G20 met at the weekend. The headlines included - "Heads of ECB, BOJ, Fed and Eurozone meet at G20. The Bank of Japan has lessons to offer on dangers of low inflation"
There is a potentially interesting development at G20. The usual uselessness of overpaid bureaucrats on a junket appears momentarily to have given way to intellectual debate about traditional economics not working. In particular the problem with inflation. Inflation has “stopped behaving as expected”. What they mean is that inflation has stopped responding to stimulus, they can't get it up (so to speak), the traditional central bank policy measures of cutting interest rates and printing money are not working and despite their stimulus measures inflation remains stubbornly stuck below 2% no matter what they do.
Inflation has been defeated by decades of anti-inflation policy and the risk now is that 'traditional' (unimaginative) anti-inflation policy has been applied for so long that inflation has gone and despite “aggressive stimulus measures” does not want to come back. Central bank policy has robotically demonised inflation for so long that they may well have killed the fatted calf, and along with it, GDP growth, earnings growth, the risk free return, investment returns and the long term wealth of current and future retirees.The multi-deacde war on inflation may have led us to an extended period of ingrained deflation and if central banks don't do a "deep rethink" of their anti-inflation genetics and their ineffective money printing, deflation will set in and deflation is a killer.
Deflation of course is something the Japanese know all about - anyone who was around in the 1980's will be able to tell you about the Japanese boom and bust. In the 1980's the Japanese economic growth smashed the rest of the world with its manufacturing practices, in particular the automation of manufacturing and in particular the automation of the car industry. It was an era of corporate national anthems (when I joined Nomura in 1985 I was handed a Cassette with the Nomura Anthem on it - it was actually quite catchy), and it was an era of workers doing tai chi in the mornings, like an invincible army, and it was an era that saw Japanese promising (unfulfillable) jobs for life. At the same time property prices in Tokyo blew through the roof and the rich 1980s Japanese stockbrokers, priced out of the property market, had nothing to buy as a status symbol but overpriced prestige non-Japanese cars like the Jaguar XJS (if you ever owned one you’ll know it made you travel sick) and the Lamborghini Countach (the car out of Wolf of Wall St – Mike Tyson owned one). Net result, Tokyo was full of over-priced European (crap) cars.
Then it all went oblong as every boom does and the stock market fell 62% in three years and proceeded to trend down falling 75% over the next 25 years. The average investor assumes stock markets always go up, talk to a Japanese retail investor over the age of 50 and they will tell you how deluded you are. Assumptions are the mother of all @#$% ups. Their stock market compounded at minus 5.39% for 25 years. In Japan they don't respect the stock market and certainly don't assume anything about equity investment being "alright in the end".
This period changed the psyche of the average Japanese investor. Stockbrokers transitioned from previously admirable and credible geniuses to being no better than a bookie (with a crap car). Investors became super conservative and as the stock market folded up the Japanese became known as savers rather than spenders, as conservative rather than ambitious, and their savings flooded out of the country into high yielding US bonds. Faced with the choice of a stock market in terminal decline, or a risk-free return from US bonds of close to 10%, they took the 10%. Capital poured out of Japan into US Treasuries. Japanese companies became starved of capital and, therefore, growth options, and the stock market lost its mojo...for 25 years.
As Japan’s savings left the country, GDP stalled and at times went negative. Negative GDP for a quarter, or in bad times, two, is normal. But Japan saw negative GDP multiple quarters on the trot and in the late 90s for almost two years on the trot - not normal, in fact, almost unprecedented in modern economic history – see the periods shown in red below.
And the consequence of this economic bust and the flightof capital was that inflation disappeared and apart from the odd blip, has never really returned and from 1999 to the election of Shinzo Abe in 2012 they have battled constant deflation. Here is a chart of Japanese inflation before and after 1990. The Japanese have experienced something the West hasn’t yet experienced but is heading towards, deflation, negative inflation.
