The Eurozone’s Japan moment
As Italy totters and Europe faces yet another series of crises-bailouts, policymakers could turn to Japan for an example of how not to act
Like some bad horror-film franchise, Europe’s drama has returned to center stage, scaring markets all over again. On Wednesday, Japan’s Nikkei 225 Stock Average screened its own sequel to the 392-point Tuesday drop in the Dow Jones Industrial Average – plunging 340 points.
This latest twist casts Italy in the starring role, but it’s merely a preview of what’s to come in the eurozone. It also includes an unlikely part for Japan.
Markets are calming down a touch, but thrills and spills lie ahead. Ostensibly, Italy’s troubles are about political turmoil. An upcoming election, punters fear, will embolden populist, Eurosceptic leaders who might further mismanage an epic debt pile.
The sheer carnage in markets seems a rerun of the eurozone’s 2010-2012 crisis. Yet here is a better way to look at things: the crisis never really ended. Governments merely tossed enough bailouts and happy talk at markets to distract us for a while.
All this will feel eerily familiar to long-time Japan observers. It’s been six years, after all, since European Central Bank President Mario Draghi made his “whatever it takes” pledge. At the time, chaos in debt-laden economies pushed the currency union to the verge of collapse. Traders loved Draghi’s resolve, a commitment that read from the Bank of Japan playbook of old.
Since then, though, the ECB and complacent governments papered over the region’s cracks. It also enabled Europe to ride out the 2016 Brexit shock. But leaders demurred on devising ways to learn to grow without increased borrowing. They punted on creating credible fiscal and banking unions to deepen the monetary one. They failed to raise their economic games. Officialdom, in other words, treated the symptoms of Europe’s troubles, not the underlying causes.
The International Monetary Fund didn’t help.
Run by former French Finance Minister Christine Lagarde, the IMF has been more generous in doling out cash to Europe, and forgiving with the reforms it expects in return for that cash, than it was with Asia in the late 1990s. The IMF erred by focusing more on carrots than sticks, enabling Rome and other change-averse governments to continue business as usual.
Though Italy is Exhibit A for the re-emergence of Europe’s woes, it’s also a microcosm. As economist Paul Sheard of S&P Global told Bloomberg: “The eurozone is very much a half-built house.” It was just that before 2010. It was that in 2013, when the Federal Reserve “taper tantrum” panicked world markets. And it is still an unfinished construction project as Italy – one of the original euro pillars – wobbles.
Bad enough that Argentina’s return to crisis is slamming Indonesia and other developing Asian economies. Now, the “C-word” – contagion – is being discussed at the table in Europe, too. As analysts at BMI Group observed: “We see risks of a much more severe correction given recent moves in debt markets. Political risks in Italy and Spain have led to a sharp rise in bond yields in both countries, and there has been contagion to other markets.”
This brings us to Japan’s role in this discussion. Were time travel possible, Japanese officials would return to earlier decisions to punt on difficult reforms. After its 1980s “bubble economy” imploded, Tokyo demurred on letting over-extended companies and banks fail. In 1997, it dabbled with creative destruction by letting Yamaichi Securities go bust. But seeing the market bloodshed after letting one of its four fabled brokerages crash, Tokyo veered to bailouts. Twenty-one years later, its economy is still dealing with the fallout of that policy choice.
Japan pressured the BOJ to go further and further to support weak links; what that did was to enable mediocrity. Along with shackling Japan with the world’s biggest debt burden, it left the economy ill-prepared to confront an ascendant China.
Even now, five-and-a-half years into Prime Minister Shinzo Abe’s revival scheme, Japan’s growth relies on monetary and fiscal steroids. Since December 2012, the BOJ has turned its quantitative-easing program up to 11 and Tokyo churned out even more debt. Abenomics, for all the cheerleading about a “Reaganomics moment in Japan,” is treating the symptoms of weak productivity and wage growth, not the causes.
Japan’s lessons have rarely been more applicable. If only European economies had done more to loosen labor markets, address rigidities that stymie startups, incentivize increase investment, coordinate infrastructure upgrades, address aging populations, engineer freer trade and brainstorm on immigration policies, its crisis might not be returning to a financial theater near you.
But it is. Have your popcorn ready.