ARGENTUS OUTLOOK
THE
INVESTMENT SOLUTIONS THAT FIT TODAY’S GLOBAL ECONOMY
Thinking About Lost Decades: Japan’s and (Maybe) Ours
February 2014 • Volume 3, Issue 2
Small Talk By W. Michael Cox and Richard Alm • AWOL investors. Stock markets have been
By the 1980s, Japan was a burgeoning economic on a roll lately, with the S&P 500 rising superpower, thought to be on its way to dominating the 11percent in 2012 and 32 percent 2013. A lot of Americans made money—but many global marketplace. The country’s startling rise led to a others stayed on the sidelines. According spate of books and articles urging the United States to be the Gallup surveys, the share of Americans more like Japan. Today, there are signs that may indeed be investing in the stock market, either directly happening—but not in a way Americans should celebrate. or through retirement accounts, stood at 52 percent in 2013. Before the financial crisis With the paeans still echoing, Japan saw its economic and recession of 2008-09, the figure was miracle run aground after 1990. Now, Japan is slogging above 60 percent, topping out at 65 percent through its third lost decade, with anemic economic in 2007. After the tech bubble burst in 2001, growth and stagnant living standards. Despite a surge in stock market participation dipped but quickly 2013, Japan’s Nikkei stock market index ended the year bounced back. The financial crisis and 58 percent below its all-time peak, reached on the last recession have apparently left deeper scars. trading day of 1989 (see chart below ). • Who do we owe? When the fiscal year ended As the Nikkei sank, the Dow Jones Industrial Average on September 30, the federal government’s (DJIA) soared, reaching record levels in the waning days debt exceeded $16.7 trillion, up from $16 of 2013. For many, stock prices suggest that the United trillion a year earlier. According to a new U.S. Treasury breakdown, some big holders States isn’t yet in the doldrums that have entrapped Japan. of U.S. debt saw their shares shrink—for Looking deeper, however, we see some disquieting example, U.S. individuals and institutions, the similarities that raise questions about whether the United Social Security Trust Fund and many foreign States has entered its own lost decade—or, worse yet, countries. China’s share rose a bit. The biggest lost decades. Investors may view the similarities as a sign gain, however, came in the Federal Reserve’s share. It went from 10.8 percent to 12.8 pointing to prolonged stagnation in the United States, or percent—due to the expansive purchases of securities under the central bank’s policy of quantitative easing. The Fed purchased 58 Stock Market Peaks: Japan’s Nikkei in percent of all new debt in fiscal year 2013. Index, January 1980=100 • Companies leaving. Newly merged Fiat and Chrysler decided in January to become a British resident for tax purposes. Activis, a pharmaceutical company, left New Jersey in October to reincorporate in Ireland. All told, 13 U.S. companies have completed or announced relocations to lower-tax countries in the past two years. Both Democrats and Republicans have proposed reducing the U.S. corporate tax rate—now the highest in the world at 39 percent. The U.S. has maintained this rate for more than 25 years. During that time, other countries cut their rates; now, the Organization of Economic Cooperation and Development average is 25 percent.
they may decide the differences between the two countries will allow the United States to escape Japan’s fate. Losing dynamism Japan’s per capita GDP grew at an annual average of 5 percent from 1960 to 1991, producing East Asia’s first miracle economy, the China of the times. Over the next 22 years, though, Japanese per capita GDP growth bogged down, averaging less than 1 percent a year. The dismal performance led to talk of Japan’s lost decades. The United States had its ups and downs from 1960 to the end of 2007—but per capita GDP grew at an average of 2.6 percent a year, good for a mature developed nation. In the past six years, through a steep recession and weak recovery, U.S. growth has been essentially flat—and total employment has yet to return to its pre-recession levels. America is now more than halfway through a lost decade. In its lost decades, Japan has been working less. Employment as a share of the population fell from 64 percent in 1999 to 58 percent in 2013 (see chart next page ). Since 1988, the average workweek fell by more than seven hours; now, a typical Japanese puts in fewer hours than an American. Continued on page 2
1989, America’s Dow in 2013
1600 Dow Jones Industrial Average
800
Nikkei 225
400
200
Fed Watch and Chart Topper: Page 3 100
50 1980
1984
1988
1992
1996
2000
2004
2008
2012
Source: Nikkei Inc., CME Group
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Continued from page 1
Americans are working less, too. The employmentto-population ratio fell from 62 percent in 1992 to 56 percent in 2013. Most of the unemployment rate’s decline in the past four years has come from decreasing labor force participation, not job creation. In its lost decades, Japan has used government largesse as a substitute for productive work and regular paychecks. Social spending as a share of GDP climbed from 11 percent in 1989 to 22 percent in 2013 (see chart below ). The United States has been doing the same, with its social spending ratio rising from 13 percent to 20 percent of GDP since 1989. In its lost decades, Japan paid for bigger government by borrowing to the hilt. Its debt-to-GDP ratio rose from 66 percent in 1991 to 243 percent in 2013, the highest among developed countries (see chart below ). Since 1988, America’s debt ratio has more than doubled, reaching 102 percent of GDP in 2013. It has now crossed the 90 percent threshold where debt becomes a drag on economic growth. The data reveal other similarities. Both countries had massive, destabilizing real estate bubbles—Japan in commercial property in the 1980s, the United States in housing in the mid-2000s. Both countries expanded government’s regulatory role. In both countries, a weak economy has kept consumer price inflation surprisingly low, even in the face of extraordinarily loose monetary policies. Similar policies, too Trying to revive slack economies, politicians in both Japan and the United States have turned to expansive fiscal and monetary policies. Their governments are running huge deficits. Their central banks have pushed interest rates to rock-bottom levels.
