Earlier this week, Japan released its preliminary third-quarter gross domestic product (GDP) figure.
According to Bloomberg, the median economist estimate was 2.2% quarter-over-quarter annualized growth. The lowest estimate was 0.8%. Out of 21 “qualified” economists, not a single one predicted a negative quarterly figure…
Yet Japan’s actual third-quarter GDP number was -1.6%.
This marks Japan’s second-consecutive quarter of negative growth, which meets the technical definition of a recession.
It seems incredible that 21 economists could be completely unaware of a recession in the world’s third-largest economy.
But what if they weren’t allowed to forecast the truth…
In reality, economists at investment banks and securities firms aren’t paid to be correct on the economy – they’re essentially just glorified marketers.
The true role of a sell-side economist is supporting the firm’s institutional asset management and private wealth management businesses.
Think about it: Their clients own risky assets, some of which have been bought on the firm’s recommendation. And in the case of Japan, no one wants to hear that it’s a mess because everyone is long Japanese equities.
As philosopher Friedrich Nietzsche supposedly said, “Sometimes people don’t want to hear the truth because they don’t want their illusions destroyed.”
And that’s just what the economic resurgence in Japan is… an illusion.
Some Bad Math
You see, for an economy to grow over the long term, it needs productivity growth and labor force growth.
Since productivity growth is slowing in Japan – as it is in most developed economies – labor force growth is necessary. This is basic math, not advanced econometrics.
Unfortunately, Japan is facing a deficit of children. That means fewer kids who will grow up and become members of the labor force.
Yet everyone seems to love Japan, despite worrisome long-term trends and the fact that its economy has now experienced four recessions since 2008.
According to Bank of America’s monthly global fund manager survey, allocations to Japanese equities have jumped to an eight-year high.
Investors are convinced that Japanese stocks are cheap due to the country’s lengthy malaise (though that’s not really true). What’s more, people seem desperate to believe that central bank stimulus does more than boost financial asset prices and facilitate debt issuance, despite evidence to the contrary.
In the end, though, those touting an economic resurgence in Japan will continue to be wrong.
They’re either “talking their book” (meaning they, or their clients, are overweight Japanese equities), or they’re completely blind to the debt dynamics and demographic factors.
Japan’s experiment shows that central planning doesn’t work.
Monetary stimulus – zero interest rates and quantitative easing – may boost the stock market and weaken the currency, but it doesn’t benefit the real economy or lead to higher wages.
In Japan, renewed economic weakness will likely force Prime Minister Shinzo Abe to delay a further consumption tax increase. According to Fitch, a major ratings agency, a delay in the tax hike is a “significant development.”
Basically, Japan’s sovereign credit rating will be downgraded. Credit default swaps on Japanese government debt are already showing an increase in default probabilities, rising to the highest levels since October 2013 (five-year CDS).
Bottom line: Japan will have a sovereign debt crisis.
The market will lose all confidence in the yen, inflation will rage, and Japanese interest rates will eventually spike. Of course, few Wall Street economists or strategists believe a Japanese debt crisis will – or even can – happen.
But even if they think a funding crisis in Japan is a possibility, don’t expect them to admit as much in public. That would mean having to be honest with clients.
Safe (and high-yield) investing,
Alan Gula, CFA