To a large extent, the current inflation level is a consequence of the coronavirus crisis. That is the main argument for labelling it temporary. However, the risk of this temporarily higher inflation is that it becomes lodged between the ears.
Especially when there is scarcity on the supply side, the logical reaction is for prices to rise. At the same time, there are currently more vacancies than unemployed people. The long pendulum from capital to labour has been set in motion. Trade unions used to be powerful, now there is the even greater power of social media. Yet it is precisely structural factors that will keep inflation high in the coming years. The just-in-time principle of globalisation has given way to the just-in-case principle of deglobalisation.
Technology has depressed prices for years, but now just about every big tech company is a monopoly, not really a market form known for lower prices. Furthermore, the government is getting bigger, also good for higher inflation and central bankers now see inflation as a solution to the debt problem and not as a threat. A structural factor that also has a major impact on inflation is demographics. The global ageing of the population will cause inflation to rise.
Deflation wrongly linked to ageing
Japan is the country with an ageing population. The working population (ages 15 to 64) has fallen from 87 million in 1994 to less than 74 million today. In 40 years’ time, it will be down to 48 million. However, this shrinking working population has meant that 13 percent of the working population now consists of people over 65. It is quite normal in Japan for people to continue working until a ripe old age. Parallel to this shrinking workforce, Japan has had to deal with two lost decades of regular deflation.
It is tempting to link these two issues, as they are both typically Japanese problems. But the deflation was not caused by demographic factors, but by the bursting of a double bubble of unprecedented magnitude. By the end of the 1980s, both the housing market and the stock market had risen sharply. The weight of Japanese shares in the world index was approaching 50 per cent and a valuation of 200 times the profits of a Japanese bank was quite normal. Those banks financed plenty of property, with loans that were worth nothing when property prices came under pressure. It took until Shinzo Abe to address this problem and Japan is still struggling to escape from the negative debt/deflation spiral.
The impact of the baby boom
After the Second World War, there was a birth wave in many parts of the world. This was especially true in 1946 and also in 1947, but in the 20 years that followed also considerably more children were born than in the period before and after. With the advent of contraception at the end of the 1960s and the breakdown of traditional religious barriers, the number of children born fell sharply. Assuming a retirement age of 65, the people from 1956 will retire this year. By stretching the retirement age a bit, we manage to postpone the problem, but not defer it.
This means that the number of baby boomers retiring in the next decade will continue to rise. Those people are also getting older thanks to better lifestyles and modern medicine. Between 2000 and 2015, the life expectancy of the world’s population increased by an average of five years. In the Netherlands, men reached an average age of 75 and women 80 in 2000. Nowadays, the figures are 80 and 84. Thanks to the power of the trade unions in the 1970s, those baby boomers were also able to save more for their retirement. It was the time when early retirement was introduced. All those pension savings depressed interest rates in the 1980s and 1990s.
It is sometimes said that the debt problem arose in the 1980s, but there was a savings bubble that made this possible. A worker who does not consume all of his or her income and who defers part of it by saving, ensures that prices can fall. After all, more is produced than consumed. Now that these people are retiring, the roles are reversed. They stop producing immediately and, thanks to favourable pension schemes and increased life expectancy, will only consume for years. Less supply and more demand simply lead to rising prices.
No one exports more deflation
Since the 1970s there has been a migration of companies to low-wage countries. With the help of container transport and improved global communication thanks to satellites, it became increasingly easy to produce goods more cheaply elsewhere. Made in Japan, made in Korea and made in Taiwan focused on cheap and less on good. They exported products at prices that Western producers could not compete with, and that put downward pressure on inflation worldwide. In recent years, China has taken over that role. Today, that country is home to the world’s factories.
Due to the strong increase in urbanisation in China, there was for years a sufficient supply of cheap labour. Those times are over. Beijing is no longer concerned about whether there are enough jobs, it is now about an affordable house, cheap education or good healthcare. This means that China needs to produce more for its own population and no longer needs to focus on exports. And there are some countries like Vietnam, Indonesia and Nigeria that could take over part of China’s role, but the effect will be much weaker. China is also aging, not because of the baby boom generation, but because of years of one-child policy. So this too will cause China to produce much less and consume much more.
So it is not surprising that deglobalisation, big tech monopolies, the pendulum of capital-labour, the greater influence of government and the policies of central banks will lead to more inflation, but don’t count on us being saved “like Japan” by a positive effect of demographics. On the contrary, demographic factors contribute to higher inflation. It is time for investors to design their portfolios accordingly.
Han Dieperink is an independent investor, consultant and knowledge expert for Fondsnieuws. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. He is currently active as chief commercial officer at Auréus Asset Management. Dieperink provides his analysis and commentary on the economy and markets. His contributions appear on Tuesdays and Thursdays in Dutch on Fondnieuws.nl, and are made available occasionally in English on Investment Officer Luxembourg.