Blain’s Morning Porridge – July 23rd 2021: To predict Europe’s future read some Japanese history..
“Our propensity to delay difficult and weighty decisions has been hurting our economy.”
This Morning – The ECB has tweaked the words and now has low interest rates forever, and a new mandate to “tolerate” higher inflation. What will it achieve? To answer look at the failed 30 year experiment in Japan and the multiple parallels. The outlook for Europe as a global economic and innovative powerhouse looks shaky.
After yesterday’s ECB strategic review approval, it’s time to address Europe – and ask the obvious question… What is wrong with Japan?
Since the Nikkei Bubble burst in 1990, Japan has slunk through 3 decades of deflation. Despite the very best efforts of the authorities to blow the Olympics – which kick off today -, we will see it’s a highly cultured, consensus driven and apparently successful economy. But there are serious issues.
It’s hardly dynamic. Japan’s corporate mindset (with a few notable exceptions) is stale, uninventive, inward looking and hidebound. Its consumer sector is lethargic at best – why buy today, when you can buy cheaper tomorrow? Consensus avoids the conflict inherent in solving the basis economic problems. Young people see little point in trying to find partners – the perception is girls spend their salaries on fashionable fripperies, while young men have better relations with their computers than the opposite sex. It remains the 4th largest economy but is destined to become the first major economy to fade into the democratic sunset.
Yet, in the 1980s the Japanese market was the place to be.
It was vibrant. It was exciting. Japanese companies were cool and were going to take over the world. The Emperor’s Palace in Tokyo was worth more than California. The Nikkei was headed into the stratosphere (certainly higher than Branson got on his not-quite-a-spaceplane). I was working at a Japanese bank and I’ve still got great mates from that period. We were writing levered puts on the Nikkei at 40k… but when it crashed.. it crashed.
Since 1990 the Bank of Japan and government have struggled to inject energy back into the economy. 30 years of ultralow BoJ interest rate policy has really, really not done much for Japan. Abeonimcs and other multiple attempts to reform and jog the economy and corporate culture out of its somnambulance has achieved the square root of a very small number. The culture, formality and red-tape of Japanese business and a general lack of entropy characterises Japan’s economic non-recovery.
Why?
The once mighty JGB (Japan Government Bond) market has become an irrelevance – the BoJ holds over 50% of issuance via its QE programme and has resolutely kept rates at zero for decades. The result is an utterly stagnant government bond market.
Government bond markets are critical for a functional economy. Japan’s experience illustrates a critical point; for a market economy to thrive it requires an effective and freely determined government bond market providing a widely accepted market risk free rate. Japan illustrates that a market set rate is a critical element for any economy to function optimally.
An efficient market setting interest rates, (as opposed to a government determined yield set too low – which is what all these experimental monetary policy initiatives have done), gives spenders and investors an accurate level to set their discount rate against investment decisions for both corporates and individuals.
If you know interest rates are too low… borrow trillions and spend on non-economic goods like buybacks. If you know the economy is deflating because rates are too low.. why purchase capital or consumption assets? Japan illustrates a key rule: setting interest rates too low has consequences – lots of them and most of them bad. Setting interest rates too low has all kinds of distorting effects across the economy.
Let’s jump the 9300 km from Tokyo to Frankfurt and do a quick compare and contrast..
Back in Yoorp..
The ECB seems determined to repeat the Japan experience across Yoorp. The ECB’s much awaited strategic review tweaked a few words, yet effectively changed the bank’s mandate from monetary stability to interest rate repression for eternity. Sounding familiar?
Strip out all the verbiage, all the analyst cack about “forceful forward guidance” (whateverTF that means), and the ECB language… but what Christine Lagarde successfully pushed through the ECB (past objections from Germany and Belgium) is a programme that predicates ultra-low interest rates for ever. I could quote the Einstein rule about doing the same thing expecting different results, but boosting the same monetary stimulus policies that have singularly failed to stimulate any meaningful boost to economic activity across Europe for the last 8 years seems pretty darn pointless.
I was a European – I’d be screaming! The ECB’s new “persistently accommodative policy stance” will require policymakers to remain “tolerant” of inflation – even when it overshoots the new 2% target. Which means they expect inflation and will roll with it – whether there is growth or not. Europe’s prime concern isn’t growth, but protecting its single market.. with loads and loads of rules and regulations to create a single market. Recognise this?
The ECB may see some inflation, but it won’t be the right inflation. As I’ve discussed a number of times recently, serious inflation is going to be triggered by supply shocks, natural disaster costs and host of other non-economic factors. The inflation Yoorp should be nervous of is cost and wage driven inflation, which occurs when the economy overheats. But, there is as much chance of European economically overheating as there is of heat stroke at the South Pole.
Instead, Europe will head down the null-entropy Japanese route – too low an interest rate actively discouraging capital investment and consumer spending. Unlike Japan, Europe is not heterogeneous – each nation will respond and evolve different, further emphasising within Europe it’s the differences that divide them that actually matter.
At this point I could try and delve into a serious examination of how different individual and corporate behaviours across Europe will play out… but where would the fun be in that? Forgive me for being a bit stereotypical about my European chums, but think along these lines:
- Artificially low interest rates is great news for Germany – the land of the Engineer lacks the imagination to do anything else except spend more on better factories and machines to build more very good German stuff.. which generally the world wants. Germany gets rich – which is great because they have to pay for the rest.
- The Italians see low rates as an opportunity to take more money from Brussels to do whatever Italians do with money… which generally isn’t improving their Economy.
- The French will herald low rates as key to improving their economy, by borrowing lots of money to employ more bureaucrats, cut the pension age, and then sparking protests from angry country folk with pitchforks or intellectuals hanging around arty cafes smoking Gitanes, both complaining interest rates are too high…
- The Spanish will anguish about Youth jobs not being created, and watch their young people emigrate to the UK to snap up fantastic barrista and short-order chef positions in Europe’s growth centre – the UK where prime minister Michael Gove has opened the borders to them…
Sorry if I sound flippant on Europe’s growth prospects, but Christine Lagarde’s success was not one of economic genius, but in doing a politicians job getting all the member nations to agree on the new programme. Well done – but that doesn’t mean it will work.
Five Things To Read This Morning
Torygraph – Bank of England cannot stop inflation surge, says Broadbent
FT – Thermal coal prices soar as demand for electricity rebounds
Bberg – Young Talent Isn’t Following the Money to Wall Street
WSJ – Fed Ramps Up Debate Over Taper Timing Pace
Out of time, back to the day job, and have a great weekend!
Bill Blain
Strategist, Shard Capital