On Europe As Japan 2.0

Tyler Durden's picture

With Greece and Spain (and arguably Portugal and a few others) stuck in dramatic debt-deflation spirals, the political need for maintaining these nations in the euro far outweigh the economic 'benefits'. As UBS notes, looking at the euro area today, one cannot help but notice the parallels to Japan of the early 1990s. Europe today, as with Japan a generation ago, is an aging society with structural rigidities, pockets of corporate excellence, but wide swathes of inefficiency; but the two most striking similarities (and not in a good way) lie in the banking system (bloated from over-leveraging, under-capitalization, and bad loans); and fiscal policy (which is inherently pro-cyclical - as the politics of monetary union preclude national level stimulus - leaving ineffective monetary transmission channels unable to help fiscal failure). As UBS concludes, the current euro's similarities to Japan are key impediments to growth - and as such we should expect sclerotic economic activity for a five-year period.

 

Via UBS: The euro as Japan 2.0

Looking at the euro area today, one cannot help but notice the parallels to Japan in the early 1990s. We expect mediocre growth in the euro zone for several years, and it is hard to see a return to trend growth within five years. Europe today, as with Japan a generation ago, represents an ageing society with structural rigidities in its markets. There are pockets of corporate excellence, of course, just as there were in Japan. There are also areas of inefficiency. The two most striking similarities with Japan lie in the banking system and fiscal policy.

  1. Japan’s banking system problems in the 1990s stemmed from bad loans. For much of the euro area the problem is more undercapitalised banks (though there are bad loans too). From an economic perspective, it is not the cause as the effect that matters. The euro is likely to experience low bank credit growth in the coming years. This constrains economic growth.
  2. The second parallel is fiscal policy. In Japan’s case, fiscal policy failed to provide much economic stimulus because the political structures of the time directed stimulus into ultimately inefficient projects. In the euro area, the bias of fiscal policy is pro-cyclical not counter cyclical, as the politics of the monetary union preclude national level stimulus. Thus, monetary policy is unable to stimulate as the monetary transmission mechanism is failing to operate effectively, and fiscal policy that is failing to compensate for monetary failures.

However, as with any software upgrade, the euro as Japan 2.0 is not the same as Japan 1.0. One of the more significant differences is the position of the small and medium-sized enterprise sector. In Japan’s case, many SMEs were weak, not just in a cyclical sense, but in a structural sense. The “hollowing out” of Japanese industry (endaka) left the SME sector without key customers. Generally speaking, the euro area Mittelstand is not in the same situation. Of course, the problems of the cyclical downturn are felt by the euro area’s SMEs, but they are better positioned to participate in an economic recovery when it comes. This is important, as small businesses are labor intensive and can contribute to employment growth in a cyclical upswing.

 

A second key difference is particularly important in analyzing the debt implications of the economic position. The euro area has not, as yet, experienced the same degree of difficulty in achieving nominal GDP growth that Japan faced in the 1990s. Euro nominal GDP growth (outside of Germany) has risen significantly in the past decade. Even in a low real world environment, it is possible that inflation in at least parts of the euro area will contribute to a higher nominal GDP growth rate, which will in turn make the process of deleveraging more manageable.

Some care is required here – it is not yet clear if this is an area of difference or similarity with the Japanese experience. Certainly the pattern of euro CPI has shown more resilience than in Japan so far. The output gap is perhaps narrower in the euro area than was the case (initially at least) in Japan. Parts of the euro area are discovering the political expediency of raising VAT rates, which of course supports inflation (Japan did not raise its consumption tax rate until 1995). Finally, of course, the ECB has acted earlier and more aggressively than did the Bank of Japan in the 1990s.

 

This has so far prevented a deflation mentality taking hold in the euro area. The risk is that the persistent low growth environment may encourage a deflation mindset in parts of the euro area. However, it is unlikely to take hold across the euro as a whole, and to that end should limit the risks of a structurally low nominal growth environment.

What this goes to suggest is that the euro is similar to Japan as to some of the key impediments to growth, and as such we should expect sclerotic economic activity for a five-year period. However, the differences in the euro as an upgraded version of the Japanese economic crisis mean that the weak growth episode is unlikely to be as enduring as that of Japan. Japan 2.0 is a five-year risk, not a two-decade risk.

 

Source: UBS

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DoChenRollingBearing's picture

Saint-Gobain (glass & construction materials) of France a BUY?  Jonathan Buck thinks it might be...  

Review of Barron's -- Dated 5 November 2012:

http://tinyurl.com/acmwpy7

 

ACP's picture

Maybe he has insider info that they're moving to a capitalist country.

sitenine's picture

Makes you think, doesn't it?

Economic freedom is essential to prosperity.  As far as history has shown, the private sector has always been better than the central government at driving economies.

One can simply state that economies are the people and what they do with the resources at their disposal.  So, when governments set out to control an economy, they aim to control the people and how resources are allocated.  Place whatever 'ism you want on this phenomenon, it is contrary to freedom.

LawsofPhysics's picture

No shit, sounds like you are just now realizing that humanity is a ponzi. Think about it, the more people you manage/manipulate the better off you are.

economics9698's picture

 

That is until the peasants figure out the ponzi and cut your fucking head off.

 

THE DORK OF CORK's picture

I could never quite understand this ageing society bollox.

If so why are all the young people unemployed ?

Orly's picture

Straight to the core, Dork.  Fifty-five and over still have all the jobs and young people are screaming to work.  It just doesn't add up, as you say.

:D

old naughty's picture

Japan 2.0,

they did it so 'well', worth duplicated.

Kimo's picture

They key word is "aging", not "aged".  The time is coming, that the young will pick up the ball.... but will they know what to do with it?  Salient Green is in your future.

Kimo's picture

Japan had exports to prop up Central Planning blunders.  Export is about to become an endangered species for all the world.

Ghordius's picture

"The risk is that the persistent low growth environment may encourage a deflation mindset in parts of the euro area. However, it is unlikely to take hold across the euro as a whole, and to that end should limit the risks of a structurally low nominal growth environment."

Very interesting article. Nevertheless I'm at loss envisioning a "deflation mindset" in the eurozone.

In the immortal words of Financial Time's Martin "GDP" Wolf in his opinion column in 2010 (from memory):


The world is trying to deflate America and America is trying to inflate the world. Since the US can print unlimited amounts of dollars in this contest, the question is only about when the world will surrender.