Demographics to challenge inequality and asset values: James Saft

September 22, 2015

Sept 22 (Reuters) – Relatively scarce labor may in the next
decades reverse some of the huge trends of the last three:
rising inequality, and falling real interest rates and wages.

The upshot for asset markets may be equally profound,
challenging the central place government bonds hold at the core
of investment portfolios as well as the value of equities.

The rise of China, the integration of the global economy and
the opening of the economies of Eastern Europe have coincided
with, and likely driven, rising economic inequality in the
developed world, as well as falling real wages and interest

The beneficiaries, as noted by French economist Thomas
Piketty, have been the owners of capital, with falling interest
rates driving higher bond returns and record corporate profits.

A new report by economists at Morgan Stanley and consultant
Charles Goodhart, formerly a member of the interest rate-setting
panel at the Bank of England, argues that what demographic
trends have driven, demographic trends can also take away.

“Is Piketty history? We think so,” Goodhart, Manoj Pradhan
and Pratyancha Pardeshi argue in a study released last week.
“Just as a larger labor force pushed real wages lower and
inequality much higher in the advanced economies, a smaller
labor force will inevitably lead to rising wages, a larger share
of income for labor and a decline in inequality.”

World population growth, now about 1.25 percent annually,
will fall to 0.75 percent globally and near zero in the
developed world by 2040, according to United Nations
projections. Not only is the supply of untapped easily
integrated labor in places like China drying up, but the aging
of the west will put local pressures on wage supply, as it
implies a booming need for healthcare workers.

Most economists agree interest rates have been driven down
by past demographic trends, as western workers were unable to
negotiate wage gains, and due to very high savings rates in
China and other developing nations. It also gave western
companies less incentive to invest, as the use of more or
cheaper labor promised better returns.

Negative demographics should in theory lower growth and
reduce savings – as the old consume their assets – and
investment. The Goodhart paper argues that savings will fall
faster than investment, driving up interest rates.

It is fair to note that the Morgan Stanley analysis rests on
some assumptions that may not hold. Firstly, that developed
countries will respond to demographic developments by
maintaining social safety nets and pension provisions, moves
that require the political will to tax and spend. Secondly,
there is the unknowable issue of technology. While the argument
is that companies will respond to scarce, more expensive workers
by investing in labor-saving technology it is unclear which
force will be more powerful.


Many economists have argued that a demographic slowdown will
be bad for asset prices, in part because there will be fewer
natural buyers saving for old age and more natural sellers
funding their lives in retirement.

Add in rising interest rates and wages to this scenario and
the damage to major asset classes could be substantial. One of
the arguments for current elevated equity prices is that
corporations now enjoy high profit margins. These, however, will
be eaten away in part by rising wages, resulting in lower
profits. Companies may have some success in holding down wages
through investment, but this will tend to drive interest rates
higher. Add in slower overall economic growth and it will be a
more difficult environment for companies.

As interest rates have a powerful effect on the future value
of expected earnings, it is fair to expect equities to trade at
a reduced premium as a result of the demographic slowdown.

The impact of rising natural interest rates also poses a
problem for government bonds, which lose value as rates rise.

Toby Nangle, head of multi-asset allocation at Columbia
Threadneedle Investments, has argued along similar lines to
Goodhart and concluded that government bonds may lose their
allure, and the central place they hold in the construction of
most portfolios. (here)

Given that many government bonds already yield precious
little, the losses investors suffer as interest rates rise will
be particularly painful. The old idea that bonds “balance” out
the risk of equities or other assets over market cycles may not
hold, leading investors to look elsewhere. That, of course,
would exacerbate the rise in market interest rates.

The last 35 years have been great for capital and lousy for
labor, at least in the developed world. The next 15 may be quite
the reverse.
(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at and find more columns at

(Editing by James Dalgleish)

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