【号外】破译低通胀的密码：主要矛盾、社会进步和市场脆弱性（原版）
总结- 想象一下，如果一个经济底层90%的人群将国民收入与顶层10%的人群平均分配。对于这底层90%的人群来说，收入的增长持续地落后于他们劳动生产率的增长。这样的经济体的供给一定是经常过剩的。这是因为缓慢的收入增长将无法刺激需求，同时快速提高的劳动生产率则不断地增加供给，造成过剩。最终，市场价格将会下跌。因此，严重并日益恶化的收入不均是全球经济在复苏了近10年之后仍然受到通缩威胁的最主要原因。
自2014年以来，工资增长的速度已经开始超过劳动生产率增长，而通胀压力也在静静地爬升。然而，收入不均的恶化抑制了通胀上升的速度，让央行官员们有更多的余地去做量化宽松试验。这样温和的通货膨胀以及宽松的货币政策使得财富集中的程度比收入更甚，进而使得资本市场更容易出现泡沫，而经济对利率的微小变动也更脆弱。
美国的收入不均已经接近两次世界大战和大萧条之前的水平。如以史为鉴，社会巨变似乎将山雨欲来。但历史上，在这些灾难性的事件发生之前，收入不均的现象都持续了很长一段时间，并保持相对稳定。如果没有主动的社会体系改革，收入不均将在未来一段时间里维持现状。
有人已经对这些极端社会现象的脆弱性开始警觉。现阶段中国社会的主要矛盾被重新定义为“人民日益增长的美好生活需要和不平衡、不充分的发展之间的矛盾”。重要会议呼吁实现更公平的收入分配和更具包容性的增长。人们不应怀疑政府实现这些社会目标的决心。过去几年的成果就是最有力的证明。
李约瑟曾感叹中国这个在古代为世界发展贡献了四大发明的古老文明，后来竟如仲永，到了18 和19 世纪更沦为了爱默生口中的“庸碌之国”。然而当下，中国的蜕变就在我们眼前发生。这是一个充满活力、神秘、自由和伟大的国度。翻天覆地的变化和创业精神的时代终将来临。因此，中国的消费应该继续成长，技术和金融创新和信贷文化将繁荣发展，通胀最终将卷土重来。随着债券长期泡沫的破裂，股票将继续跑赢。
https://v.qq.com/txp/iframe/player.html?vid=c1328txm24q&width=500&height=375&auto=0
10月31日，债灾前夕在CNBC和Bernie Lo、Emily Tan讨论2018年的A股、港股的展望，债券继续向股票轮动的采访视频节选。
这是今天的报告《破译低通胀的密码：主要矛盾、社会进步和市场脆弱性》的英文原版《Decoding disinflation: principal contradiction, social progress and market fragility 》，感谢阅读。
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Summary- Imagine an economy where the bottom 90% splits the national income evenly with the top 10%, and income gain perennially lags productivity gain for the bottom 90%. Such an economy must be in constant surplus, as slow income gain would fail to spur sufficient demand for supply driven by rapid productivity improvement. Consequently, prices will be depressed. As such, severe and worsening inequality is the reason why the global economy is still beset by the constant threat of deflation almost 10 years into recovery.
While wage gain has started to outpace productivity gain since 2014, and inflation has crept up since, aggravated inequality has worked to slow the momentum of inflation, giving central bankers leeway to experiment with quantitative easing. Such disinflation and lax monetary policy have made wealth even more concentrated than income, and 36 41019 36 14918 0 0 2131 0 0:00:19 0:00:06 0:00:13 3130 36 41019 36 14918 0 0 1894 0 0:00:21 0:00:07 0:00:14 3091 in turn made market more prone to bubble and economies more vulnerable to small changes in interest rates.
Inequality in the US is now similar to the level seen just before the two wars and the Great Depression. It would appear that dramatic social disruption is looming on the horizon, if history is a guide. But inequality had remained high and steady for a long period before these catastrophic happenings. Without a proactive initiation of social system reform, inequality can stay in this status quo for some time still.
Some are taking heed of these social extremes that breed fragility. President Xi redefines Chinese society’s principal contradiction as “unbalanced and inadequate development and the people's ever-growing needs for a better life”. He is calling for fairer income distribution and more inclusive growth. One should not doubt the government’s resolve to achieve these social aims. The feats in the past few years are the strongest evidence.
Joseph Needham once observed that China, a country that had invented so much in antiquity, by the 18th and 19th century had turned into a “booby nation” as Emerson labeled it. But now China is changing right before our eyes. It is energetic, enigmatic, rich, freewheeling and awesome. The era of intense movements and entrepreneurial creativity has dawned. As such, Chinese consumption should continue with its ascendance, technology and financial innovation and credit culture will thrive, and inflation will eventually come back. And as the secular bond bubble unravels, stocks will continue to outperform.
