personal finance

Historic pandemics data provide warning for owners of capital


There is a lot of evidence that people with money will have to give up a substantial part of their wealth over the coming years. Also, over time, younger working people will increase their share of income relative to retirees.

And no, that does not depend on which party holds or loses a handful of seats in the US Congress. Or, for that matter, on who gets to write central bank policy announcements. The trend might run deeper and longer than that.

Patterns in very long-run historical data are like insider information. They offer an information advantage for investors since few seem to want to take the trouble to read dense historical documents

Lately, I’ve been reading up on the historical record of post pandemic economies, and the relationship between population age distributions and inflation. All bad news for owners of capital.

Last June, the Federal Reserve Bank of San Francisco put out a paper on “The Longer Run Economic Consequences of Pandemics”. The authors studied the rates of return on assets in the wake of 19 significant pandemics stretching back to the 14th century.

As they say, “the results are staggering, and speak of the disproportionate effects on the labour force relative to land (and later capital) that pandemics have had throughout the centuries”.

Not good news for rich people, but “following a pandemic, the natural rate of interest declines for decades, reaching a nadir about 20 years later, with the natural rate about 150bp [1.5 percentage points] lower had the pandemic not taken place”.

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That “natural rate” has also shown a secular decline over the centuries, from about 10 per cent in medieval times, to 5 per cent at the start of the industrial revolution in the west, to near 0 per cent today.

In other words, you will really earn nothing on your money now after correcting for inflation and speculative excess. And then some of the profitless pile that remains will be taken away.

Even though both wars and pandemics cut short huge numbers of lives, the SF Fed study says: “The effect of war goes the other way: wars tend to leave real interest rates elevated for 30-40 years, and in an economically and statistically significant way.”

When you think about it, this sustained pattern makes sense. Wars destroy property and disperse money, while pandemics kill people and leave structures intact, like neutron bombs. So plagues lead to fewer people relative to land and cash, which should lead to wages going up relative to rents and interest rates.

The current policy response to the pandemic is to have the state borrow a lot of money and spend it one way or another. As the SF Fed study authors say, “the textbook response is to either borrow to smooth the shock, or to pursue aggressive stimulative policy”. However, they add “the sustainability of such debt depends crucially on the type of economic disaster confronted”.

So it would seem that instead of a postwar inflation, we could have post-pandemic downward pressure on interest rates and profits. Squinting at the charts, the study’s conclusions are, so far, consistent with what I have seen since the vaccines began to arrive late last year.

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Yes, there was an inflation scare in the bond market until late February, but that seems to have flattened out with copper and oil prices. Western governments have issued a lot of debt, but that appears to have met with a high level of precautionary savings. The banking system seems better set up to buy US Treasury debt than make new loans.

What economic and demographic dynamics will shape our lives as the Covid-19 effects begin to fade with time? I’ve been reviewing a 2018 Bank for International Settlements paper called ‘The Enduring Link Between Demography and Inflation”. According to authors Mikael Juselius and Elod Takats, “our findings suggest that the deflationary effect the age structure has had on inflation for the past four decades will reverse over the coming decades and become inflationary”. 

Briefly, the authors find that inflation increases in a population with a rising proportion of dependants (such as children and retirees) and decreases with a rising proportion of working people. The effects are similar in populations across the world and over time. This might be owing to decreases in savings rates when proportion of dependants rise and vice versa.

What economic or demographic dynamic will come after a pandemic-driven decline in rates of return? There might be a clue in how inflation responds to shifts in the (surviving) population’s age distribution.

The politics of stimulus should be seen as a form of theatre, not plans for the economic future.

john.dizard@ft.com



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