I saw a headline this week that actually made me laugh out loud: “Japan’s economy makes surprise fall into recession.”
Surprise? Really?
Japanese GDP shrank by 1.6% last quarter after shrinking by 7.3% in the second quarter. The culprit? Japanese consumer spending, which was much weaker than expected. Consumer spending makes up about 60% of Japanese gross domestic product, and Japanese consumers have snapped their wallets shut following a sales tax hike earlier this year.
The only surprise here should be that economists didn’t see this coming. Japan has seen GDP fall in three of the past four quarters. The only quarter that saw growth — the first quarter of 2014 — was an outlier skewed by the pending sales tax hike. Japanese shoppers went on a spending spree in the first quarter in order to avoid the new sales tax.
The media is calling this a failure of Abenomics, and it is — sort of. But I would argue it goes much deeper than that. The bigger failure is that economists thought Abenomics ever had any chance of success. Of the 59 quarters that have passed since 2000, the Japanese economy spent 21 of them shrinking.
And in many of the quarters that had GDP growth, the “growth” is mostly a result of poor comps from the previous year. It’s not hard to show “growth” when your previous year’s results were awful.
A little quantitative easing (OK, a lot of quantitative easing in the case of Abenomics) is not going fix an economy this broken. Hey, I’ll give credit to Prime Minister Shinzo Abe and to Bank of Japan Governor Haruhiko Kuroda for making the effort; at current exchange rates, Japan’s quantitative easing program is about three times bigger than Ben Bernanke and Janet Yellen’s “QE infinity” adjusted for the size of Japan’s economy. Kuroda is buying bonds at a rate equal to 16% of Japan’s entire economy, every year, until further notice.
So, what is the story here? Textbook economics says that making this kind of liquidity available should goose consumption and business investment. Why isn’t it working this time around?
Before I get too wonky on you, let me ask you a question: When Bernanke pushed long-term interest rates lower via QE, did your elderly mother or grandmother react by spending more money?
I’m guessing the answer is no.
Lower interest rates are a boon to younger consumers, as it allows them to purchase cars, homes and other big-ticket items with a lower monthly payment. But people in or near retirement generally aren’t the ones buying things on credit.
Well, Japan has a lot of consumers that fit your mother or grandmother’s profile. It’s the oldest country in the world with a quarter of its population already over the age of 65. Japan’s population peaked seven years ago at 128 million and hasn’t stopped shrinking since — Japan has about a million fewer citizens every year. By 2060, the Japanese government estimates that Japan’s population will have shrunk to 87 million people, and as much as 40% will be older than 65.
Japan already had the lowest long-term yields in the world before Abenomics kicked in. Dropping the benchmark rate from 0.6% to 0.5% — even to zero — isn’t going to convince a company to make major new investments, particularly when they already have overcapacity.
Quantitative easing cannot manufacture real demand. But it can cause stock and bond prices to rise, and the newly printed money makes it way into the capital markets. For this reason, I’m reluctant to recommend that you short Japanese stocks or bonds right now.
The safer bet is to short the Japanese yen. And the easiest way to do this is via the ProShares UltraShort Yen ETF (NYSE:YCS). YCS is a leveraged fund that rises when the yen falls vis-à-vis the dollar. Be careful here; during times of market turbulence, traders sometimes cover their carry-trade shorts, which can drive the yen sharply higher in the short-term.
Given that YCS is a leveraged fund, you can lose a lot of money very quickly. So, YCS is better viewed as a shorter-term trade than as a long-term, buy-and-hold position.
Disclosure: Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. As of this writing, he was long YCS.