3 years of massive stimulus spending in Japan has had no impact on the problem it was supposed to solve. This is highlighted by new government data on household spending for 2015, as the charts above confirm – they compare 2015 data with that for 2012, before Abenomics began:
- Spending was almost exactly the same at every age group in 2015 versus 2012, when premier Abe took office
- Spending in the peak age range of 50 – 59 was just ¥250/year higher, and ¥7900 lower in the 40 -49 age group
- It still declines 31% once people reach the age of 70 – critically important with Japan’s ageing population
- In US$ terms, of course, the numbers are lower due to Abe’s focus on devaluing the yen since he took office
- US$ spending in the two peak age groups of 40 – 49, and 50 – 59, has fallen by $15k/year to $29k/year
This matters, because consumer spending is 60% of Japanese GDP.
The quite scary result is that the Bank of Japan has spent ¥200tn ($1.84tn) since Abe came to power on its quantitative easing programme. Yet the Abenomics policy has completely failed to achieve its major objectives of boosting GDP and inflation:
As a result, Japan now has the world’s highest level of government debt as a percentage of GDP at 226%.
Yet premier Abe and Bank of Japan Governor Kuroda refuse to accept that their policies have failed. Instead, just like the European Central Bank yesterday, they have decided to implement their policies on a greater scale. Thus Japan introduced negative interest rates in January, meaning that the Bank now charges you to deposit money with it.
Clearly these are increasingly desperate measures, which have a vanishingly small chance of being successful. Past performance is no guarantee of future results, but it is usually the best guide that we have. And understandably, Japan’s Diet (its parliament) is becoming very concerned – Governor Kuroda has been summoned for questioning a record 25 times so far this year.
One major concern is that Japan’s value proposition for foreign investors is looking increasingly unattractive:
- Foreigners have to pay the government to lend it money (and so are guaranteed to get back less than they lend)
- They also know devaluation remains a key policy, meaning that the return in their currency will probably be lower
- And GDP growth is almost impossible with Japan’s median age now 47 years and its population will decline 600k/year by 2020
Premier Abe initially promised that he would restore the country to growth within 2 years, and push inflation to at least 2%. Today, 3 years later, his Abenomics policies have entered the end-game. Some investors will no doubt continue to maintain positions in Japan, as it is still the world’s 3rd largest economy.
But they will no doubt be keeping a close eye on their exit opportunities. When the rush starts, nobody will want to be left behind.
‘Peter Pan’ is one of the world’s most-loved children’s stories.But I hadn’t realised it had also become an economics textbook, at least in Japan. Yet the Governor of the Bank of Japan (BoJ), Haruhiko Kuroda, described his stimulus policy last week as follows to an invited audience:
“I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it.’ Yes, what we need is a positive attitude and conviction,”
As readers will know, I have consistently argued that the central banks were guilty of wishful thinking, with their idea that printing money could somehow stimulate growth in an ageing population. So it is good to know they recognise there might be some truth in the argument.
The chart above, based on Statistics Japan data, highlights the impossibility of Kuroda’s wish to restore inflation and constant growth to the levels seen before Japan’s population began to age:
- Its BabyBoom began earlier than in the West, and averaged 2.2m babies/year between 1920 – 1952
- Births then slowed between 1953 – 1983 to average only 1.7m/year
- Births have since fallen further to average just 1.2m/year over the 30 years between 1984 – 2014
- Last year actually saw a record low level of only 1m births
Thus Japan has simply run out of realistic options for growth. Its population is now set for steady decline from 2010′s level of 127m to just 108m by 2050, according to UN Population Division forecasts.
We also know, again from Statistics Japan data, that spending peaks in the 25 – 54 age group, as the second chart shows. After this, people already own most of what they need, and their incomes decline as they enter retirement. These spending patterns also matter for the economy, as consumption is around 60% of Japan’s GDP.
Japan has one of the oldest populations in the world, with a quarter aged over 65 years. Therefore it really is wishful thinking of the first order to imagine that it can possibly return to the growth levels seen when its BabyBoom was in its peak spending mode . After all, the youngest Boomer, born in 1952, is now 63 years old.
And it is also hard to imagine that the problem can be solved by either increasing fertility rates dramatically, or boosting immigration:
- Adding more babies now would simply increase the dependency ratio, which measures the number of young and old as a ratio of the working -age population. It would do nothing to boost growth for another 20+ years, till the babies began to enter the workforce
- Boosting immigration would require millions of people to migrate to Japan, and would create enormous social tensions as a result. Japan has never accepted the idea of immigration, and it is unlikely to be accepted now
The great moral of ‘Peter Pan’ is that children have to grow up and join an adult world. They cannot live in the magic world of Neverland forever. What a pity that Japan’s policymakers obviously never read to the end of the story.
