Episode #174: Amlan Roy, State Street Global Advisors, “Monetary Policy is Very Ineffective In A World Where We Are Getting Very Old”
Guest: Dr. Amlan Roy is Head of Global Macro Policy Research and Senior MD at State Street Global Advisors Asset Management Division (SSGA). He leads a Research team focused on Macroeconomics, Policy & Politics, Retirement & Demographics serving external and internal clients of State Street Group across 30+ countries.
Date Recorded: 7/12/19 | Run-Time: 57:31
Summary: Amlan and Meb start the conversation off with a discussion on demographics, why we need to understand them, and the idea that monetary policy is relatively ineffective in the demographic environment the world faces today.
Amlan then lays out some prescriptions for some of the issues he’s seeing today, including, the idea of doing away with traditional retirement ages, more fairness toward women, and updated immigration policies.
Meb and Amlan then get into negative yielding interest rates, the impacts they have on investors, and how we should be thinking about economic and finance theory. He also hits on falling productivity growth, and a trying to solve that issue in China, India, and the rest of the world by bringing more young people and women into the workforce. Amlan then shifts to some additional thoughts on growth, and his idea of the “Demographic Dividend.”
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Links from the Episode:
- 0:59 – Welcome to our guest, Amlan Roy
- 2:37 – Amlan’s view of demographics
- 8:10 – The dramatic impact of aging populations
- 8:15 – The Meb Faber Show – Episode #150: Bill Smead, “The United States Economy Is Highly Likely To Be The Strongest The Next 10 Years It’s Been Since The Baby Boomers Went Through The 30 to 45-Year-Old Age Range”
- 13:47 – The Coming Generational Storm: What You Need to Know about America’s Economic Future
- 17:02 – The problems of living beyond our means and wealth gaps
- 18:03 – The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It (Shiller)
- 19:56 – Straight Talk on Trade: Ideas for a Sane World Economy (Rodrick)
- 20:04 – Globalization and Its Discontents (Stiglitz)
- 20:59 – Solutions for stresses in the economic system
- 21:41 – What if 8% is Really 0%? Pension Funds Investing with Fingers-Crossed and Eyes Closed (Faber)
- 22:59 – The Demographic Manifesto: New People, New Jobs
- 29:19 – The economics of negative yielding sovereign bonds
- 35:47 – Triumph of the Optimists: 101 Years of Global Investment Returns (Dimson, Marsh, Staunton)
- 37:27 – The 2019 Global Investment Returns Yearbook: 119 years of financial history and analysis
- 38:45 – Stocks for the Long Run 5/E: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies (Siegel)
- 38:55 – Stock investors expectations for returns
- 45:46 – The potential for investment in Africa
- 50:11 – Why health is the most important asset that all of us have
- 51:44 – Favorite resources
- 53:44 – Most memorable investment
- 56:09 – Following Amlan – LinkedIn, State Street Global Advisors
Transcript of Episode 174:
Welcome Message: Welcome to the “Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser better investing starts here.
Disclaimer: Meb Faber is the cofounder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: These statements represent personal views of Amlan Roy as a global researcher and not those of State Street. Hey, welcome podcaster listeners. We got an awesome show for you today. I met our guest at the Milken Conference over a few glasses of wine. Got to see him talk. He’s the head of Global Macro Policy and senior MD at State Street Asset Management Division. He leads the research team there focused on macro policy, politics, retirement, demographics, all sorts of things serving internal, external clients in over 30 countries. Prior to that, he served as head of Global Demographics and Pensions, MD Credit Suisse. And prior to that is an academia too. Welcome the show, Dr. Amlan Roy.
Amlan: Thank you, Meb. It’s great to be on your show. And please called me Amlan.
Meb: Amlan. Last time I saw you, you were pacing about a great restaurant in Los Angeles giving a talk that I love. So I harassed you for months until you finally agreed to join us on the show. So thank you. I’m excited that you’re here. And by the time we’re done, we’ll probably know who wins the Wimbledon match because it’s going on concurrently.
Amlan: Oh, I expect it to be long-drawn out for at least two or three hours and, first of all, my apologies. I don’t think it was just me but our schedules and the time zones, all those things interfered, too.
Meb: Where in the world are you right now?
Meb: Oh, you gotta go. You should be going to the match. Come on, man, State Street should be paying for that.
Amlan: Yeah. I’m going to Kenya tomorrow and a very big central bank in Asia is being [inaudible 00:02:28].
Meb: Well, look, you are on the road way more than I am. You probably have some good frequent flyers. I think you give about 30 talks a year. So this will be old hat for you. So, Amlan, I was reading one of your old papers or listening to one of your videos and you had a great Peter Drucker quote that you mentioned where you said, “We do not pay attention to demographics. And when we do, we miss the point.” So what do you think about when you think about demographics? And what does the world look like you today as you travel around and give talks to all sorts of group? What’s going on your mind?
Amlan: On demographics, my interpretation of Peter Drucker is that the world is now starting to look at demographics through the kind of lens that I started looking about 20 years ago. To me, demographics is demos people, graphics is characteristics. So the etymology or the word origin of demographics alludes to people characteristics. It’s nowhere in the definition of the word do we have age, young people, old people. So if you look at the world in terms of people as consumers and workers, I claim consumers and workers affect GDP growth, affect asset prices, affect inflation, affects a bunch of things like geopolitics. And how many consumers are there in the world? There are roughly about 7.9 billion consumers today in the world because everybody in the world who’s a person or an individual or a human being, whether it’s a baby in San Francisco General Hospital or it’s the oldest woman living in Okinawa, Japan, they are consuming different things.
