Is the US, and much of the developed world, headed the way of Japan — a world of low growth, low rates and deflation? It’s a question that has been raised with some regularity since interest rates began their relentless descent a decade or so ago. 

Now, in the face of the global economic crisis brought on by COVID-19, central bank intervention in the US and Japan is at unprecedented levels. Fiscal stimulus is at a scale not seen since World War II. And the possibility of the ‘Japanification’ of the US and other developed economies is as real as ever before.  

In the past, the argument against the US following Japan’s precedent has been that the US benefits from a much younger population, a more flexible labour market and a dynamic economy that provides much easier access to credit for small enterprises to flourish. But now, the similarities between the economies are starting to outweigh the differences. 

 

An unintended consequence of crisis policies

In response to the current crisis, massive stimulus is exactly what economies need. But if maintained for too long, private sector attitudes could change in ways that promote low growth and deflation. Banks, firms and households could retrench. In short, crisis policies aimed at avoiding ‘Japanification’ could end up steering us in that direction.

• Central banks are already asymmetrical in their monetary policy. They tend to ease aggressively during crises while failing to lean against financial and re-leveraging cycles. These easing measures are difficult to unwind, so this trend is likely to continue and the “debt trap” will likely grow.
• Zero rates enable the public sector to grow its balance sheet to absorb the demand shock and related losses. In the extreme, fiscal and monetary policy could become unified, and rates markets would disappear, as advocated in Modern Monetary Theory, or MMT. Japan is arguably well on its way down this path, with the Bank of Japan holding 44% of Japanese government bonds.
• The duration of the accommodation and its role in creating zombie companies are also important. While it’s critical for businesses, especially small- and medium-sized enterprises (SMEs), to receive lifelines in the short term, low rates and various forms of extended accommodation may potentially keep alive businesses that should otherwise fold.
• Private sector behaviour can change permanently with protracted easing. For example, extended periods of low rates can allow companies on the borderline of failure to survive on cheap market financing. Meanwhile, bank profitability would weaken, resulting in less credit creation (especially for SMEs) and lower productivity. Households earning zero or negative rates would also be incentivised to save more. And all of this would contribute to a deflationary mindset

Despite higher starting growth rates, this crisis and the prolonged easing that will likely follow could result in the US and other developed markets looking progressively more like Japan.

Could ‘Japanification’ bring benefits?

In some ways, resembling Japan may not be such a bad thing. To be sure, Japan could adopt more market-based policies in many areas and work toward more flexible labour markets. But it has many positive attributes. Japan is wealthy, its unemployment rate is among the lowest in the world and it enjoys relatively low income inequality. 

There is much to admire in Japan’s corporate sector as well. As compared with its Western counterparts, it may be perceived as more resilient and benevolent. And many of its practices may be appealing to policymakers, such as:

• Higher cash levels, which serve to improve resilience 
• More sustainable dividend and buyback policies 
• Its embrace of stakeholder capitalism, with a focus on the principle Sanpō yoshi, or threeway satisfaction between seller, buyer and society — especially employees 
• More evenly distributed compensation schemes, with a significantly smaller pay gap between CEOs and average workers as compared with the U.S. and many other developed countries

While US corporations would likely be resistant to these practices, adopting them could be popular politically. Governments could implement them directly, by rescuing industries, as we have seen to some extent in the US, or nationalising them, as we have seen in some cases in France. Or the practices could be adopted indirectly, through regulation. 

The amount of additional government intervention a country experiences — in the form of government spending, redistribution and regulation — should become clearer with each election. However, the pendulum appears to be swinging toward some implementation of MMT principles. Japan’s version is based on the “three arrows” of monetary easing, fiscal stimulus and more orthodox structural reform. This approach has led to the stabilization of a debt burden that Japan largely owes itself, as the central bank is the biggest single owner of Japanese government bonds. Over time, it could lead to improved growth expectations, confidence and gentle reflation. 

If, unlike in Japan, a government’s spending and monetisation are excessive (i.e., beyond a country’s productive capacity), it could lead to high nominal growth and rapid inflation in the long run. This could cause domestic problems, as well as external ones for countries without reserve currency status or the ability to offset foreign exchange movements. The UK, Australia and Canada are perhaps most at risk among developed markets.

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.