Right now, Japan is the most interesting and entertaining market in the world. Its market has risen more than 80% since last November, after newly-elected Prime Minister Shinzo Abe promised to end two decades of crippling deflation with a doubling of the monetary base, American-style QE fiscal stimulus and structural economic reforms including deregulation of key markets and corporate tax cuts. Some pundits talked about a resurgent Japan on the global stage, and investors were buoyant right up until the Nikkei average plunged 7.3% in one trading day last month, and lost 20% over subsequent trading days.
The world’s third-largest economy is certainly due for a recovery after its markets plunged from almost 39,000 at the peak in January, 1990 to a low of 7,562 in February, 2009. The market has scraped along the bottom until the month before Abe’s election, and has recovered on the promise that the government finally has a formula for making the prices of ordinary consumer items rise rather than fall. Falling prices discourage people from buying–since it makes sense to wait for a lower price in the future–and therefore stifles growth and economic activity.
The deflationary environment that Japanese consumers have lived in will seem strange to anybody living in the U.S. A recent report in the New York Times tells us that people in the 1980s could buy soda in the ubiquitous Japanese vending machines for 80 yen (roughly 80 cents) back in the 1980s. That’s the same price you would pay if you visited a discount vending machine today. By contrast, the two liter bottle of Coca Cola Classic that you can no longer have delivered with pizza in New York City costs roughly $3.00 today, up from $1.19 in 1981.
Of course, those same Japanese consumers are also getting just 0.29% on their five-year government bond investments–and if government intervention triggers inflation and subsequently drives up those bond rates, things could get interesting in a hurry. Japan’s gross public debt is projected to hit 230% of its GDP by 2014, and this is sustainable only if the government is paying next to nothing to its bondholders.
Can Abe simultaneously navigate structural reforms through the maze of vested interests in the cozy Japanese political system, raise inflation without raising bond rates, and cut taxes on faith that it will raise economic activity and bring in more revenues? Japan may well be the next great investment story in the world, or we may be watching the latest interesting round of futility in a track record going back more than two decades.