January 20, 2014
The Deadly Ds - Demography, Deflation, Debt and DeleveragingPosted in Debt · 195 comments ·
Ahead of the big World Economic Forum (WEF) annual jamboree in Davos this week, the big institutions – such as the IMF – are setting out their stall, making predictions about the next year or so.
Many years ago the people at the WEF debased their currency dramatically by making me one of their “Young Global Leaders”. This allowed me access into the inner sanctum behind the scenes at Davos. One wonderful aspect about Davos is the people watching. My favourite event was seeing Rupert Murdoch being escorted out of a hotel by a young Swiss army conscript who had no idea who the media baron was. Apparently Murdoch didn’t have the right badge. The look on his face, a man who is not used to people standing up to him, was worth the airfare.
You do meet lots of interesting people, but unless you have a strict timetable planned out, you can spend the entire time there lost, trudging around in the snow, missing events and meetings, because the town is so packed and security so tight.
My first visit was a blizzard of hits and misses in minus 10 degrees. I learned my lesson. I won’t be going this year; you can Skype the people you need to meet all year round, and in any case most of what is said there is posted online.
One of the set pieces will be the IMF’s worldview, where the heads of the IMF – an institution not famed for its forecasting accuracy or policy consistency – will be addressed as if they have some all-knowing sagacity. They will nod their heads wisely, adopt a grave pose and deliver some morsel of wisdom to the cameras.
The IMF’s big idea was outlined on Thursday by the chief bottlewasher, Christine Lagarde: Europe and Japan must fight against deflation at all costs.
Deflation is a killer particularly if the country, company or individual has large debts. Japan has the largest debt/GDP ratio in the world. Europe, which has only 7 per cent of the world’s population, makes up 25 per cent of the world economy but 50 per cent of the world’s social welfare payments and commitments. These economies need inflation not deflation because deflation with debt is almost impossible to escape.
The major issue for both Europe (particularly Germany) and Japan is demography. I am taking Germany as the example here because it is by far the most important country in Europe. Both Japan and Germany are old countries, without enough children.
Old countries tend to save, not spend, and countries that are not spending are deflationary by nature. Look at the chart to see why Japan and Germany’s populations differ dramatically from the rest of the world average.
If you look at the world’s population pyramid, this is what the world’s population should look like and has looked like since time immemorial. There are lots and lots of young people and fewer and fewer people as you go up the pyramid. This means that there are loads of young people to pay for the old of the country – and before that the tribe. It is easy to look after the old when there are loads of young people working, paying taxes and buying stuff.
This activity creates its own inflation because there are lots of people working, buying and selling, pushing up prices. Young societies are by definition inflationary.
But what happens when this stops?
To see what happens, first have a look at the chart with Germany and Japan.
The populations of these countries are perverse. They are breeding themselves out of existence. The populations have a massive bulge of middle aged people and then, reflecting the fall off in the birth rate, the populations are not replacing themselves. As this continues, the amount of old people begins to outstrip the amount of young people.
Young people spend and go through spending spurts (when kids are born for example), but populations with aging profiles don’t have these spending spurts. Thus prices tend to fall.
And because old populations tend to be savers, they want low inflation so that they can be assured that their savings don’t lose their value. Therefore, typically the broad policy mix of these type of countries is “steady as she goes” – but this tends to lead to low growth and low inflation.
If this low inflation tips over to deflation where prices are actually falling, it is very difficult to get out of that spiral. This is because people see prices falling and think they will keep falling so the very act of falling prices postpones demand. This means that one of the basic rules of economics – the one that says when the price falls the demand goes up – is turned on its head. When there is deflation, when the price goes down, demand goes down too.
The only way to get out of this spiral is to print money as much as you can in order to boost inflation. This is precisely what the Japanese are trying to do. The Germans on the other hand are not going to countenance that in Europe. Even if they did, the European banks are so crocked that even if the central bank printed money, it’s hard to see that money cascading into the economy when the banks are not prepared to lend.
The other way to do this is to get the central banks to finance governments and simply give the cash to governments who spend it, boosting demand and prices. Such a novel idea is heretical to the Germany mainstream, who are worried about rising prices when falling prices are the problem.
One last part of the equation is debt. The more debt you have the more inflation you need. High levels of debt and deflation lead to stagnation because if you have debts but your wages and prices are not rising fast, the debt burden will overwhelm you.
This is where Ireland comes in. Look at the chart. It shows total debt as a percentage of income all over the world. Ireland is a delinquent outlier here, with total debt levels that completely surpass even our most indebted neighbours. Without inflation, this will never be paid because there is simply too much of it. Maybe – like the promissory notes – it can be rolled over, kicked out a generation and forgotten about for now. But the creditors, the old countries, wouldn’t like that.
Interestingly, Madame Lagarde of the IMF stopped short of saying that was the cure. I wonder will she say it at Davos? I suspect that is highly unlikely because a recent survey in the Financial Times reported that most people at Davos were over 60. These are hardly the people to stand up for the young and the indebted who need inflation, because old creditors like “Davos Man” want deflation, modest returns and an easy retirement.
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