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When considering a future of slow economic growth and low nominal interest rates, and particularly one that resulted largely from the bursting of a property price bubble and increasing debt levels, its natural to want to turn to the past 20 years in Japan to think about economic lessons for other developed countries today.
At the outset well concede that we dont think the United States is going down the economic path that Japan has traversed over the past few decades, as the U.S. holds several favorable economic and demographic tailwinds Japan lacked.
When we compare both U.S. and Japans core CPI and 10-year government bond yields, using an 11-year lag (U.S. beginning in 1991 and Japan in 1980), the metrics follow a remarkably similar trajectory. At the same time, the governments of both countries saw budgetary balances that appeared to be on similar paths, and the velocity of money in both countries economies (US beginning in 1995 and Japan in 1984) also followed a similar (downward sloping) path. On this latter similarity, both Japanese and US banking sector balance sheets were impaired largely by real estate-related holdings and today higher capital requirements and a higher cost of funding may keep money velocity growth muted for some time. Finally, as Japans asset price bubble deflated in the 1990s the countrys labor market saw a doubling in the use of temporary workers (to near 6.5 percent of the labor force), which then remained at this high level for more than a decade. The U.S. has also seen a marked uptick in the use of temporary labor (yet still only 1.9 percent of the work force overall) since 2009, and weve argued previously that this cost-containing measure may become a more permanent feature of our labor markets as well.
It is important, however, to not overstate the similarities between the case of Japan and that of the U.S., since there are some profound differences in their economic situations as well. Chief among these is the fact that the demographic profile Japan displayed in 1950, which served as an economic tailwind helping fuel its growth in the ensuing four decades, has faded and is projected to grow meaningfully worse in the decades to come. In contrast, the population dynamic in the U.S. is much stronger, and arguably the country has one of the best demographic profiles in the developed world today (see Figure 1). Another notable difference is the strength of the corporate sector in the U.S., which still displays high degrees of technological innovation, strong new business creation, and a productive and mobile workforce relative to many developed market peers. For instance, this strength is shown by comparing aggregate corporate return-on-equity by region, which stands near 17 percent for the U.S., 12 percent for Europe, but only 6 percent in Japan.
Figure 1: Percent Cumulative Labor Force Growth (ages 15-64)
More Favorable for the US
Source: Deutsche Bank
Additionally, in the U.S. we appear to have found a nascent floor in both commercial and residential property prices, unlike Japan real estate prices, which continued to show declines even more than a decade after their peak. Moreover, both the financial and non-financial corporate sectors deleveraged more rapidly in the U.S. case, and many of these firms have also termed-out their debt maturities to mitigate near-term bouts of market illiquidity. The corporate sector in the U.S. has also responded to the economic slowdown by getting leaner and more productive, while Japanese firms never really responded to their countrys own malaise in a comparable manner. Thus, while we think the U.S. is in store for quite slow near-term growth, and the autumn election and looming fiscal cliff add meaningful uncertainty to even this modest growth; the evidence points toward the country avoiding a multi-decade period of stagnation resembling the experience of Japan. Unfortunately, as we shall discuss in the next installment of this article, the Eurozone may not be able to escape this fate.
Rick Rieder is BlackRocks Chief Investment Officer of Fixed Income, Fundamental Portfolios.
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