Inside Deutsche Bank Debate Rages Over America Sliding Into Japan Malaise
Deutsche Bank AG (DBK)’s Ajay Kapur says the U.S. is sliding into an economic malaise similar to Japan’s so-called lost-decade of the 1990s. The Hong Kong-based strategist draws the parallel using similarities in demographics and financial-market performance.
Binky Chadha, head of the bank’s U.S. equity strategy team in New York, and Michael Biggs, one of its London-based economists, disagree, citing variations in the nations’ growth rates and credit demands.
The researchers aired their differences in a 28-page report Deutsche Bank released Oct. 17 and distributed to clients. The debate underscores the uncertainties facing the world’s largest economy. Fifty-six percent of respondents in a quarterly Bloomberg Global Poll of 1,031 investors, analysts and traders said a Japan-like scenario is “very” or “fairly” likely.
The Deutsche Bank report “mirrors a similar discussion among policy makers at the Federal Reserve,” said Tim Duy, a former U.S. Treasury economist in international affairs who now teaches at the University of Oregon in Eugene. “How much of the current malaise will be relieved by traditional, cyclical forces versus the possibility of a much more protracted period of sub- optimal growth such as that experienced by Japan?”
Robert Feldman, head of Japan economic research at Morgan Stanley (MS) MUFG Securities Co. in Tokyo, said he thinks the U.S. is “a little bit less likely” to fall into Japan-like deflation “than pessimists think.” Fed officials “studied Japanese experiences very closely,” and “the right lesson they drew is you have to move quickly and very, very big.”
‘Their Own Views’
The Deutsche Bank report presents the economists’ contrasting analyses about America’s prospects without reaching a unified conclusion. The Frankfurt-based bank, Germany’s largest by assets, is letting its researchers “express their own views, even when they do not entirely agree among themselves on particular themes or issues,” Renee Calabro, a company spokeswoman in New York, said in an e-mailed statement. “As much as clients value our conclusions, it is the quality of the debate that matters most to them.”
The bank declined to make the authors available for comment on the record.
Kapur, who joined Deutsche Bank last year and has worked for Morgan Stanley and Citigroup Inc., charts the countries’ falling bond yields and volatile stock markets to illustrate their similarities.
A 63 percent plunge in Japan’s equity prices from late 1989 to August 1992 was accompanied by a collapse in land values from 1990 to 1993, producing stagnation and deflation during the 1990s and a second decade of weakness. The Nikkei 225 (NKY) Stock Average remains almost 80 percent below the record 38,915.87 reached on Dec. 29, 1989, and land prices have fallen in 18 of the past 20 years. Real growth averaged 1.2 percent from 1991 to 2002.
In the U.S., a housing bubble burst, sending home prices down as much as a third below the high reached in April 2006, according to the S&P/Case-Shiller gauge of prices in 20 U.S. cities. The Standard & Poor’s 500 Index has fallen about 20 percent from the record close of 1,565.15 on Oct. 9, 2007, after plunging as low as 676.53 on March 9, 2009.
The yield on 10-year Treasury notes has dropped to 2.2 percent on Oct. 26 from about 8 percent in November 1994, while the yield on the comparable Japanese bond fell to less than 1 percent from about 4.7 percent.
Kapur links Japan’s asset bubbles and growth to demographics. The ranks of working-age people climbed in the 1980s as a percentage of the overall population, leading up to property booms, economic growth and budget surpluses, he said.
The U.S. experienced a similar shift when its share of people ages 15 to 64 rose in the early 2000s. The ratios peaked in 1990 for Japan and 2005 for the U.S.; now both countries face a declining share of workers for years to come, he said.
“It is not often that one feels somewhat ill while writing research,” Kapur said in the report. Still, the possibility that the U.S. and Europe will “morph into a Japan-like situation” is “the source of our physical discomfort. Of course, we hope this is purely a risk case and that we will one day be able to look back and laugh at our foolishness for even suggesting the parallels.”
