Do a Google search for Japan Demographic Timebomb and you’ll see a host of predictions about how screwed Japan is, and how you should short the hell out of Japanese Government Bonds, as the population gets older, and entitlement costs bankrupt the government.
Here’s famous newsletter writer Dennis Gartman, back in February, talking about the imminent collapse of the yen.
Kyle Bass has been making this argument over and over again lately.
Generally, so many investors have been bearish on JGB and the yen for so long, that the trade has been described as the widowmaker, since so many folks have lost money it.
OK, let’s take a step back for a second. If you didn’t already know, both the yen and JGB have seen huge multi-decade rallies. Here’s a long-term JGB yield chart.
So why has everyone been so off?
Well the funny thing is, the primary concern in Japan — the “demographic time bomb” — simply works exactly the opposite of how people think.
For one thing, in an ageing society, you would expect policies that favour cash and fixed income, rather than policies that favour growth and inflation. Not only has that been the outcome in Japan, it’s the direction the U.S. is going, as the Republican party (whose constituents skew older, and who are thus more concerned about cash) have become very anti-Fed and anti-stimulus, whereas the Democratic party is the party of inflation and the weaker dollar. Bottom line: Older people vote for deflation and that means stronger bonds and stronger currencies.
What’s more, as societies age, equity valuations compress, further making fixed income more attractive.
OK, maybe people can accept this whole deflation argument, but they think: Eventually won’t the government get so stretched that it will go bust?
The answer is no, not really.
We’ll explain two ways…
First of all, as society ages, people save even more money, and this savings goes into banks and other institutions that buy government debt. Japan is famously self-financed — it’s always run a monster trade surplus — so it doesn’t have to worry about foreigners losing their appetite for government debt. If the locals stopped saving, it would only be as a result of more spending, or more risky investments, both of which would have the result of increasing government taxes (thus naturally reducing the deficit) and increasing GDP growth (reducing the need to spend in order to maintain GDP growth).
Second — and this is a more theoretical idea — the idea of Japan running out of yen is prima facie absurd. Japan will never experience a shortage of yen, or a credit risk associated with its ability to repay a debt denominated in yen, because its government creates yen! It’s as simple as that.
What’s funny is that while folks like Kyle Bass think that Japan is a timebomb, it’s actually just the opposite: One of the safest safe havens imaginable.
Japan’s exposure to the European mess is negligible.
It’s got none of the societal cohesion issues facing parts of Europe and the U.S., as its people are 98.5% ethnically Japanese. Don’t expect to see any major divisive politics there, like we have in the U.S. Furthermore, as Japanese unemployment has remained famously low, it likely won’t be seeing any other divisive social problems associated with a large unemployed class. Remember all the wide-eyed articles about the lack of looting after Fukushima? It’s not an accident.
Bottom line: In an ageing society, you’d expect to see deflation and stronger fixed income/currency and that’s exactly what we’ve seen.
So not only would you expect Japan’s currency and bonds to behave exactly like they have, because of its other economic characteristics (cohsion, isolation from Europe, etc.) it really is the ultimate safe-haven.