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“All animals are equal, but some animals are more equal than others.” – Animal Farm, George Orwell
China’s New Principal Contradiction
Unbalanced and inadequate development. In his inspiring speech delivered at China’s 19th CPC National Congress, President Xi redefined China’s principal contradiction for the new era: “the contradiction between unbalanced and inadequate development and the people's ever-growing needs for a better life”. Despite significant progress of China’s overall production capacity, China’s development is “unbalanced and inadequate”. And this uneven development has become “the main constraining factor in meeting the people’s increasing needs for a better life”.
Fairer and orderly income redistribution. Further, President Xi envisioned the realization of socialist modernization by 2035. During the development process, middle-income group will grow considerably, disparities between urban and rural development, in development between regions and in living standards are significantly reduced. He called on the Party to continue to follow the principle of “distribution according to one’s work while improving our institutions and mechanisms for distribution based on factors of production, so as to make income distribution fairer and more orderly …. (So that) incomes grow in step with economic development, and pay rises in tandem with increases in labor productivity”. (Quoted from “Xi Jinping’s report at 19th CPC National Congress”, translated by China Daily)
In essence, President Xi sees that income distribution in China has become uneven, and he has set out to correct it. Judging from his achievements in the past few years, especially the resolve to fight corruption, we believe that the new mantra will succeed, and will usher in significant social changes that have implications for consumption, inflation, fiscal and monetary policy and asset prices.
China’s income inequality has worsened. Our analysis of the NBS household survey data confirms President Xi’s observation. In Exhibit 1, we show the distribution of Chinese urban income. The distribution of income resembles a bell curve, with an increasingly fat tail on the right end. While the rapid shift of the bell curves towards the right suggests strong income growth, and the expanding area under the bell curve suggests growing income earned by a larger population, the widening span of the bell curve alludes to worsening income disparity over time.
Exhibit 1: Both average income and income inequality are growing rapidly in China
Source: NBS, BOCOM Int’l
Note: Income distribution curve based on actual NBS household survey data for urban residents before 2012. Distribution is estimated from 2013 to 2015. For rural residents, the distribution is very similar.
Income inequality driven in part by demographics. Nobel Laureate Simon Kuznets posited that, as an economy grows, market forces first increase and then decrease economic inequality. This is because workers tend to be most productive when they are in their middle age, and less so when they are younger and still learning, or older when ready to retire. As such, the Kuznets curve, which depicts how the productivity-induced income inequality evolves across time, resembles an inverted U-shaped curve.
Exhibit 2: The life cycle of income inequality
Source: Bloomberg, Federal Reserve, BLS, BEA, BOCOM Int’l
Note: Strictly speaking, the X axis of the original Kuznets curve should be income. We substitute income with age in our chart.
In Exhibit 2, we plot the Gini coefficient against its corresponding country’s average population age. The chart shows older countries have lower Gini, or lower inequality, while middle-aged countries tend to have higher Gini. The shape of the line of best fit resembles what Kuznets foresaw, albeit somehow flatter than expected.
The “natural” degree of inequality. Given that population age affects productivity and hence income distribution, a certain level of inequality must always be innate in an economy. Or simply put, there must be an inherent “natural degree of inequality”. What needs to be explained is the level of inequality beyond this natural degree. That is, there are other factors beyond simple demographic that are driving the inequality President Xi vowed to change. Given the similarities in social systems between the US and China, we believe an investigation into the inequality and its cause in the US will shed light on the principal contradictions that China is facing.
Inflation Starting to Rise - Finally
The 10-year yield is a history of surplus value exploitation. In our special report titled “A Price Revolution: On Global Asset Allocation” on November 14, 2016, we postulated that inadequate labor compensation relative to productivity gain, or the exploitation of labor’s surplus value, has been depressing inflation and hence bond yield for over three decades (Exhibit 3). It has been the driver for the secular bond bull market.
Exhibit 3: The 10-year yield is a history of surplus value exploitation; productivity gain inadequately compensated
Source: Bloomberg, Federal Reserve, BLS, BEA, BOCOM Int’l
The fact that bonds have substantially outperformed equities for the same period also suggests that capitalists at the top of the value chain have taken it all, exploiting both business owners who borrow start-up capital, and business employees. The falling inflation and bond yield for over 30 years say much about the relationship of production, and how gains have been unevenly accrued to different socioeconomics groups.
