Wed. Oct 27th, 2021


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Welcome back. This is the last day of August, which means that the wonderful, universal statement for everything that happens in the financial markets- “it’s August, everyone is on holiday, there is no liquidity” expires. Make sure you use it for as long as possible. Email me: robert.armstrong@ft.com

Is an excess of rich people, not the middle-aged, what lowers interest rates?

My expectation that nothing would happen at the Jackson Hole conference of the Federal Reserve was wrong. The speech by Fed Chairman Jay Powell was certainly boring, but three academics dismissed the proceedings by presenting a newspaper It would be good if investors read this.

They argue that the primary driver of interest rates is not demographic change, but income inequality. This is important for investors, because the demographic trend that (in theory) put pressure on rates is going to reverse, while the trend towards greater income inequality seems to be fixed.

Atif Mian, Ludwig Straub and Amir Sufi agree with the parties of the demographic view, such as the economists Charles Goodhart and Manoj Pradhan (whose view I spent) justify amount of space here), that a significant contribution to falling rates is higher savings. Savings are chasing returns, so if there are more savings and the same number of places to place them, return rates should fall.

However, Mian, Straub and Sufi do not agree on why there are still more savings. This is not because the big baby tree generation is getting older and saving more (a trend that will soon change direction when they all retire). It is rather because a larger and larger share of the national income goes to the highest decile of the earners. Because a person can consume just as much, the few rich tend to save a lot of this income rather than spend it. It pushes interest rates directly when these savings are invested, which increases asset prices and decreases returns; and indirectly by reducing total demand.

Why does all the cash that the rich push to the markets eventually become unproductive? investmentat home or abroad? Difficult question. For current purposes, it is enough to note that this is not happening — the savings of the American rich reappear as debt, owed by the government or by lower-income American households. (In another paper, MS&S pointed out that this means that the bulk of the income that goes to the rich harms total demand in two ways: the rich have a lower marginal tendency to consume, and governments and non-rich are forced to dollars from consumption to debt to shift service. Economically speaking, high inequality is a real buzzkill.)

MS&S prefers the inequality statement for two reasons. Use data from the Feds Consumer finance survey (dating back to 1950) shows that the differences in savings rates within a given age group are much greater than between age groups. That is, savings build up faster because the rich get richer, not because the baby boomers get older. See these maps:

The Y -axis in both maps shows savings as a ratio of income. The graph on the left shows that the top 10 percent of households save much more than anyone else, and far more (proportionally) than all people between the ages of 45 and 54, the highest saving age group, as seen on the right.

Another way to visualize the same point. Here is a heat map that matches savings rates (indicated as color) and income cap (Y-axis) on the one hand and age group (X-axis) on the other:

If you go from left to right on the graph and move across age groups, there is not a big change in color. The dark red colors (i.e. the high savings rates) are full on top, with the richest people in each group.

This effect is dramatic and is a very big change. In the last 20 years, the upper deck has taken up an extra third of the national savings compared to the period before 1980:

We estimate that between 3 and 3.5 percentage points more of the national income was saved from 1995 to 2019 with the top 10 percent compared to the period before the 1980s. That represents 30-40 percent of total private savings in the U.S. economy from 1995 to 2019.

The second reason to think that the increase in inequality is a better explanation for the rise in savings is that inequality has risen during the period, as rates have fallen- that is, since about 1980. The share in the national income earned by the high to save middle-aged people, on the other hand, rose and increased as the baby boomers got older and then started retiring. That is, inequality has a much stricter correlation with rates than demographics. In fact, MS&S argues that the SCF data show that there is no relationship between overall savings rates and the share of income that the middle-aged person earns.

What would Goodhart and Pradhan say in response to this? I’m not supposed to answer for them, but two things strike me. One is that MS&S only focuses on US data, and G&P emphasizes that as capital and production capacity move across borders, the global picture needs to be looked at. Japan, for example, has not experienced declining rates or rising inflation as it has aged. This could lower prices by shifting production capacity to China. Second, G&P thinks that savings are only part of the picture; the supply of workers is also important.

I leave it to better economists to resolve the battle between the parties of demographics and inequality, but I will say that the opinion of MS&S is convincing. But who has the more right will undoubtedly be important to investors, as the two sides differ on the most likely rate from here.

A further note. I think if MS&S is right, the political implications are particularly nasty. Inequality is, in their view, self-sustaining, with the feedback loop running through low rates. Excessive saving of the rich persons; low rates push up asset prices; the rich are getting richer. Many governments are involved in monetary policy that in all likelihood makes this flywheel spin faster. How long will the people sitting outside this wealth machine – a majority of the electorate – tolerate it? It strikes me as even worse than the intergenerational conflict you would expect if G&P were right (with the old struggle to maintain the social safety net as people in the working age fight against ever higher taxes).

Those of us who own a few assets and have done so well in recent decades need to think about this.

A good reading

Rumors of mergers and acquisitions find M&A bankers annoying. The lawyers think they are doing all the work while the bankers are taking all the credit. But who finds M&A bankers annoying? Managers of private shares, apparent.

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