We all know that ageing is a matter of great concern for the advanced economies. As the proportion of people who are of working age shrinks, growth slows while more provision will have to be made for health services, pensions, etc. But while all this is well known, what impact will ageing have on asset prices? That’s the question that Elod Takáts of the Bank for International Settlements attempts to answer.
The link between ageing and asset prices seems simple enough. The author notes that in the US, asset prices have been boosted by the baby boomer generation. As the proportion of working people increases, savings increase and these are used to purchase assets. The price of assets, therefore, increases. Writes Takáts, “The theory then would imply that asset prices propelled by the boomers’ savings will be under pressure when this large generation retires and starts to sell its assets to the relatively smaller subsequent generation.”
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The author doesn’t limit his analysis to the US alone, but uses house prices from 22 advanced economies to determine the impact of ageing on them. His results show that ageing will, as expected, lower real estate prices over the next 40 years in all these countries, when compared to a hypothetical case where ageing doesn’t occur. Note that house prices may not really decline, since they are affected by many other factors. What the author is saying is that ageing results in headwinds to house prices. How much of a headwind?
The estimated ageing impact is relatively mild in the US with around 80 basis points per annum headwinds. But the drag is estimated to be much larger in most of continental Europe and in Japan. He then extends his conclusions to all financial assets, arguing that they too will face headwinds as a consequence of ageing.
The author points out the implications of his conclusions for the sustainability of government debt. Says Takáts, “Lower asset prices imply that long-run interest rates will face upward pressure in the future. These higher long-term interest rates would make debt sustainability even more challenging.” In the current environment of exploding fiscal deficits in the developed countries, the implications can be serious.
The author says, however, that unlike housing, financial assets are more global in nature as a result of the free movement of capital to buy and sell them.
The price of financial assets, claims Takáts, will, therefore, be affected not by ageing in a particular country, but by global ageing. He says that while the impact of ageing on financial assets is similar to housing, but (i) it might arise earlier, (ii) it could be somewhat weaker, and (iii) it is affected by global ageing patterns. Takáts says, “financial assets prices would face around a full percentage point per annum demographic headwinds over the next forty years.”
But if ageing affects the prices of financial assets, should not the prices of these assets rise in countries such as India, which are about to reap the benefit of the demographic dividend? The paper also notes: “If ageing affects asset prices, investors living in ageing (ie low return) economies should move their assets to more youthful (ie high return) economies until expected returns equalize.
Indeed, Higgins (1998) and later studies show that this is exactly what is happening: capital flows from ageing economies to relatively younger ones.”
Also, if, as the paper notes, the impact of the baby boomer generation of the demographic dividend in the US has been that “asset prices have increased massively... Ex-ante real interest rates have fallen, equity P/E ratios increased substantially and....real house prices climbed”, shouldn’t the same things happen in India now?
Illustration by Jayachandran/Mint
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