The Bear’s Lair: Combining the worst of Japan and Brazil

Brazil and to a lesser extent Japan have been in trouble recently. Brazil is suffering negative growth as a result of its corruption, government meddling and overspending. Japan has seen growth disappear and debt soar as it pursues Keynesian and easy-money remedies for its problems. Both countries, while different from each other, are generally seen as exceptions to the generally fairly benign trends in the global economy. Yet in reality the developed world and the Anglo-American world in particular is increasingly coming to combine the worst of Brazilian and Japanese economic pathologies.

Brazil has an excuse for doziness: it’s still a poor country, with excessively rapid population growth and a 1988 Constitution that locks in the sillier features of public spending, notably state pensions. Ever since Luiz Inacio Lula da Silva was elected in 2002 it has been in the grip of an increasingly intrusive socialism, which Dilma Rousseff, Lula’s successor since 2010, has only made worse. The country is one of the world’s most corrupt, with a $2 billion embezzlement scandal at its oil company Petrobras and a ranking well into the bottom half of Transparency International’s Corruption Perceptions Index.

Brazil’s public sector accounts are falsified (state expenditures are hidden on the books of state banks), and it is expected on a true basis to run a public sector deficit this year of 8% of GDP. Its economy will shrink this year and is now expected to shrink again next year, while the massive public expenditures for the 2016 Olympics have only exacerbated the fiscal situation and will almost certainly produce more graft than public good.

On the other hand, Brazil’s monetary policy is exceptionally sound, with interest rates consistently kept above the level of inflation in spite of massive squawking by the politicians. It also has a demographic profile with too many births, requiring excessive public expenditure but promising a “demographic dividend” in future years as its young people move into prime working age while the number of retirees remains small.

Japan, conversely, has rotten demographics. Its population is expected to decline by 30% by 2050. Since GDP per capita is what counts, not absolute GDP, this would not matter much, except that the idiot country has acquired a public debt of 245% of GDP, close to the 250% of GDP that is the maximum ever successfully worked down (by Britain twice, after 1815 and after 1945.)

Ever since its bubble burst in 1990, the country has been affected by a Keynesian mania for deficit spending, to try to fill the hole left by collapsing real estate and equity values. The result is the world’s highest public debt. If Japan had Brazil’s demographics and income per capita, there would be some hope that a reformed Japan might work its way out of the problem – a combination of more and richer people would have some chance of redemption, provided the Keynesians in Japan’s Ministry of Finance had all been compulsorily retired.

However Japan does not have Brazil’s demographics, and its Ministry of Finance does not appear about to lose its Keynesians including apparently prime minister Shinzo Abe – every year new programs of pointless infrastructure spending are announced. In addition, Japan has now acquired the world’s worst monetary policy to accompany its world’s worst fiscal policy. It has left interest rates at effectively zero for almost 20 years, and is engaging in “quantitative easing” purchases of government and other bonds that are three times the size of Ben Bernanke’s QE program at its maddest, in relation to the economy.

On the other hand, Japan is not especially corrupt, and has an excellent work ethic, top quality technology and excellent social cohesion due to its tight immigration policy. The Abe administration is even mildly anti-socialist, having just privatized the postal bank and insurance system. Had that been done a decade ago, when former prime minister Junichiro Koizumi proposed it, it might have revitalized Japan’s economy by improving its allocation of resources, pushing fewer savings flows into government debt and more into small businesses. As it is, the postal saving system has been superseded by the central bank as a force siphoning Japan’s no longer massive savings towards government debt and away from the productive sectors of the economy.

Thus however valuable postal privatization is as a demonstration that the Japanese government’s heart is at least partly in the right place, it is almost certainly too late to make a real difference to the economic catastrophe that looms just ahead as the government debt burden finally becomes unmanageable. Indeed, by forcing more of the debt to be financed from abroad, it may even hasten the collapse.

Brazil is already in deep recession and Japan looks to be joining her there, as well as being in danger of a debt default (debt default is not impossible in Brazil either, judging by recent rating agency downgrades.) However other countries need not feel smug, for much of the Western world combines the worst features of both political/economic systems:

• Most Western countries have Japanese monetary policy, with endless years of zero interest rates, combined with frenetic bond purchases. What’s more their monetary policy will almost certainly get considerably worse once the next recession hits. They do not have Brazil’s sensible inflation-fighting central bank, and if interest rates ever rise again, their debt service will soar through the roof. Accounting on a “Primary surplus” basis as Brazil did until it was rumbled in the last few months, will not alter the reality of a huge problem.
• Britain and the United States in particular have budget deficits that are out of control, like both countries. Like Brazil, much of their accounting is wayward and unreliable, so deficits are much larger than they appear, with infrastructure being finance off-balance sheet (for example, in the United Kingdom) as it is through Brazil’s government-owned banks.
• Existing standards of public sector probity in the United States and many European countries have declined far below those operative in Japan, although they have not yet reached Brazil’s level. The requirement of political campaigns for incessant fund-raising has reduced U.S. politics to a trade of legislative favors for cash that is reminiscent either of Brazil or of Mark Twain’s “Gilded Age”, which was written in 1873. From 1873 until 1988, Americans had worked hard on cleaning up their politics, at least at the national level; that progress has now been reversed.
• Debt levels are not yet at Japan’s levels (though they are above Brazil’s) but current levels of deficit will shoot them rapidly towards Japan’s level once the next recession hits, when the U.S. can expect to run a $2 trillion budget deficit. It must be remembered that Japan’s debt level in 1990 was well below the current U.S. level, in terms of GDP. Japan’s debt build-up is all the product of misguided Keynesianism over the last 20 years – a tendency that is very apparent in the U.S. and Britain.
• The United States, Britain and Europe in general have a demographic profile that is much more similar to Japan’s than Brazil’s. It is disguised only by high levels of immigration. However, contrary to pro-immigration propaganda, much of the immigration is at the low-skill end of the scale, which does not wait until old age to begin drawing from the state, but starts almost immediately. Barriers to its resource-subtraction are only marginally higher in the U.S. than in Europe. The recent tendency for immigration numbers to be overwhelmed by floods of refugees and fake refugees from the Middle East, Africa and other trouble spots has only exacerbated this tendency.
• Productivity growth has declined sharply in both the U.S. and Britain from earlier trends, reducing the extent to which rising productivity can form a fiscal lifeline to help countries escape from profligacy. In this respect, Japan’s track record is much better than Britain’s or the United States’ since 2007. As for Brazil, its productivity growth has been notoriously sluggish for decades, although it is notably better than Mexico’s.

With sluggish productivity growth, fatuous Japan-like monetary policy, fiscal policy combining deficits and dodgy accounting, Japan-like demographics, corruption rising steadily towards Brazilian levels and witless socialism growing inexorably as it did in Brazil after 2002, the U.S. and Britain have little chance of escaping the unhappy fates of Japan and Brazil, since they lack the strengths of either and have most of the pathologies of both. Without a policy reversal that seems more unlikely by the day, the U.S. in particular is destined for a grim medium-term future.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)