And they are a bunch of workers, something like 5.6 billion workers, workers make up the GDP of the world. And consumers consume the bulk of the GDP in excess of 50% of the GDP of the world. In U.S. it’s about 70% of the GDP. In China, it’s about 38%. In Japan, it’s 64%. And it varies because the consumption of chair of GDP varies. And a very important point that Peter Drucker alluded to is, when we try to look at countries, we should look at differences across countries because not all countries are homogeneous. The share of consumption is not the same across all countries, the share of exports and imports is not the same across all countries. So in Germany today during the trade wars, Germany is likely to suffer a bit more than countries like U.S. or Japan which are a bit more insulated, or even countries to some extent, like China.
So it’s important to understand the sources of GDP growth. How are consumers consuming? How are workers working to get a holistic understanding of demographics? Now, where’s the world today? I claim that the world today is in a very peculiar spot, which economists have been coming up with lots of narratives. Some of them hyped up, some of them lot of semantics, but many of them are not making a lot of sense, such as some people calling it a new normal. I don’t think it’s a normal in any sense where economic and finance orthodoxy has failed over the last 10, 12 years to come out of a low growth, low inflation, low interest rate world and we are grappling with these issues, whether it be in Japan or Italy or Germany or U.S. and expecting monetary policy, which is one hand to deliver what earlier two hands delivered in coordination or synchrony.
So think about Muhammad Ali boxing with one hand, whereas he’s used to boxing with two hands. Or Rafael Nadal who’s used to playing with both hands tennis, just having to play tennis with one hand. So that’s a big handicap. Furthermore, one hand is very bruised and overused, and I call that monetary policy. Monetary policy is very ineffective in a world where we are getting very old. So that’s so called synthesis of where I see the world and why has economics fail? I refer to two very, very distinguished economic scholars. And people say economists are arrogant, but these are people who are Nobel laureates and still criticising the profession, criticising themselves and people like me saying that economics has been very narrow minded, has been too technical, has assumed superpowers in terms of forecasting, but has been found wanting because it ignore behaviour, political institutions, trust, confidence, and other things which matter and communications.
So now, Akerlof and Shiller first wrote a book called “Animal Spirits.” Then they wrote a book, “Phishing For Phools” where they said it’s the narrative which counts. And now Shiller has published another book called “Narrative Economics” saying that it’s not just how we see things. It’s how we generate things. How the co-emcee narrates things, how the ECB narrates things, BOG narrates things. In the earlier days, there was certain mystification where Alan Greenspan would say that, “Hey, I want to leave you people guessing.” And now Bernanke believes that monetary policy is 98% communication and only 2% action. So we have seen a sea change in the world of central banking, in the world the way they communicate.
And furthermore, economists and central bankers have not understood that Meb and Justin are two very different people. If I put them in front of two computers in two different rooms and I tell them, “This is what the Fed said. This is what the ECB said. This is what Apple said and Google said.” They may not always come up with the same conclusions. I’ve played that out with traders sitting next to each other. So messaging is important. But also understanding who receives the message is important.
Meb: There’s a couple things wrapped in there I want to explore. The first is I was laughing, because we had a guest on our podcast as you’re talking about consumers who had a great quote. He’s like, “Look, if you’re born in the U.S., you come out of the womb a Disney consumer.” He’s like, “You immediately start consuming everything Disney from the age of zero on up.” But one of the biggest sea changes we’ve seen that you talk a lot about, you know, is aging. And particularly, there’s a large chunk of really old farts that are becoming almost an entirely new part of the way that we have to think about the future. Maybe talk a little bit about that, and what kind of effect that’s going to have going forward.
Amlan: That’s an excellent point. And this is a very concrete example of their academics and people like me, until I looked at things very carefully, go things absolutely wrong. So the orthodoxy of macroeconomics, actuarial science, and insurance policies is to take the lifespan of an individual and divide it into three phases. And this is what the academic gurus of the ’50s and ’60s, the Samuelson’s to Modiglianis and the Moskowitz did. So they said 0 to 15, they are young non-workers. We are largely in schools. They were modeling the world in the ’50s and ’60s. Sixteen to 64, we are working age. And 65 plus, we are retiring.
So when I started looking at demographics far more closely, I said, “Hey, let’s ask myself a question which I should be able to answer as a macro finance professor.” The question is, Meb says, “Amlan, you retire at 65.” And Justin says, “Amlan, I think you’re going to die at 85.” Let’s assume both of you are right. How much money do I need for 20 years post-retirement? Most people can’t answer that question, although we think we can because no one can predict including the gurus and the Fed and Nobel laureates what inflation will be next 20 years, what healthcare costs will be next 20 years, what assets returns will be next 20 years, the equity premia, the bond yields. And where will retire? Do I retire in DeKalb, Illinois or do I retire in Chicago? Do I retire in Pella, Iowa or do I retire in New York City?
The costs of living are different, the job opportunities are different, etc. So I discovered very late because I’m not very smart and like Peter Drucker, I’ve drank the Kool-Aid that everyone gave me as a finance, macro academic. Somebody pointed out to me in 2007, a doctor, that I was blatantly wrong and a statistical geek who doesn’t understand the real world. Why? Because an 80-year-old in Netherlands cost the government something more than 79% more than a 65-year-old in terms of health care costs. In Switzerland, it’s more than 90%. In U.S. it’s more than double. So putting all retirees in one category, 65 till the time they die, is a big fallacy because the 80-year-olds are the very old people, their wealth, their consumption, their retirement, the outlook is very different than 65-year-olds.
