Another background factor to the subsequent bubble in the US is the change in population structure. The size of the US working population (people between 20 and 64 years old) started to increase again from the mid-1990s until it reached a peak in 2007. The period during which the working population had increased virtually coincided with the period of sequential bubbles.
Usually, we observe that the age profile of life-time consumption follows a bell curve with a peak corresponding to the age cohort of 40-50-years-olds. What is more interesting is the fact that Japan’s working population also started to increase again from the early-1980s and peaked out in the mid-1990s. We see about a ten-year difference in the acceleration of the size of the working population between the US and Japan as well as asset price bubbles.
To the extent that market participants anticipate a sharp decline in the size of the working population in the future, the real long-term interest rate will fall. If this view is true, the bubbles in Japan and the US shared a common cause.
It follows that the most likely place for the next bubble is China, where the size of the working population will peak out in the mid-2010s. Per-capita consumption will accelerate until the mid-2010s, yet the real long-term interest rate will be maintained at a low level in the preceding financial liberalization.
Thus, it is thoroughly possible for China to achieve high growth until the mid-2010s, mainly based on domestic demand. Actually, Japan enjoyed domestic-demand led growth in the post bubble period, where the net exports contribution to growth was virtually zero in sharp contrast to its stellar performance during the high growth period. The slow recovery in US consumer spending may also mitigate the risk of widening global imbalance.
In light of Japan’s experience, China should be cautious about the mounting internal financial imbalance in view of the discrepancy between external and internal financial liberalization processes under a less flexible exchange rate regime. The lopsided financial liberalization after the establishment of the Yen-Dollar Committee in 1983, coupled with a sharp appreciation of the Yen after the Plaza Accord in 1985, provided fertile soil for the dangerous seeds of synchronized bubbles of land price and equity prices to germinate. Furthermore, the US government requested an increase in public investment of 430 trillion Yen over ten years at the US-Japan Structural Impediments Initiative in 1989-90, aiming to confine Japanese money to the domestic market. The use of Chinese money is another big policy agenda not only for the US and China, but also for the world economy.
Kazumasa Iwata is Head of the Economic and Social Research Institute in Japan’s Cabinet Office and formerly Deputy Governor of the Bank of Japan
Kazumasa Iwata’s observation of the relationship between population aging and long term interest rates is interesting and its implications far reaching.
If this relationship holds into the future, say true for China’s impending population aging, public policies in China must make sure that the expected lowering long term interest rate and the likely increased savings as a result or response by people be channelled into productive capacities or assets. This is also the lesson learnt from the US assets bubbles and the role long term interest rates and saving and investment imbalance played in that process, as Chairman Bernanke has admitted.
Hope new financial regulations to be introduced worldwide will provide policy makers with tools to deal with the future financial challenges and the population aging challenges.