– “I’m favouring equities and gold over bonds” – John Stepek
– We’ve spent our entire lives in a massive economic anomaly
– A growing population gave us fiat money and an exceptionally inflationary five decades
– We’ve unleashed the fiat currency genie from the bottle
by John Stepek of Money Week
For most of history, inflation wasn’t really an issue.
Prices went up and down, but mostly were flat or only rose very gently over the very long term. And by long term, I mean centuries and even millennia.
Then along came the 20th century, and the latter part of it in particular.
Let’s just say that, when it comes to inflation, we made up for lost time.
An exceptionally inflationary five decades
I’ve spent a chunk of this week poring over the latest Deutsche Bank Long-Term Asset Return Study, from Jim Reid and his team. Every year, they look back at historic returns and focus in on a few topics. This year, it’s all about inflation, and it’s fascinating.
The key point they make is this: we’ve been living through a unique period of financial history.
“The 1950-2000 period is like no other in human or financial history in terms of population growth, economic growth, inflation or asset prices.”
In other words, the only economic environment that almost all of us alive today have ever known, is a whopping great historical outlier.
For example, between 1800 and 1938, consumer prices in the UK were pretty much flat. Since then, they have risen 50-fold. In the US, from 1800 to 1913, prices rose by about 52%. Since then, they’ve risen 24-fold. It’s a similar story in other nations, with Brazil being the worst-hit since 1900 and Switzerland the least inflationary.
So inflation has positively exploded during all of our lifetimes. And not just general price inflation – asset prices have surged too.
What is this down to? Reid and his team conclude that at its root, this is down to rampant population growth.
From 5000BC, it took the global population 2,000 years to double; it took another 2,000 years for it to double again. There weren’t that many of us, and lots of us died very young, so it took a long time for the population to expand.
Fast forward another few centuries, though, and it’s a different story. As a result of the Industrial Revolution, lifespans and survival rates improved – the population doubled again in the period between 1760 and 1900, for example. That’s just 140 years.
Yet that pales compared to the growth we’ve seen in the 20th century. Between 1950 and 2000 – a mere 50 years – the population more than doubled, from about 2.5 billion to about 6.1 billion.
How a growing population gave us fiat money
So what impact did that have in inflation terms? To cut a long story short, it put a great deal of pressure on the monetary system. Under the gold standard, the money supply could only grow very slowly compared to the volume of goods and services available.
That means you get deflation. (Very, very simple illustration: say you’ve got ten apples one year and a gold money supply of ten ounces – each apple sells for an ounce. You then have a productivity miracle and you get 20 apples the next year, but you don’t mine any more gold. So each apple would sell for half an ounce.)
Falling wages and falling corporate profits make for poor politics. And of course, a “hard” money system also makes it harder to finance things like war and welfare states, which both get a lot more expensive when you have huge and growing populations.
When a monetary system ceases to work politically, it gets ditched (this, by the way, is the fundamental flaw with the gold standard – it can only survive as long as populations will tolerate it). Which is exactly what happened.
The post-World War II Bretton Woods monetary system linked currencies to the US dollar, which itself was backed by gold. But in 1971, mainly due to the cost of the Vietnam war, Richard Nixon severed the dollar’s link with gold. The rest is history.
Of the 87 countries in Deutsche’s sample, none has seen average annual inflation fall below 2% since 1971. And only 28 have averaged below 5%. Meanwhile, the peak period for incidents of hyperinflation across the globe was between 1980 and 1999 (not post-World War I, as Weimar aficionados might assume).
So a booming population gave rise to rocketing demand and in effect, shepherded in the fiat currency system. And thus we had unprecedented levels of inflation.
What happens next may surprise you
So what’s next? Well, here’s where you might be surprised. A lot of people still labour under the impression that we’re just going to keep multiplying – like bacteria – until humans are squeezed up against each other across every inch of the earth’s surface that we haven’t scorched or drowned.
That dystopian vision is simply mistaken. In fact, the rate of global population growth actually peaked at 2.09% in 1968, according to Deutsche. And this year it is set to fall below 1.1%. That’s the first time that’s happened since annual estimates began in 1950.
And if population growth continues to slow at the currently expected rates, then it will never double again, certainly not within any of our lifetimes (barring a cure for death, obviously).
So one of the key factors that made the 1950 to 2000 period so unusual in economic history – an incredible boom in population growth – is now fading away.
So what does that mean? Are we now heading for a disinflationary future? One where prices are broadly stable as opposed to exceptionally volatile? A return to the 1800s?
Well, not so fast. Yes, we might get back there in the long term. But the short-to-medium term looks a little different.
You see, population growth might be slowing. But we’ve already unleashed the fiat currency genie from the bottle. And as Reid points out, “inflation in a fiat currency world is a political choice and very easy to create if there is the appetite.”
So given current levels of debt (as my colleague Dominic discussed yesterday), the temptation of many governments will be to “continue to run deficits for a long period of time and ensure that central banks monetise this debt”.
Meanwhile, although population growth is easing off, the demographics don’t point to a more deflationary world. The Deutsche team notes that inflation became less fierce from the 1980s. We all think of this as being the point at which Paul Volcker – the heroic Federal Reserve chairman – jacked up interest rates to kill off inflation.
But you know what else happened in the 1980s? China rejoined the global economy, and added a huge quantity of people to the working age population. A bigger labour supply means cheaper workers.
And this factor is now reversing. “The consequence of this is that labour will likely regain some pricing power in the years ahead as the supply of it now plateaus and then starts to slowly fall.”
There are also debates over whether or not an ageing population is inflationary or deflationary – the jury is out on that one, but I can see the arguments for both. But the final clincher, for me, is the fact that anger about the lack of real wage growth has given rise to a group of politicians who look increasingly likely to aim to shift rewards from capital to labour – one way or another. That means higher wages, and that means inflation.
So to sum up – in the very long run (30 to 100 years, says Deutsche) – we might revert to the long-term mean of slow population growth (or even decline) plus a harder monetary regime (perhaps “the offspring of cryptocurrencies”) that keeps inflation in check.
But it’ll probably only come about as a result of a political backlash to a “great inflationary reset”, as Reid puts it.
Our view has long been that we’d see an inflationary crisis next, and obviously one reason I enjoyed reading this research is because it backs up my view (no point in lying about these things – you’ll never be a better investor if you don’t at least recognise confirmation bias).
But the arguments are pretty convincing. It’s another reason I’m favouring equities and gold over bonds
News and Commentary
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