Feet of Clay


Japan is again becoming an important place to watch. As a futurist, I believe its long term prospects are interesting once again, following years of stagnation. Robotics (the theme of Davos this year), renewable energy (think Paris COP21) and even the future symbiosis of the military and technology companies (although no one wants to talk about it), all point to the possibility of a resurgent Japan longer term.

However, there is another reason why Japan is important; and this is because its further evidence of the underlying sickness in the global economy.  On Friday, the Bank of Japan lowered interest rates to negative rates. Since Mr Kuroda became Governor in early 2013 and the BOJ made its policy U-turn it was pumped Y1.7 trillion into financial markets, or 40% of GDP.  It has achieved its target of 2% CPI for only one month (when they raised the sales tax) and the economy is again weak with industrial production down 1.6% in December. However, the Bank of Japan is merely symbolic of the global phenomenon of deflation. The fact that the decision was made immediately after the Governor returned from Davos is probably no coincidence. Now $5 trillion of the worlds sovereign debt is trading at negative yield. Germany saw its 10 year touch 0.3% on Monday.

And Economist Lakshman Achuthan this week wrote that: “After years of ZIRP and QE attempting to pull demand forward from the future, central banks are increasingly powerless when it comes to the economy itself. They can “print” money, but not economic growth. The world is watching, so those who are thought to walk on water cannot afford to be seen to have feet of clay.” I couldn’t agree more.  Central banks are facing a wall of deflation and perversely they have probably been contributing to it.

Throughout 2014 and 2015 we warned about the dangerous imbalances building up in the bond markets as a result of easy credit. Investors around the world were “forced” to look for yield. Much of this went into corporate bonds in Asia and some of it was used in the US by corporates to buy back their own stock (and creating the illusion that everything was fine). In Asia, the money was allocated to capex despite the precarious nature of aggregate demand in the global economy, adding to the already excess levels of capacity.

Now its “crunch time” because aggregate demand in the global economy seems to be worsening. Last year the IMF was concerned about the growing number of economies entering recession as global trade soured.  Will the world’s largest economy – the USA – join them?  I think it is this fear – not merely a China slowdown – that is shaking global markets this year. We have been pointing to the slow down in many leading indicators, such as the ISM new orders, as evidence that the US is moving towards recession.

Now the consensus of economists are moving in our direction albeit reluctantly. According to a Financial Times poll, the consensus now assigns a 20% possibility to a recession in the US vs. 15% in December. Stocks are also highlighting that something is very wrong with the economy; over 30% of US stocks are now down 30% from their 52 week highs. Furthermore, credit markets seem to be unhinging in the US.  In January, distressed corporate debt in the US rose 22% from a month ago and up 162% from a year ago according to S&P Capital IQ.  The number of distressed users has shot up 84% y-y as well across all industries in the economy.

In December, the Fed tried to prove to the world that the US economy was in recovery mode by raising rates. I suspect the Federal Reserve will do a u-turn later in the year; already the Deputy Governor has hinted about the possibility of NIRP. By then, however, I think that financial markets will have figured out that the bankers at the Fed also have “feet of clay”.  More QE or ZIRP in the US or anywhere is unlikely to work.


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