The Most Important Paper Of The Next Decade

Whenever I tell people the next big crisis will come from inflation, not deflation, the looks of disgust are worse than when someone says Justin Bieber’s music is not that bad. And when I try to tell them that the true bubble is in fixed income, not stocks, they look at me as if I just slipped the Biebs into the next-up slot on the Spotify playlist.

“Where will the growth come from?” they often ask or, “demographics will keep inflation subdued for another generation,” they retort.

And I must admit, I have always had difficulty articulating how inflation would manifest. Usually, I would go with the classic, “throughout the millennia, governments have always resorted to inflating their way out of debt, and this time will prove no exception.”

But that has always left a sour taste in the mouths of the deflationistas who cannot imagine anything but falling prices and moribund growth. These investors need a theory why the trend will change. And it has always been difficult to slap any research in front of them as the Lacy Hunt deflation crowd seems to have the market cornered with their articulate forecasts that the trends of the last 30 years will continue ad infimum, and that interest rates are going to zero throughout the entire developed world.

Until now…

In a Bank of International Settlements paper from this summer, Charles Goodhart and Manoj Pradhan present a powerful argument that demographics are about to usher in a sea change. I am surprised the paper is not receiving more attention, but I guess with everyone so focused on the supposed coming deflation, this sort of research is not all that popular.

But you should go read the paper titled “Demographics will reverse three multi-decade global trends“ today. I suspect it will be one of the BIS papers of the next decade.

Here is the abstract:

Between the 1980s and the 2000s, the largest ever positive labour supply shock occurred, resulting from demographic trends and from the inclusion of China and eastern Europe into the World Trade Organization. This led to a shift in manufacturing to Asia, especially China; a stagnation in real wages; a collapse in the power of private sector trade unions; increasing inequality within countries, but less inequality between countries; deflationary pressures; and falling interest rates. This shock is now reversing. As the world ages, real interest rates will rise, inflation and wage growth will pick up and inequality will fall. What is the biggest challenge to our thesis? The hardest prior trend to reverse will be that of low interest rates, which have resulted in a huge and persistent debt overhang, apart from some deleveraging in advanced economy banks. Future problems may now intensify as the demographic structure worsens, growth slows, and there is little stomach for major inflation. Are we in a trap where the debt overhang enforces continuing low interest rates, and those low interest rates encourage yet more debt finance? There is no silver bullet, but we recommend policy measures to switch from debt to equity finance.