Demographics drives demand. If it doesn’t, then its hard to think what does.
So forecasting economic growth depends on two key variables:
- If you have lots of young people in your adult population, then you should have fast growth
- If you have lots of older people, then you will be lucky to have any growth at all
Of course, economic policy can make things better or worse in relation to these outcomes. A supply-side focus is ideal during a period of fast growth, as this will remove blockages and reduce the risk of inflation. Similarly, a demand-side focus is needed in the second scenario, seeking to boost people’s ability and willingness to spend.
But if, like today’s policymakers, you prefer to believe that the algebra of monetary policy can magically create constant growth, then you really are pushing on the proverbial piece of string and have instead become a modern-day alchemist.
Today’s world is captured in the chart from the Wall Street Journal (WSJ), showing inflation tumbling across the Eurozone.
December’s inflation rate was just 0.8% on average. And whilst individual country performance diverged, the downward picture is clear across the continent. All that is needed for outright deflation to occur is a catalyst such as a fall in commodity prices. These look very unstable, as the blog has discussed recently in respect of cotton and aluminium. So the arrival of deflation is probably now just a question of when, not if.
This, of course, has long been the blog’s forecast with its Cycle of Deflation model. And the issue is not just confined to Europe. US inflation is falling in a similar pattern, with the latest level just 1%. Whilst China’s Producer Price inflation was strongly negative at -1.9% in December. China’s surplus manufacturing capacity is now effectively exporting deflation to the world.
What does this mean for us as individuals, and companies? It seems the experts agree with the blog’s own analysis last month. Thus the WSJ notes:
“People and companies hold off from spending, believing that prices will fall further, causing demand for goods and services to fall…. Central banks can respond by lowering their benchmark interest rates. But the ECB’s refinancing rate is already just 0.25%, leaving little room to cut further..banks are likely to start charging customers for deposits, encouraging depositors to withdraw money and hoard it.
“Those already suffering most of the pain will be asked to bear more. Or they won’t be able or willing to bear more—and will default on their debts. That would have severe knock-on effects for domestic banks and other creditors, threatening further hardship.”
There were, and are, plenty of policies that could be put in place to help close the demand-gap that has opened up. But policymakers first need to recognise the cause is the combination of increased life expectancy and lower fertility rates. Until then, they will continue to proscribe the wrong medicine.
They continue to believe that handing out free cash is all that’s needed. But as all doctors know, handing out pills to a perfectly healthy patient does no good at all.