Furthermore, the 80 plus who are called the very old are the fastest growing age group in the world, fastest. They are growing at rates, which are four, five, six times rate of the average population growth. So I’ll start off with Japan as an example. In 1970, Japan roughly had something like 46% debt to GDP. Its 80 plus population was 1% of the total population. Today, when its debt to GDP is more than 50%, its 80 plus population is more than seven times. I easily translate this to a country in deep, deep trouble in Europe called Italy. When I started doing demographics, Italy used to be the fourth of fifth oldest European country. Today, it’s the oldest European country and Italy faces a very, very big debt problem in EU 28 with one of the highest debt burdens, but also it’s the oldest country.
Italy’s populism comes from demographic features. And we got a paper on this saying that Italian demographics underlines low growth, debt instability, and populism. So why do we see this? Highest youth unemployment rates in Europe in the last 30 years now belong to Italy, they used to belong to Spain, and just after the global financial crisis. Second, Italy has a big gender bias. Male versus female labor force participation rates. Third, Italians, although healthy, are retiring earlier than their retirement ages. This puts an enormous burden on their public debt.
And the biggest reason for growth of public debt in Europe is the growth of the 65 plus but more pertinently and more particularly, the growth of the 80 plus. In Europe drops the 79% to 82% of taxes go on pensions, health care, and long-term care. But it’s not just a European problem, this is also a problem in U.S. Last month, I was in D.C. where I was speaking to your pensions experts and speaking at conferences as well as people who are supposed to bail out a lot of companies which may be in trouble in terms of pensions. And I argued to them that the present value deficit of Social Security, Medicare Medicaid, according to Larry Kotlikoff, who’s one of the guru’s in terms of generational accounting and has been on the Council of Economic Advisers, three times he’s written a book, which is a must read, for every American, it’s called “The Coming Generational Storm.” He’s written many other books, too.
And 210 trillion is the present value deficit of Social Security, Medicare, Medicaid, that give or take something like 5 trillion. How do Americans get rid of that? To get rid of it, solutions can be very radical. One solution could be create a lot of inflation. And that would be very inimical to the older generations. Old people lose out if you create inflation that benefits go down. Second could be that you put an enormous burden on the smaller younger generation and that would be increasing taxes. My argument is simpler. It’s I say take it. And I learned this again from a client because I’m not smart enough, take 210 trillion or 220 trillion and divide it over 100 years let 4 generation sharing it so that no one generation suffers that.
So I do think the basic problem in the world is we over promise to older generations. And that is the biggest mistake of corporate governance. People talk about corporate governance without realising the biggest mistake of corporate governance is making long-term promises. So let’s assume you or Justin are my boss. And I come and ask you, “What is my salary of compensation package going to be for next year and year after next?” You’re going to say, “Are you crazy? I don’t know. Are we going to make profits? Are you going to deliver? Are you going to work properly?” So if you can’t give me a guarantee for next year or year after next, how did all of corporate America, corporate Japan, and corporate Europe make pension promises 20, 30 years into the future? And no one question it. No one questioned it because it was an empty pension promise which never came in the money.
In the ’60s and ’70s, most people would die by 65, 70. So if you have three, four, five maximum a decade of post-retirement, today you have people who are at the age of 70 have more than 80% probability that they are going to live till 95 in countries such as Italy, Sweden, Japan, Germany, and also parts of the United States, which are fairly wealthy. But the U.S. faces a very big problem. It’s a problem that Americans really ought to introspect and deal with because it puts America in really a bit of a laughing spot sometimes. America spends or U.S. spends 18% of GDP roughly on out. And the median age of Americans is 38.3 years, roughly 8 years lower than Hong Kong and Japan and lower than most of Europe.
And largely, this is because of things which can be sorted out, which Mr. Bloomberg tried. One is supersizing, another is obesity, third is inefficient healthcare, and fourth is that Americans work too hard. An average American in San Jose or in Santa Monica making $2 million is not happy with the size of their home, maybe it’s a $5 million home, they aspire to a $10 million home. So instead of working 340 days in a year, they go and start working 350 days in a year to drive themselves to an early grave. These are issues that Americans really need to balance prosperity against quality of life.
Meb: Five million dollar home. Amlan, I was just looking at tweeted a couple months ago that there’s like 20 homes in Los Angeles listed for over 50 million, including 8 homes listed for over a 100 million. So I’m really, really unhappy because I’m a renter and I’m nowhere near $100 million house.
Amlan: Absolutely. And this is a very, very big problem. And I think history books according to John Taylor at Stanford will come back and say that two economic heroes were financially reckless in giving us a very gold gilted’s dream and selling it to the average Americans. And many would blame Greenspan and Bernanke for keeping interest rates too low. And making an average person like me earning $35,000 a year or $40,000 in Nebraska, think that I can really afford a $3 million home. So selling that dream is something that even people like Shiller criticised in a book called “The Subprime Solution.” So we should live within our means. But inequality is at an all-time high. Never before have we seen in America that the top three richest individuals have close to 50% of its private wealth. That wasn’t true during the time of the Carnegie’s, etc.
But that’s not just in U.S. U.S. is not the most unequal countries in the world. The most unequal countries in the world are in emerging markets. Number one, Brazil, number two, India, number three, China. So you’re talking about $100 million home. The most expensive private residence in the world lies in the second most polluted city in the world called Mumbai. And the value of that is 2.1 billion. It’s owned by Mr. Ambani and it’s hardly three quarters of a mile away from the second largest slum in Asia. So growing inequality is also something that you see a lot more in emerging markets, not just in developed countries.
