Japanification of Global Yields – By Daniel Gauci

As a country, Japan has always been ahead of the curve in terms of development, especially since the end of the Second World War. Its innovative culture and drive towards all that is technological has ensured that Japan as a country stands out as an avant-garde country. One such unwelcome innovation is the era of negative yielding debt, in the tune of trillions of US dollars. The situation where lenders pay borrowers, for the privilege of providing them with credit twists the fundamental wisdom of credit.   

Japanification for the investment world, is the idea, that an economy could endure a prolonged period of low growth and expansion accompanied by low levels of inflation. In the second half of the 20th century, Japan’s growth was remarkable and sustained. This came to an abrupt end in what is now referred to as the lost decade of the 1990s. In this period the Japanese GDP contracted from $5.33 trillion to $4.36 trillion, while real wages (adjusted to inflation), have never returned to their previous levels.

What led to this downfall was a set of unique yet correlated economic events, with the most prominent being the Plaza Accord, in which major economic powers agreed to depreciate the US dollar against the Japanese Yen and the German Mark. This resulted in a decrease in Japanese exports, and a wild speculative asset price bubble. In an effort to halt the speculation, following the market collapse of 1989 the Bank of Japan (BOJ) raised interest rates reaching the highest level at 6.0%. After which the BOJ gradually reduced further its interest rates to reach 0.0% in 1999.

We can identify three waves of Quantitative Easing, with the first one being in 2001, followed by a smaller one in 2006 and the most extensive program starting in 2013 which continues to date. This 20-year process of easing has resulted in low unemployment, modest wage growth and a slow economic expansion, which despite being weak is the best the country has experienced since 1992. The implications of Japan, loom large on other countries, especially the European Union at large. The main parallels one could draw are that both central banks have, maintained their accommodative stance, coupled with an ever broader, asset purchase programme, whilst both experiencing a sluggish growth and ageing population also in both cases there is little evidence of a solid path towards policy normalisation. Japan’s debt to domestic product looms large at 254%, most of which is Government related.

In essence, the long term risk, is this liquidity trap in which interest rates are low and savings rates are high, rendering policy ineffective as investors shy away from capital markets as a result of insufficient returns, or the expectation of higher interest rates in the future. Such stance hurts both the economy and the investors alike.

If central bank intervention in the form of quantitative easing is considered to be the medicine by which central bankers aim to revive an ailing global economy, then we can come to the conclusion of sorts that it is now the medicine which is making the patient ill.  This conclusion stems from the sheer duration and scale of what has to be a short term macro-economic stimulus exercise, which has run into years for major developed economies. The boost from the medicine, has well run its course and it is hard to tell whether it is delivering any further results, however, the medic is afraid of the impact of getting the patient off the prescription.

We understand the struggle of investors, as the previous investments which used to secure sustained positive returns have been reduced to mediocrity. The ways of the past do not work as they did any more. Achieving sustainable returns without notching the risk factor higher has become a more arduous and complex task. This is because, the sources of growth exist, however, one requires to access higher risk weighted investments which will deliver increased returns over a portfolio, only as long as the investor is able to get his allocations and timing right. Achieving either one of the two is difficult even for professionals, for this reason, it is of utmost importance that investors should invest only on a long term basis. This way investors, allow their strategy to run its course and actually weather through the different stages of the market cycle. The importance of diversification especially for risk averse investors is of utmost importance, as holding to a single asset class may harm the client’s portfolio.  

Revisiting the principle for accommodative monetary policy, is the idea that through making credit more freely available economies will be able to grow faster, as the hurdle of the cost of capital is set lower. It is argued that this has steered the global economy out of a greater recession, with potentially more severe costs both in terms of capital, and other hardships such as higher unemployment and lower consumption. However, at this stage it has become clear that the problem is no longer the access to capital. Continuing in this course only masks deeper fundamental problems at the expense of investors and provider of capital.

The trouble is that there is no consensus on what the actual fundamental issue is. We can imply that the problem is a mix of lack of increase in productivity which has basically flattened since the great recession, together with income growth. Another factor would be the increase in dependency of the ageing population, which weighs down on the working population as in the case of Japan which is worsened by the abysmal birth rate and the stubborn pursuit of not allowing migration to replenish the population deficit.

The way out of this will not be an easy ride. The drive towards the fourth industrial revolution and the green new deal, are two buzz terms relating to the increased automation and a drive to change the world to new sustainable energy sources. This will provide a boost in terms of providing the increased productivity and a large increase in the demand for capital towards an area that actually generates growth. Also, on a more difficult scale we will have to re-think our income and incentive structure. The concentration of wealth in the hands of the few has increased exponentially, to a stage that even those at the top of the pyramid have started to realise that this does not bode well even for their future. The ability to distribute wealth, in a more equitable manner, will have us re-think the current tax and income structures, which are clearly re-enforcing the existing structure.

 

This article was prepared by Daniel GauciHnD Management, CeFa Investments, anInvestment Advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]; http://www.jesmondmizzi.com








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