Confronting the Zombie Economy

March 27th, 2013

by Eric Schaefer

In a surprising turn of events, the perennial also ran of the world equity markets for the past 23 years has suddenly become one of the top performers. Japanese equities have been a losing proposition for the past generation — squeezed of value by an unrelenting deflationary spiral. While deflation may be good for long-term bond prices, it (in the Japanese experience) has been devastating for share prices.

The catalyst for the sudden reversal of fortunes is the Liberal Democratic Party's (LDP) landslide victory in the recent December 2012 elections. The LDP's standard bearer during the campaign was Shinzo Abe, who briefly served as Japan's prime minister from 2006 until his resignation in 2007. Although it was the LDP's economic policies which created the bubble economy which went spectacularly bust in 1989, and although subsequent LDP led governments have only exacerbated Japan's economic malaise, voters felt that after four years with the Democratic Party of Japan (DPJ) at the helm, the country was once again adrift.

While many voters consider the LDP corrupt, bureaucratic, hidebound and geriatric, they seem to concede Abe, in some ways, breaks the mold of the LDP political operator, who is more comfortable with concluding business in a smoke filled back room than leading from the front of a podium and microphone to energize the electorate. When Abe was first elected prime minister in 2006, at 52, he was the youngest man to win the office. Even at 58, Abe is at least a decade younger than his LDP predecessors as prime minister. Another point of differentiation is, Abe is perhaps one of the few top serving Japanese politicians to have studied in the United States. This may account for push to raise the nation's level of proficiency in English. It also helps explain why he is stressing English language proficiency as a key requirement for the next Bank of Japan (BOJ) head. And, finally, there is Akie Abe, his wife. She is a Roman Catholic in a country where Catholics account for 0.5% of the total population. In short, Abe may strike some as a LDP apparatchik, but he does seem at least to be his own man. In a country in which the establishment needs to be shaken up, being a conforming non-conformist may confer an advantage.

This inclination to be different is illustrated by Abe's choice to replace Masaaki Shirakawa as the BOJ head. Haruhiko Kuroda, the new central bank chief, does not have the typical Japanese bureaucrat's pedigree. Kuroda has spent the past eight years as the president of the Asian Development Bank (ADB). The ADB has become an avenue of sorts for Japan to both exercise its influence and assume a leadership role in the region. Japan's arsenal of soft power is extensive, but in view of its history, even this must be exercised carefully and judiciously. As head of a multi-national organization, the lingua franca of which is English, during a tumultuous period for the world economy and financial markets, seems to have given Kuroda a worldview and flexibility decidedly different than his more home grown contemporaries. Indeed, his expressed willingness to experiment with the unconventional levers of monetary policy to reinvigorate the Japanese economy has helped push the Yen lower and Japanese share prices higher. Thus far, the financial markets seem to be of the opinion that if any man can successfully re-inflate the Japanese economy, Kuroda is that man.

Neither Abe nor Kuroda has an easy task. Japan's population is aging and barely expanding. Both demographic trends exacerbate the deflationary spiral, since population growth underpins economic growth. A more open immigration policy, encouraging foreigners to live and work in Japan, would help ease some of the demographic pressure. The nation's continued reluctance to entice foreigners to emigrate to Japan contrasts to the popularity of Japanese cuisine, entertainment, technology and aesthetics in the rest of the world.

Winning the zombie war will not be easy. But at least the battle has been enjoined.

Notes on Sources and Methods:

MSCI publishes a range of single country and regional indices. Each performance index (with dividends reinvested net of withholding taxes) is a free-float adjusted market capitalization weighted index which is widely used to track the performance of the equity market of the specific country. All returns are expressed in US dollar terms.

The baseline for the Japanese equity index performance is Sep 13, 2012. On this date, the Yen/US $ exchange rate reached its highest level (over the past year) before commencing its decline. Remember the more Yen a single US Dollar buys indicates a weakening in the value of the Japanese currency.

You cannot invest in an index. Performance shown includes the re-investment of dividends, net of applicable withholding taxes, and excludes any management fees, expenses and sales charges associated with most investment products.

(Sources: Federal Reserve Board; Central Bank of Japan; Lipper; AIFS estimates.)

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