Of course, if you hand out Yen 80tn/year ($480bn) in stimulus, as the BoJ is now doing, and devalue 50% versus the dollar, you will get a short-term jump in the growth rate. But then the rate will fall back again, as Japan’s working age population has to pay for the cost of this short-term stimulus through higher taxes.
The greatest pity is that premier Abe chose to ignore the wisdom of the BoJ’s previous Governor, Masaaki Shirakawa. He understood all too well that demographics are far more powerful than monetary policy.
The last 10 days have seen turmoil in major currency markets:
- The Swiss National Bank gave up trying to devalue versus the euro, and the franc jumped 30% in minutes
- The European Central Bank (ECB) launched its €1tn Quantitative Easing (QE) programme, causing an immediate 3% fall in the euro’s value versus the dollar
These are major moves by any historical standard, and highlight how earlier ‘currency wars’ have broadened in scale.
Their origin was in 2009, when the US Federal Reserve launched its first QE programme. One of its key impacts (whether intentional or otherwise) was to devalue the US$ – thereby supporting export growth and the US economy. By 2011, after the Fed’s QE2 programme, the US$ Index was down 19% as the chart shows.
But then the Bank of Japan launched its own QE programme. And in October last year, when the US$ Index seemed likely to fall again, it launched its QE2 programme. Last Thursday, the ECB began its own QE programme, effectively joining the war on Japan’s side.
Japan and Europe have ageing populations and so cannot generate domestic growth. By weakening the currency, the ECB and Bank of Japan expect to compensate for this by generating growth in export markets. In turn, however, these competitive devaluations create major risks for the global economy, as the greatest central banker of modern times, Paul Volcker, has explained:
“Central banks are no longer [acting like] central banks,” he warned, amid a discussion about Japanese and American monetary policy. I think it gets dangerous when they lose sight of the basic function of the central bank. The key issue concerns what this “function” should be. The basic function of a central bank is to defend the value of the currency,” he insists, as his highly successful experience in the 1980s “taught him how limited a central banker’s powers really are”.
CHINA HAS ABANDONED STIMULUS FOR A ‘NEW NORMAL’ APPROACH
The problem is that currency wars are a zero-sum game. Today, Japan and the Eurozone are winning at the expense of the USA and Switzerland. Thus the US$ Index has broken out of a 30-year downtrend, and is at an 11-year high.
Effectively, though, this means that 2 of the world’s 4 largest economies are effectively waging a currency war against the largest economy, the USA, as well as against Switzerland. This cannot end well.
Within a few weeks, the Fed will find that the US recovery is suddenly weakening again:
- The collapse of the shale gas/oil bubble means US jobs growth will soon reverse, and housing starts slow
- US companies will lose market share in export markets as Japan and Europe become more competitive
- The rise in the value of the US$ will also help to ensure that the US slips into deflation.
- And so the Cycle of Deflation will likely move forward another stage, towards protectionism and tariffs
Of course, there is another way forward, which avoids this zero-sum game.
China’s new leadership realised 2 years ago that its previous policies had been a complete mistake. It has since adopted ‘New Normal’ policies, based on an acceptance that ageing populations inevitably lead to lower economic growth. As Zhou Xiaochuan, governor of the People’s Bank of China, told the World Economic Forum in Davos last week:
“If China’s economy slows down a bit, but meanwhile is more sustainable for the medium and long-term, I think that’s good news”
Unfortunately, very few of his peers seem to be listening to his common sense message.
WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 57%. “Current market fundamentals do not support any significant upturn on benzene pricing”
Brent crude oil, down 53%
Naphtha Europe, down 53%. “Buying appetite in downstream petrochemical markets is thin as polyethylene players wait for the February ethylene contract to settle”
PTA China, down 44%. ”Buyers were mostly purchasing on a need-to basis, adding that the market outlook remains uncertain”
¥:$, down 15%
HDPE US export, down 23%. “Most domestic export prices continued to slip on lower ethylene and energy market values”
S&P 500 stock market index, up 5%
The Great Unwinding of policymakers’ failed stimulus programmes is now clearly underway in the global economy. The headlines this week all focused on the latest International Monetary Fund (IMF) report:
“IMF says economic growth may never return to pre-crisis levels.”
