How Contagious Ought Japan’s Crisis Be?

March 17, 2011

One would think from watching global stock exchanges over the past week that everyone’s fate hinges on Japan’s.  After all, Japan is the third largest nation-state economy in the world, having only recently been displaced from the second slot by China. 

For the past two decades, however, Japan has lacked the dynamism that built it into the world’s second most powerful economic engine.  So high was the norm for Japanese economic growth in those postwar years that until 1990, a different definition was utilized to characterize a recession in Japan, that being any period of a half year or longer when GDP expanded more slowly than a 3% annualized rate.  By comparison, real Japanese GDP grew just 1.1% per annum over the last 21 years between 4Q89 and 4Q10.  Global growth didn’t collapse as Japan underwent this very negative metamorphosis.  Even in the United States which has some similar problems to those that felled Japan, growth in the past 21 years averaged 2.5% per annum versus 3.1% annualized during the previous 21 years.  Japan’s reinvention as a slow-growth economy partly reflects the topping out of its population, a factor not found in the United States or many emerging markets.

Japan’s story can be seen in three key financial trends:  the Nikkei-225 stock index, the yield on 10-year government bonds, and dollar yen.  At the end of 1989, they were respectively at 38916, 5.72%, and 143.70.  They are now at 8963, 1.21%, and 79.09.  Over the intervening period between then and now, these vital Japanese market signs averaged 15978, 2.55%, and 113.69.  It is Japan’s misfortune to have remained a chronic excess saver through two decades when it experienced deficient nominal growth.  Japan’s current account surplus in 1989 equaled 1.9% of GDP, and it appears likely to run between 3.0% and 3.5% of GDP both this year and next.  Japan is a chronic exporter of capital, and the low level of domestic interest rates and share prices has raised the incentives for Japanese to deploy wealth in higher-yielding other countries.  That dynamic mitigated but did not stop the yen from appreciating, and now some of that overseas wealth is needed at home, so the yen faces new upside risks.  

The table below documents for each calendar year since 1990 the highs in the yen against the dollar, lows in the 10-year JGB yield, and lows in the Nikkei index.  The figures paint a picture of relentless weakness.  The rest of the world has had two decades to adjust to a different kind of Japan.  The earthquake means weaker Japanese growth in 2011 than would have occurred otherwise but stronger demand in 2012.  The immediate period ahead will be just another chapter in a long saga of economic under-performance.  And plausibly, Japan might post stronger two- or three-year economic growth than would have been the case before the quake changed history.  The long-term prognosis is of course guarded because of mounting Japanese fiscal strains and the aforementioned demographic headwinds.  Japan’s problems shouldn’t infect the rest of the world economy anymore than they did in the nineties or noughties.  Investors need to bear in mind that whereas the Nikkei is just 26.5% above its March 9, 2009 level, the Dow Jones Industrials, S&P 500 and Nasdaq show net advances for the same period of 79.5%, 88.0%, and 107.8%.  Likewise, the British Ftse and German Dax are 60.8% and 80.3% higher now than then.

  USD/JPY Low 10Y JGB Low, % Nikkei Low
1990 123.7 5.36 20,222
1991 126.1 5.43 21,457
1992 118.6 4.52 14,309
1993 100.4 3.01 16,079
1994 98.55 2.98 17,370
1995 79.85 2.50 14,485
1996 103.15 2.34 19,161
1997 110.60 1.58 14,775
1998 111.75 0.67 12,880
1999 101.25 1.23 13,233
2000 101.35 1.54 13,423
2001 113.60 1.04 8,062
2002 115.45 0.91 8,197
2003 106.92 0.44 7,604
2004 101.83 1.20 10,299
2005 101.67 1.18 10,789
2006 108.97 1.42 10,661
2007 107.23 1.41 14,838
2008 87.15 1.17 7,163
2009 84.83 1.20 7,055
2010 80.25 0.83 8,824
2011 76.36 1.16 8,605

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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