And this is what ferments populism, you know. When people see that, just like some CEOs or some people in society making multiples of thousands or tens of thousands of what the average hard-working American makes, that’s when you see some kind of populism not just in America, it’s happening in UK, Brexit, you can see it’s happening in Greece, it’s happening in Italy, it’s happening also in parts like Germany. And this right wing movement is not something which is happening without any economic fundamentals. Lot of people claim that these right wing movements are happening because inequality has worsened because of globalisation and international trade.
So there’s a brilliant book written by somebody who’s in a minority is my contemporary called Danny Roderick. It’s called “Tough Talk on Trade,” where he says that trade has…and this is echoing also what Joe Stiglitz said, in a book called “Globalisation and Its Discontents.” That globalisation has served some countries well like China, India, etc. But it’s also deserve lots of rich countries where the average hard-working American in the Midwest or in some factory city has suffered a lot also because of globalisation. So has the average German, so has the average Italian. So the backlash is not without its causes. So emerging markets have benefited. The average median, I would say, or the inter design between the lowest quartile and the third highest quartile. So between 25th percentile and 75th percentile, the middle class and the lower middle class is who have won the biggest grant. So that’s why there’s some sympathy for Mr. Trump to put these tariffs on. So it’s not without cause.
Meb: There’s about three big issues, at least, that we’ve kind of talked about in this whole sort of diagnosis. I want to talk a little bit about prescriptions. One that you mentioned was…and I’m going to touch on all three and then let you roll. The first you’re talking about this new age demographic. And, you know, is the answer do we just give everyone who turns 90s get him to join the Hemlock Society and say, “You guys gotta move on. We need to make plays for younger people.” And then part and parcel you also mentioned inequality. What’s the answer there? Everyone is talking about wealth tax, all these other ideas. And last, of course, is politicians and companies promising the world to employees whether it’s through pensions that are just hugely chronically underfunded.
We wrote an old paper called pension funds investing with their eyes closed and fingers crossed. So there’s a lot of these fractures going on, you know, not just in the U.S. but around the world. What are some of the things you think that are actually prescriptions that would help alleviate some of these stresses? Is it something that the system just breaks? Or what do we do about it?
Amlan: I must do one thing which I forgot to do because the brilliant Justin had highlighted this when I spoke to him yesterday. Please note that these comments are mine and mine only as a free thinking researcher. They cannot be attributed to State Street or any other institution that I belong to. Okay? So this conversation between you and me and I’m passionate about a better equal world. So I’m kind of…
Meb: I feel like, Amlan, I think this qualifier means whatever you’re getting ready to say is going to be really, really interesting. I feel like anytime anyone says, “These views are my own,” is just teeing it up for something really interesting. So let’s hear it.
Amlan: In 2000, we wrote a document which I used to be very ashamed of. It’s very radical. And it’s the only document you have a copy of it, it’s a document which has charts going back a million years. It was a policy prescription written along with my two of my co-authors when I was in Credit Suisse. It’s called “The Demographic Manifesto.” How should countries solve the aging problem of a growing massive old people to be supported by a shrinking mass of young people? And we came up with…I wasn’t as wise as I am, hopefully, through two decades of doing research on demographics, but four prescriptions we came up with.
Number one, in a world where people are growing older, we need to abolish retirement age. The retirement age of 65 needs to be consecrated to the trashcan or the rubbish bin. Because 65 was the age determined by Otto von Bismarck in 1892 as the age of retirement when life expectancy in Germany was only 46. Most people didn’t live on until 65. So making a pensions promise of there was akin to me saying, “Hey, Justin and Meb, I will give you all my wealth once I turn 200. If you’re going to wait till when I’ve turned 200, that’s something the problem again, odds on that are very low.” So that’s the first policy prescription, banish retirement ages, ask people to work part time, part year or part week. And that would require changes in labor law, legislation, education, skills training because I may be an old skilled person, but somebody needs to employ me. So that could be one solution in a world where we are saying we don’t have enough workers, people are too old.
The second solution is let’s be fair towards women. Women are 50% or more of the population or right about 50%. In most of the G20, women are better educated than men at high school and college levels. Yes, there’s a big labor force participation gap in the top 6 countries ranging from 20% in Japan, to roughly about 9% in France. U.S., UK are about 10%, 12%. And we also pay women lower. So the second prescription was with the use of technology, allow women to better balance work life with home life. Because the argument that women should stay at home because they have kids, they don’t have kids, let’s assume that a woman graduates at age 22 from undergrad, they don’t have kids for entire 45 years that they really need to handhold and enable them to go through all the, let’s say, travels of life and ensure that they reach the age of 40.
In most countries, which are very small and where their policies, they allow women to better balance work life by home life by creating daycare centers, giving them subsidised childcare by giving them tax breaks, and enabling them to be able to also transition from when they have two kids to slowly getting back into the workplace. I’m thinking about Nordic countries as well as Netherlands because fertility rates, number of children per woman in all those countries used to be close to 1.3 or 1.4, now through proactive and more conducive and I should say more generous policies or equality towards women, female labor force participation rates have come up while at the same time we are seeing male labor force participation rates have gone down. So somebody could facetiously look at the data and say, “Men are getting lazier whereas women are working harder to make their burden felt.”
The third solution is selective immigration. I think most rich countries have been far too liberal on immigration and have taken an immigrants without asking basic questions. When I invite somebody to my home, let’s say, who I’ve met on the subway or to bar at a party, I should be asking few questions. I should be asking if they come into my house, will they come and break the TV in my house? Will they steal my beer cans and my wine from my fridge or other kinds of things? So it’s always imperative for the home country to ask, “How many immigrants do we need with skills? Do we need immigrants? Do we need short-term? Do we need long-term? Can women do the jobs?” And I don’t think any of the countries have asked those questions in exactly that kind of framework in the ’70s, ’80s, and ’90s. Now some have started asking, including the U.S., but the best advanced countries on those have been Canada and Australia, which always asked those skill-based questions.