And then, in response, the US Federal Reserve suddenly realised that the US economy was not as strong as it had hoped. As the Wall Street Journal headlined yesterday:
“Federal Reserve officials have become more concerned that weak overseas growth and a strengthening U.S. dollar will crimp the domestic economy and hold down inflation, an outlook that has made them more inclined to stick to low interest rates.”
This confirms the blog’s suggestion back in August, when it highlighted the start of the Great Unwinding:
“Recent speeches by the new Fed Chairman, Janet Yellen, have been equivocal at best, suggesting she is not clear about the best policy to adopt. There is also the fact that to some extent, events are moving out of central bank control”
Market action in the US Dow Jones Industrials Index confirms the volatility that is now developing:
- The Dow fell 1.4% on 1 October, before jumping 1.2% last Friday
- It then fell 1.6% on Tuesday this week, before jumping 1.6% on Wednesday
- Yesterday it fell 2%, leaving it down 3.6% since its peak at the time of the Alibaba float last month
Meanwhile Brent oil has fallen $24/bbl since its late June peak. And no, that isn’t a typo. Brent traded at $114/bbl between June 19 – June 23, and closed last night at $90/bbl. The US$ has been equally volatile:
- Against the Japanese yen it has risen from $1 : ¥101 in early August, to $1: ¥108 last night
- Against the euro it has risen from $1 : €0.71 in early May, to $1 :€0.79 last night
These are enormous moves in such as short space of time, and will be extremely destabilising for the global economy. Very soon, no doubt, the IMF will have to revise down its estimate for global growth for a 4th time this year.
THE OUTLOOK REMAINS VERY SCARY
The reason for this drama goes back to the legacy of the failed stimulus policies seen since 2008. They created a tidal wave of liquidity which destroyed the ability of markets to undertake their key role of price discovery:
- Markets completely lost touch with the reality of supply/demand as a result of this liquidity
- But now, supply and demand balances are starting to matter greatly as the stimulus policies come to an end.
The blog developed its original analysis of the Great Unwinding in 5 posts during August – September. Very clearly the risks that it then identified are now coming true.
In response to many requests, it has now combined these posts into a special Research Note. Please click here to download a copy. And do please feel free to circulate it to your colleagues and business partners for discussion.
Next week, the blog will also launch ‘The pH Report’. It aims to help companies and investors survive the Great Unwinding of central bank and government stimulus now underway.
Question: Why will Starbucks reduce the menu price for its venti green-tea frappucino in Japan next Tuesday, when the price is actually going up?
Answer: Because the government hopes the lower menu price will fool people into thinking the price has gone down
It is, of course, a nonsense. And no doubt most Japanese will be quite annoyed that their government thinks that they could be fooled so easily. They will, after all, find themselves paying Y572 ($5.58) for their favourite tea on Tuesday, not today’s Y550, even though the menu says Y530. Thousands of other retail businesses will be adopting the same tactic, under a new law passed last October.
But the reason for the tactic is even more worrying. As the chart above shows from the Financial Times:
- Japan’s tax revenues have been declining since 1990, when its own BabyBoomer-led SuperCycle ended and its credit bubble burst (blue line)
- Yet successive governments have refused to accept that older populations mean lower economic growth
- They have instead spent Ytns on failed stimulus programmes (red)
- The IMF and OECD calculate Japan’s debt is now $80k for every man, woman and child
Or to put it another way, current gross central government borrowings equal 24 years of tax receipts.
Japan is thus a clear example of the way in which yesterday’s ‘demographic dividend’ has become ‘demographic deficit’. And one sign of the seriousness of the situation is the Starbucks example. Imagine how desperate the government has become, that it would even think of such a tactic, let alone pass a law to allow it.
The blog has argued since premier Abe came to power that his policies simply cannot work and are contradictory. For example, one key policy is to devalue the yen. This pushes up domestic prices and reduces consumption. Yet a second policy is to increase GDP by increasing household consumption.
This is why the government is now in such a mess. It needs to pretend that prices are going down in order to try and convince people to increase consumption. But the failure of its vast spending programmes means it now has to increase consumption taxes to try and stop the debt rising further.
This kind of economic nonsense wouldn’t matter if Japan was an obscure country in the middle of nowhere. But instead it is the 3rd largest economy in the world. Even more worrying is that economic policymakers in the West think Abe is doing the right thing, and are now mirroring his spend and borrow policies.
