Beware the slow “creep” that could devalue your investments. In their book, The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival, Charles Goodhart and Manoj Pradhan make the point that changing demographics has the potential to reduce the value of your portfolio.
Since the end of World War II, there have been several major changes in the supply of labor. First, there were the baby boomers born from 1946 to 1964; eighteen years later, they powered a surge of 75 million new young fresh faces that led a migration from cities to suburbs and prompted a building boom in housing, schools, fast food, and shopping malls. They were young and their numbers put pressure on reducing existing wages in skilled and unskilled jobs. At the same time, women began to enter the labor market at unprecedented rates. They too put downward pressure on wages and salaries.
As the world recovered from World War II, trade opened up around the globe. That meant labor markets that were cheaper than the United States. Once again that added to labor supply put further pressure on holding down wages in America. Companies realized that they could manufacture overseas using cheap labor and ship back to America for a lower price than paying higher wages in the United States.
The cheap labor was fueled further by the rise of China with four times the number of laborers as in the United States. Chinese labor has become more skilled and better equipped but is still less expensive in the last few decades compared to American workers.
This expansion of the labor pool has probably kept American wages lower than they might have been otherwise. But that is about to change. In 1980, 40% of the world’s population lived in extreme poverty. By 2019, that was down to 8%. The pandemic may have slowed the growth in wages worldwide but as the world economies open again, the chances are that the extreme poverty rate will continue to fall.
What does all this mean for investments? As a rule of thumb, inflation is driven two thirds by increasing wages and one third by increasing commodity prices. Prior to the pandemic the United States was already experiencing increase in wage rates:
2015 1.6% increase in wages
2016 2.5% increase in wages
2017 2.5% increase in wages
2018 2.9% increase in wages
2019 4.0% increase in wages.
Most baby boomers will remember the double-digit inflation of the 1970s, but that trend was already well underway in the 1960s. Rising from one percent annually in 1960 to almost six percent in 1969:
By the early 1970s, the economy was in “Stagflation”. The economy was experiencing inflation and recession at the same time.
The dollar from 1960 to 1980 lost 70% of its purchasing power. What that meant was, on the average, what cost $1 to buy in 1960 cost $3 to buy in 1980. In 1960 a first class stamp was 4 cents, a Coke was 10 cents, a dozen eggs 57 cents, and a gallon of milk was 49 cents. By 1980 the first-class stamp was 15 cents, a Coke was 35 cents, a dozen eggs were 91cents, and a gallon of milk was $2.16.
How did the stock market do? In 1966, the DOW hit 1,000 for the first time and would not pass that 1,000 again until August 1982, 16 years later. From 1966 the DOW sold off 20%, before rising again to 1,000. Then it sold off 30% before rising again to 1,000. Then the DOW sold off 40% before recovering to 1,000. Finally it sold off 20% before passing the 1,000 mark in 1982.
Conventional wisdom by economists is the world is operating with low interest rates and no inflation and that will continue almost forever. I do not believe that. We have seen a pick up in the inflation rate that is similar to the early 1960s. Inflation is a long, slow process. But it is devastating to portfolios.
Oh, by the way, not only are wages rising, but almost every commodity price is setting a multi-year new high. Inflation? It is 2/3 wages and 1/3 commodities. It does not explode upward, but increases gradually in the beginning and then accelerates.
There is, in my opinion, one way to overcome the impact of rising inflation. That is done by building a “margin of safety” into portfolios. That margin of safety is having abundantly more wealth than one would expect to need. The downside to that strategy is simply having more money. The sooner the process begins the better.
We have seen this past week that Texas knew at least since 2011 they needed to weatherize their energy producing equipment. They waited. Waiting until the storm hits is too late. Now is the time to prepare. We are doing that for our clients at AFC.
 Charles Goodheart and Manoj Pradhan, The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival, Palgrave Macmillan (2020), Print.