2017年7月28日星期五
 
Martin Hennecke
Chief economist at The Henley Group mwh@thehenleygroup.com.hk
"The macroeconomic problems of Japan are staggering. The country does not have any natural resources and following the Fukushima nuclear disaster foreign energy dependence has been on the rise."

Land of the rising debt
28/07/2014


The macroeconomic problems of Japan are staggering. The country does not have any natural resources and following the Fukushima nuclear disaster foreign energy dependence has been on the rise.

At the same time, the population is in decline. Also, the nation's sovereign debt is the highest of all developed nations in percentage terms, with an out-of-control trajectory possibly to be reached soon, according to projections by the Bank of International Settlements.

Even the nation's finance minister, Taro Aso, admitted recently that the situation has become very severe, as national debt crossed the 1 quadrillion yen (HK$76.2 trillion) mark for the first time this year.

The main reason Japan has been able to avoid an Argentina-style debt crisis has been due to its domestic investors putting the vast majority of their hard-earned savings into bank deposits and sovereign bonds at essentially zero yield.

After getting burned by a 30-year equity and property bear market, they are willing to put up with the low returns. After all, it is better not to gain anything than to lose heavily. This approach was fine as long as Japan was in a deflationary environment. That is not the case anymore.

With Japan's core consumer price index having just moved decisively from deflation into inflation, it appears to be only a matter of time before the Japanese awaken from their slumber to realize that a 0.5 percent yield on 10-year Japanese government bonds is not exactly a very profitable strategy when inflation is notably higher and rising.

In turn, the government, faced with the prospect of investors exiting JGBs en masse amid negative yields, may be forced to increase the interest offered for holding its bonds. Yet at a 225 percent debt-to-GDP ratio, this will be hard to afford and may trigger a debt crisis.

One way to be positioned for a JGB crisis could be to go short JGBs, that is, to place a bet on their prices to fall. But this move may be quite risky, if a strong drop in bond prices does not materialize, or happens at some very distant point in the future.

Then investors shorting such bonds will have to pay the interest coupon and/or cover derivative rolling costs and other charges that can be costly over time.

Also, we need to ask if it's not likely that Japan will seek to avoid a debt crisis at any cost, to the point where the country will decide to print unlimited amounts of yen, using it to buy JGBs to keep their yields down if necessary !V leading to something like an unlimited quantitative easing. If they did so, then JGBs would not fall, but the yen may drop sharply as the debt burden gets reduced in real terms via currency devaluation.

For these reasons a safer way to seek protection and potentially profit in such scenario may be to opt for time-honored default- and inflation-proof precious metals, led by gold. The precious metal just so happens to be trading at very attractive prices presently after having witnessed a sharp drawdown since 2011.

Last but not least, if we think about a somewhat less fatal scenario, whereby Japan may muddle through somehow with a limited drop in JGBs amid a progressively weakening yen and rising inflation, then which asset class may benefit?

Sure, some Japanese may still think about gold in such a scenario as well.

But bricks and mortar, that is property, may well come to the mind of the majority of ordinary citizens first when thinking about how to achieve better inflation protection and positive real yield compared with holding cash in the bank or in bonds.

Japanese property is not really cheap in nominal prices compared with global averages, but then it never really is because of the limited land size. When looking at historical price-to-income and price-to-rent ratios though, Japan is clearly one of the most undervalued property markets.

Moreover, some relief from the demographics problem !V fewer people need fewer houses !V may materialize soon, as Prime Minister Shinzo Abe's government is reported to be considering an adjustment of the country's restrictive immigration policies.

Accordingly, although this seems counter-indicative at first sight, a limited exposure to Japanese property !V via, for example, residential real estate investment trusts !V may be an attractive contrarian bet on Japanese citizens moving a good part of their cash back into real assets on the expected rising inflationary risks associated with the nation's debt problem.

Investors seeking to take such a position however should be careful about how to gain exposure, as significant valuation differences apply in investment vehicles providing exposure to this asset class.

 


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