The untimely departure of Japanese Prime Minister Shinzo Abe leaves the world's third largest economy at a crossroads.
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Hey everyone, welcome back. This week we will transition over to developed markets in discussing the monetary situation in Japan.
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Last Week Briefing:
Paging Paul Volcker… The Turkish Central Bank, in a shocking move, hiked their policy rate from 8.75% to 10.75%. This massive hike aims to quell the selloff in the Turkish Lira this year. — Wall Street Journal
A leaked document revealed that China Evergrande Group, the largest real estate developer in China, sought government relief amidst looming cash concerns. Shares in the company fell 15% during trading hours on Friday. — Reuters
Peter Thiel, founder of Paypal, and Richard Li, chief executive of Pacific Century Group, are partnering up to form an SPAC. The two billionaires share a goal of acquiring a technology company in Southeast Asia. — Bloomberg
Zambia is requesting a 6-month moratorium on $120 million in interest payments, effectively defaulting on their debt. The IMF warns that nearly one third of African nations are debt-distressed, or are slowly approaching that status. — Bloomberg: Next Africa
The Great Stagnation
Ever felt like you’ve done so much, only to make little progress? Alas, you’re not alone. Japan’s economy has been virtually “stuck” since the 1990’s.
Indeed, Japan’s absent growth in gross domestic product (-6.2% since 1995) and their stock market (-40% since 1989) have remained a blemish on the world’s third largest economy. In the financial world, the story of Japanese torpor has served as an objection to the old Portnoy adage that “Stocks go up”. This economic phenomenon would become known as Japan’s Great Stagnation, or the Lost Decade. In this letter, I’ll run with the former, as their economic struggles have clearly outgrown the label of the latter.
How did we get here?
Following their defeat in World War II, Japan was forced to shake off their imperial nature as a concession to the Allied powers. The Empire of Japan, prior to the war, allocated nearly a third of government spending towards their military and defense. Their new constitution, which specifically restricted Japan from waging war, allowed Japan to reallocate government expenditures towards services like education and technology. As a result, Japan quickly achieved one of the world’s highest literacy rates while simultaneously capturing a competitive edge in high-growth industries like manufacturing and electronics. Even during the Cold War, in which seemingly every major economy picked a side between the United States or Soviet Union, Japan prioritized economic growth and maintained harmonious trade relationships with both parties. This post-war success would become known as Japan’s Economic Miracle. The country’s gross domestic product grew an average of 10.5% through the 1960’s then maintained a healthy 4.3% average annual growth rate from 1970 to 1989. The Yen saw gains from Japan’s burgeoning trade surplus as the country emerged as the economic and cultural center of the world. Japanese products like the Sony Walkman and Nintendo’s NES were enormous successes in foreign markets. Everyone wanted a piece of the new, modernized Japanese marketplace.
Adding to the Yen’s growth were the Plaza Accords. France, the U.S., and the U.K. agreed to intervene in global currency markets with the goal of cheapening developed market currencies. After all, a cheaper U.S. dollar should theoretically create a level playing field for export competition. The Yen would appreciate 50% against the dollar between 1985 to 1989.
Unfortunately, a stronger Yen meant that Japanese goods grew more expensive on an exchange basis. Consequentially, foreign buyers did not hold the same appetite for Japanese imports as they once did. In an effort to weaken the Yen and revitalize exports, the Bank of Japan cut their policy rate to 2.5% from 5.5%. and loosened credit constraints on financial institutions. Rather than a healthy resurgence to export growth, what followed was a spurt of exuberant borrowing and a rise in shadow banking activity (banking services from non-bank entities) from institutions like Mitsubishi, the car manufacturing conglomerate. These borrowers manically dumped their money into Japan’s real estate and stock markets as people were desperate to partake in the nation’s hyperbolic growth.
In other words: FOMO.
Mitsubishi Bank would merge with Bank of Tokyo in 1996, forming MUFG
To the Japanese, it was all one big party. There was no limit to how manic their economy could get. It was said that if you dropped a ¥10,000 (~$100 today) note on the ground in Tokyo, it’d be worth less than the space it occupied. Japanese real estate moguls, enriched by the newfound strength of the Yen, scooped up popular American properties such as Pebble Beach and Rockefeller Center. The Imperial Palace in Tokyo (which wasn’t for sale, mind you) was appraised at a higher value than the entire state of California. Japanese stocks casually traded fifty to seventy times earnings as the Nikkei 225 returned a little less than 50% annually. By the end of the 1980’s, the Nikkei had grown almost 500%.
Like all speculative episodes, this too, would come to a messy ending. In 1989, the Bank of Japan hiked interest rates back to 5.5% to try and stymy some of the reckless borrowing gripping the market. Additionally, clunky restrictions were placed on real estate transactions which helped curb speculation in Japanese housing. These measures were effective, but maybe a little too effective…
The end of Japan’s borrowing spree ushered in a period of deflation. Growth in the Japanese consumer price index (CPI) — traditionally used as a barometer for inflation — fell to 0% from 2%. Consumer and corporate spending plateaued. Japanese banks were forced to write off over ¥50 trillion (~$475 billion) in non-performing loans between 1995 and 1998. The Nikkei shed over $2 trillion in market capitalization in 1990 alone. To this day, the Nikkei 225 has yet to return to the levels seen since 1989.
