This post is in conjunction with a series of posts I will be publishing leading up to the publication of a book I am currently authoring covering many of the topics I will be discussing here. My promise to you is that this Substack will be ɟɹǝǝ, forever, to you, my reader.

Introduction

I. What historically constituted a recession

II. Recessions in the context of localized demographic decline – Japan

III. Recessions in the context of global demographic decline – today

IV. What is wealth?

V. Why the current metric? – different metrics

VI. Blackrock’s “unemployment-free recession”

VII. A century of complexity shedding or ruthless technocracy?

INTRODUCTION:

Last July, Blackrock appeared to have woken up to the demographic issues and their effects we described here back in May.

“The shrinking supply of workers in several major economies due to aging means a low unemployment rate is no longer a sign of the cyclical health of the economy. Broad worker shortages could create incentives for companies to hold onto workers, even if sales decline, for fear of not being able to hire them back. This poses the unusual possibility of ‘full employment recessions’ in the U.S. and Europe.”

It may be surprising at face value that the effects of demography-induced tightness in the labor market are only now starting to be noticed by large asset management firms. After all, demography is a slow-moving macroeconomic giant that is fairly easy to track in real time especially in jurisdictions that have the necessary robust bureaucracy to be able to accurately garner simple facts about their population.

Secular demographic decline is, on a relative basis, a completely new phenomenon in recorded history. Previous civilizations did undergo a number of brief epochs where fertility decline – or more precisely – fertility decline relative to non-natural rises in mortality, damaged demographic health and in some cases outright ended the existence of the civilization that existed at the time. However, no prior major civilization managed to conquer mortality as the post WWII epoch we live in presently has. To put this contrast into perspective, historically higher degrees of child mortality meant that a brief TFR (total fertility rate) decline from 6.0 children per woman to 4.0 children per woman proved civilizationally fatal. Today, larger families that would be considered normal a few centuries ago in nearly all cultures make headlines in foreign-language papers.

Demographic decline in the manner that it manifests today in the developed (and increasingly developing) world is historically unique. With child mortality minimized, most conditions treatable, and longevity becoming an ingrained norm, the actual TFR needed to sustain a population long term is 2.1 children per woman – a rounding error from a true mathematical replication. Given that the pace of advances in medicine has been so rapid, technology has enabled jurisdictions around the world to see their populations continue to grow and economies run without demographic headwinds even as TFR declines well below replacement for decades. This creates a phenomenon where the demographic momentum of previous generations’ higher birth rates, coupled with an expansion in life expectancy and thus also retirement age creates a multi-decade lag effect on demographic decline (the length of which can vary depending on how low fertility goes). Unlike the Greeks, Romans, or Maya, modernity has been able to create conditions where entire generations can essentially forgo childbearing while simultaneously exerting a period of positive pressure on the national economy, a phenomenon known as the demographic dividend.

The issue with this, as pointed out in our previous post on this topic, is that eventually the larger population cohorts have to retire and demographic momentum runs out of steam. Younger generations are unable to replace their older counterparts in number, competence, and experience. This phenomenon creates the massive secular tightening trends in the labor market that we see today. In turn, this manifests itself in the end of unemployment, and with it, the need to re-evaluate and re-frame what this means for monetary policy in a myriad of economic conditions. What is a recession if we have no unemployment? How does this influence the mandate of central banking institutions? How might it change their mandate? Are the current metrics of checking on the health of the economy obsolete? What does it mean for central banks when degrowth isn’t the end of the world? A new framework must be devised.

I. What Historically Constituted a Recession

Since the end of the Second World War, a general informal consensus has formed that a recession is roughly defined by two consecutive negative quarterly GDP prints. This is oversimplified: 2022’s Q1 and Q2 GDP prints were both negative in the midst of declining unemployment. Outside of some real-time politics and attention-seeking headlines, there is broad consensus that there was no recession in 2022.

In fact, the strength of the direct relationship between GDP and unemployment (Okun’s law) has been on shaky ground even before the 2008 financial crisis, and has been directly challenged by both the Kansas City Fed and the Cleveland Fed. Well into the mid-2000s housing boom, GDP growth’s relationship to unemployment appeared to be completely decoupled.

Actual determination of a recession is polyvariable. Nonfarm payrolls (unemployment), factory orders, discretionary spending, durable goods, and so on all factor into the identification of a recession.

Unremarkably, when we look back to previous economic downturns, every recession was marked by job loss and higher unemployment. As the income of large swaths of the population falls, consumer spending falls, and business revenue declines. This leads to spiraling unemployment, the result of which is disinflation or sometimes outright deflation. Inversely, we would expect, with abnormally low unemployment, for there to be inflation. In economics, this relationship between unemployment and inflation is called the Phillips Curve.

