In recent years, every now and then, parallels are made between Europe and Japan suggesting that Europe has entered a period of secular stagnation. Indeed, when the yield of the German Bund fell below 0% last quarter, some investors feared once again that Europe was turning Japanese.
Since 2008, growth has been tepid in Europe. Real private consumption is only 5% higher, equivalent to a yearly growth rate of 0.5% and investment is only now approaching the 2008 peak. The only bright spot has been net exports, which have doubled since then. In order to boost the economy, central banks reduce interest rates with the hope of spurring borrowing and therefore consumption. Twenty years ago, Japan first cut rates to 0% and since then, not only have official rates never exceeded 1% but they have hovered close to 0%. Growth, on the other hand, has generally remained anaemic. Likewise, the ECB has lowered official rates to 0% and, ten years after the crisis, any attempt at normalization has been kicked down the road. The fact is that low interest rates have had an indirect negative impact on the economy via the banking system. In both Europe and Japan, households and enterprises rely primarily on banks for their financing. This contrasts with the US where access to capital markets is more commonly used. The complicated situation of banks, due to falling net interest margins, stricter regulation, weak growth and political woes, has restrained both the old continent’s and Nippon’s banks from easily conceding loans.
Demographics is also a key similarity between both regions and probably the key structural problem explaining the low growth, interest rates and inflation. An ageing population and declining workforce has a direct impact on all these factors. As more and more people prepare for retirement, they tend to save more and, at the same time, labour supply diminishes, reducing growth and investment. Interest rates fall as savers chase fewer investment opportunities and in order to encourage borrowing. Another consequence is the negative impact on public deficits as governments are faced with increased healthcare costs for the elderly and less income from taxes.
Although Europe presents symptoms of the Japanese illness, there are a few relevant differences that point to a less critical situation in Europe and these differences may help it avoid a deflationary spiral. To begin with, in Europe, although inflation is still well below the ECB’s target of 2%, it is still positive, averaging 1% since 2012. This is a much better situation than in Japan where, despite 20 years of low interest rates and, more recently, a slew of unconventional policy tools, since 1999 inflation has been negative half the time. Japan is the only developed country where wages have fallen. Since 1996, inflation adjusted wages have dropped about 13%. The longer growth and inflation remain low, the more people are prone to save and postpone consumption. A decline in inflation also makes debt more burdensome and punishes borrowers. Of importance as well is the fact that the destruction of wealth in Japan after its twin real estate and financial asset bubbles burst was unique both in terms of scale and the impact on consumers. Counting the value of real estate and stock, Japan’s loss of wealth was equivalent to three years of its GDP. Moreover, the build-up of the debt overload in Japan before the crisis and its evolution thereafter was also very different to Europe. Credit growth in Japan reached 25% in 1990, whereas by 2008 in Europe, it was around 10%. Japan’s public debt-to-GDP has ballooned to almost 240% today, whereas in the euro zone, this ratio has dropped from 92% in 2014 to 86%.
That is not to say, however, that certain countries are not suffering a more complicated situation (for example, Italy with public debt at 130% of GDP). Finally, the ECB was also quicker to respond and address the problems.
Although Europe is suffering from low growth, interest rates and inflation, several important aspects are indicating a less dire situation than Japan. Monetary policy and other unconventional tools have, without a doubt, been necessary to support the economies of both regions, but their success in addressing the more structural problems has been limited. Going forward, Europe is still very dependent on external demand for growth and should perhaps try to attack its large current account surplus resulting from the northern bloc’s predisposition to save more that it invests. Combating Germany’s and other northern countries’ fiscal orthodoxy could give Europe another leg of growth and help it out of the doldrums.
Column by Jadwiga Kitovitz, Director of Multi-Asset Management and Institutional Clients of Crèdit Andorrà Group. Crèdit Andorrà Financial Group Research.