No Japan scenario for eurozone
In the period 1986-1991, Japan experienced a double bubble, one in the real estate market and one in the stock market. Economic growth was fuelled by low-interest rates due to the strong yen, a lot of government spending for political reasons and high investments by the private sector. At one point, the land under the Imperial Palace in Tokyo was worth more than the entire state of California and the weight of Japanese shares in the world index was approaching 50 per cent. On the last day of 1989, the central bank intervened by slightly raising the policy rate, signalling that further rises in land prices and also share prices were undesirable. What followed were two lost decades in which Japan even faced deflation, partly due to the deflating bubbles.
Japanese banks got into trouble, as customers were no longer able to meet their payment obligations. Because of these bad loans, Japanese banks became increasingly reluctant to provide new credit. This made it difficult for healthy Japanese companies to attract capital for new investments. SMEs in particular had a hard time because of their dependence on bank loans for financing. The ruling LDP was too intertwined with the Japanese business community to tackle the problems. No nationalisations, no bad banks, just ‘extend and pretend’. Pretend that nothing was wrong. It was not until Koizumi’s reign (2001- 2006) that a reform agenda emerged. With the start of Abenomics (2012), the central bank and government were in line and the recovery started. Shinzo Abe appointed Haruhiko Kuroda as governor of the central bank, which finally came up with an appropriate response.
The period of Japan’s recession coincided with the end of the Cold War, which gave Japan a different position in the world. Especially within Asia, Japan suddenly had competition from several sides from countries that had copied Japan’s trick. Countries such as South Korea, Taiwan and also China came up with high investments in, among others, infrastructure, financed with the proceeds of export. This was only possible by keeping their own currency cheap and suppressing their own consumption. In a short time, the world’s factories were set up in Asia. They exported deflation to the rest of the world and Western consumers benefited. Japanese companies could not compete on price with the products from neighbouring countries and consumer prices also fell in Japan. In 2001, globalisation went into overdrive as a result of China joining the World Trade Organisation. Since then, the Japanese too, have been able to buy all products from Alibaba for a tenth of the price, and with much shorter delivery times than in Western Europe or in the United States.
As if the double bubble and the end of the Cold War were not enough, Japan’s population is also ageing rapidly. This is linked, as in many other countries, to the end of the Second World War, which resulted in a baby boom in Japan. As the Japanese became rich (and they still are), they had fewer children. Culturally, things were not easy in that respect either. Until the 1960s, marriages were arranged. After that, men and women had to find each other spontaneously. Now, honour and insult and the accompanying loss of face that causes shame play an important role in Japan, not a nice combination to get to know each other. After Sweden and the United Kingdom, Japan is the country with the most single-person households. In Sweden and the United Kingdom this is because of the many divorces, in Japan because they never get around to getting married. Because of Japan’s ageing population, many people assume that this is one of the causes of deflation. That is not correct. It is true that ageing causes lower economic growth, not per capita by the way, because in the two lost decades economic growth per capita in Japan has been higher than in the United States, but ageing is not a cause of deflation. People who retire do not produce more, but they do consume (especially if they have a solid pension pot). More consumption (demand) and less production (supply) mean, ceteris paribus, that the prices of goods rise. Again, that this was not the case in Japan is due to the implosion after the double bubble and the end of the Cold War. Now there is a labour shortage in Japan, also because Japanese prefer not to see immigrants. As a result, however, it is quite normal for people in Japan to work on into old age. Culture also plays a major role here; contributing to society is highly valued in Japan.
The Japanese double bubble has now deflated. A few years ago, I attended a presentation by an American asset manager where a young portfolio manager blithely told me that Japanese equities were so cheap because they always had been. He should know. Also, China and large parts of the rest of Asia are no longer exporters of deflation. The Asian growth model has been definitively abandoned with the rebalancing of the Chinese economy. China is not only going to produce more but now also consume more. Moreover, China is also ageing rapidly, so labour is becoming scarce there too. Unlike Japan in 1990, China has no neighbour to supply Chinese consumers with cheap products. At the same time, consumption in the world will double in the next ten years, partly because one billion people in Asia will rise to the middle class. Not exactly an ingredient for deflation.
From time to time it is popular to compare ageing in Europe with ageing in Japan, which is a direct indication that the combination of exuberant monetary policy and ageing in Japan has not led to inflation. In addition, the parallel of the Great Financial Crisis and the euro crisis with the Japanese double bubble is drawn, but in terms of valuation the Japanese bubble really is a case apart. Europe is probably worse off in more ways than Japan was in 1990. In Japan, the people (and the companies) are rich, but the government is poor. This is because Japan combines the European welfare state with an American tax system. Meanwhile, the central bank in Japan holds about half of the Japanese national debt, but the same central bank also possesses enormous foreign exchange reserves, a legacy from the time when Japan tried to weaken the yen. In Europe, debt is a bigger problem across the board, not least because the eurozone is still a divergent system. Yet a Japan scenario is unlikely here simply because in the eurozone we do not have counterparts for the two main factors that caused deflation in Japan (burst of double bubble and end of Cold War). Inflation is a much bigger problem for savers and bondholders than for equity investors, but the equity market itself seems to realise this. The outlook for Japanese equities 30 years on is bright, hopefully, the eurozone can take a leaf out of this new Japan scenario.