Central banks throughout the G7 spent well over a decade after the Great Recession trying to push the economy leftwards along the Phillips curve to the point that during the pandemic era some central banks were willing to let inflation run hotter than target supposedly for the purpose of counteracting the deflationary backdrop of the previous decade. In the midst of demographic decline, is it possible that central banks got what they wanted? Are policy makers stuck with the present backdrop of a tight labor market and secular inflationary pressures? We will explore this concept as we dive further.

II. Recessions in the Context of Localized Demographic Decline – Japan

Japan has been cited as a canary in the coal mine with regards to a myriad of dimensions both economically and now demographically when it comes to examining the trajectory of other major developed economies.

In 1957, Japan crossed below replacement fertility for the first time since rigorous population records have been kept, and was one of the first industrialized countries to do so last century. Thirty-two years later, and Japan entered its lost decades of deflation and low-to-no-growth. Western Europe, by and large, crossed below replacement fertility after 1964 (Iberia in 1981). Fueled a little longer by Eastern Europe, the lack of a major asset bubble until the 2000s, and strategic manufacturing – especially in the case of Germany – the rest of the G7 did not experience the deflationary pressures that Japan did until the early 2010s.

The academic consensus has been for decades that an aging demographic is associated with deflation due to reduced demand from a less demand-intensive elderly-skewed population largely subsiding on fixed income or benefits. This is predicated on data that has shown in the past that the most consumption-heavy demographics are middle-aged, usually at the peak of their careers. (However this appears to be changing).

There is a trend here: this phenomenon has played out only in a vacuum – i.e., these countries and economic blocs were isolated in their demographic pressures which in turn allowed other manufacturing economies to be the recipients of outsourcing and dump cheap goods back onto the aging consumer markets, thus keeping goods cheap.

Did economists ever consider what would happen when the frontier ended?

What happens when the supply of goods cannot remain cheap by relying on foreign inputs? What happens if every major manufacturing intensive jurisdiction suddenly ran into the exact same demographic problems at the same time?

III. Recessions in the Context of Global Demographic Decline – Today

In nearly every industry, the cost of labor is the biggest input cost. When the tidal wave of economic and trade liberalization started in the 1970s, and with it the arrival of globalization, outsourcing jobs and factories to jurisdictions with cheaper labor costs became infamous for hollowing out American manufacturing through to the 2000s. Countries with lower standards of living, healthier demographics, larger labor pools, more lax regulations, and physical infrastructure to support manufacturing were the main beneficiaries of this process.

However, with fertility precipitously on the decline in the developing world, many frontier markets that have been recipients of manufacturing outsourcing have seen proportionally similar or even greater labor tightness than in high income countries. Even in highly standardized simplistic and automated industries like textile manufacturing, the upper limits of outsourcing are being pushed. Bangladesh, the world’s second largest producer of textile products, whose’s births per annum peaked in 1982, is now experiencing mass violent strikes for weeks after workers rejected a 19% wage hike while unions are demanding a 219% wage hike. Upward pressure on labor costs have pushed clothing giants like H&M to begin outsourcing to Ethiopia – where labor costs in the textile industry are at present roughly 70% cheaper than Bangladesh, ($26/month vs $95/month as of present – with unions demanding $208/month, and the current offer being $113/month). To name a few examples, larger emerging manufacturing hubs like Indonesia and India have been facing similar pressures in their respective labor markets.

With the present secular decline in global fertility now proliferating most acutely throughout virtually every single jurisdiction with the necessary infrastructural prerequisites for industry and higher-order services to exist (such as abundant and ubiquitous electricity), the supposed catastrophic global deflationary effects of demographic decline seem to have been entirely absent, with the sole notable exception perhaps being China in the immediate present given the present mismatch between manufacturing jobs and the highly educated new entrants into the Chinese labor force. On the contrary, as we’ve neared the event horizon of the post-2008 generation approaching adulthood (where TFR fell off globally), we have seen consistently higher key inflation metrics, especially with regards to labor and services.

Ultimately, while an older demographic skew may depress demand as larger older age cohorts become less agile and move past peak spending years, as the top of the population pyramid begins to be filled in and the elder cohorts’ productivity begins to decline, supply, especially in services, becomes constrained – driving the secular sticky inflation we see today. Unlike in past cases of societal aging where this tightness can be mitigated through either outsourcing and to some degree migrant labor, today, the types of markets who are seeing a flurry of manufacturing growth by virtue of offshoring such as Vietnam pale in comparison to the size and scale the likes of China or Brazil.