For anyone that lived through it you will remember Japan as the basket case of the financial markets all through the 1990s right up until Shinzo Abe became Prime Minister. He has now been Prime Minister for seven years and 60 days. Prior to his election Japan went through politician after politician after politician. Between 1990 and the election of Shinzo Abe they went through 15 prime ministers with an average lifespan of less than 18 months, with one lasting 64 days and others lasting 69 days, 263 days, 266 days, 358 days and 365 days. They were the political fall out of a failing economy and they took the blame after the Bank of Japan ran out of policy levers. Politicians tried all manner of fiscal policy to stimulate growth, including a Ruddesque cash hand out which did nothing. Every move failed and every election the voters looked for change and fell for yet another hollow promise.
Sidenote: Which only goes to prove that politics is all about money. Rich governments last a long time, poor governments get rhown out (even if its not their fault). An example would be the longevity of many (corrupt, immoral) European presidents and prime ministers during the pre-GFC period in which politicians borrowed into oblivion. And when the @#$% hiot the fan they quietly shuffled away to their chateaus and castles saying “Ce n'était pas de ma faute”. Another example would be the Howard/Costello government in Australia that lasted from 1996 to 2007. Heralded as political geniuses, the reality is that my grandmother could have run the country during the resources boom which showered the government with cash and ensured its re-election.
Back to G20 - The G20 might well listen to the Bank of Japan and the lessons Japan has learnt over the last 30 years. Western economies and Western inflation have become numb to the money printing and interest rate cuts and the longer it continues the more catastrophic the end game.
As the newswires report, an ageing population and technological advances (globally competitive pricing) prevent inflation from responding to even aggressive stimulus measures and the world’s most powerful central banks need a “deep rethink” - traditional policy, built for an inflation paranoid world, isn't working. Central banks need to rethink how they define their goal (low inflation is not it), and what tools they use to achieve that new goal.
'Avoiding deflation' would be the better goal at this point and the Japanese are the experts.
AND ANOTHER PROBLEMMarkets being ‘babied’ - From a stock market point there is an additional central bank problem building dangerously. It is nothing to do with economics, it is to do with the central bank attitude towards their financial markets. Since the US financial system’s brush with death in 2008 we have seen the emergence of a new post-GFC central bank priority - the health of the financial markets.
Never before (the GFC) did the central banks concern themselves with the financial markets. The markets were seen as just that, as “markets”, free and fluid, self-pricing and natural. Until the GFC the financial markets were the barometer of economic and central bank success, and at the same time they were allowed to be the barometer of failure as well. All that has changed.
Now the financial markets are being manipulated. Now, the Federal Reserve Chairs, from Ben Bernanke onwards (he oversaw the GFC) have molly-coddled the financial markets. Since Bernanke, central bank policy has taken into account the impact of policy decisions on the bond and equity markets. Bernanke started it and the concern has been perpetuated by Janet Yellen (who added the description of “Chicken” to Hawk and Dove) and now Jerome Powell.
The Federal Reserve, encouraged and now bullied by their new President, are treating the financial markets like a baby that cannot stand on its own two feet and needs constant attention and protection.
It is a dangerous cocktail.
Unfortunately, despite a few journalists suggesting it, it is unlikely that G20 have the time or urgency for a “deep rethink”. It would take a strong individual to take the lead. Jerome Powell is not the man. We can but hope that Christine Lagarde, clearly an intellectual, clearly a strong independent, has the vision to see the urgency of the problem and the clarity of purpose to solve it.
Without central banks changing their mindset we will continue to head towards deflation, zero interest rates and stubbornly low growth. And if that wasn't problem enough, at the same time this central bank molly-coddling will continuously inflate financial markets into a bubble that could precipitously burst.
We can but hope that at some point, some genius in the central bank structure, stands up, speaks their mind and changes tack.
Without that, we are investing on borrowed money and borrowed time.
The best thing that could come out of G20 is Christine Lagarde turning to Shinzo Abe and saying “Shinzo, tell us what to do”.
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