Bubbles are great fun while they last. But they are much less fun when they burst. For the past 20 years, central bank stimulus has created some of the largest bubbles ever seen. But now, led by developments in Japan and China, they are bursting.
It took 20 years for the bubbles to reach their peak. And we are probably still some months away from their final bursting. But as noted here in May, the epicentre of the crisis is likely to be in Asia:
- “Japan’s debt is now 263% of GDP, and its ‘Abenomics’ policies are now unravelling. Against this background, it is hard to see Japan’s $4.3tn economy being able to grow enough to repay its extremely high levels of debt. It risks seeing interest rates rise to world levels from today’s 0.5%, or seeing the currency come under major pressure as investors sell out
- “China’s debt is 295% of GDP, and its real estate bubble impacts 29% of GDP. The Zero-Covid policy has strained domestic confidence in the government, whilst demographics in the shape of its rapidly ageing population are set to collapse real demand. And now, its real estate bubble is bursting”
It usually takes a while for the consensus to catch up with developments on the ground. In 2006-8, for example, we were told we “didn’t know what we were talking about” when we warned of an approaching “subprime crisis”.
But now, as in Q3 2008, the consensus is starting to catch up. Last weekend saw the Wall Street Journal headline the excellent Lingling Wei’s detailed analysis:
“China’s 40-Year Boom Is Over. What Comes Next?
“The economic model that took the country from poverty to great-power status seems broken, and everywhere are signs of distress”
The issue, as John Richardson and I have highlighted, is that China’s growth model has been supply-side based, via infrastructure and property development. As the charts confirm, this has been at the expense of domestic consumption:
- Household consumption is only around 38% of GDP, versus 68% in the USA
- Investment has averaged 44% of GDP since 2008, versus the global average of 25%
JAPAN IS LIKELY TO BE THE CATALYST FOR THE DEBT CRISIS
Japan, however, is likely to be the catalyst for the start of the crisis. It is fast running out of options as the chart shows:
- Its ‘Abenomics’ stimulus policies began in 2013 after the election of the late Shinzo Abe as premier
- Its debt has since risen from Yen 1.5tn to Yen 7.3tn today, whilst the exchange rate has fallen sharply
- It was Yen 80: $1, but has since fallen to Yen 145: $1 today, and risks going much lower
The problem, of course, is that Japan (like China) has an ageing and declining population. And so markets are gradually starting to realise that rising interest rates will quickly make the repayment cost unaffordable.
The Bank of Japan (BoJ) is therefore stuck between “a rock and a hard place” as the second chart confirms:
- It is having to buy record amounts of bonds to keep interest rates below its target 1% level
- As a result, the exchange rate is falling and now threatens to hit a new low below Yen 150 : $
As and when this happens, the BoJ will be forced to allow interest rates to move above 1% and head towards global levels. In turn, Japanese investors will likely then sell US Treasuries as they will be able to get a realistic yield at home. This will have major knock-on effects on global rates.
Japanese investors currently own $1.1tn of US Treasuries, and are the largest foreign buyer. They have been forced to do this, as yields in Tokyo have been so low.
- But as Japanese rates move higher, they will likely start selling and instead invest in Japanese bonds
- In turn, this may well push US yields higher, towards 5%, creating a vicious circle for borrowers
- This would likely also have a negative impact on stock markets and further reduce consumer spending
- There could also be second-order impacts, as higher US rates could likely push the dollar higher
This Scenario highlights the potential problems caused by the end of stimulus programmes.
A whole generation has been brought up to believe that markets always go up, and that interest rates are always near zero. And very few people are focused on the risk of an Asian Debt Crisis.
This suggests some (maybe many) people will panic – and start to invent their own explanations for what is happening. In turn, this could lead to a whole range of random developments in the markets, as different theories gain temporary credibility.