Interest Rates Falling – Welcome to the Low Growth, Low Inflation World

Gerry Brady June 5, 2019 109 No Comments

The central bank in Australia is called the Reserve Bank. They have recently realized (at last) that CPI inflation is no longer a threat and that the Australian economy is actually having difficulty in growing. Today, 4th June 2019, they finally lowered their key interest rate after delaying a decision for 6 months.

I have consistently written over a long period of time about the new economic paradigm of persistent low economic growth, low CPI inflation and low interest rates in the advanced economies (of which Australia is one). But most central bankers in those economies persist in regarding themselves as “inflation fighters”. This error in perception has actually been damaging over the last 10 years since the GFC (Global Financial Crisis) of 2008 because interest rate settings have been kept too high for too long. The fact is that central bankers have a very big influence upon economic expectations and if they are consistently wrong in their assessments of the present and the future, then those errors in judgement will feed into the economy.

Most economists say that central bankers only affect short term interest rates. But that is not true. If short term interest rates are rising or persistently forecast to rise or persistently not lowered due to an incorrect perception of a future “inflation threat”, then all the settings of yield in new government bond issuances will be distorted in an upwards direction. The steepness of the government bond yield curve over 20 – 30 years will be exaggerated. Over time as the “inflation threat” does not materialize, the secondary market for those bonds will manifest these errors and the market will become distorted by buyers seeking the exaggerated yields. Thus, the whole government bond yield curve will start to progressively move downwards and will approach flatness (or inversion) because of this distorted search for yield.

This is what has happened over the last 12 months in the yield curves for government bonds in the US, Japan, Germany, France, the UK, China, India, Hong Kong, South Korea, Singapore, Thailand, Canada and Australia. I have looked closely at all of those national bond yield curves and they have all undergone the same 12 month journey to lower and lower yields. Interest rates are falling right across the advanced economy world.

Only one conclusion can be reached from such an analysis — ALL of those central bankers got it wrong 12 months ago. ALL of them overestimated the “threat of future inflation”. ALL of them set their key benchmark interest rates too high. And, as a result, ALL of them created distorted yield curves as governments set their new bond yields at unsustainably high levels.

These central bankers do not watch the impact of demographic change. They do not watch the dynamics of energy supply. And they do not understand the deflationary impact of technology which can be exponential in effect. They understand their old enemy, CPI inflation but they are ill equipped to understand the drivers of dis-inflation (falling rates of inflation) and deflation (negative inflation).

In regard to the impact of technological change, robotization is a good example. Robots can be programmed to make other robots. Robots making robots making robots. Who would have thunk it? And, with the advent of the Internet of Things, many robots will soon be engaged in communicating with other robots. I call it The Machine Conversation. More and more efficiency should be the natural outcome of that and there is simply no way that this dynamic can be CPI inflationary. Thus, it must be disinflationary or deflationary.

Lower and lower relative energy costs and aging demographics have similar effects and those effects can be similarly exponential (they feed on themselves).

Let’s look at oil prices. West Texas crude oil was priced at US$ 145 in July 2008. It is now just $ 53 (and falling recently) and has been as low as $ 29 in early 2016. It is often said that energy underwrites all economic activity and oil is the energy source that is generally regarded as the sine qua non — in other words, without oil, nothing happens. So, using that rationale, how can we be facing any threat from CPI inflation if the price of oil has reduced by this great margin over the last decade?

In regard to demographics and aging, the growth in total annual global population of the below 60 years age group peaked in 1988 and has been falling ever since. There was a second lower peak around 2010 but, since then, the growth of this critical age group has fallen almost every year. In the OECD nations plus Russia, China and Brazil, the growth rate of this age group has gone negative. It went negative in 2016 and forecasts out to 2050 show continued negative growth.

The 0 – 60 year age group is the critical group for economic activity. After 60 years of age, we are no longer forming new families, purchasing homes and furnishing them. Most consumerist activity occurs below the age of 60 years. That is why it is important to watch the demographic trends in that group.

Dis-inflation is the lowering of inflation rates. Deflation is negative inflation rates. Central bankers and governments have not yet grasped that this is the new economic paradigm. They continue to fight inflation and expect GDP “growth”. They are living in the past. Until they understand this, they will continue to make errors in both monetary policy (interest rate settings by central banks) and fiscal policy (government expenditure).

Low CPI inflation, relatively low energy costs and increased technological change are here to stay. What happens next? In economics, “things work until they don’t”.

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