Demography is Destiny: Covenant’s Weekly Synopsis (August 23, 2019)

August 26, 2019


In this week’s edition:

· Financial Markets – Volatility continues, but credit markets are stable.

· Central Banking 2.0 – The extraordinary is now ordinary.

· Demography is Destiny – China has a population problem.


Last Week Today. Germany auctioned the first long-term, 30-year 0% coupon bond but demand was well below expectations, as the government only sold bonds valued at 884 million Euros vs. a 2 billion Euro target. Might this signal peak negative interest rate policy, in that the markets expect interest rates will rise sometime in the next 30 years and hence there are better investment opportunities than locking-in a negative return? | At the Jackson Hole soiree, Fed Chair Powell’s keynote speech was notable for what he didn’t say as much as what he did, in so much as he did not try to walk the market back from expectations of a rate cut in September. More on Powell’s speech in Central Banking 2.0, below. | Early this morning President Trump announced he had at least one phone call with China and they want to negotiate. China has not confirmed any requests occurred.

Financial Markets. In what looked like a nice bounce-back after three weeks of consecutive declines, equity markets unraveled on Friday. Fed Chair Powell performed well in Jackson Hole, soothing markets Friday morning, but in another episode of “He said, Xi said,” President Trump and China’s President Xi escalated the trade war once again via new tariffs. U.S. stocks fell nearly -3% on Friday, erasing gains for the week. Also, while international stocks were higher through Friday, that’s because their markets had closed before the U.S./China fireworks went off. As equity markets fell, bonds were bid higher, pushing some segments of the yield curve deeper into inversion. Putting aside the unusual shape of the yield curve, the 10-year bond is now yielding only 1.54%, leading to lower mortgage rates. Indeed, 30-year mortgage rates have moved lower from a peak of 4.8% in late 2018 to 3.75% today (Source:, which should offer a bit of a tailwind for the struggling housing sector.  For specific weekly, month-to-date and year-to-date asset class performance, please click here.

While equity markets have been volatile, and each violent decline brings another batch of pundits calling for a recession, credit spreads are painting a different picture. Corporate bond defaults characterize recessions as companies are unable to repay or refinance maturing debt. Hence, in advance of an economic downturn, risky bond prices generally fall (pushing yields higher) in anticipation of future write-offs. As the chart below highlights, the corporate credit market is not signaling an imminent recession.



Central Banking 2.0. In response to the Financial Crisis and the ensuing Great Recession, the major central banks adopted extraordinary monetary policies. These policies, designed to address slow growth and low inflation, were intended to be temporary but instead appear to be the “new normal” in central banking.

  • Federal Reserve (Fed) – The Fed began normalizing monetary policy in October 2014 by ending QE3, and began raising interest rates in late 2015. Over the next three years, the Fed raised interest rates nine times, pushing the Fed funds rate up from 0.25% to 2.5%. The Fed also began to wind down its QE-bloated balance sheet in late 2017. However, the Fed cut rates in July and ended its Quantitative Tightening program early. More rate cuts are widely expected.
  • European Central Bank (ECB) – The ECB adopted a negative interest rate policy (NIRP) on June 11, 2014, lowering its official deposit rate to -0.10%. The ECB cut rates three more times, and by 2016, the deposit rate was -0.40%. Last year, when the Fed was raising rates, the ECB suggested they would begin normalizing rates in 2019, but in light of slow economic growth have backtracked on those comments. Instead, the ECB is now proposing a continuation of ultra-easy monetary policy that will include a rate cut (deeper into negative territory) and a resumption of their Quantitative Easing (QE) program which began in 2018.
  • Bank of Japan (BOJ) – The BOJ initiated QE in April 2013 and implemented NIRP on January 29, 2016, lowering its bank reserve deposit rate to -0.10%. The BOJ has never suggested an end to either policy, and since starting QE, the BOJ’s bank reserve balances have increased 738% from 42 trillion Yen to 352 trillion Yen in July (Source: Yardeni Research).
  • Peoples Bank of China (PBOC) – While the PBOC has not delved into NIRP, it has pumped the economy with credit creation. Since 2008, bank loans exploded by nearly 400% from $4.4 trillion in December 2008 to $21.4 trillion as of July 2019. Keep in mind that in China’s communist, centrally controlled nation, banks (and bank lending) are controlled by the government via the PBOC.

