While American economic watchers are lamenting the lower-than-expected Gross Domestic Product numbers released on Friday (2.5 percent vs. an expected 3 percent), and as Europe’s economic malaise only deepens (Spain reaches a historic 27.2 percent unemployment), another fiscal crisis is brewing on another troubled continent.
The second and third largest economies of the world, China and Japan respectively, are facing a monumental challenge to sustain or create economic growth. Both nations possess aging populations, growing deficits and massive market-distorting government involvement within their economies.
Due to different reasons, either could precipitate the next global economic crisis.
China is commonly portrayed in the media as an unstoppable economic juggernaut with an insatiable thirst for natural resources and relentless economic growth. However, recent slowdowns and a meteoric rise in land prices are troubling nascent economic trends in the world’s most populous nation.
Average real estate prices have risen 9.3 percent, while Hong Kong’s prices have jumped 23.6 percent over the last year, an ascent on par with the American real estate boom days in the mid-2000s. Driven by escaping capital flowing from the easy money policies of the world’s central banks, this price spike is clearly unsustainable.
This fact is not lost on Chinese officials. In an attempt to cool the market, the government has sought to deflate this bubble by instituting a new 20 percent tax on homes akin to the 2008 American housing collapse. As a consequence, the Chinese economy missed its forecasted 8 percent quarterly annualized growth and came in subpar at 7.6 percent.
While such a small decline might look insignificant, future economic growth is projected to stumble further in the coming quarters and a slowing China will have repercussions across the world, dimming one of the only bright spots in a world full of economic disappointments.
Further, in recent years official Chinese economic statistics have come under question, so the actual state of economic slowdown in China very well could be understated by its erstwhile communist oligarchy. Will China be able to cool its numerous economic bubbles before they bring the world’s second largest economy to its knees, or will an overheated market cause a disorderly derailment of the Chinese economy?
Japan is an even more worrying case of economic danger. The world’s third-largest economy has embraced “Abenomics” named for its greatest proponent, Prime Minister Shinzo Abe, who promises to beat the stubborn deflation that has gripped his county for the past decade and a half. Like our own Federal Reserve’s Quantitative Easing program that purchases $85 billion monthly in securities, the Bank of Japan is buying $75 billion worth of government bonds each month and Abe is aggressively pursuing fiscal stimuli through higher domestic spending.
However, since Japan’s economy is much smaller than the United States economy, these asset purchases have a much greater cumulative effect relative to our own domestic QE, and since November of 2012, the Japanese yen has fallen 25 percent against the dollar. This currency devaluation has prompted calls from other central banks to match the yen’s fall and threatens to instigate a global currency devaluation war.
Unfortunately, the effects of “Abenomics” could also precipitate a major fiscal disaster. Japan currently possesses the world’s highest debt to GDP ratio at 236 percent, and devotes 21 percent of its annual budget to servicing the interest on that debt, despite a record low yield on 10-year bonds of under 1.4 percent.
If Abe, as promised, succeeds in inducing inflation of 2 percent, yields will also have to rise, straining the Japanese government’s ability to pay the interest on its enormous debt. Further, at the current rate of debt purchases, the Bank of Japan will own an equivalent to 65 percent of the annual GDP in governmental bonds (compared to the U.S. Fed’s 25 percent), and any debt divestment will likely prove calamitous to the price of Japanese bonds as the market is swamped with excess supply.
By gambling that historically low government bonds yields will continue indefinitely, Abe and the Bank of Japan are setting the stage for an epic bond market meltdown in the world’s third largest economy.
Economic headwinds and dangers continue throughout the world resulting from overleveraged governments, monetary manipulation, and fiscal profligacy. Whether in Europe’s troubled Eurozone economic basket-cases, the United States’ underperforming and anemic recovery, or East Asia’s dispiriting economic prospects, the world is desperately in need of a reduction in debt, lower regulatory burdens, and less distorting government interference in national economies.
Until those prerequisites are met, dangerous risks to the world economy will remain.