Japan has been in a deflationary spiral for more than two decades, and its economy and markets still do not show much promise for improvement. My research reveals that Japan’s average inflation rate over the past 15 years has been a negative 1.5 percent. Let’s investigate how this deflationary spiral happened, why they have not been able to recover, and how different our economy is in the U.S from theirs.
The best way, in my opinion, to understand the Japanese economy and culture is to visit Japan in person. Our youngest son’s university recently organized a trip there, so we decided to tag along as chaperones. Although we were somewhat reluctant to travel around the globe at first, it turned out to be one of those once-in-a-lifetime experiences.
At the core of Japan’s deep economic problems were two significant financial bubbles that burst. The first was a 1990s real estate bubble. According to Forbes magazine, Japanese real estate skyrocketed 160 percent over six years starting in 1991. It then immediately fell 64 percent and has remained in this realm over the past several decades. Japan’s net drop in the value of real estate would be equivalent to U.S. housing falling 55–65 percent, roughly double the 34 percent decline we saw at the bottom of the housing crisis in 2009. Click here for a chart.
The second major financial bubble that burst was the stock market in the 1980s, with the Nikkei stock index peaking at almost 39,000 in 1990, and then falling over 32,000 points to 6,995 in 2008. Last month, the index stood at 14,235 following more than a decade of slow appreciation. If you as a Japanese investor had invested your 401k in the stock market at the highs in the 1980s, you could have lost roughly 80 percent of your savings. This would make almost anyone a little leery of the market.
Another significant challenge for the Japanese economy is its demographics, as it has a much older population than the United States. If you combine the fear created by the crashes in real estate and the stock market over the past several decades with its aging population, you have a perfect formula for very slow, cautious growth. Additionally, the recent nuclear reactor problems only contribute to these market issues.
The combination of these factors, along with the natural disasters Japan has experienced over the years, has created a huge amount of savings and an aversion to risk unlike any other country in the world. Japanese investors are very focused on their savings, with the primary goal of making sure they have enough to retire. This helps explain why their interest rates are so much lower than those in the United States (see chart on page 20) and why U.S. bond yields are so attractive to the Japanese government. Japan trails China as the second-largest foreign holder of Treasuries with over $1.1 trillion.
Currently, the yen is roughly 1/100th of the U.S. dollar, which means the 10,000 yen is worth approximately $100. The yen has fallen sharply since the 1980s but has been on the rise since late 2012.
We certainly learned a lot about Japan, its culture and economy, and I would recommend a visit if you ever have the chance. In conclusion, there is a wise old investment adage that states, “the only perfect hedge … is in a Japanese garden.” We may have discovered that perfect hedge near the Imperial Palace in downtown Tokyo.
Our economy, although clearly still in recovery mode, now looks much better to me in perspective. I now more fully understand why Federal Reserve Chairman Ben Bernanke initiated the quantitative easing programs, which today total more than $3.2 trillion in government bonds purchased. The possibility of a deep deflationary spiral like Japan’s left the Fed with no other reasonable choice, in my opinion.
Jeff Goble is executive vice president and managing director, investment banking, at UMB Bank, n.a., Kansas City. His email address is Jeffrey.Goble@umb.com.
Graph Source: Bloomberg, Wall Street Journal
Photo caption: The “perfect hedge” near the Imperial Palace in downtown Tokyo. Photograph by Jeff Goble.
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