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What do you think of this correlation?

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M&G investments put out some interesting pieces under their Bond Vigilantes blog. I came across this chart of theirs on Twitter, where they pose the question, is there causation behind this very strong correlation. I think there probably is, but it could be one of those correlation charts that are regularly produced that show inflation is highly correlated to the number of gold medals won at the Olympics, or some such random pairing…. What do we all think?

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    Posted by Robert Pearson
    Posted on 10/09/2017 6:10 AM
    61 views
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    Hi Robert,

    It makes a lot of sense actually. At the most basic level GDP = Growth Rate of Population + Growth Rate of GDP per capita. It’s really hard to have a growing economy where you don’t consistently have more people because the existing people have to be so much more productive. Interest rates are largely a function of economic growth since they’re basically priced off of the real growth of the economy.

    This is one reason why I have been fairly adamant that the USA will not experience high rates any time soon – the growth just isn’t going to be there to cause it and demographics are a big part of that.

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    Cullen Roche Posted by Cullen Roche
    Answered on 10/09/2017 1:38 PM
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      I agree that there is probably causation, but come at it from a slightly different perspective. Older households tend to be savers, preparing for retirement, whilst younger households need to be borrowers, to buy all the things they need to set up for their life ahead. In equilibrium, the demand for savings from older households matches the demand for borrowing from younger ones and returns on savings/cost of borrowing hovers around some sort of natural equilibrium level (if such a thing exists).

      If you move out of balance, with ‘too many’ older households wishing to save, but limited desire from younger households to borrow, the rate of return on savings products is going to be pushed lower. Conversely, if you have ‘too many’ young households, their demand for borrowings cannot be met by the desire for savings from the older households, which naturally pushes borrowing rates, and thus rates of return on savings, higher.

      I think I might have mentioned previously that I am fascinated by the effects of post war baby booms in various countries, as the cohort of baby boomers moved through childhood, into young household formation and borrowings, through repayment in middle age before accumulating savings ready for retirement. You can see the effect they had on the economy and interest rates at each stage. Each country’s baby boom was slightly different – Germany, for example had a very short but intense baby boom a little bit later than other countries. Japan has an immediate post war baby boom, and another noticeable echo baby boom years later as the first cohort of boomers all had children at the same time.

      At some point soon all baby boomers are going to be in retirement and will presumably be dis-saving (effectively running a deficit). I’d be interested in any views on what this might lead to. Who will run a smaller deficit, or even switch from deficit to surplus to compensate? Will boomer spending be inflationary, or will it only affect certain sectors?

      BTW, there was some criticism on Twitter of that piece from M&G, as it excludes some notable economies that don’t fit, such as Switzerland.

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      Posted by Robert Pearson
      Answered on 10/09/2017 3:03 PM
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