Chadha, his New-York based colleague, says the comparison is “overdone,” and he doesn’t see the U.S. following Japan’s pattern. Nominal gross domestic product is now about 4 percent higher in the U.S. than in Japan, and deleveraging in the U.S. “has been swift and is already further ahead today than in Japan after 20 years,” he wrote. American companies also are reporting a recovery in profits, he added.
Biggs called the two nations “superficially similar, fundamentally different,” partly because demand for credit, which fell in Japan, still is growing in the U.S.
“We agree that U.S. debt levels are high and will need to come down, but we do not believe that this deleveraging process needs to be a drag on demand growth,” Biggs wrote. “The starting point for the U.S. is so dramatically different from Japan in the 1990s that it seems unlikely to us that the U.S. should suffer a lost decade of weak demand growth.”
Japanese economists also disagree about the outlook for the U.S. Takuji Okubo, chief Japan economist in Tokyo at Societe Generale SA, says he doesn’t think America faces decades of stagnation; Hiromichi Shirakawa, a former Bank of Japan (8301) official, says the odds are rising that it will because of Europe’s debt crisis.
“The U.S. wouldn’t go on the same path as Japan did if there were no European problems,” said Shirakawa, now chief Japan economist in Tokyo at Credit Suisse Group AG. “But unfortunately the U.S. has to address another big shock amid a recovery.”
Japan’s “disastrous” decade of stagnation and deflation wasn’t inevitable, said John H. Makin, a former consultant to the U.S. Treasury and the International Monetary Fund who is now a resident scholar at the American Enterprise Institute for Public Policy Research in Washington. Instead, it was the result of “a series of persistently wrong economic-policy decisions.”
The Bank of Japan didn’t start lowering its benchmark interest rate until July 1991 -- about a year or more after stock and real-estate prices started to fall -- and it waited until February 1999 to push borrowing costs down to zero. Not until March 2001 did the central bank implement quantitative easing, creating excess reserves in the banking system by buying long-term Japanese government bonds.
Fed Chairman Ben S. Bernanke, as a Princeton University economics professor in 1999, criticized Japanese officials for mishandling their economy and creating a “self-induced paralysis.”
Under Bernanke, the Fed began cutting the target for its benchmark rate in September 2007 to ward off a recession sparked by fallout from the housing-market collapse. It was the first of 10 moves that drove the federal funds rate on overnight loans among banks to near zero by December 2008. Even with the effort, the U.S. sank into an 18-month slump in December 2007.
The Fed began its first round of quantitative easing in December 2008 after the collapse of Lehman Brothers Holdings Inc. and the central bank’s $85 billion bailout of insurer American International Group Inc. (AIG) The $1.7 trillion program of purchases in Treasuries, mortgage debt and government-agency bonds ended in March 2010. That was followed by a second round of bond purchases totaling $600 billion completed in June.
Fed Vice Chairman Janet Yellen, in an Oct. 21 speech in Denver, said a third round of large-scale securities purchases may be needed, given a “disappointingly slow” recovery, “tepid” job growth and the chance that Europe’s sovereign-debt crisis may pressure U.S. financial companies.
Unemployment has been at or above 9 percent in 27 of the last 29 months, and GDP rose at a 2.5 percent annual rate in the third quarter, according to the Commerce Department, below the 3 percent pace for 2010.
Nomura Securities International Inc.’s Paul Sheard says the U.S. has avoided the type of monetary-policy missteps that led Japan into a deflationary spiral.
“Japan had already slipped into deflation by the time the Bank of Japan started more nonconventional policy” in 2001, said Sheard, global chief economist in New York at the unit of Nomura Holdings Inc. (8604) “The economy couldn’t grow its way out of the problem.” By contrast, “the Fed moved very quickly and aggressively to keep the U.S. economy from slipping into deflation, and succeeded.”
Whether similarities can be drawn between the U.S. and Japan “is a mixed bag,” Makin said. “In some areas, we’re struggling on the fiscal-policy front. Certainly, the Federal Reserve has been more proactive than the Bank of Japan in preempting deflation. So the jury is still out on whether we are headed for a lost decade or working our way out of it.”
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