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Turning Japanese – 2019

Also a great song from 1980 by The Vapors but …

…Yesterday morning (21/2/19) saw the release of Germany’s Purchasing Managers Index (PMI) for February. The index fell to a 74 month low of 47.6 versus an expected 49.8. Order books saw the biggest fall for six and a half years.

So, negative Euro interest rates are not working in Germany and consequently extremely low interest rates are having little benefit elsewhere in the Eurozone. Germany is running a massive current account surplus, in 2018 it was USD294 billion (Japan’s was USD173 billion) equating to 7.4% of a not too impressive gross domestic product (GDP). The percentage has been higher, in 2015 it reached 8.9% of GDP and importantly has been above the European Commission’s threshold of 6% since 2011. You get the feeling that Germany should be doing more to stimulate its domestic economy – the International Monetary Fund (IMF) agrees. Incidentally, the Eurozone posted a current account surplus of USD18 billion in 2018, 3.0% of the bloc’s GDP. It fell to its lowest figure in two years according to the European Central Bank (ECB) which might please @realDonaldTrump who probably has Germany/Europe in his trade sights when he’s done with China.

But haven’t we been here before? Japan.

Below is the history of Japan’s current account surplus as a percentage of GDP from 1980 to 2018


 

 

 

 

 

 

 

 

 

Here is Germany’s over the same timeframe, note that it was a deficit post reunification until the end of last century.


 

 

 

 

 

 

 

 

 

 

There is another significant similarity in the ineffectiveness of Japanese banks and their role in promoting economic growth until the re-election of Prime Minister Shinzo Abe on a reform agenda in 2012. European banks remain beset by bad debts, Germany’s are no different.

 

Compare then the interest rate structures of Japan and Germany over time by comparing their ten year government bond yields. Firstly Japan:


 

 

 

 

 

 

 

 

 

 

 

Now Germany:


 

 

 

 

 

 

 

 

 

 

 

For investors who don’t find zero interest rates attractive, what lies ahead for them in the stock market? Well Japan, having seen rapid economic expansion in the 1980’s, nosedived before flatlining subsequently, the meaningful pick-up only commenced when Abe returned as PM with an economic reform and governance agenda in 2012 as the graph of the Nikkei 225 shows below.


 

 

 

 

 

 

 

 

 

 

 

So what next for Germany’s Dax 30 Stock Market Index? The graphic evidence is below.


 

 

 

 

 

 

 

 

 

 

 

I could put up more comparative charts pertaining to debt to GDP where Japan has one of the highest ratios at 253% – that’s not good but not too difficult to fund or rollover when you borrow:

  1. in your own currency
  2. at rates close to zero
  3. you have a domestic audience keen to hold your debt

Germany’s debt to GDP ratio is a respectable and relatively low 64%, by the way Italy’s is 132% (for reference, the UK’s is 85% and the US’s is 105%). These numbers and the graphs previously, sourced from Tradingeconomics.com

The current economic academic trend is called Modern Monetary Theory (MMT) which, to put it simply, advocates borrowing vast amounts to boost your economy as long as:

  1. your cost of funding is below nominal GDP
  2. you borrow in your own currency

Basically, you get your payback through growth exceeding the cost of borrowing. So Germany has plenty of room but history of less than 100 years ago and the runaway inflation of the Weimar Republic, whose end saw the emergence of Adolf Hitler, prevents the use of MMT in Germany.

And as Japan proved, it doesn’t necessarily lead to a better economic outcome without the leadership to materially impact the way the economy behaves. The Nikkei 225 and the more representative Topix didn’t respond until Shinzo Abe changed direction, promoted corporate governance and reduced the impact of moribund Japanese banks.

There is a banking problem in Europe, there is a lack of political leadership in the major economies, Merkel and Macron have been devalued and only Germany can really claim to borrow in something akin to its own currency. By the way, the Euro has been a major benefit to Germany. Any country running that kind of current account surplus should see its currency rise but that would throw the rest of the Eurozone into deeper economic trouble.

The Eurozone needs its own MMT – a massive fiscal stimulus and a change of attitude if it is to avoid the kind of economic stagnation that Japan endured for twenty years. If not, it could well be sayonara EU. The EU concept might be founded on peace but it needs to look beyond that to what it can achieve economically for the benefit of its aggregate population and Germany needs to lead.

We have little exposure to Europe in the T. Bailey Growth Fund and where we do it is either through thematic funds whose market place is global or via index agnostic, smaller company funds that can access the better but harder to find companies that can exhibit the sort of growth we seek. Dynamic has no direct exposure to Europe. We avoid exposure to traditional banks in either fund globally.

This piece is not a reflection on the current Brexit situation but you might expect a slowing Europe to want to maintain a healthy relationship with a country that had a 2018 trade deficit of £67 billion with it and for Germany, where the UK trade deficit in 2018 was £20 billion. Source: HMRC