTH. 30
1 1 $7k PER CAPITA THRESHOLD HIT:
27 27
0 0 JAPAN 1969 KOREA 1988 CHINA 2007
24 24
-1 * AFTER-TAX PROFITS (CCA/IVA ADJUSTMENT) BUSINESS -1
5YR AVERAGE %

INVESTMENT NET OF DEPRECIATION. ESTIMATE PRE-1960. 21 21

-2 -2 KOREA
50 55 60 65 70 75 80 85 90 95 00 05 10 15 18 18
15 CHINA 15
Source: BEA, NBER; Minack Advisors 12 12
JAPAN
9 9
6 6
Note a few points about Exhibit 6: 3 3
0 0
-3 -3
First, the core of secular stagnation is an excess of -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50
YEARS AROUND $7K THRESHOLD
saving relative to investment. The gap between Source: IMF, Cabinet Office, NSO, Oxford Economics; Minack Advisors

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Saturday, 31 October 2015
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Saturday, 31 October 2015