IN A British television show, “Doctor Who”, the titular character is able to travel anywhere in time and space in his Tardis police box. Given access to that technology, what useful message would this columnist impart to his previous self, nearly 12 years and 550 columns ago?
The first lesson would be to avoid confusing the economy with the financial markets. If you looked at share prices alone, you might assume the intervening period had been calm; the S&P 500 index is around double its level when this column began in September 2006. But though the markets have long since recovered their sangfroid after the crisis of 2008-09, the trend growth rate of developed economies has never regained its strength. That is a bitter irony given that the crisis originated within the financial sector, bringing to mind a teenager who crashes their parents’ car and leaves them with the bill.
In part, the market’s resilience was owing to the remarkable strength of corporate profits, something else that would not have been obvious 12 years ago. Back then American profits were only just reaching a post-war high, relative to GDP. When they plunged in 2009, it looked like a return to normal. But the pre-crisis levels were rapidly regained and, indeed, surpassed. Explanations for the strength of profits include less competition in some industries, in particular technology, and the way globalisation has suppressed wage growth. In turn, this sluggish growth of real wages was a significant factor in the rise of populism, another big development of the past 12 years.
The second lesson would be never to underestimate the power of central banks. Readers would have scoffed if this column had forecast, back in 2006, that short rates would be cut to zero and below; that trillions of dollars of government bonds would trade on negative yields; and that even the ultra-cautious European Central Bank would join its peers in wholesale purchases of government debt. But quantitative easing happened without creating the inflation that many feared. And it perhaps averted another Depression.
Another timely tip back in 2006 would have been to relax about China. Those who worried about a banking crash or “ghost cities” full of vacant skyscrapers have yet to be proved right. China’s economy may be growing a little more slowly, but it has not stalled. More broadly, there have been crises in specific emerging markets over the past decade, but nothing as widespread as the turmoil of the late 1990s.
Perhaps these were obvious monsters, like the Doctor’s foes, the Daleks, who could be confused by the simple expedient of throwing a coat over their heads or (in early series) defeated by their inability to climb stairs. The greater financial dangers may be the equivalent of the Weeping Angels—living statues that creep up on you when you are not looking.
For example, experience has shown that there is no innovation, however seemingly benign, that the finance sector cannot overcomplicate and overextend. Securitisation was a good idea when first adopted, but ended with the mess of subprime loans that were sliced and diced into a dog’s breakfast. Exchange-traded funds (ETFs) are an excellent idea—a low-cost way for investors to own a diversified portfolio. But there are now too many funds and too many unnecessary varieties, such as ones that bet on trends in volatility or invest in ETF providers.
One day, this overexpansion may turn out to be a problem, especially as some ETFs have a liability mismatch. They offer instant liquidity in assets, like corporate bonds, that are fundamentally illiquid. Market-makers known as authorised participants (APs) are supposed to step in and keep the price of ETFs and asset values aligned. But as Helen Thomas of Blonde Money, an economic consultancy, points out, it is not clear which APs back which fund, nor whether it is easy for them to hedge their risks. What will happen in a sharp market downturn?
Markets have recovered from the crisis of 2008. But some day a combination of high valuations, illiquidity and the withdrawal of monetary stimulus by central banks will cause a problem that takes more than the Doctor’s sonic screwdriver to fix. Forecasting exactly when that will happen is the tricky bit and, sadly, Buttonwood’s Tardis can only go backwards, not forwards, in time.
Indeed, the moment has come for a change. Eventually, after a few series, Doctor Who has to regenerate and be replaced by someone younger, and with a better script. The same is true of columnists. Thank you all for reading.
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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