And the last prescription I give is you don’t need to bring in people into your country as immigrants if you do not have the wherewithal or you think that they will cause havoc or they will live in ghettos or they will may not contribute enough because different countries have different policies for that. You could have for noncore activities, ship your job over to some country like India, or Colombia, or Poland, or Hungary, where they are processing centers, which are looking at the X-rays and scans of Copart Institute in Seattle, or let’s say a Mayo Clinic in U.S. or one of those other big hospitals like Mass. General. So you could outsource those kind of activity.
So those were four of our solutions. They are very radical, but I believe they are still applicable. And different countries need to do different mixes of those policies. Because even countries like Japan are opening up to immigration. How many countries in the world if I went to the Nordics or UK would I see that the Dean of one of the biggest University is a black person? Unthinkable in Japan. Sumo wrestling referees are women. Koizumi has enough people in his cabinet which were women and now Abe-san has also got enough women. So I do think that countries are changing. But the big problem is a political problem.
There are too many old people and they vote a lot. Young people don’t vote. So the voting power is all with the gray haired people who are voting to have their Social Security, Medicare or Medicaid sacrosanct while they may have retired at 63 and the live till 90 or 95, who’s gonna pay for it? Our smaller, younger generation, their taxes will go up. And we are also not promising them the same type of jobs as earlier. So the younger generation is facing a bit of a backlash where they have to look after the older generations and also possibly pay higher taxes for the baby boomer generation, and those who are older.
Meb: Talk to me a little bit about…I mean, by the way, those are far too sensible suggestions for most of our politicians to adopt. But they make sense. There’s a couple other topics I want to talk about. Briefly, we’ll talk about some investment concepts. One to me is in the economics profession, so somebody who’s been both on the academic side and the practitioner side for a while. One of the big surprises to me that you look around the world today, and there’s a lot of discussion about it is the realisation that there’s a large part of the world that has negative yielding sovereign bonds. And from an economics idea, I’d love to hear you talk a little bit about that. Do you think about that at all? Could U.S. ever go negative? What’s the whole…because to me, that’s probably one of the biggest surprises I’ve seen over the past 10 years.
Amlan: Absolutely. And you’ve taken me back to my first point. We live in a very abnormal world. Classical economics never had to deal with interest rates which are negative. There was a Bank of England spokesperson who gave a lecture recently and said that in the G10 countries, 87% of the bonds on negative in real terms. The traditional models of asset allocation, derivatives, or asset pricing, all based on positive term structures where the treasury bill was probably at 2%, real rates sometimes were 4%, 5%, 6%, and nominal rates were 8%, 9% sometimes. But those days are gone. Today, in a world where interest rates are negative, I call it an abnormality because interest rates in a perfect equilibrium sense should be related to the marginal productivity of capital.
Capital in an economic sense, therefore practice, labor, capital, entrepreneurship, and land. So the price of land is rent. Price of labor is wages. Price of entrepreneurship is process. Price capital is considered interest rate. So what does this say? This says that when Justin and I go back to Adam Smith and [inaudible 00:31:31] and traditional economics, when Justin borrows, let’s say, $100 from Meb, he doesn’t come and give him $100 bill, which is torn and absolutely decrepit, which Meb would need to go into a particular branch of the Fed to exchange. So rather than giving out a positive interest rate, you’re giving a note which is going to cost somebody an opportunity in terms of their time. So that’s like giving negative interest rate on loan.
So negative interest rates on a loan or negative interest rates are something very unnatural. Most asset pricing models, you know why long-term capital fail is because long-term capital, in all their models only thought about positive inflation, positive interest rates, etc. If you take negative interest rates and you take negative prices, a lot of the economic models explode because they don’t convert. So mathematically, lot of the constructs that we’ve built on pricing have been of a world where interest rates are positive. If interest rates are negative, then in an asset allocation sense, no one should be putting money towards bonds which are yielding negative interest rates. They could put them towards a safe asset, which used to be a treasury bill with maximum zero return.
But negative means I give you money and you come and punch me in the face and I suffer for lending your money. So in this kind of an environment, the notion of fixed income of government bonds needs to expand and fixed income should include bonds which are like emerging markets, which are like high yield, which are like corporate bonds, which are like infrastructure bonds because negative real interest rate should not be even allowed in the admissible investment opportunity set. And this takes me to one of my biggest mistakes that we as finance people made. So in the ’60s, ’70s, ’80s when real interest rates were 3%, 4%, 5% on long bonds, which are 10-year, 20-year, 15-year bonds, we built our basic theory and a paradigm where we said long-dated bonds are better matches for long-dated liabilities. And those long-dated bonds were giving you positive real returns.
Today, when they are giving you negative real returns. I say do not partake or invest in those long-dated bonds. Invest in bonds, which are giving you positive deals like corporate bonds, high yield infrastructure, but those things inherently are more risky and therefore you will need to do better risk management with those kind of things. And we saw what happened with CBOs, CLOs, etc. I used to work in an investment bank, which was one of the largest in credit derivatives in the world. So I’ve seen from very close how the credit derivatives market developed and the subprime market developed and what happened to it. So on asset allocation, I claim we need to move away from a world where we had only three pillars, public equities, government bonds, and cash. That is what [inaudible 00:34:46] Modigliani’s asset allocation models, Moskowitz’s mean, variance model, etc., were based on.
