Why should commercial real estate professionals in the Pacific Northwest be concerned about what’s going on in Japan?
Answer: Because the Japanese are determined to share their economic problems with the rest of the world. In the years ahead, Japan’s economic problems will adversely impact both our economy and our investments. How U.S. leaders respond will determine how much fallout there will be from Japan’s risky economic strategy.
But let’s back up a moment and review what’s going on.
ﾷ Japan has suffered through 24 years of economic stagnation. As a result tax revenues have been declining during this time period. Revenues are now down to where they were in 1985. In contrast U.S. tax revenues adjusted for inflation are more than double where they were in 1985.
ﾷ The declining tax revenues have resulted in a staggering amount of sovereign debt. Japan’s current debt-to-GDP ratio is 245%; in contrast the U.S. debt-to-GDP ratio, which is gi-normous, is 105%.
ﾷ Over the next 17 years Japan’s working age population will shrink by 17% from 81.7 million to 67.7 million. With fewer people working, the burden of servicing the public-sector debt will be higher for each individual worker.
ﾷ During this same time period retired workers will increase from 23 per cent of the population to 32 percent putting an added strain on the Japanese entitlement programs.
And we thought the economic situation in the U.S. was bad!
So what is Japan’s new economic strategy to get out of the economic quagmire that they’re in? They are taking a page out of Federal Reserve’s playbook – quantitative easing. Simply put quantitative easing is a central bank policy of buying government bonds in order to lower interest rates to stimulate the economy. Quantitative easing is also inflationary – expanding the money supply will reduce the value of the yen in relation to other world currencies which is what Japan needs right now as they have been in a deflationary cycle for years.
But what Japan is doing is significantly more disturbing than anything we’ve done in the U.S. In five years since the beginning of the Great Recession America’s monetary base has increased by less than 20 percent of GDP. In contrast, by 2015 Japan’s monetary base will balloon to almost 50% of GDP. There is no example in our lifetime of a developed country aggressively expanding its money supply to this extent. There are many downside risks. Here are two:
ﾷ A currency war is likely to result. By reducing the value of their currency Japanese exports become more competitive. Just in the past year the yen has depreciated 20% when compared to the dollar. That’s good news for Japan’s export market. However do you think South Korea or China are going to idly stand by and watch their export market to the U.S. slump because their products are not as competitive as they once were to their Japanese competition? They too will be forced to respond by doing something similar.
ﾷ Seeds have been sown that likely will cause the eventual collapse of the Japanese bond market. When it becomes apparent that a government is financing itself mostly with freshly printed money, institutional holders of bonds begin to lose confidence in government bonds. When this occurs bond investors at the very least stop buying bonds. In order to avoid a collapse in the government bond market the Japanese central bank will have to raise bond yields which they can’t afford to do. Currently 20% of the Japan’s budget is allocated to pay the interest on their debt. If interest rates on Japanese bonds were to rise to a mere 2.2%, 80% of tax revenues would go just to pay the interest on their debt. This is an untenable situation.
I have watched with fascination the economic turmoil in Europe and have concluded there is no easy solution to their financial mess. My opinion about Europe has not changed. It’s only a matter of time before their economy collapses under the weight of their own malaise. But the more I read about Japan’s economic woes the more I realize that Europe will not be the next economy to collapse. No that honor will go to Japan.
Sources: Japan Declares World (Currency) War III – Seeking Alpha, by Ian Wyatt, June 4, 2013; Abenomics – A Dangerous Game – Seeking Alpha by Michael Rands, June 13, 2013; Banzai!, Banzai!, Banzai! – Thoughts from the Frontline by John Mauldin, June 8, 2013.