An ageing planet and the future path of interest rates

The Economist has a special report about ageing societies and mounting public sector debt.

It’s hard to summarize fully, but the argument is that it’s hard for governments to contain spending when their populations are ageing and demand more pensions and health benefits, but produce very little and therefore do not contribute much in taxes (certainly net of what they receive).

Historically, ageing populations have been able to get away with this by lending to younger countries to allow their growing populations to combine with a growing capital stock to boost the world’s output (especially of tradeable goods). Sadly, that doesn’t work if all countries are getting old together, and the big one, China, is well down that path. A path which, surely, Xi Jin Ping will fail to block off, in spite of his attempts to make citizens produce more children.

The conclusion would be that interest rates are going up. Of course, demographics is only one of many reasons for this. It’s seems impossible to think they won’t and yet this has been true for a long time, and long-term yields are still very low.

But there is another factor. China is going to implode at some point. Its banks turn empty blocks of flats and unused roads and bridges into money. This flood of money causes interest rates to remain low, especially as China sells a ton of stuff to the West on tick, which drives global interest rates down (China is a huge buyer of US Treasury Bonds). Japan also invests a lot in China.

When the implosion happens, the RMB will collapse, probably the banks will fail (they are state owned, so it’s not clear what failing would look like). This will unleash a tsunami of deflation throughout the world.

The excess liquidity in the Eurodollar system is what Jeff Sneider at Eurodollar University is always banging on about, along with the fact that the dollar curve is inverted a lot which means that a big recession is on its way. (And I can confirm from experience that the inversion, or at least flattening, is still happening.)

Bonds are still too dear for inflation to stick at above 4%. Maybe it’s a reverse China shock which will be the event that the market has priced in.

Wrap

I am writing this at 1650 GMT, so US markets have a long time before closing. From what I can see, we have the following trends: - (US) bonds are up, yields are down. Presumably, on the assumption that the economy is going down the pan, and that the Fed is about to pivot, and that the mid-terms will see the Democrats lose their slim majority in Congress, and possibly in the Senate too. (I think the theory is that with what France describes as ‘cohabitation’: different tiers of govt. controlled by opposing parties, ) - the dollar continues to drift lower, which I guess is reflective of the drift in yields and the assumption of a pivot, but also of the expectation that a recession will heal the trade deficit (unless it’s a synchronized global one, which is not inconceivable). - oil is down, about 1%, but after a good run so far in November.

What I’m reading

Gold may yet have its day. It seems amazing that with inflation hitting 10% in most of the OECD, that the gold price has barely changed in a year. OK, it has in terms of GBP, but not USD, which is the price metric almost always used. Given that almost nobody alive has experienced a time when gold was important for settling trade imbalances, I can see why most people don’t want to have anything to do with the barbaric relic. At least oil, coal, copper, and silver have genuine real consumption demand, not to mention nickle, cobalt, germanium and neodymium.

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