Today, we need to move away from those and embrace alternatives, such as hedge funds, commodities, real estate, infrastructure or private equity because those new asset classes or new ways of investing give us positive returns, they are riskier so we need to do better risk management. The trick out there is we don’t have very good data in history on these new asset classes compared to the traditional asset classes. So that’s where the science and the art of asset allocation mix. So one has to make calculated calls on how do you take real estate, private equity hedge fund with shorter histories and mix them up with government bonds, private public equities and cash?
And on this, there’s a brilliant book which every asset allocators to try to understand how history of assets returns work and it’s called “Triumph of the Optimist.” So it’s another title could be stocks, bonds, bills, and inflation across 17 countries for more than 112 years, written by Dimson, Marsh, and Staunton. And every year, Credit Suisse comes up with an update because after they wrote the book, they partnered with Credit Suisse to do annual updates. What that shows is that the equity premia in U.S. which every country took a sacrosanct because U.S. had better data, better finance, better investments, and better finance knowledge compared to the rest of the countries. Today, the equity premia of U.S. cannot be used as a proxy by Australia investors, Nordic investors, or Belgian investors.
Yet when I entered the profession in the ’80s, only U.S. had the best data. And those were on the Chicago [inaudible 00:36:36] and everyone used them. Now other countries have developed good databases and the bond yields the equity premia, the stock returns are very different when you go from Germany to France to it. And they are very different when you go from the U.S. to Canada. So when you’re looking at asset allocation on a global basis, you have to ask yourself, “What type of an investor do we need to serve?” What type of a portfolio do we need to hold? And is that a home country bias?
Meb: You just gave my normal speech that I’ve been giving the last few months. That’s actually my favourite investing book. We had Professor Dimson on the podcast a while back and I tell all the listeners, I say, “You should buy this book. It’s expensive. It’s like 100 bucks.” So I say, “You can get it from the library or go to the year old employers Credit Suisse’s, they do an annual update, global investment returns yearbook.” And we’ll post show notes links to this. But if you want an entire MBA and investing reading the last 10 years of updates is probably the best thing you could do. It is a series of pro level. I learned probably more from that book in series than probably any other list of publications.
Amlan: Absolutely, Meb. And what I’m saying is we need to upgrade today. And pardon my using an NBA analogy, the books of Graham and Dodd and the shop books, etc. which came out in the ’60s and ’70s are even some bits of it in the ’80s, it’s like NBA of the time when Larry Bird and Hakeem Olajuwon and Magic Johnson played. Today, we are in a world where you’ve got Kobe Bryant and the new Mr. Durants and, etc., in the world and they are playing at the level which is absolutely unfathomable, whether you look at it in terms of technology or investment. So we really need to understand the history of investment. And it’s a book which I’m not recommending only because they are friends of mine, I use it in my first asset allocation lecture whether it be for MBAs or PhDs. There similar kind of a book, which is a companion book, you could look at is “Stocks for the Long Run.” But that only pertains to the stocks this year which is like the admissible.
Meb: That’s interesting. As we talk in the U.S. where we say, as you look around the world, U.S., I mean, you almost call it a high yield market at 2, in whatever percent but even then, with U.S. stocks, we believe price to return probably lower than they have historically. We talked recently, Schroeder’s puts out a yearly publication. But it says the same thing as everyone else, where they say that investors expect over 10% returns. And it’s a global phenomenon. And, you know, the pension funds, expect 8%. So even if it’s 8%, or 10% but the opportunity said is giving you around 3%, it’s either setting up the case for a lot of disappointment for a lot of people and pension funds or you got to really start to think outside the box of traditional, like you mentioned, the CAPM just basic assets, because otherwise, or you can just be happy with your 2% returns move on. But it creates a situation that’s probably not attainable for most investors.
Amlan: No. And you can see that in U.S. states. You make a brilliant point there, Meb. Because look at U.S. state pension plans, whether it’d be State of Georgia, State of Illinois, State of Rhode Island, or California where you people are, most states take their livelihoods and they’re discounting it earlier, they used to discount it at 8%. Now they pump their chest when they’ve adjusted the discount rate from 8% to 7.25%. And I told them, “When is the last time you ever in a single year made 7.2%? Then how come you’re discounting your livelihood?” So they are allowed to cheat on their livelihood. I do think they need to be a bit more honest with the public and say, “Gone are the days where we could afford to give you 7%, 8%. We give you 3%. That’s good.” But let me also turn it the other way around. I am one of the biggest fans of people who’ve had 30, 40 years histories of great bonds performance.
And legends like Bill Gross and Alan Howard, if they are finding it very difficult in a world of low interest rates to make money, what does that say for some average folks like me? It’s not going to be easy. And we should understand that they made money during a period interest rates were very high. Let me give you another example. Why aren’t banks lending more money? Because if interest rates are so low? Where do they make money? Because they are being taught you need to be cautious about lending money to young people and young people need the most money. Old people aren’t going to engage with you at low interest rates. So low interest rates are the basic anathema or the curse of investment because you are asking banks to keep interest rates very low.
And with low interest rates, my analogy is it’s as if you’re telling somebody buy a can or a carton of Tropicana which used to cost $5, now you say please, “Go and sell it in for a quarter.” Even if the cost of production be 20 cents, no one wants to sell it at a quarter. Similarly, with banks, if you tell them, “Hey, keep interest rates this law,” where do banks make money? If interest rates are very low, there’s very low return to entrepreneurial capital, too, to risk taking. So if we want to reward risk taking, idea is you borrow at 3%, you have conviction in your project, you get returns of 8%, 10% in your project, return on 3%, some interest rate, let’s say, 3.5% and you net 4.5% and he’s happy.
