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Monday, January 5, 2015

JGBs Are Doomed Because Of ... Demographics? Good Grief.

After losing money for almost two decades on the thesis that "the IMF-calculated gross debt-to-GDP ratio for Japan is too high", JGB bears are rotating into another structural thesis why the JGB market must collapse - demographics. (Why German bunds and Swiss bonds are spared from this single-minded hatred of low nominal yields is beyond me.) This complements the pivot towards talking about "yen collapse" instead of a JGB calamity. The problem with this theory is that being worried about demographics is akin to worrying that a steamroller two miles down the road is heading in your direction.

"Japan's Demography Will Eventually Crush Its Economy"

Mark Adonis at Forbes is the latest to argue that demographics will be doom of the JGB market. The trigger for his musings is the fact that the number of births in Japan has hit an all-time low. He correctly argues that we will be reading similar headlines in early January for about 20 years or so  - Japan has "record demographic loss" in the previous year.

His ominous conclusions:
So far Japan’s economy, particularly its government bond market, has been remarkably resilient in the face of all of this demographic pressure. But this can’t continue forever. At some point it will become clear to everyone that Japan has rung up debts that it has no ability to pay back other than through printing money: there simply aren’t going to be enough economically productive citizens. I don’t know precisely when this realization will occur. The graveyards are famously full of traders who bet against Japanese government bonds, and you’d need to have a very large appetite for risk to try to precisely time such a huge change in sentiment. But I have a suspicion that a few more cycles of terrifying headlines (“births at an all-time low! deaths at an all time high!") ought to do the trick.

Why This Worry Is Incorrect

Mark Adonis is an expert on demographics, but he does not hold himself out as having expertise in government bond markets. He at least realises that "graveyards" are full of people who bet against the JGB market. (Although an investor would have to be remarkably silly to lose a lot of money betting against JGBs at current yield levels.)

I will return the favour and opine on demographics. We should not care what percentage of the population is old, rather we need to look at the dependency ratio - the ratio of non-working citizens to working citizens. And guess what? Little kids and adolescents do not work. If you have a baby boom, you are increasing the number of non-producing members of society. However, if you look at the historical record, OECD nations had no difficulty in providing for everyone during their post-World War II baby booms.

The reason why this is possible is that modern capitalist economies are demand-constrained; there are sufficient economies of scale that it is easy to flood any market with overcapacity. The only trick for a business is being able to be profitable when faced with limited demand. All that will happen is that the present mind-boggling variety of goods and services that are available would be slightly smaller than otherwise, as there is less room for new small businesses. (Larger businesses have greater economies of scale, and they would push out smaller firms if there is a struggle to find workers.) And it is unlikely that the global overcapacity in manufactured goods will disappear as long as we remain in our current economic regime. Japan has ample foreign currency assets to finance the purchase of imports.

Additionally, demographics is an extremely slow-moving structural factor. Even if Japan starts to hit output capacity constraints (which as I argue above, is unlikely), it would take a long time to get there. The Japanese government can shift monetary policy within days, and fiscal policy within months. There is no way that these instruments can be overwhelmed by the slow pace of demographics.

(Slightly) Negative Population Growth Is A Good Thing

Japan bears are throwing everything at the wall, and hoping something will stick. I have seen two complaints about Japan in other articles:
  • Japan is vulnerable because it is dependent upon imports of resources from overseas, and they are in an increasingly rough geopolitical neighbourhood; and
  • the Japanese population is shrinking towards nothing!
They fail to see that these two complaints are actually contradictory - shrinking your population is an entirely sensible policy if faced with resource constraints. By contrast, the American policy of growing its population through immigration, doing nothing to encourage conservation and hoping that energy imports will magically be created by petrochemical fairies is not exactly a brilliant long-term plan. (Closer to home, Canadian policy is similar. Our cold weather helps Canadians be one of the largest per capita users of energy in the world. But Canada's large natural endowment of energy resources relative to our small population makes it hard for local politicians to worry about constraints.) 

People who grumble about geopolitical risk from shrinking population are somewhat behind the times - 70 years, to be precise. Nuclear weapons have changed military doctrine, and massed infantry and tank charges are no longer the pinnacle of Great Power strategy. Japan is currently behind the American nuclear umbrella, and I have little doubt that Japan has the ability to develop its own nuclear arsenal extremely rapidly if it chose to do so.

