Market Screams for a Correction, According to Shinzo Abe

Shinzo Abe, Prime Minister of Japan, issued a warning at the G7 meeting. The G7 is a meeting between the world’s major economies. Included in the group are Canada, France, Germany, Italy, Japan, the UK and the US.

Abe said the situation facing the seven leaders was dire. He suggested the world was in a similar situation to that of 2007–09.  Abe backed up his claims with graphs, one of which showed a 55% slump in commodities between 2014 and 2016.

He argued that we could, potentially, witness a crisis like that of the 1930s. Yet this had little effect at the meeting. The remaining six members believed the US economy was improving. And they seemed to think activity in Europe had been picking up.

But I have a sneaking suspicion that Abe’s words fell on deaf ears because of Japan’s track record. The country has fought with deflation for more than two decades. And their weak economic growth still persists.

Fiscal policy and its lack of effectiveness

Just weeks after taking office in 2012, Abe announced plans for some new policies to jolt Japan’s stagnation. His three-pronged approach combined fiscal expansion, monetary easing and structural reform. But it could be all boiled down to this: pumping money into the economy to increase spending.

Abe’s immediate goal was to boost domestic demand and gross domestic product (GDP) growth. It might be still too early to tell if ‘Abenomics’ is actually working. Yet pumping money into the system and expecting people to spend hasn’t worked in the past.

During the 1930s, lawmakers doubled federal spending. Yet this had little effect on getting the populace to spend. Unemployment remained above 20% until the Second World War.

Japan responded to their 1990 recession by passing 10 stimulus spending bills over eight years. Borrowing to spend built the largest national debt in the industrialised world. Yet their economy remains stagnant.

In 2008, then US president George Bush tried to beat the recession with a round of tax rebates. The recession continued to worsen, and many believe we are now holding off a big correction.

The six other G7 members were more concerned with China. They discussed their growing frustration with China’s middle income class.


The trap Chinese need to avoid

The Chinese middle income class earned around US$8,655 in 2014. While this might seem drastically low, remember that the cost of living is not the same everywhere.

The average consumer in China spends around US$7 a day. And according to Goldman Sachs, nearly half of all personal spending is on food and clothing. Around 9.2% is allocated to activities like travel, dining out, sports and video games.

To put this in context, the average American spends around 17.3% of their income on recreation. From the graph below you’ll get a better idea of Chinese consumer spending.

Chinese Consumers a Breakdown

Source: Goldman Sachs, Chinese National Bureau of Statistics

What’s worrying economic leaders is whether China’s population can move out of the middle income class. The idea is to move your population into the middle income class first, and then into the ‘upper’ middle income class. But the inability to do this is what’s commonly referred to as the middle income trap.

And because China now seeks to grow through consumption, this could be a problem going forward. Countries like Brazil and Turkey had moved their populations into middle income status by the 1970s. China reached these levels back in 2010.

However, the problem is that Brazil and Turkey have made little ground since then. And the fear is that China might meet the same fate.

There was one who shared Abe’s concerns, however. The billionaire Bill Gross has warned that the ‘system itself is at risk.

The biggest bubble in history

Gross founded the giant bond fund manager PIMCO before leaving almost two years ago. He’s predicted a day where central banks will lose the ability to prop up asset prices.

Gross pointed to Japan and Europe as being the instigators pushing bond yields drastically low. Both have pushed interest rates past zero. And right now both are in a horrible position. There’s only one place interest rates can go — up.

With bond prices so high, the hint of a rate hike could make those longer term maturity bonds worth a lot less. Why? Because prices and yields are inversely related; just assume that lower interest rates raise prices.

Therefore, the incentive of buying bonds is non-existent. With interest rates at all-time lows, there’s only one place for bond prices to go. That’s why it could be said the bond market is one of the biggest bubbles right now.

Härje Ronngard,

Junior Analyst, Money Morning

PS: If you believe Abe and Gross, things are looking risky. But there are five things you could potentially do to boost your retirement wealth, regardless of what happens.

Money Morning’s income specialist, Matt Hibbard, can show you five ways to leave you with more money in retirement. In his report, ‘Five Things You Can Do to Boost Your Retirement Pot’, you’ll learn how to take control of your future wealth. To get your free copy of Matt’s report, click here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

Money Morning Australia