Exhibit 4: Inflation has indeed risen since late 2014
Source: Bloomberg, BOCOM Int’l
Once labor compensation started to rise faster than productivity gain, as it has been since late 2014, inflation should follow. As such, we concluded that bond yield should rise, the secular bond bull market should end, and stocks should outperform bonds. Those were our conjectures from one year ago.
Inflation has risen globally since 2014. Since our last year’s special report, stocks have so far massively outperformed bonds. The 10-year yield has seen its low in 2016, and had an epic surge in the weeks following Trump’s win. Contrary to consensual perception, inflation across the globe has been rising (Exhibit 4). The start of this inflation upswing was in around late 2014, coinciding with the inception when wage gain started to outpace productivity gain. The dramatic recovery of commodities has sent PPI surging, and the inflation pressure from upstream will likely be passed onto downstream in the near future. But for now, the absolute level of inflation is still low.
The Secret of Disinflation
Inequality suppresses inflation. The secret of disinflation lies in how labor income gain is allocated towards different socio-economic groups within the working population, and its effect on final demand – not just the relationship between productivity and wage gain. We compare top 10% earners’ national income share in the US with the historical trend of US long-term interest rate in Exhibit 5.
The history of inequality in the US. The timing of when income concentration in the US rose and fell is interesting. During the two wars and the Great Depression, capital income had been severely destroyed for the elites, and probably never been able to fully recover because of progressive estate taxation. Further, the fall in income concentration can be explained by wage controls of the war economy. The National War Labor Board, established in January 1942 and dissolved in 1945, was responsible for approving all wage changes. Exceptions to wage controls were more frequently granted to low-wage earners, while executive salaries were frozen in nominal terms from 1941 to 1945.
Exhibit 5: Income gain accrued more towards top earners, further depressing wage gain relative to productivity
Source: Bloomberg, Federal Reserve, Thomas Piketty, Gabriel Zucman, NBER, BOCOM Int’l
Note: Long-term yield for recent years estimated from annual average of US long-term treasury yield.
This phenomenon is shown in the precipitous fall in the income concentration (reverse scale in Exhibit 5) from the late 1930s to 1940s. After that, income concentration continued to grind lower from the mid-1940s till early 1970s.
Then, income concentration started to increase again since the early 1980’s, while inflation and long-term interest rate had been falling. This secular change coincided with a series of tax reform initiated by the Reagan government to cut taxes across the board, simplify tax codes, broaden the tax base, and eliminate tax shelters.
The effect of US Tax Reform. In 2012, the Library of Congress issued a report analyzing the effects of tax rates from 1945 to 2010. The report concluded that the reduction of top tax rate did increase income inequality. That is, tax cuts for the top appear to be associated with the increasing income concentration. In the Economic Recovery Tax Act of 1981 (ERTA), transfer payments were made to people in the lower tax brackets. Unfortunately, this Act put the US government in deficit, while failing to increase income and thus consumption at the bottom.
By the summer of 1982, the double dip recession, return of high interest rates, and ballooning deficit convinced the Congress that the ERTA had failed. Afterwards, most of the personal tax cuts were backed out in September 1982. When Reagan left the office, the national debt had tripled. The ERTA is an example of how a tax reform without deficit neutrality, as the one that Trump’s administration is undertaking, will not succeed.
Labor income is the main income source for both the top and the bottom. Income concentration is even more pronounced as you move up the income concentration percentile (Exhibit 6). Alarmingly, income inequality is now at a similar level to the period preceding the Great Crash of 1929, as well as just before WWII.
Exhibit 6: Top 1% income share vs. bottom 50% has been widening globally.
A glimpse at the top and bottom income earners’ pre-tax income composition reveals that it is the surge of labor income amongst the top earners that has aggravated social inequality since the 1970s. The percentage of top earners’ income coming from labor income has surged since the 1970s. If the bottom earners’ income had not been increasingly tax-exempt, inequality would have been much worse. Further, the percentage of bottom earners’ income coming from capital has been rising. And so has that of top earners since the 2000s (Exhibit 7).
Exhibit 7: Labor income rises much faster for top earners than for bottom ones.
Source: Bloomberg, Thomas Piketty, Gabriel Zucman, NBER, BOCOM Int’l
The secret of disinflation. Note that inflation is being depressed because wage gain is slower relative to productivity gain for the bottom masses. Such an economy must be a surplus economy where supply (productivity driven) is far greater than demand (wage driven). And oversupply exerts downward pressure on prices.
Some may point out that top earners are indeed more senior than bottom earners, and thus the more productive are likely to earn more. But even if allowing for the Kuznets effect aforementioned, for a country at the age group of the US, age difference alone between top and bottom income earners cannot fully account for the significant difference in income inequality.
