On the Japan Myth, Predictions for 2012 and Gold
January 15, 2012
The prevailing popular opinion on Japan is that it has suffered two “lost decades” – implying minimal economic growth and falling asset prices , and is typically held as an example of a dire economic condition to try and avoid. While Japan has indeed suffered economically from the bursting of its bubble in 1990, and it faces some serious structural issues today, the popular perception does not quite hold up to closer scrutiny. Richard Koo (Nomura Research Institute) and Daniel Gross (Director of the Centre for European studies) have written on this topic and I summarise below their key arguments:
Daniel Gross’s Thesis:
- Japan has indeed had a low economic growth of 0.6% over the last decade when compared to a growth rate of 1.7% experienced by the US. However, a large part of Europe had similar growth rates over the last decade – notably Germany at 0.6%, Italy’s at 0.2% - with only France and Spain performing a bit better.
- Additionally, comparing GDP growth rates can be misleading as they do not take demographics into account. The best method to compare growth rates of developed countries is the GDP per working-age population (WAP-defined as population aged 20-60) which measures the true productive potential of a country and how efficiently it has utilised that potential.
- On the basis of this measure, Japan’s GDP/WAP growth rate has exceeded that of the US by about 0.5% per annum, and that of most of Europe. This is because Japan’s working-age population has been declining by 0.8% while that of the US has be increasing by about the same rate.
- Japan should be held, not as example of stagnation, but rather of how to squeeze maximum growth from limited potential.
- Another indication that Japan has efficiently utilised its potential is its unemployment rate which has remained constant over the last decade (and never exceeded 5.5%), while the unemployment rate in the US has approached 10%.
- A good rule of the thumb to estimate average long term GDP growth rates of the G-7 countries is to add 1% of productivity gains to the growth rate of the working-age population. As German and Italian working-age populations start to decline rapidly after 2015, they can be expected to face a Japan like scenario. By contrast, the US, UK and France should continue to experience growing (albeit slowly) working-age populations and there relatively higher GDP growth rates.
Richard Koo’s Thesis:
- Japan faced a severe balance sheet recession in 1990 with the bursting of its real estate and stock bubbles – the loss of wealth due to steep falls in real estate prices (down 87%) and stocks, was equivalent to 3 years of its 1989 GDP – by contrast, the US only lost one year of its 1929 GDP, in terms of wealth, during the Great Depression.
- With the ensuing massive deleveraging by the corporate sector by repayment of debt – equivalent to 6% of GDP - and household savings of 4%, Japan could have lost 10% of GDP every year like the US did during the Great Depression.
- However, Japan managed to avoid a depression due to its aggressive fiscal spending which managed to keep GDP above its 1990 peak and unemployment below 5.5% (see chart below) . The government spending maintained incomes in the private sector and allowed businesses and households to pay down debt.
- The government cumulatively borrowed about 460 trillion yen (92% of its GDP) from 1990-2005 to save a potential loss of GDP of about 2,000 trillion yen (assuming GDP would have gone back to its pre-bubble 1985 peak without government action). This happened without crowding out of the private sector, inflation or high interest rates as the private sector continued to deleverage until 2005.
The above analysis is quite compelling. Japan has managed to do quite well despite some serious headwinds-foremost among them being their declining working-age population and a lack of natural resources. They are an extremely egalitarian society, with a rich cultural history, and continue to enjoy comfortable living standards and high life expectancy. This is perhaps something that all developed nations should aspire for.
Year in Review and Predictions for 2012:
I have provided below charts (via Macromon) which illustrate 2011 performances for a range of major equity markets as well as some bonds, currencies and commodities. Following a simplistic (yet surprisingly accurate) method of predicting performance for the year ahead based on the “reversal of fortunes” principle, it would suggest out-performances by the following asset classes in 2012:
In the words of the 85 year old market veteran and doyen of newsletter writers, Richard Russell:
“Below is the last day of the year quotes for gold.
"This year’s close for gold marks the 11th year for a higher year-end gold closing. To my knowledge this is the longest bull market of any kind in history in which each year’s close was above the previous year. This fabulous bull market will not end with a whisper and a fizzle. I continue to believe that the upside gold crescendo of this bull market lies ahead. We are watching market history".
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