Alice laughed: "There's no use trying," she said; "one can't believe impossible things."
"I daresay you haven't had much practice," said the Queen. "When I was younger, I always did it for half an hour a day. Why, sometimes I've believed as many as six impossible things before breakfast."
– Alice in Wonderland, Lewis Carroll
I wrote several years ago that Japan is a bug in search of a windshield. And in January I wrote that 2013 is the Year of the Windshield. The recent volatility in Japanese markets is breathtaking but characteristic of what one should come to expect from a country that is on the brink of fiscal and economic disaster. I don't mean to be trite, from a global perspective; Japan is not Greece: Japan is the third-largest economy in the world. Its biggest banks are on a par with those of the US. It is a global power in trade and trade finance. Its currency has reserve status. It has two of the world’s six largest corporations and 71 of the largest 500, surpassed only by the US and comfortably ahead of China, with 46. Even with the rest of Asia's big companies combined with China's, the total barely surpasses Japan's (CNN). In short, when Japan embarks on a very risky fiscal and monetary strategy, it delivers a serious impact on the rest of the world. And doubly so because global growth is now driven by Asia.
Japan has fired the first real shot in what future historians will record as the most significant global currency war since the 1930s and the first in a world dominated by true fiat money.
At the risk of glossing over details, I am going to try and summarize the problems of Japan in a single letter. First, a summary of the summary: Japan has painted itself into the mother all corners. There will be no clean or easy exit. There is going to be massive economic pain as they the Japanese try and find a way out of their problems, and sadly, the pain will not be confined to Japan. This will be the true test of the theories of neo-Keynesianism writ large. Japan is going to print and monetize and spend more than almost any observer can currently imagine. You like what Paul Krugman prescribes? You think he makes sense? You (we all!) are going to be participants in a real-world experiment on how that works out.
But first, I want to mention a very special event, that is of great relevance to this discussion, and that will be coming your way in just a couple weeks. I'm going to get together in New York with five of the most powerful investing minds in the world – Kyle Bass, Mohamed El-Erian, John Hussman, Barry Ritholtz, and David Rosenberg – and we're going to totally take apart the New Normal environment in which we all find ourselves and then rethink and rebuild it in a way that will help you not only survive it but profit from it. Investing In the New Normal will feature a full hour of our unfiltered conversation and uncensored analysis. It will come to a computer screen near you on Tuesday, June 11, and you will want to be there! The event is free, and you can register here. Seriously, a full hour with those five guys. How cool is that? I will make sure you get a few powerful take-aways that will impact your thinking and your investing. And now, let’s take a look at that hard windshield and that big bug.
In no particular order, let’s look at some facets of the daunting task facing Prime Minister Abe and the country of Japan.
After the collapse of what might still be the largest economic bubble in history, in 1989, Japan is still mired in a 24-year non-recovery. Nominal GDP in 2011 was almost exactly what it was 20 years earlier, in 1991 (MeasuringWorth.com). You can find other ways to measure nominal GDP which indicate limited growth; but compared to the US and China, nominal growth in Japan has been paltry.
That lack of growth takes on special importance because when we measure national debt-to-GDP we use nominal GDP as the denominator. If debt is growing and the economy is not, that debt-to-GDP ratio can grow very rapidly. From the Financial Times at the end of March:
Japan’s central bank governor has told parliament that the government’s vast and growing debt is "not sustainable," and that a loss of confidence in state finances could “have a very negative impact” on the entire economy. The warning comes as Shinzo Abe’s administration attempts to drag Japan out of more than a decade of deflation with aggressive monetary and fiscal stimulus.
In January, weeks after taking office, the government unveiled a Y10.3tn ($109bn) spending package while leaning on the Bank of Japan to buy more of its bonds – a strategy described by Morgan Stanley MUFG Securities as "print and spend". Speaking to lawmakers on Thursday, BoJ governor Haruhiko Kuroda noted that, while the government bond market has been "stable," Japan’s gross debt to GDP ratio – expected to top 245 per cent this year, according to estimates by the International Monetary Fund – is "extremely high" and "abnormal".
Japanese households and corporations are saving even as the government runs deficits close to 10%. As a way to compare, a 10% deficit in the US would be $1.6 trillion.
There are two and only two ways to grow an economy in real terms. You can grow your working population, or you can increase your productivity. That’s it. Japan does not have the option of growing its population (or has not chosen to), and it is actually quite difficult for an industrial economy to grow its productivity. If your population is actually shrinking (see chart below) and productivity growth is less than 1%, then real GDP growth is just not possible. We are going to revisit this uncomfortable fact later.
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