Japan's "lost decade" is now into its third decade, and the Japanese people and their government have had enough. After ostensibly the longest running quantitative easing policy in history, on April 4th the new Central Bank Governor Haruhiko Kuroda announced a very aggressive program to inject $1.4 trillion in monetary stimulus into the Japanese economy. The stated objective is to end a prolonged bout of deflation, initially targeting 2% inflation in approximately two years. That goal appears to have been extended by a year because of disagreement among members of the board of the Bank of Japan.
$1.4 trillion will effectively double the monetary base. The purchase program, which will include not only government bonds but equities and REITs, in terms of relative GDP is more than twice the size of the current program being pursued in the United States by the Federal Reserve. According to Anthony Mirhaydari of MSN Money Japan's debt to GDP is already at 245%, the highest in the developed world. Just where this will lead nobody knows. In the meantime, though, the Japanese stock market as measured by the Nikkei 225 is up 30% year to date, and global interest rates are testing all-time lows. Despite a European Commission report criticizing French public finance and industrial competiveness, the yield on 10-year sovereign debt is 1.82%. As reported by Bloomberg, peso denominated Mexican government 10 year yields are resting at 4.72%.
Deflation has been acceptable to Japan's savers because purchasing power is maintained in spite of low interest rates. However, savings are declining as the population ages. Capital goods exports, particularly to China, have picked up the slack. That source of revenue, which supports the current account, appears to be waning. Inflation would hopefully spur domestic consumption and put pressure on nominal wages. However, it seems to us that Japan is going to the well one more time, pushing down the value of the yen to reinvigorate their export machine. In a slow growth global economy, other countries may be reluctant to relinquish such an obvious competitive advantage without taking countermeasures.
There is, of course, no assurance this new, more aggressive policy will work. It may just compound an already deteriorating situation. Current tax revenues do not cover expenditures on social security, education and debt service. Should interest rates rise with inflation, debt service alone could become a problem. And, of course, a weaker yen makes imports of energy more expensive, both to consumers and corporations. Japan may have to rethink its current policy of moving away from nuclear power as the bills from importing hydrocarbons mount.
For the moment, global yields are extremely low. James Grant, publisher of Grant's
Interest Rate Observer, publicly laments the decline in credit analysis as next-to-nothing interest rates "dull the effort to distinguish good investments from bad." He warns of
misallocation of capital and unintended consequences of central bank forays into policies without historical precedent.
Michael Cembalest, Chief Investment Officer of J.P. Morgan Asset Management, speculates that Japan's structural problems will resurface in the future, but that these new policies may continue to favorably influence financial markets. We agree with him that this may be a tradable moment, but be prepared to take profits at some point.
John Hess Managing Principal (203) 655-4700 jhess@nsinvestors.com www.nsinvestors.com | Falgun Jariwala |
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. They are those of the authors. Investing involves risk, including loss of principal. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. International investing involves special risks such as currency fluctuations and political instability and may not be suitable for all investors.
1. Gary Shilling'sInsightMarch 2013