On top of this, the demographic momentum of the likes of Vietnam or Indonesia is far closer to being stalled out when compared to their predecessors during their period of steep growth. When the National People’s Congress passed the Corporation Law in 1993 which solidified China’s re-entry to capitalist markets, China had a TFR in the 2.3-2.6+ range the five years prior. Eighteen-year-olds at the time were born to a cohort whose’ mothers yielded a TFR of 3.58 back in 1975. By the time tariffs collapsed with Vietnam’s accession to the WTO in 2007, Vietnamese fertility for the previous 5 years ranged between 2.07-2.28. If we were to be fair, Vietnam’s value-added manufacturing as a percent of GDP really only started a secular climb higher after the Obama administration’s public reconciliation with the country with the signing of the U.S.-Vietnam Comprehensive Partnership in 2013. By that benchmark, for the five years prior Vietnamese fertility ranged between 1.99-2.10. Migrant labor too, skilled and unskilled, both within the realm of domestic and cross-border migration is seeing supply from historic sources such as Thailand or Korea dry up, with new sources of demand cropping up in places such as Japan. Relatively labor-rich India is having problems fulfilling job openings domestically. Compound this with the reality that demographic projections with regards to fertility have been massively optimistic, and the picture becomes even more dramatic. Even just recently, projections for the population of China for 2100 have been revised from last year’s projection of just under 800 million to 525 million while India’s internal numbers have shown that demographic decline is much more advanced than UN estimates might suggest, with the UN report suggesting India’s population will reach 1.5 billion by 2100 echoing a similar 1996 report that placed the Chinese population at 1.52 billion by 2050. Even the likes of Ethiopia, who has seen fertility cross below replacement in the capital city at the beginning of the century, will not be immune from this phenomenon.

There is historical precedent for this phenomenon. Even prior to World War I, France had been experiencing a century-long decline in fertility. Combined with the particularly harsh demographic devastation of the war and strong tariffs which isolated French outsourcing, demographic pressures enabled France not only be the last major economy to devalue its currency in the Great Depression, but outright weather most of the major ailments of the depression. While other economies devalued their currencies in an attempt to boost exports and lower unemployment, French unemployment peaked at merely 5%. There was no major banking crisis with only one major bank failing, wages grew higher than pre-depression post-WWI trends for the entire depression, and peak to trough deflation and GDP decline were both milder in France (see table 10 & figure 2) relative to the US and other European countries (France 19.4%, US 23.4%+).

Paul Beaudry and Franck Portier make the case that France’s Great Depression was actually worse than the American depression, predicated on the fact that France’s GDP per capita underperformed when comparing detrended historical mean French GDP per capita growth (1896–1994 ex 1914-1918, 1930-1945) vs. detrended historical mean American GNP per capita growth (1919–97 ex 1930–46). This comparison is dubious at best – neither of the world wars were fought on the soil of the lower 48. Including post-war recovery GDP growth without including wartime devastation allows for years like 1946, where the French economy expanded by over 50%, to set a very high bar for normalized annual GDP per capita growth. This completely ignores physical economic destruction during the war. By this metric, if we were to use this methodology on say, Sudan, we would scarcely have many years to establish a trend at all let alone for that trend to be realistic in any capacity – even for high growth African markets. Even if we are to detrend both countries by the same annual GDP per capita growth as Beaudry and Portier have done, by the time the depression came to France, the comparatively tiny generational cohort reaching working age born during WWI would clearly create conditions that, in the absence of an otherwise bad economic backdrop, created barriers for French economic growth in the 1930s. If anything, the fact that by 1938 the French economy had still managed to outperform its American counterpart in the midst of its massive labor crunch stacked on top of the Matignon Agreements gives credence to Michał Kalecki’s hypothesis that labor productivity growth was resilient in the latter half of interwar France, which would have counteracted negative pressures as a result of the rise in the Age Dependency Ratio (especially when adjusted for life expectancy) against GDP per capita. Today, it is likely that the only salvation for the global economy is to turbodrive growth in labor productivity – which in simpler terms is called “innovation” and “automation.”

Ultimately, in the absence of trade liberalization, manufacturers in France could not economically offshore to jurisdictions where labor was comparatively frictionless. In doing so, France provides historical insight into the demographically-induced inflationary pressures we see today in a historical microcosm. The insulation that this provided against what would be hallmarks of a traditional depression, can best be illustrated by the sentiments French diplomat Edmond de Fels expressed in a 1932 Le Figaro article:

“For our part let us rejoice in our timid yet prosperous economy as opposed to the presumptuousness and decadent economy of the Anglo-Saxon races.”

