Each increase in gross domestic product would fizzle as quickly as it began, undermining rallies in equity markets.
You can see it in the body language when speaking with Japanese officials. It is a kind of physical resignation that, well, here we go again: deflation, negligible growth, political maneuvering. There is also an air of lament that Japan is an example of what many economies don’t want to become.
I could see it in Hiroshi Nakaso’s eyes last week, as the Bank of Japan executive director explained, for the umpteenth time, why interest rates in Asia’s biggest economy are near zero percent. The same goes for Hiroko Ota, Japan’s former economic and fiscal policy minister. “The worst is over but I can’t say the economy is heading for a recovery at all,” Ota said in a June 4 interview. It’s probably even worse news that Ota, now vice president at the National Graduate Institute for Policy Studies in Tokyo, says Japan’s recovery may be “W-shaped,” instead of V-shaped.
The reason for pessimism is that Japan’s experience with a W-shaped recovery may be a harbinger for the biggest economies. Concerns about a Japan-like “lost decade” in the US and elsewhere are well-known. That spectre is becoming less likely as trillions of dollars of stimulus work their way through the economy. Talk of another Great Depression is now giving way to fears of an historic inflation surge. What is becoming more likely, though, is the W-isation of the business cycle.
Bear-market rallies
The bear-market-rally argument making the rounds in Asia and the US is preferable to this one. It would merely mean that today’s rallies will look a bit overdone in the weeks ahead. The prevalence of W-shaped cycles could be with us for years. That would be terrible for the “green shoots” supporters who claim the worst is over in global markets. Here’s how it would look: Each increase in gross domestic product would fizzle as quickly as it began, undermining rallies in equity markets. Not a lost decade, yet not one that investors would enjoy. Such a scenario would reflect steps that policy makers are taking to restore growth.
From Washington to Beijing, officials are still treating the symptoms of the crisis, not the cause. Throwing money at the problem was fine for a while. It is now time to revamp regulations, retool economies and restore trust in markets. Consumers worried they won’t have a job in a month need to rely on the economic outlook. Investors must be confident that the top-rated security they are buying won’t soon be worthless. Banks need to be sure that money they lend won’t lead to more bad loans. Restoring that trust will require bold action by governments and market regulators.
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Twilight zone
The price that Japan paid for avoiding tough decisions is now seen in the country’s extreme vulnerability to global export trends. Japan is stuck in the economic equivalent of the “Twilight Zone.” It’s often forgotten that Japan’s growth in the first half of this decade was underpinned by the largest public debt among developed nations and zero interest rates. Healthy and organic growth it was not.
The risk of a W-shaped world economy has been a preoccupation of Stephen Roach, chairman of Morgan Stanley Asia in Hong Kong, in recent years. Markets “that want to price in a classic ‘V-shaped’ recovery, I think, are in fantasyland right now,” Roach said on June 4.
Even China, the nation many view as best positioned to avoid the worst of the global recession, may be heading this way as the effects of stimulus efforts wear off. At that point, the fourth-biggest economy will face a dismal export environment.
China puzzle
That scenario makes the debate over what New York economist Brad Setser calls “the China puzzle” all the more relevant. On his blog, the former US Treasury official has been exploring why China is growing when other export powerhouses aren’t. A particular area of focus has been shifts in China’s policies before and after the September 2008 collapse of Lehman Brothers Holdings. One preliminary conclusion: China had more capacity than most large exporters to stimulate domestic demand once the “Lehman shock” devastated global markets.
The real post-Lehman surprise may be how economic cycles and markets gyrate and don’t go very far for a while. Part of the problem is the “bubble fix” phenomenon pervading financial centres such as London, New York and Tokyo. Central banks have slashed interest rates toward zero. Marc Faber, the Hong Kong-based publisher of the Gloom, Boom & Doom report, rarely misses an opportunity to compare today’s markets to a relapsing alcoholic, and central banks to irresponsible bartenders. To dole out more booze, as monetary officials have been doing, is the wrong medicine. That’s where markets find themselves, and investors are getting tipsier by the day. The MSCI Asia Pacific Index has surged 49 percent from a five-year low on March 9. Equities from Mumbai to Shanghai to Tokyo are rallying on rising confidence that the worst of the global recession has passed.
Perhaps investors are right to revel in recent good news. If we are merely scaling the slope of a W-cycle, though, today’s bulls won’t be happy a few months from now.
The author is a Bloomberg News columnists The opinion expressed is his own