After all, between 1980 and 2014, annual real growth in top 1%’s income was four times as much as that of bottom 90%. And for the top 10%, it was three times as fast as the bottom 90%. Productivity difference as a result of age, education and technology innovation cannot fully explain such a dramatic difference in growth rates. As such, if the top 10% is substantially overcompensated relative to this group’s productivity gain, then the bottom 90%, the majority of the society who takes slightly more than 50% of national income, must be substantially undercompensated (Exhibit 8).
If so, the significant lag in labor income gain behind productivity gain in the bottom 90% must have been a significant drag on final consumption. As far as we know, the CPI basket tracks an average person’s consumption habits, rather than the top echelon. As inequality worsens, this drag will be even more significant, depressing final demand and hence inflation even further. And this, we believe, is the secret of disinflation (Exhibit 9).
Exhibit 8: Top earners’ annual income grew four times as fast as that of bottom earners’ between 2009 and 2014
Inequality is a global phenomenon, and it is worsening (Exhibit 6). Such dramatic disparity has occurred before, in 16th century Spain, 17th century Holland, the Gilded Age and the Roaring 20s in the US. These eras were all weaved with disruptive productivity gains from technology breakthrough, creative financial innovation, cooperative governments, and an influx of immigrants and conquests of rich lands overseas. The trend was best exploited by the rich and the educated of the time. What we are witnessing is really the rhymes of history.
Explaining the exception to our thesis – continental Europe and Japan. But here is the rub: our thesis is that the inequality between different income groups, or wage gain well below productivity gain for the bottom masses, is the cause of disinflation for the past three decades (Exhibit 3). If so, why the more developed, more egalitarian European countries and Japan are perceived to be facing more severe deflationary threats?
Exhibit 9: Inequality and inflation strongly and inversely correlated
In Exhibit 4, we have shown that inflation globally has been on an upswing since late 2014, coinciding with the inception when wage gain started to exceed productivity gain. That is, inflation has been rising, even in the egalitarian Europe and Japan. However, the extent to which these egalitarian countries’ inflation has risen may be less than that of the US, a poster child of social inequality. Therefore, these countries may appear not entirely consistent with our thesis.
While we believe social inequality is the dominant cause of disinflation (but has begun to mean revert Exhibit 9), idiosyncratic factors in various countries must have affected inflation. For instance, we note that these countries are in general older (Exhibit 2), have different social norms towards inequality, and have more progressive tax regimes that re-distribute gains between different socioeconomic groups.
Between the US and France, the composition of top income is very different. The French top income still primarily consists of dividend income, although wealth concentration has lessened significantly since WWII, as capital has been severely destroyed by the wars and has never been able to recover. In the US, the coupon-clipping rentiers have been overtaken by the ascendance of the working rich whose wage gain significantly outpaced productivity gain.
Exhibit 10: French labor earnings gain relative to productivity gain, and compared with CPI
Source: Bloomberg, BOCOM Int’l
Further, the egalitarian countries are experiencing slow productivity gain due to advanced age (Exhibit 2); wage may be increasing at an even slower pace due to rigid employment regulations (Exhibit 10). Even so, inflation in France has begun to tick up.
Implications and Outlook
Some inequality is inherent and is good for growth. Given that a natural degree of income inequality exists in an economy due to demographics, inequality cannot be completely eradicated even if China “improves institutions and mechanisms for distribution based on factors of production”. That said, if disparity in income is due to difference in productivity, then such disparity will indeed spur productivity growth.
Financial innovation, market deepening and the boom in consumer finance in China. Further, given the diverse consumption propensity inherent in various income groups with different levels of productivity, younger generations will find it difficult to consume before its productivity matures. Also, without a well-functioning financial market, the group with peak productivity would find it difficult to save and invest for its future retirement.
With rising income inequality, financial reform and financial innovation will thrive. And with policy guidance, it will likely to accelerate in the coming years. Already, we have seen a flourishing consumer credit market and relaxation of foreign ownership of China’s financial sector, as well as financial innovations such as market index options and futures.
China’s consumption is under-represented globally compared with the size of its population; consumption will continue to grow with income. Globally, Chinese consumption of various discretionary consumer goods such as healthcare, education and media, home care, etc is still significantly lower than the international average relative to Chinese population as a percentage of the world population (Exhibit 11).
Exhibit 11: China’s demand for consumption goods is depressed relative to demand for capital goods
Source: USGS, WSA, Brook Hunt, BP, Euromonitor, WHO, PWC, BOCOM Int’l
Note: Cement, steel, coal, aluminum, copper, electricity, oil and auto are calculated in volume, all the other categories are calculated in value.