The obvious issue here is that while unemployment may have not been as severe or the effects of the Great Depression not as drastic on the population in France, valuations predicated on growth assumptions started declining even before the Dow peaked in September 1929 (see figure 2). If the French economy outperformed, and conditions were tangibly better for the average worker, would the economic backdrop of the 1930s have been marred merely by a recession rather than a prolonged depression? With the generation of 1914-1918 coming to adulthood at that time, it is likely that there would have been impediments to economic growth as well as manifestly inflationary pressures similar to what we see presently in aging societies. Giving credence to this idea is the fact that, prior to WWI, France’s economic stagnation with relation to her neighbors and traditional competitors was a secular trend that coincided with her demographic transition.

Today, central banks in the G20 are primarily concerned with unemployment and inflation. This necessarily places the Phillips curve at the front and center of policy. That said, policies implemented by central banks for decades have relied on tools designed to reduce unemployment via increasing demand through asset value appreciation such as the (explicit) attempt to use Arthur Pigou’s “wealth effect” through the supposed effects of QE, in essence working off of the idea that valuation expansion is upstream from maximum employment. With the demographic of those who own assets increasingly concentrated in age cohorts who are past retirement age, continued policy in this direction in the face of structural labor tightness has the potential to strain labor scarcity when current dynamics could make it increasingly difficult to enact policy designed to stimulate growth without spilling petrol on the kindling of inflation.

This begs the question: what is the metric for the wealth of nations?

IV. What is Wealth? – Different Metrics

It is needless to say that GDP growth is difficult with global stalling demography. As we have already outlined, it is also hard to get unemployment, even in Japan. But if labor is such a large component of generating value, is GDP really the right metric of measuring the health of an economy and the prosperity of its constituents? The answer is complicated.

The end goal of economic output is to generate the means and necessities to sustain life, and ideally comfort. Generally, the better one performs at doing so, the greater one would be rewarded for it. If a large economy with a centralized government – say, China – were to attempt to resolve its demographic crisis with humanoid robots, this would prove to be a far more onerous and redundant task: would robots be able to directly generate demand for residential housing? Robots, or AI for that matter, are rational tools whose’ needs are not as complex and wide-ranging as humans, and whose ultimate purpose is to enhance activities that sustain and enrich life. They cannot be made into consumers unto themselves without sentience. A raw stagnation or decline in GDP is, therefore, not a direct threat to the wellbeing of the population it serves if that population is declining, so long as degrowth can be managed gracefully. Some countries such as pre-war Ukraine have already seen this distinction become notable. Even if global fertility were to rebound tomorrow, the momentum toward degrowth, both demographic and otherwise, will necessitate addressing degrowth on a global scale this century.

Wealth is ultimately agent-relative. While an ever rising population and perhaps also an ever-rising GDP serves growth models and valuations, the erosion of the former does not necessarily preclude a society from getting wealthier, even in terms of absolute GDP.

Much of the foundation of Keynesian economics, today’s dominant school of economics, comes out of the breadlines of the Great Depression. Half of the Federal Reserve’s own mandate is dedicated towards ensuring full employment – a recognition that the human agent is the economy’s end-user. Yet, global demographic decline presents a unique situation for the architects of monetary policy. Short of an outright depression, the mandate of full employment will nearly always be satisfied, while simultaneously the very tightness that makes the full employment half of the mandate so easily satisfied makes the other half of the mandate extremely difficult to satisfy. The last major frontier markets that are labor-rich enough and have the demographic health to sustain outsourcing growth for more than a generation are, for the time being, largely electricity–deficient. Under these new conditions, more mature markets could experience prolonged GDP stagnation, or even decline, while maintaining a steady or even a tight labor market.

If the human agent is the end-user of sorts of economic productivity, then the data in focus should be centered around increased worker productivity, innovation, rising standards of living, distribution of wealth, unemployment, and other agent-relative metrics.

V. Why the Current Metric?

The main opposition to this approach comes from those whose’ interests are aligned with, and who are positioned to gain from, the assumption of perpetual absolute growth. Capital interests have come to rely on asset appreciation and the expansion of earnings multiples during the 38 year long bond bull market (1982-2020). The dispensing of the notion that achieving maximum employment – without the effects of inflation – is downstream from valuation expansion, which is to say that the inverse of the wealth effect could be used to secularly retard the inflationary pressures of global demographic decline, is an audacious proposition that will take a significant amount of pain (and likely lessons learned) to ever be accepted. The only major new proponents of this perceptual shift has been climate advocates, but even they have felt pushback by those who see greenification and growth as not mutually exclusive.

