Avoiding the Japanese Financial Disease
The world has changed. Growth isn’t like what it used to be. And if growth isn’t readily available, that might be bad news for the investment world in general.
Japan may well represent the path of “change” we’re on globally. And that doesn’t look pretty.
Back in the 1970s and 1980s Japan was the home of innovative business models and progressive economic policies. These were seen as the cornerstone that propelled the country’s spectacular post-World War II growth story.
But now Japan only resonates long-term slump, economic mismanagement and huge government debt levels. After decades of unparalleled growth, Japan’s downturn took hold in the early 1990s when its asset price bubble burst and had a massive structural impact on the economy.
It wasn’t long before Japan became an economy where inflation, real interest rates and growth all sat close to or below the zero percent level. Efforts to resurrect the economy have so far failed.
Unfortunately, there are signs the negatives within the Japanese story may be spreading.
Where does that mean for the rest of us?
The worry is that the global economy has caught the “Japanese disease” – i.e. secular stagnation and efforts to stimulate growth failing to have an impact. The key to whether it takes hold is whether global governments and central banks have learned the lessons and take a more proactive approach
Relying on interest rate cuts alone wasn’t enough to inflate the Japanese economy. Instead, the slowdown triggered deflation, with households delaying or cancelling purchases, expecting prices to be lower in the future.
The global economy is slowly moving towards the Japanese way. Central banks have spent years slashing interest rates and injecting more cash into economies. The aim was to stimulate growth in the post-global financial crisis world. But the rebound hasn’t materialized and inflation remains too low and moving towards deflationary levels. The European Union is a particular worry, as consumer prices continue to fall.
The Organisation for Economic Co-operation and Development (OECD, which promotes economic growth, prosperity and sustainable development) recently warned that the world economy is slipping into a self-fulfilling “low-growth trap.” In such a scenario, slow growth would become a norm that would be hard to escape from.
How did we get here?
Demographics, the explosion of debt globally and the disparity in wealth between the rich and poor are all part of the story. Low interest rates are also a natural consequence of too much government borrowing after the financial crisis. Essentially, 2008-09 changed a lot of things that we haven’t been able to reset.
Nowhere to hide
One issue trouble now is that growth is slow everywhere and no one region is strong enough to bail the others out. For some context, before the global financial crisis, over the 1980 to 2008 period, world GDP growth averaged 3.5%, according to economist Stephen Roach. That compares with 2009’s mere 0.028% increase and its later weak rebound.
Global authorities have also been slow to act. For years Japan resisted the restructuring and structural changes that might have supported a rebound. Instead, the economy spiraled lower. Prime Minister Shinzo Abe’s recent three-pronged attack on reviving the economy looks set to only have a limited impact.
The problems are spreading
Symptoms of the Japanese disease are evident across the world. Bubbles in the real estate and credit markets inflated US consumer spending after years of cheap credit. When the markets burst, the heavily indebted, savings-short households were badly affected.
Between 2008 and 2015, growth in inflation-adjusted consumer expenditures averaged just 1.5%, according to Stephen Roach. This was less than half the 3.6% pace of the preceding 12 years. Like Japan, the US now finds itself struggling to move beyond a low interest rate position with little in the way of sustainable growth to show for it. When rates do rise soon, hold your breath…
Europe is mirroring Japan even more. The continent has limped from one crisis to the next. The policy response has been quantitative easing and, now, negative interest rates, which is a similar approach to Japan. But the efforts to stimulate growth in the region and generate inflation have failed so far. The European banking sector is starting to look a lot like Japan’s – struggling with poor quality balance sheets. Tough decisions need to take place in Europe, even if the general public is resistant.
Emerging markets aren’t much help at the moment either. The resource-rich economies of Russia, Brazil and the Middle East are feeling the impact of low commodity prices. China’s slowdown also isn’t helping.
This has huge implications for investors. The Japanese stock market is less than half the value of its 1989 market peak after its struggles. The fear is that if the disease does spread this could signal tough times ahead for global stock markets.
What can policymakers do to counter the threat?
How can these countries put themselves on a better footing?
For the US that may mean pushing the general public to reduce household debt and increase long-term savings. In Europe, banking industry reform and a coordinated government response look essential.
China needs to find ways to get its population to spend more as it reshapes itself into a consumer spending-led economy. The country also needs to address overcapacity in industries, such as the steel and cement sectors, which is driving deflationary pressure.
Japan needs to find ways to remain productive with a rapidly aging society and declining workforce.
Ultimately, a strong and coordinated policy approach to structural change could be the only answer. The OECD believes there has to be “collective action across economies to raise public investment in projects with a high growth impact would boost demand and improve fiscal sustainability.”
Left untreated, there’s a danger the Japanese disease becomes ingrained in our biggest economies and potentially infects everywhere. If that does happen, expect stock markets to struggle globally.
Shares like growth, not stagnation. In that environment, safe havens like gold will continue to be a popular home for cash.
Edited by Rick