Unsatisfying Conclusion

The unfortunate part of his article is that his conclusions are boring. Concluding that the JGB market will sell off some time in a multi-decade period is not exactly going out on a limb. But if I read between the lines ("a few more cycles of terrifying headlines") would create an estimate of a JGB crash potentially starting around 2018. As a result, I will add this prognostication to my "JGB Collapse" list.

(c) Brian Romanchuk 2015


  1. Your post provided impetus to write my own post. It can be found at

    My focus is on the increasing bank accounts that seem to me to be the inevitable result of unbalanced trade. The accounts are found in both unbalanced trade countries. The mechanical process is illustrated in a very simple chart.

    I do not comment on potential inflation from the JCB current policy. The mechanics are one thing and the political decision to continue to travel to where the mechanics predict is another.

    1. I took a look, you made good observations. As you point out, trade forces people to hold assets in foreign currency. Since they are willing to hold those assets now, it is hard to see why this will suddenly change. (In fixed exchange rate systems, people often flee when there is a risk of the exchange rate fix changing. This is why the history of fixed exchange rate systems is the history of crises.)

    2. Elderly and wealthy households net save except for low and middle income retirement households. These financial assets are matched to liabilities of younger debtor households via financial intermediaries or government acting like FIs. The lack of younger cohort to take up debt at high interest rates drives down interest rates and drives up efforts to save money for retirement since ROI is so low. I think demographics may in part drive liquidity trap or savings glut in a mature economy with large central govt and central bank acting to prevent deflation.

      Debit and credit mechanics of loans and money creation in each country, and of FX swap via banks and speculators, would be very instructive, I have not found a reference showing these mechanics in simplified expression. Bruce Greenwald lays blame for global crisis on trade imbalances driven by productivity and industrial policy in Germany, Japan, China in this short video:

      Joe Leote

    3. There is a strong correlation between "secular stagnation" and an ageing population. The problem is that it is an event that happened once, while the ageing population is also unique. It could be viewed as a coincidence. I will have to think about this, and may return to the topic.

  2. In an SFC model one must infer causation because actions of agents cause the generation or destruction of financial instruments under specified conditions. Demographics should play a causal role in a model with individuals who are dependent as children, work and take up debt in adulthood, save for retirement, either invest or must spend down wealth in retirement, and who wish to have stable purchasing power over time to make reasonable consumption and investment plans for the future.

    1. Technically, those "life cycle" considerations are simulated in Overlapping Generations (OLG) models, which are a class of mainstream DSGE models. When I refer to "SFC Models", those are the Post-Keynesian models which often do not model these life cycle effects. (The OLG models may be stock-flow consistent, but they are not "Stock-Flow Consistent" models. Yes, economic theories are often poorly named.)

      Demographics should matter for saving, all else equal. The problem is that a good portion of national saving is driven by businesses and capitalists, and the level of profits is determined by the cycle, and not the life cycle planning of individuals.

      If governments wished, they could loosen fiscal policy and run the economy on a "high pressure" basis - low unemployment, but with strong inflationary pressures. These policies would overwhelm any demographic tendency for slower growth and low interest rates. However, the political preferences of older citizens may make such policies untenable, and so demographics affects the economy indirectly - by changing policy preferences.

    2. I am still contemplating the following ideas. Minsky follows Shumpeter's view that firm managers generate financial instruments when planning production, which I think is an SFC model.

      Ignoring the foreign sector ownership through the financial system should collapse into two aggregate households, a creditor household and a debtor household. Both households hold nonfinancial assets. The creditor household holds financial assets which are liabilities of the debtor household. I think the valuation of nonfinancial assets and cash flow to the debtor household to service past debt is the key to understanding a stable or unstable capitalist economy since the working class takes up all of the debt and must have a price floor under wages to validate asset prices and debts.

      This relates to the investment cycle theory because a loss of investment causes debtors in the wage markets to lose income and default on past obligations in greater numbers than expected by the managers of firms who provide cash flow via making deals.

      So if the government puts a price floor under wages it can validate past asset prices and debts but does so either by taxing the high income class, selling debt to that class, and/or driving the economy toward inflation if private credit markets are also increasing purchasing power of the working class.


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