Central banks have been incredibly reluctant to suggest anything close to the idea that the wealth effect even could be used in reverse. One of the most notable examples showcasing the effects of this reluctance in the midst of the new global labor backdrop is perhaps the recent development that even stagnant Japan is starting to see the necessary ingredients for secular wage growth after three decades of deflation. The current BoJ position as of January 2024 is that inflation as it stands could be unsustainable and reliant on the Yen’s rapid depreciation. This is a classic case of putting the cart before the horse. Given Japan was the first market to fall below replacement fertility after the Second World War, Japan has been saddled with a legacy of the jurisdiction which has been fighting deflation the longest. The BoJ’s extreme reluctance to meaningfully pull away from accommodative monetary policy and Japan’s overall dependence on QE, NIRP, and the like, is a direct result of Japan being the first economy to experience acute demographic decline – which, as referenced earlier, when experienced in isolation, had immense deflationary pressures and had placed the BoJ in a deflation-fighting setting for nearly three decades. The phenomenon of demographic decline is, however, no longer isolated. Japanese outsourcing coupled with rising foreign labor costs, especially in China, creates conditions which reduce the marginal advantage of outsourcing. This phenomenon leads to increased import costs which when compounded with the BoJ’s sustained dependence on accommodative policy – exacerbated by the carry trade – fuels the devaluation of the Yen and thus what the BoJ views to be the driver of inflation in the first place. This is hardly unsustainable. The BoJ’s sticky accommodative monetary policy is a symptom of demographic decline and thirty years of attempting to use the wealth effect to spur growth and inflation. Now that Japan, and moreover the developed world, got what they wanted, capital interests and dependence on 2010s era policy and its legacy of assuming a fragile economy are coming into direct conflict with achieving central banks’ mandates, and with it an assortment of unusual propositions from 50 Hudson Yards.

VI. Blackrock’s “unemployment-free recession”

“You can’t have your cake and eat it.”

At the beginning of this post we pointed out the peculiar use of “full employment recession” in Blackrock’s July paper. The very implications behind the assertion that such a thing could exist, as pointed out earlier in this article, undermines the very foundation of even what defines the nomenclature used in the fields of economics.

As a whole, this type of nonchalant disregard for the fact that conventional economic models are breaking around the world in real time is an example of a broader institutional strategic incompetence. From the weaponization of cross-border transaction settlement mechanisms, the destruction of Nord Stream, the timing of the SPR drain and refilling, coupon to bill issuance during the COVID ZIRP era, nonsensical approaches to net-zero, divestment from critical commodities, to Washington’s attempt to wage war on virtually every continent, evidence of degrading governance and mismanagement of capital is evident everywhere.

Fundamentally lower borrowing costs and its downstream effects perpetuate and exacerbate wealth concentration at the household level. The advent of globalization and thus a global labor market put negative pressures on wages in developed markets, increased global supply and shareholder value, and by virtue of reducing domestic demand on labor within markets with high standards of living, puts negative pressures on global aggregate demand. Combine this with the fact that wealth concentration is deflationary, and there is suddenly no mystery as to why the 2010s was free of inflation. With the advent of geopolitical disentanglement and demographic decline coming to ahead presently in the ex-LDC Global South, the beginnings of a new global monetary regime is here to stay.

SOFR (Secured Overnight Financing Rate) futures contracts have been chronically overdovish in assessing Fed policy even before the hiking campaign first kicked off two years ago. Fed dot plots have been consistently wrong and the track records of other major central banks ex-Asia have been equally embarrassing. Because recessions generally spur stimulus and accommodative policy, market participants, especially after the precedent of prolonged ZIRP era after the 2008 financial crisis, have been quick to jump the gun on front-running stimulus and more accommodative policy while many policymakers have been reluctant to abandon the idea of a historically low neutral rate (though with some discussion starting in the opposite direction). This haphazard recklessness is particularly dangerous given the inefficiencies financing cost volatility incur – inefficiencies spurred by consistently wrong guidance in the midst of a potentially rapidly destabilizing new paradigm for the global economy. For many market participants and policymakers alike the waters being tread today are completely uncharted; expectations predicated on the past will have little standing in the future. The navigators of this century have an enormous responsibility, and perhaps hold the fate of the very future of our civilization itself.

VII. A century of complexity shedding or ruthless technocracy?