FRAMINGHAM, Mass. — When the Federal Reserve cut interest rates last week and stopped balance sheet reduction, one’s first thought was that the stock market and oil prices would rise. But just the opposite has happened. Why the reversal?
Having served on the Federal Reserve Bank of Boston’s Advisory Council, I know the Fed fears deflation much more than inflation. They have a complete arsenal to fight inflation—interest rates, reserve requirements, open market operations—but limited tools to flight deflation. The old adage is that you can lead a horse to water but cannot force it to drink. Falling demand and the expectation of lower prices (deflation) ignites a vicious cycle of delayed purchases, delayed investment, falling gross domestic product and more deflation that ends in a recession or worse.
The Age Connection
Unlike Japan, we have been lucky to not see this deflationary cycle in the U.S. since the 1930s. The great recession of the late 1980s was a financial-sector, classic debt-driven bubble pop in asset prices—not a recession or deflationary spiral.
The Fed’s concern is Europe and China, as Chairman Jerome Powell has mentioned several times. Europe and much of Asia are in recession now and experiencing deflation. While the cause may be excessive regulation, trade chaos (tariffs and Brexit) and other factors specific to these countries, there is no denying that an aging population is a prime driver.
The median age is about 38 in China and the U.S., according to the Central Intelligence Agency Factbook, but it is higher in much of the rest of the developed world. This ranges from median ages in the low 40s in Canada, South Korea, the U.K. and France to the mid-40s in Greece and Italy, and the late 40s in Germany and Japan.
A graying population is less productive, draws on more resources than it produces and is generally downsizing and selling more than it is buying.
And while those of us older than 60 love to think 60 is the new 30, the reality is 40 is the threshold to economic stagnation. The U.S. and China are approaching that point, and most of the rest of the world has blown, crawled or limped beyond that. In the U.S., 4 million people turn 65 every year and 4 million die, with only 3 million born. The median age of women in the U.S. is 40, and with the median age for their first marriage at 28, I would not expect births to pick up.
The Coming Slowdown
What this does mean for oil prices?
They should soften with this global slowdown, and a stronger dollar softens demand. Another interesting sign from the recent rate cut was a much stronger dollar. But economic activity is always a bigger driver in currency flows than interest-rate differentials, so world currency is telling us that the weakness outside the U.S. is more concerning. Equity traders reacted by saying a stronger dollar will hurt exports and widen trade deficits, causing more trade tensions.
So $40-per-barrel West Texas Intermediate, here we come!