“Japanification” has gone from disease to epidemic. Before the global financial crisis of 2008-09, Japan’s problems were widely considered to be the product of peculiarly Japanese tendencies. The idea that other countries might follow the same path of super-low interest rates and feeble economic growth seemed an idle fancy.
No longer. For the past few years the Eurozone has been slowly but surely succumbing. Now the outlook for the rest of the world is darkening as bond yields plummet everywhere, from Australia to Scandinavia.
But is Japanification a destination or a passing phase? To put it another way, does the phenomenon herald a multi-decade era of “secular stagnation” in which prices barely budge, or is it a temporary affair caused by misguided policy choices and market distortions?
For investors, the question is absolutely critical. If the former, the prospect is for a long bear market for equities which would ultimately drag down growth stocks, prime real estate and other currently “hot” assets. If the latter, the outlook would be disastrous for bondholders, but better for global growth, wages and salaries and investors in ordinary well-managed companies.
Bonds or Gold?
Understandably, the markets are conflicted; 40% of the world bond market is trading at negative yields and Germany has just launched a 30 year bond with a yield of precisely zero. At the same time, the gold price has risen by 25% in the past 12 months, taking it toward multi-century highs in real terms. Paying that much to protect your wealth (gold is a store of value, not a return-generating investment) only makes sense if inflation is on the way.
The best evidence for the secular stagnation thesis is Japan itself. Government bond yields first dipped below 2% in the late 1990s and have never subsequently recovered that level.
Why shouldn’t that happen elsewhere? After all, under mild deflation, time loses its meaning. Wages, consumer prices, asset prices and therefore interest rates can flat-line or gently decline for decade after decade, as was the case in 19th century Britain.
There is one good reason for questioning the “Japan as destination” thesis. The world abandoned the gold standard five decades ago; the only monetary standard existing now is political desirability. And Japan’s socio-political fundamentals are quite different from the experience of most Western countries.
To be sure, Japan’s “two lost decades” were a wrenching experience for a population accustomed to job security and rising living standards, but they produced little in the way of political fracture or “gilets jaunes” style social disorder. Indeed, the stoic and orderly public response to the triple disaster (earthquake, tsunami and nuclear meltdown) of March 2011 confirmed that, despite the long economic malaise, Japan’s social capital remains intact.
There were indeed stresses, but they were largely internalized, as the disturbing surge in suicides of the late 1990s – concentrated in laid-off middle-aged males – attests. Prime Minister Abe’s reflationary economic programme, implemented from 2013 onwards, has generated record-high levels of employment. Happily, the number of suicides has declined by a third, reversing the entire increase.
Source: OECD
Abe himself is an establishment figure from a powerful political dynasty. The changes he made to Japan’s macro-economic settings and international profile may have represented a break with the recent past, but were well supported by his Liberal Democratic Party which has dominated post-war Japanese politics. His instincts are pragmatic, not radically populist – as shown by the return to fiscal tightening once economic conditions had improved.
Politically, most Western countries are not in the same postcode. Well before “Japanification” sets in properly, societies are already polarizing and political systems buckling. The likelihood is that politicians, whether populists or mainstreamers, will ultimately go with the flow and ramp up economic stimulus by all means possible – though it may take a crisis, perhaps this time more political than financial, to supply the final push.
Gilets Jaunes registering their point of view
Enter Boris
For that reason, the best glimpse into the future from here may come not from Japan, but from the U.K. The British political system is unusual in the absolute power it gives an election-winning executive. The lack of a written constitution and other institutional checks and balances means that change, when it comes, can be rapid and radical.
That is exactly what happened with the electoral triumph of Margaret Thatcher in 1979, which foreshadowed the dominance of free-market conservatism (sometimes called “neo-liberalism”) in the U.S. and elsewhere for decades to come.
Until recently, it appeared that the most likely scenario for another radical reset in the U.K. would be an election victory by veteran left-winger Jeremy Corbyn, leader of the opposition Labour Party. However, the political dynamics unleashed by Brexit are pushing the ruling Conservative Party, under recently appointed Prime Minister Boris Johnson, toward tax cuts and increased spending on policing, the National Health Service, full-fibre broadband and other projects. Whatever the outcome of the Brexit drama, austerity is off the menu for good.
Partly over Brexit concerns, the Bank of England has squeezed interest rates down far below their natural level. The 10-year bond yield is a mere 0.5%, but expected inflation for the period (as measured by the yield gap between conventional and inflation-adjusted bonds) stands at 3.4% and regular pay is currently rising at almost 4%.
That mismatch is extreme, even by the standards of post-2008 monetary policy. Combine that with loose fiscal policy and a currency trading near 50-year lows in real terms and you have the most powerful reflationary policy mix in the developed world.
Forty years ago, the U.K. was the pioneer of a new economic doctrine that prioritized the conquest of inflation and led to disinflation and, ultimately, the spectre of deflationary stagnation. Now it could be the harbinger of a move in the opposite direction.
As before, it may take years for the full effect to show, but if larger economies adopt a similar approach, that would kick-start a global inflationary super-cycle. Then Japanification would be a thing of the past, even in Japan.