Small wonder that some Japanese have now begun to rebel. Last summer, voters elected a former fund manager, Takeshi Fujimaki, to Japan’s Upper House of parliament on ‘a platform of economic Armageddon’. His view is that:
““A market crash is inevitable. The only question is what measures we can take today to lessen the damage.” His argument was that “Japan’s debt was out of control, and it was only a matter of time before everyone dumped government bonds, sending yields soaring and the yen skittering all the way to 1,000 against the dollar”.
An early sign of Abe’s confusion came last year, when he replaced Masaaki Shirakawa as Governor of the Bank of Japan for arguing that today’s “low growth was mainly attributable to demographics, or more specifically, a rapid aging of the population”.
Thus there is nobody at the top of government to point out the risks that Abe’s policies are creating. But Tuesday’s tax rise shows Shirakawa was right when Governor to warn:
“The implications of population aging and decline are also very profound, as they contribute to a decline in growth potential, a deterioration in the fiscal balance, and a fall in housing prices. Given that other developed countries will face the same problems despite some differences in timing and magnitude.”
Before too long, we may all find ourselves ordering a drink at Starbucks, only to find that the actual price has gone up.
Newton’s 3rd Law of Motion states, “To every action there is always an equal and opposite reaction“. Thus the forces of two bodies on each other are always equal and are directed in opposite directions.
Policymakers forgot this Law in their response to the 2008 financial Crisis. Instead they believed that cutting short-term interest rates in the major economies to zero, and thereby reducing 10-year rates, would force investors to make riskier investments and so stimulate economic growth.
5 years later, of course, it is clear there has been no recovery to SuperCycle levels of economic growth, despite their $33tn of global stimulus. Instead, as Mexico’s central bank governor admitted at the weekend, the policy simply led to “large short-term speculative capital inflows” – exactly the ‘equal and opposite reaction’ that Newton’s 3rd Law would have predicted.
The chart shows what has happened to interest rates for 10-year bonds over the period. It shows them in August 2008 (red column) when the Crisis burst, and then on 1 May 2013 (blue), just before policymakers finally began to reverse course. It also updates the position to last Friday (green). Its focus is on the weaker European economies (the PIIGS – Portugal, Ireland, Italy, Greece, Spain) and the stronger global economies (the JUUGS – Japan, UK, USA, Germany, Switzerland):
- August 2008 rates were very similar across most countries at around 4%
- Only Japan was much lower at 1.5%, as its ageing population had led to deflation
- But interest rates then diverged quite strongly until May 2013
- In the PIIGS, Portugal, Ireland and Greece went through messy defaults
- In the JUUGS, by contrast, rates fell to all-time lows over the period
The decline in the JUUGS’ interest rates thus created the basis for the speculative capital outflows that Mexico’s governor identified..
Since May, however, rates in the JUUGS have begun to rise quite steeply. They have jumped by 60%-75% in Germany, the UK and US; and nearly doubled in Switzerland. Even Japan’s rates have risen.
Thus it is clear that the Crisis is now entering a new and even more dangerous phase. The $33tn spent on stimulus is equal to around half of global GDP. It is hard to see how this debt can ever be repaid, given that it financed a speculative credit boom, rather than the production of useful goods and services.
Policymakers should not have ignored Newton’s Law. Nor should they have refused to accept the critical learning from Japan, that ageing populations create economies which have low or even negative growth. These economies also have deflation rather than inflation, for the simple reason that older people no longer buy many new things, as the kids have left home and they already own most of what they need.
As we show in Boom, Gloom and the New Normal, the West is now going through Japan’s experience. The 1983-2007 SuperCycle saw large numbers of BabyBoomers in the Wealth Creating 25 – 54 age group. Now the average Boomer is 55 years old, and so the world is entering a New Normal of low or negative economic growth.
Thus as Newton would have predicted, the short-term speculative capital flows are now disappearing:
- The first casualties are countries such as India, Brazil, Indonesia and South Africa who never reformed their economies, and instead allowed imports to rise uncontrollably. They have large deficits on their current accounts, which cannot be financed now the speculative inflows have become outflows
- The next casualty will be the supposed ‘recovery’ in Western housing markets. This has been driven by rental market investors, not homeowners. As Goldman Sachs report, “more than half of all US homes sold last year and so far in 2013 have been financed without a mortgage“, versus less than a quarter before the subprime crash.
What happens next is difficult to forecast. The worst case is that interest rates will continue to rise, as investors head for the exits. This would likely cause stock and commodity markets to fall, as many investors have borrowed heavily to finance their positions . Margin debt (their total borrowing) is currently at a near-record $377bn level in New York. In turn, deflation would be almost inevitable under this Scenario.
Newton, however, would probably not be surprised at seeing his Law confirmed once more.