A recent survey of fund managers found that whilst they are generally very optimistic about global markets — even more than fund managers normally tend to be – when asked about what their main concerns are, it transpired that their focus had changed. No longer was Europe regarded as the primary threat to the world economy, although it remained a problem. Rather, and pushing aside the PIIGS as the bogey-countries, the new threat identified by the money guys was a two-headed monster on the other side of the world.
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Not that long ago, only good things could come from East Asia, or so it seemed – but no longer. True, to say that Japan is a problematic place is not news, but people have gotten used to that idea. However, the potential for Japan to ‘go off the rails’ – in simple terms, for the once-mighty Japanese economy to actually collapse – is now one of the major issues that has come to the fore in recent months, the survey found. Indeed, that is hardly surprising and any finding other than a tendency on the part of money managers around the world to lose sleep worrying about Japan would have been extraordinary and would have reflected gross complacency on their part.
After all, economists and analysts have followed, mostly with amazement and horror, the formulation and implementation of the new Japanese government’s policy to break the country’s deflationary spiral by massively increasing the money supply and deliberately seeking to create inflation. The good news, from the viewpoint of Prime Minister Abe and Bank of Japan Governor Kuroda is that the latest data show the policy is having the desired impact. GDP rose much more than forecast in the first quarter of this year, as consumption jumped — suggesting that the general public was getting the message and understood that it needed to get out and spend, because prices were going to go up. Indeed, the slumping value of the yen on the one hand and the soaring prices of shares on the Tokyo Stock Exchange on the other are strong signs that the program is creating both the motive — higher inflation — and the means — capital gains — for people to spend more.
However, the bond market is also aware of what is afoot and its response has not been so helpful. After an initial slide when the program was announced, prices of government bonds stabilised for a while, but over the past week the slump in their value has recommenced. Prices crashed across the board and yields soared — ten-year bond yields jumped from 0.58% to over 0.9% in a few days –obliging the central bank to intervene by pumping an additional slug of money into the markets, thereby achieving at least a temporary calm. But is it clear that Japanese institutional investors are now selling domestic bonds and sending money overseas. Since the Japanese government is running a huge budget deficit — most of its expenses are paid for by borrowing and only a minority by actual government revenues –any rise in yields makes new government borrowing more expensive and brings the country nearer the point where the government will no longer be able to obtain new loans to repay the old ones. That is what is known as bankruptcy, and if it is a real threat to the third biggest economy in the world, that is surely grounds for concern.
Meanwhile, just across the water, China continues to disappoint. The great fear here is that the Chinese economic miracle, which has plainly run out of steam, is being neither replaced by an alternative source of rapid growth, nor renewed by extending the old invest-and-export model. The result is that the economy is slowing and that the slowdown becomes a self-reinforcing process, so that the news is full of analysts reducing their growth projections for China even further. Of course, any developed economy – and many developing ones too – would be delighted to achieve the ‘reduced’ growth rates now expected for China, of 6-7% per annum. But the Chinese economy and the Chinese people are used to a double-digit pace of growth and have not yet adjust to the 7-8% level of the last year or two, so that a further markdown must mean further dislocation.
Ironically, whilst fewer and fewer Western analysts and investors believe that ‘Abenomics’ can succeed in Japan, or that the Chinese economic miracle can keep going, they hope and pray fervently that they will be proven wrong on both counts.