C is for Complexity
on May 24, 2012

JUUGS May12.pngThe blog’s series on the VUCA world today reaches C for Complexity.

Interest rates are key to company profitability. They determine rates of return for new investments, and their affordability. They also have a major influence on consumer spending patterns.

The debate over their future direction is just one example of current Complexity:

• Financial investors mostly argue that rates will go higher, perhaps much higher, in the major economies
• The world’s largest bond fund, PIMCO, even argued in January 2010 that UK bonds were sitting on a ‘bed of nitro-glycerine’

The blog has never agreed with this view.

It argues that the ageing Western population means investors now focus on return of capital. They also need to save more and spend less, as they are uncomfortably aware that their pensions are too small to fund their extra decade of life expectancy compared to previous generations.

It also coined the term JUUGS to describe the countries whose bonds would be perceived to provide the greatest safety – Japan, UK, USA, Germany and Switzerland. It has since followed their progress by comparison with the PIIGS (Portugal, Ireland, Italy, Greece, Spain).

The chart above shows 10-year interest rates today (blue column) in the PIIGS and JUUGS versus May 2010 (red):

• Average rates in the PIIGS were 5.8%, double the 2.7% in the JUUGS
• Today, they average 12% in the PIIGS, and just 1% in the JUUGS
• Rates have risen in all the PIIGS, whilst falling in all the JUUGS

The blog originally set out its argument in the Financial Times in September 2010. It was then developed further as chapter 2 of Boom, Gloom and the New Normal last June.

It argues that Japan is the role model for what is happening today. The JUUGS’ interest rates are only following the path taken there in recent decades. The reason for the correlation is that Japan’s own babyboomer generation are ~10 years older than in Western countries.

Of course, it could be that the blog has simply been lucky so far with the results of its argument. And it agrees rates could certainly jump if demand ever returned to Supercycle levels, as expected by the market consensus.

Thus the debate over interest rates highlights the Complexity of the financial world. Those whose judgement turns out to be wrong may well lose a large amount of money as a result.

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