Inside investment: Turning Japanese?
Demographics are the forgotten dimension of investment. The experience of Japan suggests we should pay more heed.
Next month Queen Elizabeth II will celebrate her 88th birthday. By the end of 2015 she will be the longest-reigning British monarch, outstripping her great grandmother, Victoria. It is a good job that she remains in robust health. In 1960 the Queen sent letters of congratulations to 592 centenarians in the UK. This year there will be around 13,000 cards despatched from Buckingham Palace; by 2060 the Department for Work & Pensions estimates that there will be 455,000.
The longevity of the British monarch and her subjects, and the increasingly onerous nature of the letter-writing duties both entail, is just one illustration of an unfolding demographic revolution. People are living longer all around the world. During the baby-boomer years population growth and longer life expectancy was an economic win-win. The dependency ratio – the number of people of working age paying taxes to support those of school age and in retirement – was stable.
Now ageing has gone global. Japan and Germany, with more than 20% of their populations above the age of 65, are in the doddering, grey vanguard. Japan’s overall labour force began to shrink in 1998. That was nine years after the Nikkei 225 peaked. The ludicrous overvaluation of the Japanese equity market in the 1980s coincided with a period in which its population was at the prime age for wealth accumulation and risk-taking. The middle-aged want to save for their retirement, but like growth assets because they do not yet need income.
Intriguingly, 1998 was also the first year of full-blown deflation in Japan. Demographics might also help to explain another enduring investment puzzle. When the stock market peaked in 1989, Japanese government bondsyielded 8%. Short JGBs has been a pain trade that has threatened the careers of many macro managers since. It looks like a no-brainer: by any conventional measure, Japan should be bankrupt. The debt-to-GDP ratio now stands at over 220%.
Until the mid-1990s, Japan’s debt levels were broadly in line with its G7 peers. Fortunately, its ageing population are happy to buy all those JGBs. The elderly consume less and if prices are declining, any real yield, however scant, is wealth enhancing. Some of these pensioners were also lucky enough to get out of the equity market before 1990.
There is a stable disequilibrium. Japan’s debt looks unsustainable. But Japan’s ageing population thinks that JGBs are great and the over-65 population will double in the next 20 years. Sharp-elbowed global bond vigilantes own less than 5% of Japan’s debt. They are neutered wallflowers at the Darby and Joan club’s JGB jamboree.
A stable disequilibrium
Against this backdrop, the efforts of prime minister Shinzo Abe to engineer inflation and growth by doubling the monetary base are both economically and politically bold. If inflation exceeds the level of JGB yields, Japan’s old and wealthy, reliant on their bond-heavy postal savings accounts, will not be happy.
A report card for Abe’s three arrows– monetary and fiscal stimulus plus structural reform to boost productivity – would currently read: ‘So far, so OK.’ Deflation has been reversed and animal spirits revived. In 2013 the Japanese stock market index recorded its biggest annual return since 1972. However, Abenomics is just a turbocharged version of a policy mix that has been tried before. Japan had a zero interest rate policy coupled with quantitative easing two chair (persons) of the US Federal Reserve ago and its fiscal largesse is one reason why its debt-to-GDP ratio has ballooned.
The general government balance has averaged -6.6% over the past 20 years, but aggregate demand has barely budged. It is far from clear that Japan has had inappropriate monetary or fiscal policy. Productivity levels are broadly in line with the rest of the G7, although female participation in the workforce is modestly lower. Debt and deflation might be the bedfellows of demographics.
This might not be an exclusively Japanese phenomenon. Two of the biggest asset bubbles in history – the dotcom debacle of 2000 and the credit crisis of 2007 – had their centre in the US. This was when the largest cohort of the post-war baby-boom generation was aged between 40 and 55 and most likely to be accumulating wealth and buying risky assets.
In terms of the percentage of the population over the age of 65, the oldest countries after Japan are Germany, Italy, Greece, Portugal, Austria, Belgium, Spain and France. All of these countries are in the eurozone. Inflation in the euro area is less than half the European Central Bank’s 2% target. But ECB president Mario Draghi still insists: "We do not see much of a similarity with the situation in Japan in the 1990s and early 2000s."
History does not repeat itself, but it very often rhymes. In demographic terms, Europe is already turning Japanese. Those elderly Germans, having had their fingers burnt by the Neuer Markt in the 1990s, are also likely to adopt Japanese-style savings habits. European government bond yields might fall further, credit bubbles could get frothier and the ECB’s monetary policy is likely to get more experimental.