In an op-ed column in Financial Times yesterday, Gavyn Davies wrote about the effect of demographics on interest rates. His conclusion seems to be that demographics–not cyclical factors–may be the entire story behind why interest rates can remain so low without sparking an increase in business investment.
The demographic argument has three aspects:
–the slowdown in growth of the working population means that companies need to spend less on productivity-enhancing machinery. This means lower issuance (supply) of corporate debt finance, therefore less upward pressure on rates. I’m not sure I buy this, but one might equally argue that the price of tech machinery always falls and arrive in a way I find more plausible at the same conclusion
–life expectancy is increasing. Therefore workers have to save more to support themselves after they retire, thus increasing demand for bonds
–a large proportion of the population is working, meaning the number of savers is high …and workers save more than non-workers. This percentage will gradually decrease as the Baby Boom retires. But for now the population is in prime saving mode. This, again, means high demand for bonds.
According to a Federal Reserve research paper Davies cites, demographics explains basically all the downward pressure on rates since 1980.
I think that we’re now truly at a point of inflection with interest rates. I’m torn between two lines of reasoning in support of that conclusion, however.
The demographic argument is effectively that the current regime of extraordinary efforts to keep interest rates low is doing more harm than good. It hurts savers, compelling them to accept lower returns for their savings than they would get otherwise, while having no positive effect on corporate borrowers. If anything, the current stance of world monetary authorities mere fuels speculative financial markets activity. Therefore, extraordinary money stimulus should be removed.
On the other hand, as they say, the market doesn’t bottom until the last bull capitulates. In the current situation, this translates into: the economy doesn’t begin to grow more vigorously until the last growth advocate begins to despair that the turn will never come. That demographic explanation, i.e. abandoning the conventional business-cycle view, can be seen as evidence of that despair.
I don’t expect that rates will rise quickly or that they’ll rise very much–another aspect of the demographic argument that the conventional view of the “normal” level of rates has them pegged much too high.
Initiating the process in a systematic way will, however, gradually dispel the anticipatory anxiety about rate rises currently in financial markets. That should, if nothing else, make for smoother sailing.