That’s the way the capitalistic world used to work very well in the ’60s, ’70s, and ’80s. I would be remiss if I didn’t talk about productivity growth all over the world for this. And the reason for labor productivity growth falling is that as we get old our productivity growth falls. The highest productivity growth belongs to young people. And to get high GDP growth, my answer in China, India, and rest of the world is employ more young people and employ more women. So if by along the increased level of productivity growth by employing more young people, more women, and by using technology efficiently, we will create more growth which will have good spillover, to employ both young and old people.
And it is a myth to say that old people take away young people’s jobs. Because my challenge to all of America is can anyone do Mr. Alan Greenspan or the job of Mr. Bernanke or the job of Larry Summers today? And the answer to that is no 20 or 25 or 30-year-olds can do it. Likewise, none of those three names I’ve mentioned can do the job of a 25-year-old in a McDonald’s or a Target or in a Best Buy. So if that would be the case, I don’t think old people necessarily take away young people’s jobs. And that is also borne out by research from pensions think tank which I highly recommend every American subscribe to or those who can sponsor should sponsor. It is outstanding. It’s called Center for Retirement Research in Boston College.
Meb: As we look around the world today, you’re getting ready to hop on another flight. You’re in London heading to where? Did you say Middle East, then Asia?
Amlan: I’m going to Kenya for a central banking FinTech conference. And guess what? This is an Afro-Asian FinTech conference. FinTech leader of the world is a country called Singapore and their central bank organises an annual conference which you should go and attend. It’s every November. Last year, I attended as a speaker. There were 46,000 people from 115 countries. I was also on a panel with the founder of Skype, young talent who’s thinking about technology to solve a lot of the problems of 10 to 25 years into the future. So from Singapore, the learning…Africa wants to learn and use FinTech because in Africa, a lot of these countries like Kenya, Ghana, Angola, South Africa, you can do. They’re very, very advanced in terms of payment systems on phone, even in rural parts.
So they want to use FinTech as a basic breakthrough order disruptor in terms of avoiding the inequality gaps. And this can be a left lobe which gets young and old men versus women, advantaged versus disadvantaged together. So the panel I’m speaking at is how does FinTech help people in films or micropensions, savings and allow for better social impact in poor countries. And what lessons can we learn from countries like Singapore and countries like Malaysia and India in terms of pensions for the African continent?
Meb: Well, you know, and Africa is interesting because it’s like the exact opposite of much of the developed world as far as demographics. I think some of these countries, if you look at the population distribution is just so, so young.
Amlan: I want to give you something very spectacular about Africa, which I might forget. And there was a rock star called Bob Geldof. When I gave a one-hour talk, he said you didn’t mention Africa. And I said, “Well, I’ve written a paper on can Africa attain its demographic dividend?” And the demographic dividend is a film which is misunderstood by most investors and politicians. Everyone tends to use it. And it is core to emerging markets growth. The demographic dividend is that when rural countries industrialise and this happened in Asia and Latin America to the likes of Singapore, Korea, Malaysia, and few others, where when countries industrialise, men and women move from rural to urban areas, they educate them better, better educated kids and the smaller population leads to higher GDP growth, but smaller population that is GDP per capita growth. How does industrialisation and stages of growth lead to high GDP? For capita growth, the impact of demographics to high GDP per capita growth is called demographic dividends. It is not GDP growth, it’s GDP per capita. That is living standards growth.
So I wrote a paper why does Latin America not in the demographic dividend yet? It should have ended. And the answer to that was inequality, corruption, poor health, and crime. So people ask me, “Can Africa get the demographic dividends?” And to that I wrote a paper where I said there are only two things that are in the way of Africa becoming the next Asia or even better. And number one is health. Niger and Malawi, they’re opposite end of the spectrum of the largest longest lived countries. Hong Kong in Japan have median age. One-third of Hong Kong and Japan at 15.2 years and 15.3 years. So a lot of people in those countries because of political instability, coups, fighting between tribes, etc., the average male dies off by 25. Therefore, we need political stability, better quality of life, rule of law and order. That’s the most important thing.
And the second thing is we need better health. The biggest killer in Africa is not HIV AIDS, it’s water-borne diseases between the ages of 0 to 2 where the cause of typhoid, cholera, malaria, and those other kinds of things, infant mortality rates are high. So people think that if you have…and, again, Meb, in your construction, I saw leads to what convention does and you equated Africa’s youth to demographics. Remember, youth is not about demographics. I repeat demographics is not about age alone. It is about other features. Beyond age also. Gender affects consumption and work. So does education, sort does family background, so does where you grew up. So age is just one statistic as a consumer or worker.
So I go and tell the governments of India, China, Africa, just because you have millions of young people, that does not automatically engender demographic dividend. To get a demographic dividend, you need progress in terms of policies, on education, health, labor, political institutions, democracy, all coming together. However, I will caveat it by saying that sometimes in the poorest of countries, democracy is not the best functioning. When you’re hungry, yes, that’s not the time that you need to tell somebody, “When I’m on the starvation field that, Amlan, you need to recycle something.” It’s after I’ve managed to have a glass of water or breathe some clean air and I have a belly full of food that I can think about those things. So we need to create jobs and healthy workers will lead to a demographic dividend, but just workers 400 million Indians and 600 million young Chinese does not guarantee a demographic dividend if they are unhealthy, unemployable, fixed, or if they don’t have jobs to look forward to.
Meb: There’s a lot of food for thought in there. Amlan, as much as I want to keep you for another hour or two, we got to start winding this down because we got Nadal, Federer on. And who’s your prediction, by the way? Who do you think takes it today?
