There can be little doubt that dramatic advances in financial technology and the instantaneous global delivery of news and data have greatly eroded the barriers that separate markets. As a result, international markets now track one another much more closely. However, investors should not confuse short-term market correlation with actual economic fundamentals. Outside the United States the case for healthy economic growth remains strong.
The many investors who cannot conceive of a scenario in which a slowdown in the United States would not bring down the rest of the world would be well advised to remember how little impact Japan’s “lost decade” had on the global economy.
In the early 1990s, after years of bubblelike expansion in its equity and real-estate markets, the Japanese economy, then and now the second largest in the world, began a swoon from which it has only recently recovered. Japanese real estate declined 75 percent, and by 1998 the economy had contracted by nearly 20 percent from its peak. Toward the end of the cycle in 2003 and 2004, the Nikkei average had declined 80 percent from its peak levels. According to the IMF, the percentage of the global economy contributed by Japan declined from 17.9 percent in 1994 to 11.1 percent in 2004.
While the Japanese economy was imploding, the rest of the world chugged ahead. World GDP in 2004 was a stunning 56 percent larger than it was 10 years earlier. Despite fluctuations caused by the dotcom crash and the Asian debt crisis, most world stock markets ended the period substantially higher. It is notable that growth in Asia (ex-Japan) outpaced the world, despite the importance that Japan previously had within the region.
Japan’s leaders made huge policy blunders that prolonged the lost decade. Financial booms are famous for creating bad investments and asset mispricing (think $200 per share for Pets.com). When booms go bust, markets attempt to reallocate resources and reprice assets. Often these movements can create widespread fear. After Japan’s bubble burst, the government reacted to political pressure by conspicuously interfering with free-market mechanisms. By guaranteeing the debt of bankrupt corporations, the Japanese government gave rise to a legion of “zombie companies” that were kept alive long after their usefulness expired.
Though these moves succeeded in delaying some of the pain, they also made the Japanese slump last longer than it should have. Unfortunately, based on the flood of recent proposals that have come from the Bush administration, the Fed and all the presidential candidates, the United States is fully prepared to do the Japanese one better in terms of market interference. The Fed’s recent bailout of Bear Stearns, as well as its decision to extend credit to brokerage firms holding worthless subprime bonds, provide just a glimpse of the road ahead.
The United States currently represents a larger piece of the global economy (21 percent) than did Japan in 1994. But given the ease with which the world handled the crash of its No. 2 economy, why could it not survive a stumble by No. 1?
In sharp contrast to the large surpluses run by Japan in the 1990s, the United States today runs enormous trade deficits. In other words, Japan was then a net contributor to the global economy while America is now a net drain. Another major difference is that Japan had enough domestic savings to finance its foolhardy “solutions.” America continues to depend on lending from abroad. If these lenders simply refuse to pony up, letting the United States collapse as a consequence, the impact on the global economy will be much lighter. Of course, there can be little doubt that the U.S. dollar’s status as the reserve currency has created more global exposure to the U.S. banking system than was the case with Japan. As a result, the short-term financial disruptions will bite, especially for America’s chief creditors. However, it is important to note that Japan supplied the world with consumer goods and capital, while the United States is mostly a consumer of these things. The good news is that demand is not something uniquely American.
The past decade has seen an economic revolution in which much of the developing world embraced capitalism, and European unification created a new center of financial leadership and stability. It is these fundamental factors, not the capacity of American consumers to take on debt, that led to the phenomenal returns delivered by non-U.S. stocks during that time.
Once it becomes clear that the world does not depend on American consumption, these markets will resume their upward trajectory. The current uncertainty provides a supreme buying opportunity.