All the so-called stimulus hasn’t stimulated much. Japan has kept its central bank’s lending rate at less than 1 percent since 1995. It has quadrupled the national debt by spending on infrastructure and social programs. Low interest rates and big deficits haven’t revived the U.S. economy either. Yet, governments in both countries persist in the delusion that stimulus will work—a policy parallel that most likely helps explain many of the unfortunate similarities in economic performance. Neither country has been willing to try a heavier dose of capitalism as a remedy for economic malaise. The Economic Freedom of the World report measures the degree to which 144 countries allow markets and individual choice to guide their economies. Japan ranked No. 11 in 1990 but tumbled to No. 32 in the ensuing two decades. The United States stood second in the world in economic freedom in 2000; it sank to No. 19 in the latest reading. A final thought. Japan and the United States are different in ways that could affect the trajectories of their economies. The United States is more individualistic, diverse, optimistic, entrepreneurial, and open to change. Our country is becoming energy-rich again, thanks to “fracking” technology. Japan faces a rapidly aging population. Rigidities still beset its labor market. We shouldn’t ignore these differences. Nor should we use them to concoct scenarios where the lessons of Japan don’t apply to the United States. The most important lesson, of course, centers on the futility of Keynesianstyle economic policies. Already halfway through one lost decade, America can escape the fate of Japan by curtailing government and freeing the private sector to produce growth, jobs and wealth.
On Similar Paths: Working Less, Spending More, Going Deeper Into Dept Social Spending-to-GDP Ratio
Employment-to-Population Ratio 66%
24%
64%
Japan
22% Japan
62%
Debt-to-GDP Ratio 250%
200% Japan
20%
60%
150%
18% 58% United States
16%
56% 54%
14%
100% United States United States 50%
52%
12%
50%
10%
1980 1985 1990 1995 2000 2005 2010
0%
1980 1985 1990 1995 2000 2005 2010
1980 1985 1990 1995 2000 2005 2010
What It Means for Your Clients After two years of outsized stock market gains and some reports of an improving economy, many investors are probably feeling more confident. Dr. Cox delivers a sobering slap: the U.S. economy is already more than halfway through a lost decade. Not many Americans will look at it that way. It’s a disturbing thought—but investors shouldn’t ignore unpleasant realities. One of The Argentus Outlook’s recurring themes has been the importance of the economy’s overall performance to investing. The macroeconomics of investing dictates the microeconomics of it. No investment strategy fits all times and circumstances. In making investment decisions, your clients should forge expectations for economic growth, inflation, interest rates and the policies that influence them. In addition to these macroeconomic staples, investors should look for data that’s not on everyone’s radar screen. Sampling a variety of indicators and a range of sources is a good idea. That’s what Dr. Cox did in comparing Japan and the United States. He looked at stock markets, economic growth, interest rates, inflation, labor trends, spending trends, public debt and an intriguing measure of economic freedom. John Maynard Keynes famously said: “In the long run we are all dead.” But investors shouldn’t become strictly shortterm creatures, fixated on the latest Fed meeting and blind to the longer-term prospects of economies and policies. We may not know whether the United States will follow Japan into a decades-long stupor, but we should at least consider the possibility. At least some of your clients may want to incorporate that bit of information into their investment decisions. By Argentus Partners, LLC
Source: Bureau of Labor Statistics, Organization for Economic Cooperation and Development, St. Louis Fed
About Michael Cox
Richard Alm
W. Michael Cox is director of the William J. O’Neil Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business. He is chief economic advisor to Argentus Partners, LLC.
