I continue to observe the Japanese markets with interest, not because I am heavily invested there, but because I continue to be concerned with how the “Japanese experience” may foretell trends that could occur in the U.S.
Japan has been caught in a dreadful bout of asset price deflation for more than 20 years. Deflation is the trend of assets, particularly stocks and real estate, losing value over time. Asset price deflation saps prosperity and leads to lower living standards.
Japanese deflation has involved two important financial paradigms, interest rates there have been at super low levels (below 1 percent) for a long time, and Japanese stocks are currently valued at roughly 40 percent of their value in 1990, making it virtually impossible for many Japanese families to create wealth and achieve financial goals.
Economists properly point out many differences between the U.S. and Japan as societies, and why these differences may lead us to a different and better future. An economy needs human beings in order to grow and the Japanese as a society are aging quickly, have low birth rates and not permissive of immigration. None of these factors apply to the U.S. which is a good thing.
Like Japan however, financial wealth in the U.S. is concentrated in a large aging segment of our population, the baby boomers. As a population ages it tends to become more risk averse and less prone to invest in stocks or real estate. Also like the Japanese government, the U.S. federal government is heavily in debt. Over time this high debt level is likely to create a drag on overall investment and growth in our economy.
What concerns me is that in an effort to reverse the deflation trend, the Japanese Central Bank is conducting a program much like the money printing, bond buying program being run here in the U.S. by our Federal Reserve called Quantitative Easing (QE).
The Japanese QE program inspired a huge stock market rally in Japan, driving markets higher by 80 percent from December 2012 to early May. Since early May, however, the Japanese stock market has sold off by over 20 percent as Japanese investors continue to expect and demand more and more QE as every weak economic number is met by a desire for monetary stimulus.
As these demands grow more intense, I believe the effectiveness of the overall policy is reduced. Like an addict, markets simply cannot get enough easy money to satisfy an irrational craving.
U.S. investors are also caught in this addictive trap, displayed Wednesday when the stock market sold off by nearly 1.5 percent simply because our Fed chairman reminded investors that the Fed’s QE program would someday, but not soon, end.
QE is an unconventional and aggressive policy. It is also one of the last tools in the monetary tool box. If these policies become ineffective due to irrational expectations, I don’t know what comes next. The real question is: does anybody?