by Brad Houle, CFA
Senior Vice President
The Japanese economy has been stagnant for the last 20 years following the real estate bubble burst at the end of the 1990s. In addition, Japan has a rapidly aging workforce, low birthrate and very restrictive policies regarding immigration. Japan has been caught in a cycle of deflation whereby prices decline and consumers delay purchases as they believe prices will continue to decline. This negative feedback loop has been very damaging to economic growth.
Japan’s Prime Minister Shinzo Abe is undertaking a bold experiment in an attempt to pull Japan out of this economic malaise. Dubbed “Abenomics” by the press, the plan is using three-pronged approach: aggressive monetary easing, structural reforms to make Japan more competitive and fiscal stimulus. The plan is essentially similar to the quantitative easing presently being used in the U.S. but on steroids. The Japanese government has a stated goal to drive the inflation rate to 2 percent and reinvigorate the economy. Thus far, the program has been successful in the short-term. The Japanese stock market is up more than 30 percent, consumer confidence is higher and the yen has depreciated against many currencies. Tiffany, the high-end jeweler, reported that sales in Japan were up 20 percent last quarter attributed to the government’s attempt to stimulate the economy. The depreciation of the yen is welcome in that it makes Japanese exports more affordable to the rest of the world.
Bold economic experiments are never a riskless endeavor. Japan has a serious debt problem which raises the jeopardy of Abenomics. According to IMF Data, Japan’s debt-to-GDP ratio is projected to be 238 percent for 2013. The United States, although not a sterling example of fiscal discipline, is projected to have a debt- to-GDP ratio of 105 percent this year. Japan has been able to finance most of its debt internally. Savings is a cultural norm in Japan and its citizens have been financing Japans debt at very low levels. According to Pavilion Global Markets data, the weighted average cost of all Japan’s debt is less than 1 percent. Since the announcement of Abenomics, the interest rate on the Japanese 10-year bond has moved from below .5 percent to nearly 1 percent. This reaction is largely due to increased inflation expectation, which is the point of Abenomics. The peril of the situation is that Japan is borrowing mostly short-term to finance long-term liabilities, which can be problematic. This type of risk is called “roll-over risk” because as short-term bonds come due, they might have to be refinanced at higher interest rates. This is fine to a point; however, at some point if interest costs rise too far—the situation could become unstable. If current bondholders lose confidence or Japan has to seek substantial capital from outside countries, Japan could have a serious financial crisis. While we are not predicting an eminent financial crisis, we do feel it is important to have an awareness of the high stakes involved with the present Japanese economic policies.
Our Takeaways from the Week
- Fears of Japanese bond prices and the long-term effectiveness of Abenomics have created skepticism and concern, taking down Japanese markets for the past two weeks
- Despite the Dow dropping 200 points on Friday, it ended higher for the sixth straight month. The S&P 500 and NASDAQ also fell today but gained for the seventh straight month