Amlan: If it goes to five sets, Nadal takes it because he’s got better stamina. But otherwise, I think Federer has always got the edge on grass. If this was played on neutral courts, then it’s difficult to predict. Nadal is supreme on clay courts. I think on grass, if Federer gets the first two sets then Nadal can’t come back.
Meb: That’s a good example. I mean, Federer, he should have forced retirement by now. He’s an old Fur in these demographics. He’s still whipping everybody.
Amlan: Yeah, but look at it, that’s why it’s a good note to end on health is the most important asset that you have. I have personal examples of friends who are worth more than 100 million, but they’ve had 3 bypasses, their oxygen capacity is 40% of a normal average person of their age. So then you can’t enjoy life. And I think Federer, Nadal, and Djokovic are supreme because they are taking care of their health in ways that John McEnroe and people like Borg and others, even heroes like Pete Sampras never managed to take care of.
Meb: Yeah, well, it’s interesting talking about Federer, too, because the biggest thing he’s mentioned over the past few years is he actually has amped up the amount of rest he takes. He’s not killing himself on the circuit but takes a little more rest. And he’s an old man. A couple more things and we’ll let you go. First, you mentioned a lot of great resources. And listeners will link to those in the podcast notes, for books and papers and ideas. Anything else that’s been either particularly influential or anything that’s been on your shelf, as you’re on the airplane reading or thinking about that you thought has been really interesting in the past? Let’s hear it.
Amlan: There’s a great book, which was released in Milken. And it was released by somebody who was the political guru of Bill Clinton. However, he decided to ditch Hillary Clinton somewhere halfway through her campaign. And he’s called the king of consumer service. His name is Mark Penn. He coined the term hockey mom, soccer mom, Luddites, etc. So he’s brought out a new book called “Microtrends Squared.” And if you can internalise “Microtrends Squared” and I recommend everyone buy that book because that would be the biggest insight I can give you on stock picking, other than giving you quant models which are new or know a bit but I don’t do regularly. It’s a fascinating read into changing society. And it goes hand in hand with a more technical book.
So if you want to be pedantic, scholastic, and more technical, read a book written by the guru of International Affairs, Kissinger calls him unparalled. He’s no longer live, Sam Huntington who wrote tremendous two books, “Clash of Civilisations” predicting the trade war, predicting China, etc., in the ’80s. But the second book on the American identity that he wrote is fascinating reading called “Who are we?” How is the average person in Sacramento different than the average person in San Francisco or in Chicago, and how the American identity has evolved over time? Those are, I would say, one is international, another is understanding society. And if you have to do good investments, you don’t just need good model. You need the gutsy of the Warren Buffett or the infusion of the Bill Gross’s of the world.
Meb: As you look back over your career and I don’t know how relevant this is, but I’d love to hear if there’s anything that comes to mind as on a personal basis. That’s been your most memorable investment. It could be good, it could be bad, it could be stocks. It can be something else. Anything over the past few decades that’s been a great investment.
Amlan: My three most important calls were one in [inaudible 00:54:09] the day U.S. Treasury said no more 30-year bond issuance. I said us will come back and do 30-year bond issuance in 2001. Long bond used will go from four to three to two. My second most memorable call, which turned out to be right was in 2006 saying Greece will fail because Greece is like GM, Chrysler, and Ford multiplied by 15. And my third most important call was saying that youth unemployment will create the Arab Spring. And now I’m warning about China and India having very high youth unemployment.
But on a personal basis, I’m most proud of giving advice on a question asked by one of the richest people in Germany, who’s a household name and multi, multi billionaire on what can you tell me which country should I invest in? And I gave them two countries, which I believe worked very well for him. What didn’t work for me, also ,I must be honest and tell you is sometimes you get taken to a pension fund in deep trouble, they need emergency surgery and I’m a person who’s kind of like a good medical professor. So I’m not the guy who is going to open up your heart and do cardiovascular surgery.
So once I was put in a position where a pension fund was in big trouble, and I was doing big picture thinking. They didn’t need me. That was my first meeting what they should have at that time use is the best derivative salesperson to help them protect their portfolios. So sometimes, big picture people should not be brought when it’s a time of crisis. I’m useful when probably you have a bit more thinking space. But I’m always grateful that market speakers that we are imperfect and a more holistic view and looking at different times and looking at investments in contrarian ways, oftentimes help, because if everyone was to follow their own, you wouldn’t be making money.
Meb: Amlan, I’ve had a great time chatting with you today. We could easily go on for a few more hours. Where do people follow you if they want to keep up with your writings, your to-do’s, your speeches, all that good stuff? Is there a way to keep up with all your goings?
Amlan: I’m very controversial, so I’m scared of being misquoted, but I am on LinkedIn. Other than that, folks lines of State Street, they can always ask for a meeting through sales people like you do or else, try to follow. Google me. When I left accreditation after 19 years, I wasn’t allowed to take most of my papers, but I found them on sites of universities, central banks, etc. And I’m on LinkedIn, so you can always email me. At best I’ll tell you, I don’t have a good answer and Justin’s buddy or Justin has a much better answer.
Meb: We’ll add all these links to the show notes listeners so you can check out a bunch of Amlan’s papers and videos and books we mentioned and everything in between. Amlan, thanks so much for joining us today.
Amlan: No, thanks a lot.
Meb: Well, listeners, we’ll post all these links to medfaber.com/podcast. Send us any feedback you got at firstname.lastname@example.org. Subscribe the show on any of the platforms, RadioPublic, Breaker, iTunes. If you wanna start your own podcast, check out Podbean. Thanks for listening, friends, and good investing. These statements represent personal views of Amlan Roy as a global researcher and not those of State Street.