In the past, Chinese consumption has been heavy on capital goods such as cement, steel, coal and copper, etc. for development purpose. In recent years, we have seen a dramatic surge in Chinese consumption in auto, consumer electronics, appliances and education. The Singles Day sale single-handedly created by Alibaba is now the biggest global shopping event. Not surprisingly, these sectors have been the best-performing sectors this year. Discretionary consumption tends to accelerate with income growth (Exhibit 12), and the golden era of consumption has dawned on China.
Exhibit 12: Convex consumption curve indicates strong income sensitivity of the discretionary consumption items
Source: USGS, WSA, Brook Hunt, BP, Euromonitor, WHO, PWC, BOCOM Int’l
Note : Each dot denotes one country. Per-cap GDP on x-axis, and consumption for each commodity on y-axis. The convex curves are fitted from the dots.
Exhibit 13: Concave consumption curves for staples indicate weaker income sensitivity
Source: USGS, WSA, Brook Hunt, BP, Euromonitor, WHO, PWC, BOCOM Int’l
Note : Each dot denotes one country. Per-cap GDP on x-axis, and consumption for each commodity on y-axis. The concave curves are fitted from the dots.
Inflation likely to creep up. With wage gain starting to outpace productivity gain, inflation pressure will start to rise, as it has been since late 2014. But as discussed in depth before, productivity gain is being accrued to top income earners, while the bottom masses’ labor income growth lags significantly. This income concentration will mean that demand is suppressed for the bottom masses constituting 90% of the population but only earning 50% of total income. As such, the structure of a surplus economy remains intact where oversupply exerts downward pressure on prices.
We note that the severity of income inequality in the US is similar to that just before the Great Depression, and just before the WWII. It is alarming, as history would suggest looming disruptive social changes on the horizon. But we also note that pre-WWII, income inequality remained high and steady for well over a decade – until the wars severely destroyed capital base.
That is, secular changes take time. At first, such changes are almost imperceptible, before they can gather enough momentum to accelerate. It takes well over 10 years for Piketty’s seminal paper “Income Inequality in the United States, 1913-1998” to culminate in his magnum opus “Capital in the 21th Century”. Such persistent income inequality will help ease rising inflation pressure.
Interest rates will rise; social system more fragile. Should income inequality persist, its effect on uneven productivity accrual and hence inflation would mean that central banks can afford to raise interest rates at a measured pace. Consistent low rates will encourage further aggressive risk taking, and will lead to further wealth concentration that is already substantially more severe than income inequality. However, such social system with extremes is brittle, and is sensitive to small changes in fiscal and monetary policies. Eventually, it will lead to a sudden collapse of the financial market. Investors should heed warning.
Rotation from bonds to equities should continue, stocks continue to outperform. Our bond yield vs. earnings yield model (EYBY model hereafter), which has helped us pinpoint the bottom of China’s stock market after mid-2014, as well as the peak of the bubble in June 2015. The model has also helped us negotiate the rough waters after the bubble burst.
In December 2014 when we were preparing the 2015 outlook, the model forecasted the looming market bubble, but the year of 2015 should finish at not much higher than 3,400. The Shanghai Composite finished at ~3,300 one trading day after the last trading day in 2015. In December 2015 when we were preparing the 2016 outlook, the model forecasted the trading range for 2016 should be 2,500-3,300, versus the actual range of 2,638-3,301; in December 2016 when preparing for the 2017 outlook, the model forecasted in 2017 the Shanghai Composite should spend at least eight months below 3,300. And the index didn’t break 3,400 until Oct 9, the first trading day in October after the Golden Week.
Our EYBY model continues to show relative value of equities relative to bonds since June 2016 (Exhibit 14). As equities’ relative value continues to improve, the trend of rotation from bonds to stocks should persist – till this trend exhausts after it has reached the extreme defined by the lower bound in Exhibit 14.
The pace of how fast equity valuation can expand relative to the rise in bonds’ yield determines how far the stock indices can rise, as funds rotate from bonds to equities. As liquidity conditions should tighten on the margin, and bond yield should continue to rise, it is likely that the market will be increasingly unwilling to ascribe a higher valuation multiple for each unit of earnings. But as inflation continues to tick up, nominal earnings growth should continue into the late economic cycle, and should more than compensate the pressure on valuation from rising bond yields.
Exhibit 14: Rotation will continue from bonds to stocks, until the trend exhausts.
Source: Bloomberg, BOCOM Int’l
Hao Hong, CFA
2017-11-13