Analysis: Ageing, indebted Japan holds lessons for others

A man looks down as he walks through a financial district in Tokyo May 19, 2011.

LONDON (Reuters) - An asset price bubble pops, hitting bank balance sheets and tax revenues. As growth weakens and the economy flirts with deflation, the real burden of servicing debt increases.

Companies race to pay off debt, further dragging down growth. Government spending takes up the slack. Monetary policy is akin to pushing on a piece of string, so even zero interest rates have scant impact. Population decline compounds the vicious circle.

That is a rough summary of Japan's plight over the past 20 years. Worryingly, it may also turn out to be the template for other mature economies, especially in Europe.

"In terms of nominal GDP growth, things are playing out in a very similar way to how they did in Japan," said Albert Edwards, global strategist at French bank Societe Generale.

In a presentation for investors in London, Edwards said world markets, too, were following Japan's "ice age" lead.

Corporate dividend and earnings yields tracked bond yields lower in the 20-year global bull market for stocks that ended with the dot-com bust in 2000.

Since then, equity yields have climbed even as bond yields have continued to fall - the very same trend that began in Japan 10 years earlier as the country's property and share prices started to fall to earth.

"It's exactly what happened after their bubble burst in the 1990s," Edwards, a self-proclaimed "perma bear" on equities, said. "Prior to that there was a very close correlation in equity and bond yields."

Bullish equity analysts point to this divergence between corporate bond and corporate earnings yields to argue that share prices are undervalued.

But Ajay Kapur, a strategist for Deutsche Bank in Hong Kong, disagreed. He said it was understandable why stocks were "cheap" by this measure.

"Equities are correctly worried about demographic turning points in almost every developed market and the potential impact on trend earnings growth, about excessive leverage, still-expensive property markets, heightened GDP volatility and more frequent recessions," Kapur said in a report.

DEMOGRAPHY IS DESTINY

Economists have generally played down the implications of Japan's prolonged stagnation for Western economies that are now wrestling with apparently similar balance sheet recessions. These occur when firms and households are forced to reduce their excess debt by cutting consumption and investment.

But Kapur said it would be a crucial error to dismiss Japan's malaise since 1990 as somehow reflecting specific national 'cultural' traits. Many other countries were displaying similar features.

In the next five years, all of the 18 developed countries for which Deutsche has property market data going back more than half a century will see a decline in their working age population ratios.

Sixty percent of them will show an absolute decline in the number of citizens of working age, something that Kapur said was unprecedented.

Also without precedent is the fact that all of the countries on Deutsche's radar have outstanding bank credit that exceeds 100 percent of GDP.

This combination of adverse demographics and high debt is lethal for property prices, which are still way overvalued in most countries in relation to incomes and rents, Kapur said.

It was difficult to dismiss this confluence of events.

"We probably need to go back to times of significant wars (and plagues) to see this sort of an environment, where leverage rose and working age populations declined," he wrote.

"This time is different."

NEW PECKING ORDER

Karen Ward, an economist with HSBC in London, agreed that Japan's demographic profile was probably at least as much to blame as aggressive deleveraging for its economic stagnation. Growth in the labor force began falling steadily in the mid-1980s and numbers started falling outright a decade later.

Of course, the working age population is just one ingredient in the growth mix. Still, Japan's experience shows that ageing will be a big drag on mature, heavily indebted economies that are already near the productivity frontier and thus have less scope for rapid technological catch-up.

The United States ought to benefit from steady immigration, demographers say. But by 2020, the workforce in western Europe will shrink by 2.4 percent, including a 4.2 percent contraction in Germany, according to a Boston Consulting Group study.

Looking further ahead, HSBC projects that Germany's working population will shrivel by 29 percent by 2050, Russia's by 31 percent and Japan's by 37 percent.

Over the same period, the population of many African countries will double. Nigeria will log a rise of 3 percent a year in its workforce - in contrast to a 1 percent decline in Russia and Japan - and will have as many people as the United States by 2050.

"Even if some of these countries remain relatively poor on a per-capita basis, they could see a dramatic increase in the size of their economies thanks to population growth," Ward said in a report.

On current projections, Pakistan will be the sixth most-populous nation by the middle of the century. And the Philippines could be the world's 16th-biggest economy, HSBC reckons.

"As the projections for working population stand, demographics alone could explain a large part of what are likely to be huge differences in economic performance in the coming years," Ward said.

(Editing by Hugh Lawson)