A comparison of bubbles and deflation in Japan and the US

- Lessons from Japan’s burst bubble and deflation
Concern over deflation in the US — There is growing concern that economic sluggishness and a declining inflation rate in the US will become protracted, just as happened in Japan. Compared with Japan, the damage caused by the bursting of the bubble in the US has been smaller as the bubble was far smaller. The response of the US government has also been more effective.
US housing bubble was small — In Japan, official residential land prices rose 88.0% during a five-year period from 1986 to 1991. In the US, land prices increased only 47.1% during the five years from 2001 to 2006, which is the reason why the aftereffects have been milder.
No stock bubble in the US — Between its low in October 1982 and its high in December 1989, TOPIX rose 5.5x, while the S&P500 increased only 2x between its low in March 2003 and high in October 2007.
Serious structural problems specific to Japan — The reasons behind Japan’s protracted low economic growth and deflation lie in the combined effect of two factors: (1) serious damage caused by the bursting of the bubble, and (2) a decline in Japan’s potential economic growth rate. The latter factor became a serious issue after Japan resolved its non-performing loans problem in 2004.
Factors exacerbating Japan’s bubble — A distorted shareholder composition and fragile corporate finances exacerbated Japan’s problems. The entrenched practice of cross-shareholdings magnified the impact of the bubble breakdown. The scale of the damage inflicted on corporate balance sheets resulted in excess debt becoming a long-term issue that dragged on until around 2004.
Differences in demographics and corporate sector competitiveness — We think the core scenario for the US will be a gentle decline in the economic growth rate and a low inflation rate. However, unlike in Japan, which has been hurt by an aging society and the weakening international competitiveness of the corporate sector, we see only a remote possibility of declining economic growth and excessively low inflation becoming a long-term problem in the US.
- Structural problems that prolonged Japan’s deflation
Macro factors — We think that demographics and fiscal deterioration had a large part to play as macro factors in the low growth rates Japan experienced in the wake of the collapse of the Bubble and in exacerbating and prolonging deflation. According to IMF forecasts, Japan’s government debt-to-GDP ratio is set to hit a lofty 222.3% in 2010, versus 92.6% for the US.
Large tax increases almost inescapable — We believe that big hikes in Japan’s consumption tax rate are all but inescapable because of the deterioration in the fiscal position. Consumer unease about social security and tax hikes is depressing consumption and keeping the savings of the elderly elevated. Homes where the head of household is over 60 have 60.7% of total savings.
Demographics — The US population has risen by 12.6% over the last decade, while Japan’s has risen by a mere 0.7%. Growth in the working-age population in the US is rapid and growth in the population under 15, the workforce of the future, is also firm.
Micro factors — The US overwhelms other countries in its international competitiveness in the craft of manufacturing. US corporations also boast impressive profit growth potential. Japanese corporations’ international competitiveness in manufacturing, growth potential, and profitability fell a long way after the collapse of the Bubble. Apple and Sony are good examples of this.
Japan’s manufacturing prowess on the wane — It used to be said that Japan was good at manufacturing but in contemporary high-tech fields such as computers, semiconductors, LCDs, telecom equipment, pharmaceuticals, and aerospace, Japanese firms cannot compete with giant overseas corporations.
US firms highly profitable — Of the world’s top 100 manufacturers (excluding energy firms) ranked by net profit in fiscal 2009, just five were Japanese. The top-ranked Japanese firm, Takeda Pharmaceutical, only placed 34th. There were 46 US firms in the top 100.
- Deflation in Japan and the US structurally different
Differences with Japan — The long-term downtrend in inflation rates is not a phenomenon peculiar to the US but something we have observed worldwide. We also note that cyclical factors specific to the US are pushing down the nearterm inflation rate. We do not believe that the US will experience long-term deflation, as its potential growth rate is higher than that of Japan.
Inflation rates falling globally — Inflation rates have been falling substantially in China—to an average of 1.9% in the first decade of the 21st century from 7.8% in the 1990s—and in India—to 5.6% from 9.5% over the same span. We think that global inflation rates have undergone a structural decline that has nothing to do with GDP growth rates.
Structural factors in common around the world — Growth in imports from emerging economies such as China and falling import prices have kept down the rate of goods price inflation in the US. Supply chain management has grown more sophisticated as IT costs have come down and technologies have spread. Falling prices for IT equipment have also had a considerable impact on inflation rates.
Cyclical factors unique to the US — In July 2010, the US core CPI was low, at 0.9% YoY. Rent, which accounts for 41.6% of the core index, fell 0.7% YoY. We expect rent to remain on a downtrend over the near term, depressing US interest rates.
No change in the uptrend for equities globally — Over the last year (as of August 17), the S&P Global Equity Index (ex Japan) has risen 10.6%, the US index 10.1%, the Europe index 8.9%, and the emerging index 19.0%. However, the Japan index has fallen 12.7%, battered by the strong yen.
Domestic-demand stocks may have the near-term edge — The S&P Global Equity Index PER (forward fiscal-year basis) has fallen to 9x, making us think that much of the concern has been priced in, as exemplified by the rapid decline in the US long-term interest rate. While yen strength and falling share prices may continue near term, we forecast a rally in Japanese equities from autumn.

No comments:

Post a Comment