Richard Alm is writer in residence at the William J. O’Neil Center for Global Markets and Freedom at Southern Methodist University’s Cox School of Business
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W. Michael Cox’s Fed Watch: The Federal Reserve’s long-anticipated “tapering” has finally begun. In December and again in January, the central bank lopped $10 billion off its monthly purchases of securities. So quantitative easing shrunk from $85 billion in November to $65 billion in February. The recent actions will create expectations of further tapering. Sometime this year, quantitative easing should be done—perhaps by summer’s end. At the depths of the financial crisis, the Fed had good reason to pump money into an economy gasping for liquidity. The Fed’s early quantitative easing helped the economy avoid a huge contraction in the money supply, massive deflation and an even worse recession. The policy just went on for way too long. The next few months aren’t likely to be smooth, even if the Fed reduces its asset purchases in an orderly
fashion. On its own, passing the Fed gavel from Ben Bernanke to Janet Yellen will create uncertainty; new leadership always does. The jitters will be compounded by the phase-out of quantitative easing. What’s more, quantitative easing’s end is only one step toward returning Fed policy to pre-financial crisis normalcy. Yellen and her colleagues still have a lot of work to do. Most important, they will have to decide the timing and pace for selling assets accumulated during quantitative easing. The Fed’s balance sheet grew from $800 billion at the end of 2007 to more than $3.5 trillion today. Selling too fast will drive down asset prices, spiking interest rates. Going too slow will leave too much money in the system, bringing higher inflation followed by higher interest rates.
America has no place to hide from rising interest rates. They’re as inevitable as death or taxes. The rates are already at or near all-time lows, government debt is piling up and past Fed policies have left a mess to clean up. For years, Fed watching has been an obsession for investors and the financial gurus. The end of quantitative easing won’t change that. All eyes will remain on the Fed. Monetary policy is still far from normalcy; in fact, the Fed may now be moving on to the most difficult part of extricating itself from the policies of the recent past. In 25 years at the Federal Reserve Bank of Dallas, Dr. Cox rose to chief economist and senior vice president, advising the bank’s president on monetary policy and other economic issues.
Chart Topper Texas Twosome: Houston, Dallas Stand Out Among Top 15 MSAs 700,000 27% 600,000 500,000
Job Gains Since Trough Job Gains January 2000 to Trough Net Job Gains January 2000 to November 2013
18% 5%
400,000
17% 15%
300,000
18%
12%
200,000
4% 13%
2%
1% -1%
-17% Detroit
San Francisco
Boston
Minneapolis
Seattle
3%
Chicago
-400,000
Los Angeles
-300,000
Atlanta
Phoenix
Miami
Washington, D.C.
-200,000
New York
-100,000
DFW
0
7%
Philadelphia
100,000
Houston
In the nation’s 15 largest metropolitan areas, employment bottomed out some time between January 2008 for Houston and July 2011 for Phoenix. From each city’s low point, job gains have been greatest in New York at 396,541, Los Angeles at 390,567, Houston at 352,130, and the Dallas-Fort Worth (DFW) area at 344,634 (green in chart ). For years, residents of New York and Los Angeles have been hearing about Texas’ great job growth. So they’ve finally got their chance to puff out their chests—but they shouldn’t get too carried away. The Texas cities can offer a solid rebuttal. As a share of employment, Houston leads in post-recovery gains at 12.7 percent, followed by DFW at 11.2 percent. The recession was relatively mild in Texas, and the DFW and Houston areas didn’t suffer as much as other big cities. In the past three years, their employment growth was more about adding new jobs than recovering lost jobs. Going back to January 2000, Houston leads the nation by adding 690,826 jobs, a 26.6 percent gain (green plus red in chart ). DFW comes in second with an increase of 541,959, or 18.3 percent. Houston and DFW had strong job growth both before and after the recession. Not many other places can match that. Washington, D.C., comes the closest—but it’s not exactly a bastion of free enterprise.
-500,000 -600,000
Source: Bureau of Labor Statistics
About The Argentus Outlook A monthly publication of Argentus Partners, LLC, the newsletter strives to deliver current economic information relevant to investing and operating in today’s complex global economy.
Chief Executive Officer: Douglas Gill, CFP® Publisher: Susanna Joiner, Chief Marketing Officer Editor: Richard Alm Contact: marketing@argentuspartners.com
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Important Disclosures: Information herein in this newsletter and has been obtained from sources believed to be reliable, but its accuracy and completeness cannot be guaranteed. This newsletter is for informational purposes only, and should not be considered as an offer, invitation or solicitation to subscribe, purchase or sell or any securities, and is not intended to provide any specific investment advice or recommendation. You should review your personal financial situation, investment objectives, goals and risk tolerance prior to investing. All indices referenced are unmanaged and an investor cannot invest directly into any index. The economic forecasts and projections illustrated in the newsletter may not develop as predicted and there can be no guarantee or assurance that strategies promoted will be successful. All expressions of opinion reflect the judgment of Dr. Cox and his research conducted for Argentus Partners, LLC at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. This research material has been prepared by Argentus Partners, LLC. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that Argentus Partners, LLC is not an affiliate of and makes no representation with respect to such entity.