Magazine article Newsweek

Will China Follow Japan into Economic Stagnation? as Japan Resorts to Negative Interest Rates and Stocks Tumble, China Must Be Worried That It's on the Same Economic Track

Magazine article Newsweek

Will China Follow Japan into Economic Stagnation? as Japan Resorts to Negative Interest Rates and Stocks Tumble, China Must Be Worried That It's on the Same Economic Track

Article excerpt

Byline: Bill Powell

The men who oversee China's economy are a prideful lot. Smart and competent, the products of their country's most elite institutions and, in some cases, elite Western schools as well, they have overseen a growth miracle for more than three decades, lifting the world's most populous country from penury to being the second-largest economy. While a financial crisis crippled most of the developed world in 2008-2009, China sailed on, barely scratched.

But now, though they may not like to admit it, Chinese policymakers must look across the East China Sea at Japan's economic turmoil and wonder if what they are seeing is the late stages of a disease that they themselves have caught--and have yet done very little to treat.

There was a time, late into the 20th century, when Western pundits, academics and politicians convinced themselves that the 21st century would be Asia's. ("The Pacific Century," this magazine called it in a cover story in 1988.) The miracle economies of East Asia--Japan, South Korea, Taiwan--had led the way, and China was gearing up to follow. And even though Japan fell down in the early 1990s and has not been able to get up, China seemed to fulfill the prophecies, racing ahead with year after year of rapid growth. Which makes the current economic plight of both countries all the more stunning: Japan and China are now the sick men of East Asia.

That is not to say that their plights are identical, but the similarities are greater than the differences: Both growth miracles were driven by domestic investment, which fed export-led growth; both countries suppressed domestic consumption and elevated savings rates to fuel that investment-led growth. Both countries piled on debt to do so. Moreover, for decades now, Japan has been an aging society with a shrinking workforce, detracting from its gross domestic product growth. China over the next two decades will be much the same.

The effects of the disease Japan has not been able to shake for nearly 30 years are again on full display. On January 29, the Bank of Japan announced that it would implement a policy of negative interest rates in order to forestall yet another onset of deflation. For years, Japan held to a zero interest rate policy (ZIRP) and massive injections of yen into both the bond and stock markets to try to stimulate growth and, thus, at least a little inflation.

Since late 2012, Prime Minister Shinzo Abe's hyped "Abenomics" promised structural reforms that were also supposed to help boost growth. They haven't. The fact that ZIRP has now turned into NIRP (negative interest rates, which means banks must pay the central bank in order to hold their excess cash, in the hope they will instead lend the money to companies) was an admission that everything the government has done over the past three years hasn't worked.

The dire plight of Japan is hard to overstate. If the current quantitative easing policy of the Bank of Japan continues for the next few years--and central bank chief Haruhiko Kuroda seems committed to it--then the assets (government bonds and equities) on the central bank's balance sheet by 2018 will be greater than Japan's economy. The Bank of Japan buys virtually all the debt the government issues and holds roughly 60 percent of the equity market's exchange-traded funds. Japan's fiscal deficit is nearly 8 percent of GDP, and gross government debt will be 260 percent of GDP by the end of fiscal 2016.

Yet real household income in Japan is more than 6 percent lower than it was in 2013, just after Abe came to power; 37 percent of the workforce is on part-time contracts, and the labor market is contracting by 1 percent per year. Little wonder that household spending is anemic and business investment weak, despite the fact that companies are sitting on record amounts of cash.

The move to NIRP set off a mini-panic in Japan's markets; it seemed to dawn on everybody that nothing the government had done had been effective, so why would NIRP be any different? …

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