28 March 2010

China and Japan

Dylan Grice and Albert Edwards at SocGen, along with commentators like Peter Tasker, have for some time been drawing parallels between Japan in the 1980s and China now. 1

In summary, the high GDP growth rate and investment levels, the widening ratios of price to earnings on stocks and of price to incomes on property as well as the apparent resilience of all these measures to external shocks, such as the stock market crash of 1987, all of which were features of the Japanese economy over 20 years ago are now seen in China.

There is another parallel, less widely-discussed but noted by Grice. Just as Japan’s labour force began to fall in the 1990s, so China’s working age population is due to start shrinking from around 2015 onwards.

So, the demand deflation in Japan that was originally a response to the bursting of multiple asset bubbles has continued now for over 20 years largely because of the shrinking labour force (and not because of changes in productivity which, as Grice points out, has continued to improve). It is plausible to imagine China suffering a similar fate.

Another potential point of similarity between Japan then and China (and the rest of the world) now is the behaviour of stock markets.

According to Edwards 2, equity valuations before the bubble burst in Japan were “dominated by movements in bond yields” but this broke down after 1990 and gave way to a series of rallies driven by government-induced cyclical recoveries followed by new market lows. We don’t yet know if that is what is going to happen now, but the current upturn in markets almost everywhere certainly looks like it is being driven by a “government-induced” cycle, which may be reaching an end soon.

The long-term lesson, apparently, is to watch interest rates on the way up and cyclical indicators on the way down.

1 For example:

China rushes towards a Japan-style bubble By Peter Tasker, Financial TImes, 3 November 2009.

The lesson from Japan? China will be the biggest bubble the world has seen, Popular Delusions, Dylan Grice, 15 September 2009

2 Next leg in Ice Age equity de-rating nears as key leading indicators top out., Global Strategy Weekly, Albert Edwards, 19 February 2010

d. sofer