Let me start off by saying that I'm bearish on the longer-term outlook for Japan. The combination of a shrinking population, an aging demographic and the lowest birth rate in the developed world is a toxic trifecta for economic growth. Japan has been in a structural decline since the bubble burst in 1989 with bad loans and insurmountable debt in the financial system. They have been operating in a monetary stimulus (quantitative easing) environment since 1997 with near zero rates. In February, 2016, they moved to a negative rate policy and investors laughed out loud by selling stocks – and the yen strengthened.
This long-term structural headwind will be tough to overcome. Still, despite all this, I currently see investment possibilities in Japan for the nimble ETF investor.
We find ourselves in an environment today where, because of changing global demographics, some aspects of monetary policy have become less effective than in the past. Monetarism was largely developed by Milton Friedman during the 1950s and 60s when the demographic tailwinds were blowing like a Category 5 hurricane. He believed controlling the money supply was key to controlling inflation – it worked for many years until the tailwinds shifted dramatically.
The reason all the economic stimulus isn't working as it has in the past is because low rates are a double-edged sword, especially for retirees. On the one hand, some borrow more and spend (causing misallocation of capital and asset bubbles), but on the other hand, it impairs spending for others. If you're retired and living off your investments, you're going to spend less if your fixed-income portfolio can't generate a decent return. In aggregate, this offsets much of the stimulus coming from others as the percentage of the population in retirement rises – a trend that is expected to last decades because of low birth rates. Unfortunately, the current path of monetary policy globally suggests that the central banks of the world will continue to appropriate your savings in the name of current consumption.
A fusion of fiscal and monetary policy
The latest version of stealing from the savers is about to be launched in Japan in an effort that is tantamount to scaling Mount Fuji playing Pokemon Go. Ben Bernanke studied the Great Depression and was a student of Prof. Friedman. During his famous speech in November, 2002, Mr. Bernanke borrowed a phrase from Prof. Friedman, suggesting that in a crisis, the Fed could drop money from helicopters to stimulate the economy. He was promptly given the nickname Helicopter Ben. (Bank of Japan Governor Haruhiko Kuroda had a visit a few weeks ago from Helicopter Ben.)
Back in the 1930s, Japan initiated a policy equivalent to "helicopter money," using the BoJ to directly finance deficit spending by the government. The money-financed fiscal program worked, but turning off the budgetary spigot afterward proved impossible – with adverse consequences for the economy.
Since Mr. Bernanke popularized the phrase, helicopter money has become synonymous with fusion of fiscal and monetary policy. There are many ways to structure it, but basically the government injects cash straight into the economy with tax cuts or infrastructure spending programs. The Bank of Japan's balance sheet already totals more than 80 per cent of gross domestic product – and the policy is really not working – except when the yen weakens. Globally, what low rates have done is cause a gross misallocation of capital. We would be remiss if we did not ask, Why do we keep doing it? "Unlike debt-financed fiscal programs, a money-financed program does not increase future tax burdens," Mr. Bernanke wrote in an April posting on his Brookings Institution blog. I could spend pages telling you why deflation is bad and central banks need to fight it – bottom line, a little inflation is a good thing. Expect Japan to bring out a last-ditch plan to weaken the yen and not further engorge the BoJ's balance sheet.
Following Prime Minister Shinzo Abe's re-election in December, 2012, he launched a massive yen weakening stimulus policy that included buying Nikkei equity based ETFs. The markets are already responding to this expectation of helicopter policy stimulus following the recent election where Mr. Abe won a strong mandate. The Nikkei is up more than 10 per cent and the yen is down more than 6 per cent. I have been accumulating positions in my global growth and global dividend strategies in Japan ETFs that hedge the currency risk of a falling yen (HEWJ-NYSE, DXJ-NYSE, CJP-TSX) and participate in the upside of the equity markets. I don't think they stop this coming round until the yen is closer to 150 against the U.S. dollar.
This would likely lead Chinese and South Korean governments to respond with their own currency devaluation schemes (arguably under way in China already), and all kinds of uncertainty over the next few years to compound Europe's negative rate conundrum. At some point the U.S. equity market and commodity prices respond in a negative way, but Japan will likely outperform.
My libertarian blood is boiling on this one, but it just might just be time to explore some alternatives that have a better chance at stimulating growth and raising the well-being of the world – it's just that zero interest rates and helicopter money are not it.
The idea of universal basic income (UBI) replacing many of the existing social safety nets could be the new fiscal policy. As long as it is never clawed back based on how hard you work or how much money you earn; this would add an incentive for people to work, unlike the current policies. The new monetary policy could be a flat tax to fund the UBI, offset by an increase in consumption tax so that those who consume more pay more. Corporate taxes would be dropped as much as possible to help companies invest in productive capital and labour. It would go a long way to address some of the demographic challenges the world faces. These economic challenges are deep and the governments of the world, including the Liberal government in Canada, are not effectively addressing these facts. Rolling Old Age Security back to the age of 65 from a more suitable 67 was simply negligent. Put the economy back on track by boosting the private sector and stop manipulating it with dated policies that probably will not work.
Nevertheless, Japan is poised to outperform because this is the system we have to deal with, so with low rates from here to as far as the eye can see, you need to work harder to find sources of return, and that's why we've been looking to the Land of the Rising Sun.
Larry Berman is co-founder of ETF Capital Management. He is a Chartered Market Technician, a Chartered Financial Analyst charterholder and is a U.S.-registered Commodity Trading Advisor.