Japanification of the Global Economy

Over night the stock markets around the world declined 10% – a big number for the major markets. Many are citing the COVID-19 virus crisis induced disruptions as the main reasons for this panic in the financial markets.

If the global economy was healthy and had economic policy bullets left coming into this crisis, perhaps the current market behavior can be described using words like emotional, psychological, or over-reactions.

However, just like how virus is devastating to weak and unhealthy, the global economy was showing signs of policy fatigue and imbalances coming into the virus crisis. The financial markets are saying that the “emperor has no clothes” or that the global economy is fragile.

The virus crisis is forcing markets to analyze and price in the state of the global economy 10-plus years into the free money world. This sudden Japanification of the global economy is rattling the financial markets.

Welcome to the lost decades everyone.

The Lost Decade(s)

I remember how people described the 1990s as the lost decade for Japan. After many robust years where the world focused on learning how Japan got it right, there was this sudden economic malaise.

Record low interest rates and significant deficit and debt-driven government spending were touted as the right remedy to restore the lost mojo for the Japanese economy.

Well two decades after the lost decade, Japan’s economy is still struggling. Now the interest rate is negative and the public sector debt to GDP is at 400%, yet the once almighty Japanese companies are declaring bankruptcy and the economy is still fighting deflation and no growth.

The lessons from the lost decades of Japan for the rest of the world are that low interest rate and large fiscal deficit spending are no longer effective policy tools in today’s global economy.

Yet this is precisely what every country did over the past 10 years to overcome the shock of the Great Financial Crisis in 2008.

To be more precise, Japan gave the world empirical evidence that the debt-financed fixed-asset expansion (capacity, infrastructure, and property) is a false growth that transforms into a devastating liability without matching improvement in the aggregate demand.

Yet, the global economy is already at a zero interest rate and 10 years into a massive fixed-asset expansion. No wonder the markets are freaking out.

We Built It but They Didn’t Come

When you have near-zero cost of capital, funny things happen. Every marginal project becomes viable and looks profitable. So what if for that 5% increase in marginal demand, 10 companies that increased capacity to capture that demand increases at the same time.

You end up with an excess and idle capacity. Well this is kinda what happened.

We are now living in an over-capacity of everything (manufacturing, services and, distribution of both). No wonder there is deflation even with zero interest rate. We have been measuring the capacity expansion as economic growth. The set up today and the cloudy outlook suggests that what was an asset can switch into a liability quickly.

If this is what financial markets are looking at, we might be in for a longer rough patch.

Bad News for Politicians—No More Quick Fixes Available

People will analyze and write about how got here for many years to come. A simple answer is that people wanted a painless world now and politicians gave them the pain killers. In retrospect, what they did is just buy time and borrowed from our children to finance it.

In the near future, an extreme view will get an audience, and a new globalization will mean “me first” rather than cooperating. Before the dusts settle, there will be much noise on who to blame and how the new ideas can make the global economy grow again and make us feel good and safe again. Don’t be fooled by it.

Thirty years into Japan’s lost decades, they have not found a solution yet. Finding solutions may not mean making people feel better but making people feel less bad.

This is a very bad news for politicians-especially in the countries with no more useful policy bullets left (Japan and EU). Oh, and by the way, this virus crisis will give another demand shock to the global economy that was struggling already with an over-supply of everything relative to demand. It looks like other than toilet paper, demand will shut down for a while around the world. It is one thing we could not afford to have.

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David Chon is a Korean-American from New York working in Hainan. He has over 30 years of global finance and investment experience. He is currently investing in businesses in China.

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