by Bryan Perry

August 22, 2023

Back in 1989, Japan was the target of global criticism as wealthy Japanese investment pools, corporations, and individuals were buying up American trophy properties at sky-high prices – like when Mitsubishi Estate Co. paid the Rockefeller family $1.4 billion for an 80% stake in Rockefeller Center complex in Manhattan in payments made in 1989 and 1990. By early 1995, however, Mitsubishi had lost more than $600 million on its investment and put the property under bankruptcy protection.

Other Japanese investors overpaid for Van Gogh paintings, Hawaiian hotels, Westin Hotel, and the Pebble Beach Golf Resort. During the late 1980s the Japanese yen had appreciated greatly against the U.S. dollar and the Nikkei 225 traded to an all-time high of 38,195 on the last day of December 1989. The bubble finally burst after the Bank of Japan tightened monetary policy at the start of 1990, triggering the collapse of equity and land prices. By September 1990, the Nikkei index retreated 50% to just half its record high.

Last Friday, the Nikkei index closed at 31,450 – still 20% off where it peaked over 33 years ago.

Back then, the Bank of Japan’s interest rates were at 2.5%, the lowest since the central bank transited to a floating exchange rate in the early 1970s. Easy access to credit in the 1980s, low unemployment rates, and accelerating economic growth stoked the torrid 1980s stock market rally until the BOJ tightened monetary policy and sent that red-hot economy into what many coined as a “lost decade.”

Today, Japan’s national debt is pushing 280% of GDP due to an aging population that is putting growing strain on public finances, requiring increased spending on healthcare, pensions, and social security.

Sound familiar?

COVID-19 pushed Japan’s debt/GDP ratio from an already-lofty 236% in 2019 to nearly 260% in 2020. In the first quarter of 2023, debt as a percentage of gross domestic product in China soared to 279.7%, according to central bank and statistics bureau data compiled by Bloomberg. That was an increase of 7.7 percentage points from the previous quarter, the biggest jump in three years (see chart below).

China's Debt to Gross Domestic Product Ratio Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

China Now Faces a 1990-in-Japan-Like Array of Problems

China now faces a similar Japan-like array of challenges. First, they face a double-edged labor sword with their unemployed young work force. For decades, China enforced a one-child policy that created a scarcity of young workers. A summary by the Pew Research Center estimates that China’s population has already begun to decline and that the economy will have fewer than three people of working age supporting the public pensions of each retiree. Because three workers cannot possibly produce the taxed income to support a retiree, Beijing is creating more debt to support its pension obligations.

The second side of the double-edged labor sword is that young workers had to wait to obtain educational degrees and internships during COVID, while companies were taking a more cautious approach to hiring new employees. As a result, China’s youth unemployment rate has doubled in the past four years, with the unemployment rate for young people (aged 16-24) soaring to record highs above 20% during May of this year. The rate has now gotten so high that China’s National Bureau of Statistics stated last week that it would suspend any future reporting on youth unemployment.

Chinese Unemployment Rate Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

This is the kind of labor unrest that can sow the seeds of civil unrest. Kenneth Rogoff, a professor of economics at Harvard University, said, “China’s economic ascent draws parallels to what many other Asian economies went through during their periods of rapid urbanization, as well as what European countries such as Germany experienced after World War II, when major investments in infrastructure boosted growth. At the same time, decades of overbuilding in China resembles Japan’s infrastructure construction boom in the late 1980s and 1990s, which led to overinvestment.” Rogoff summarized, “They are running into diminishing returns in building stuff,” and, “There are limits to how far you can go with it. With so many needs met, economists estimate that China now has to invest about $9 to produce each $1 of GDP growth, up from less than $5 a decade ago, and a little over $3 in the 1990s.”

The law of diminishing returns is also hitting China like a slow-moving tropical storm. Despite the efforts of Beijing authorities and the BOJ to stimulate financial markets, China has some deep-rooted problems that risk putting their once-hot economy into a long-term deflationary spiral. Looking at both of their primary stock market indices, the large-cap index that is tracked by the iShares China Large-Cap ETF is testing the lows of 2008 while the Shanghai Composite is faring considerably better.

China Large Cap and Shanghai Index Charts

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

How Chinese officials handle the current commercial property crisis will provide a better tell as to whether their problems remain localized or whether there is any risk of contagion to global markets and specifically to the U.S. market. Property developer Evergrande was 2021’s shock wave story, when they defaulted after a liquidity crisis and eventually filed for Chapter 15 bankruptcy protection in New York last Thursday. Now, Country Garden, which once was China’s largest developer, is at risk of default in the next few weeks. That news sent Hong Kong’s Hang Seng Index into bear market territory on Friday.

As the global financial community waits in high anticipation to see if China can stabilize the commercial property market and the shadow banking sector, it stands to reason that investors should think twice about investing in Chinese stocks. There are plenty of excellent stocks on sale in the U.S. where the economy is on much better footing. Yes, the U.S. needs to resolve its own pending debt spiral as has been seen by the recent bump in bond yields in reaction to the huge bond auctions taking place this month.

Investors will get a chance to find out just how much of a vigilante Fed Chair Jay Powell is when he speaks at Jackson Hole later this week. The Federal Reserve is the world’s biggest central banker, and what Powell says could put a line under current market weakness or exacerbate the current volatility. He needs to provide a vote of confidence the market is seeking, so the U.S. can thrive, even if China doesn’t.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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