In 1999, the Bank of Japan would introduce Zero Interest Rate Policy, or ZIRP, as an attempt to try and restart Japan’s sluggish market. You see, this was the first “Lost Decade” of Japan’s Great Stagnation. The Yen appreciated (deflated) 25% against the dollar, asset prices continued to capitulate, and the country fell into a liquidity trap— where expansionist monetary initiatives had no material influence on the Japanese economy. Japanese savers eschewed interest-bearing products like bonds to hold Yen. Could you blame them? Japanese treasury bills yielded less than 0.10% by the end of 1999.
This prolonged stagnation would ultimately provoke an aggressive Keynesian experiment known today as “Quantitative Easing” or “QE”. The Bank of Japan, looking to induce inflation and backstop falling asset prices, would print an exorbitant amount of money to purchase government treasuries and commercial paper. The crazy thing is, this worked! Only until it didn’t. The resurgence of inflation and real GDP growth in the mid-2000’s was swiftly derailed by the 2008 Global Financial Crisis. Although Japan was certainly not alone in this crisis, Japanese economists feared that they had run out of firepower. Interest rates couldn’t possibly go any lower, right?
Merry Christmas: Japanese people are known for indulging in what popular American cuisine on Christmas Eve?
Assets held by Central banks, since 2001
Following the Global Financial Crisis, every developed country and their mother was carrying out quantitative easing — except Japan. You see, Japan feared they had exhausted their resources. They were already at 0% rates. Negative interest rates would’ve only exacerbated the ongoing liquidity trap. Similarly, expansionary policy would surely be a futile endeavor, just as it’s been since the 1990’s. It wouldn’t be until the election of Shinzo Abe in 2012 when the Bank of Japan would initiate QQE, or Quantitative and Qualitative Easing. QQE was carried out in line with Abe’s “Abenomics” agenda. Abe, a traditional conservative nationalist, believed that the expansionist monetary policies actually worked, they just weren’t enough. By dialing up the magnitude of QE, Japan would experience the same growth briefly seen in the mid-2000’s. QQE enabled the Bank of Japan to purchase anything from government treasuries, to corporate bonds, equities, and even real estate investment trusts (REITs)— an unprecedented privilege for a central bank. This new plan sought to add ¥60-70 trillion per year to the central bank’s balance sheet in order to achieve average inflation of 2%. That figure was almost immediately bumped up to ¥80 trillion annually, as the Japanese economy significantly undershot their 2013 policy targets. In 2018, the Bank of Japan’s asset holdings surpassed the total gross domestic product for Japan.
In 2016, the Bank of Japan would finally slash rates below 0%, two years after the Danes, Swedes, and Swiss issued negatively yielding treasuries, to help stimulate inflation in the Japanese economy. Once again, QQE had instigated a brief resurgence in inflation, real GDP growth, and rising prices for consumer goods only to fizzle out a few years later. The continued failure of monetary stimulus, however, has not deterred the Bank’s Governor, Haruhiko Kuroda, from further stimulus. Amidst the coronavirus pandemic, the Bank of Japan committed to unlimited bond purchases to help keep rates low and foster inflation.
Shinzo Abe dressed as Super Mario at the 2016 Rio Olympics
How do you manage economic deflation AND a global pandemic?
That’s the cardinal question for Yoshihide Suga: The former chief cabinet secretary under Abe’s administration and the next Prime Minister of Japan. Suga, who hails from a humble farming background, is gearing up to take the reigns of the world’s third largest economy amidst the worst global recession since 2008. This, as you’ve read above, will be no easy task. Japan’s Debt-to-GDP is soaring above 200%. The central bank’s assets are spiking exponentially, with no tangible influence on economic data. All of this goes without mentioning Japan’s dwindling population, which has been a significant obstacle to Japan’s economic objectives.
Structural issues aside, Shinzo Abe was wildly popular in Japan. His Abenomics platform was effective, and mildly successful. Suga, based upon his cabinet, is expected to carry on his predecessor’s agenda, potentially adding small tweaks like raising the minimum wage and issuing more immigration visas to combat the aging population. Similarly, Suga will seek to strengthen diplomatic ties with the United States and other Asian nations, amidst the looming threat of the People’s Republic of China. Suga’s tenure in office could be limited, however. Next September, Japan will host an election for what was scheduled to be the conclusion of Abe’s term. The recovery from the coronavirus economy will almost certainly dictate Suga’s tenure in office.
Fun Fact: There are more pets in Japan than there are children.
Merry Christmas: Japan is notoriously known for their traditional consumption of Kentucky Fried Chicken on Christmas Eve.
The Global Capitalist
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There doesn't seem to be much meat to this article. Real GDP per capita growth has been strong. Public sector debt is just another form of currency and its creation is driven by private sector demand to hold yen.