Consider this set of facts: a major economy goes into a tailspin after an overheated real estate market collapses. Central bankers slash lending rates to near zero, and pump cash into banks, but economic activity stubbornly refuses to pick up, leading to a dismal cycle of falling prices and lower investments, international irrelevance, and years of lost potential.
Sound familiar? Some might say that it accurately describes Japan in the waning days of the 20th century, and perhaps the United States and Europe in the second decade of the 21st.
The buzzword is “Japanization.” It encapsulates all of the worries about the economies of the West and the possibility of a ‘lost decade’ as experienced by Japan.
Believers in Japanization think Western economies are turning into versions of the Japanese economy of the last 20 years. That is a zombie economy with political gridlock, little economic growth, near-zero interest rates, and a terrible stock market but a robust bond market.
One undeniable similarity between the U.S. and Japan is the bursting of a real estate bubble, followed by stimulus to keep the economy from falling off a cliff.
Today, another notable similarity between Japan and countries like the U.S. and the U.K. is their very low borrowing costs.
In fact, what happens next in this key area may indeed offer a clue to investors about Western economies’ future course.
Why? Because in Japan, since yields fell below 2% in 1996, they have never risen above it for any sustained period of time. And their economy has never enjoyed any sustained period of growth.
There is good news. There are many differences in the economic background between the 1990s and now.
For instance, today we have large emerging economies like China and India which have burst on the scene and are still growing. In fact, Morgan Stanley recently estimated that emerging markets will generate 80 percent of global GDP growth in 2011-2012.
However, these economies may not be strong enough yet to sustain overall global economic growth.
The growth of internal consumption in these countries should be enough to keep their GDPs growing in the mid-to-high single digits and the world economy from falling off a cliff. Just think of all the industrial goods Germany sells to China, for example.
Another difference is the response of the Japanese authorities then and Western authorities today to the current crisis.
The response of the Japanese authorities was timid to say the least. Meanwhile, led by Ben Bernanke, developed countries are following a controversial policy which it is hoped will be successful – money printing on an unprecedented scale.
However, the success of the Fed’s QE1 and especially QE2 has been rather limited. The sustainability of any stock market rally, based on a pickup in economic activity, will ultimately decide whether those talking about Japanization are correct.
On the one hand, Japan has an aging population where about half of the people may be retirement age by 2020, while the U.S. stays younger, thanks to immigrants and their higher birth rates. On the other hand, Japan has remained relatively free of social dissent in part because an estimated $15 trillion in personal savings enabled them to weather to downturn. In the U.S., many households are a lost job or health crisis away from economic disaster.
In Japan, two decades of near-zero interest rates, deflation and little growth led to a permanent change of investors moving out of stocks and into government bonds, even though Japan’s credit rating was cut in 2002.
The Japanese 10-year bond is yielding 0.99% and the Nikkei is still down 75% from its peak in 1989.
For now, the odds still favor U.S. monetary stimulus and emerging market strength overcoming the Japanization of the United States. But the outcome is by no means certain.