In Central Banking 1.0, lower interest rates fueled economic growth and pushed inflation higher. In Central Banking 2.0, the bankers added extraordinary monetary policy measures to the traditional tools to combat persistently low inflation and economic growth. When the central bankers didn’t get the results they wanted, they applied more NIRP and QE and, as a result, the extraordinary has become ordinary.

Yet, the reality is that QE and low interest rates can only do so much in the aftermath of the Great Recession (and a lower “neutral interest rate”, the rate at which interest rates are neither restrictive nor stimulative). As Chairman Powell said in his Jackson Hole speech, “Low inflation seems to be the problem of this era, not high inflation” and as Europe and Japan have shown, negative interest rates and QE are not the solutions for overcoming low inflation.

The Fed is certainly aware of the ineffectiveness of Central Banking 2.0 and is not settling for a “stay-the-course and hope for the best” approach. Indeed, as Powell laid out in his Jackson Hole speech: We face heightened risks of lengthy, difficult-to-escape periods in which our policy interest rate is pinned near zero. To address this new normal, we are conducting a public review of our monetary policy strategy, tools, and communications—the first of its kind for the Federal Reserve. We are evaluating the pros and cons of strategies that aim to reverse past misses of our inflation objective. We are examining the monetary policy tools we have used both in calm times and in crisis, and we are asking whether we should expand our toolkit. [emphasis mine].

Demography is Destiny. From 1979 to 2015 China enforced a Malthusian[1] family planning regime limiting families to raising a single child to control population growth and, according to the Chinese government’s logic, avoid nationwide starvation. The one-child policy resulted in the forced sterilization of women, late-term abortions, human trafficking in babies, and even the murder of infant girls to comply with the policy but raise a son. Indeed, the overall sex ratio in China became skewed toward males, and by 2016, there were 33.6 million more men than women (Source: Britannica). Forty years on from the start of the one-child policy, the legacy looms large as China’s demographic composition has transitioned from that of an emerging market (e.g., a high concentration of young people) to a developed economy (a la Japan), in which the elderly comprise the largest population demographic.

Indeed, below is a chart (click to enlarge) comparing the age-distributions of the populations in Japan, China, and the U.S. beginning in 1990 and as forecast through 2050. Which one is different? As the chart highlights, both China and Japan have fewer young people supporting their elderly population today, which over the next 30 years will only get worse (note how the pyramids become increasingly top-heavy in 2025 and 2050. Whereas, the U.S. population includes a much better and youthful composition over these periods, a portion of which is attributable to immigration.


Source:  Business Insider

Facing the dire demographic effects of their one-child policy, in 2016, the Chinese government began allowing married couples to have two children. However, reversing the effects of a ruthlessly enforced 25-year policy is proving difficult. In 1979, just prior to implementation of the one-child policy, China’s women averaged 2.75 births each, but today it stands at just 1.62 births (meaning the average couple is not having enough children to replace themselves). Indeed, in 2018, China’s birthrate was the lowest since the People’s Republic was founded in 1949, with only 15.2 million births vs. the 21 million to 23 million births expected by the government.

The practical implications are numerous: a shortage of young adults to support the elderly; greater reliance on the government for housing, medical care, and food; a declining population and workforce leading to slower growth and higher labor costs. The latter effects are already evident as China’s official GDP growth slowed from 14.2% in the early 1990s to 6.9% today. Moreover, even before the Tariff War began, rising labor costs in China pushed companies to either relocate manufacturing back to the U.S. or source cheaper labor from countries like Vietnam. There is little China can do to change the demographics of their society except for implementing a two- or three-child policy (i.e., mandating parents produce more children) or adopting an aggressive immigration strategy to attract younger workers. Both measures are unlikely, and hence, the Japanification of China appears unavoidable.

Housekeeping note. Over the summer, I injured my shoulder, and I will have surgery this week to repair years of wear and tear. I’ll be in a sling for a good six weeks, so depending on my recovery and ability to type, I’ll be taking at least a two-week hiatus from writing the Weekly Synopsis. When I return, we will pick-up our Behavioral Finance series with an exploration of Cognitive Biases. We recently completed a six-part series focusing on Emotional Biases, which can be reviewed in the weekly synopses beginning with the June 14th edition. In the meantime, we’re working on bringing you new ways to access our material, including podcasts and videos. Look for an announcement and new content in the coming weeks.

Be well,


[1] Malthusian: of or relating to Thomas Malthus or to his theory that population tends to increase at a faster rate than its means of subsistence and that unless it is checked by moral restraint or disaster, widespread poverty and degradation inevitably result.