Low interest rates are here to stay

[FireLane]

I've been wondering why bond interest rates have stayed at rock-bottom levels. I thought it was a consequence of QE and other economic support measures that pumped floods of cheap money into the system. But this article makes a good case that there's a more fundamental reason for it:

https://fullstackeconomics.com/sorry-deficit-hawks/

According to the author's argument, the real reason for low interest rates is the aging of populations in developed countries throughout the world. Tens of millions of retirees, following standard asset-allocation advice, will naturally switch to more-conservative portfolios as they get older. This creates an excess of demand for bonds that drives interest rates down:

The most important of these is the impact of an aging population on capital markets. As Bernanke put it, “one well-understood source of the saving glut is the strong saving motive of rich countries with aging populations, which must make provision for an impending sharp increase in the number of retirees relative to the number of workers.”

...Since Bernanke’s speech, the entire world has aged substantially. Even India, the only one of the world’s 10 largest economies that is not traditionally considered to have an “aging population,” will by 2028 resemble the age distribution of South Korea circa 2000.

There are about 700 million senior citizens in the world, and this number grows by about 30 million each year. These people need to save. As they approach retirement age they lose the relative certainty and predictability of future paychecks. They naturally benefit from a more conservative investment portfolio. That means holding more bonds.

...Some people mistakenly believe that today’s low long-run interest rates are a deliberate policy choice of central banks. It’s true that central banks can control the rates on short-term debt in the near term. But central banks face significant constraints over longer time periods. If they try to push rates in the “wrong” direction, this will lead to harmful consequences like high unemployment or high inflation. So the decades-long trend of falling interest rates is fundamentally driven by market forces, not the whims of central bankers.

If this is correct, the situation that Japan has been in is going to become the norm throughout the developed world for decades to come. I wonder if this affects asset-allocation theory for early retirees.

I would think that bonds can still stabilize a portfolio, but at the cost of less yield than ever, which could mean that people who plan on being retired for a very long time need to be more stock-heavy to get enough growth to sustain their portfolio. Maybe even 80/20 isn't aggressive enough anymore.

[BicycleB]

Interesting theory! Maybe they're on to something.

Will await wiser posters.

[ChpBstrd]

I've held this attitude for at least 3 years, and advocated a no-bonds option-hedged stock portfolio as an alternative. Too many people think of inflation and high interest rates as being a result of too many dollars or too much debt, when in fact inflation is a factor of monetary velocity - how often an average dollar changes hands.

The article glosses over or ignores a couple of other items in support of its thesis:

1) The US trade deficit pays for the US budget deficit when foreign traders who receive dollars for their goods use those dollars to buy treasuries. Thus, as globalization grows, more and more freshly-created dollars exit the U.S. That made-in-China item you just bought resulted in dollars appearing in a Chinese dollar account, where they will be used to buy Treasuries. Those dollars will not be received by people living in the U.S. who could use them to buy assets. Thus, the dollars disappear from the economy.

2) It's not just U.S. retirees who are hoarding dollars - retirees all over the planet are hoarding dollars because crisis after crisis it has proven to be the most reliable currency. The graying of the entire planet sucks up dollars and creates a disinflationary undertow. Why are people in other countries willing to work so hard for dollars? Because their own currencies are too shaky to retire on. Ask a Turk or an Argentine.

3) If interest rates in the U.S. go up, foreign and U.S. investors flock to carry trades, where they borrow yen or euro or whatever and buy higher-yielding US assets. Thus, rate increases draw in demand from all over the world, which raises the price  of debt instruments, which pushes rates lower. Liquid markets and derivatives in the U.S. make the carry trade uniquely easy.

4) Wealth inequality means that rich people are hoarding dollars, which are spent at a much slower frequency than poor people spend them. Give a millionaire a dollar, and he will invest the funds, which means it will not be used to purchase items in the CPI basket, maybe for decades. Give a poor person a dollar and they will spend it that week, because they have acute needs. As more dollars accumulate in accounts of the rich, the average velocity of dollars decreases.

[marcus_aurelius]

Informative article. Thanks for posting.

It's hard to predict inflation, but FWIW, I agree with the author's thesis that cheap money is here to stay, and the US will increasingly look like Japan. The aging of the world's population will drive down demand. I will also add that on the supply side, technology is generally deflationary, and the growing digitization of multiple industries will drive down costs.

[bacchi]

This guy thinks otherwise.

https://finance.yahoo.com/news/stagflation-in-2022-is-the-current-dominant-risk-infracap-ceo-175210666.html

Hatfield noted that it is likely the Fed will need to raise interest rates at least twice in 2022 because of where the brunt of inflation is coming from, which is the housing and consumer durable sectors

He also mentions steel, which is still much higher compared to the 5 year trend. And soybeans, copper, and wheat.

https://tradingeconomics.com/commodity/soybeans is a good site for historical commodity prices.

This is a humorous remark.

“If you mark CPI to market — so in other words, specifically look at housing — and instead of using the BLS methodology of asking homeowners every six months whether they think rents have gone up, you just look at the market. [And] if you just look on the internet, which maybe the BLS should learn how to use, then the CPI would be really running 8% year over year,” he said.

(bolded)

[roomtempmayo]

It's an interesting idea, but it sort of relies on the assumption that there are (or ever could be) so many dollars in savings out there that the Fed has lost functional control of the money supply. 

That seems like kind of a stretch.  Over the past couple decades, we've continually seen the Fed invent new stimulus tools.  Why couldn't they invent new tools to raise interest rates if they wanted?

I think the more compelling case against significantly higher rates is that they're now politically impossible.

The American economy is hugely dependent on rising, or at least not declining, home values.  If mortgage rates went to even 5%, we'd see a huge correction in the housing market.  Maybe not a crash, but enough to tamp down all the cash out refi money that's currently flowing into home improvement, college tuition, and general consumption.

There isn't enough productive power in the American economy to take up the slack if the asset gains stop.  We as a society are too old, too sick, and too geographically misallocated to produce enough to meet our economic expectations without padding our productivity with asset appreciation.

The likely longterm outcomes seems to be a largely unsuccessful effort to beat back Japanification with monetary policy.