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Why Investors Are Worried About 'Japanification' In Europe

Wayne Duggan

Over the past week, #japanification has been trending among economists and investors on Twitter. The term has been on investors’ minds since the European Central Bank warned last week that economic growth in the eurozone would be much lower in 2019 than it previously anticipated.

What Is Japanification?

"Japanification" is the idea that an economy could endure a prolonged period of low-growth expansion accompanied by low levels of inflation. As a result, interest rates tend to stay low. While the U.S. Federal Reserve has made a series of rate hikes in recent years, neither Japan nor the ECB has raised interest rates since the 2008 financial crisis.

Why Does It Matter?

Prior to 1991, Japan’s economy was booming. When an asset bubble burst in 1991, economic production plummeted.

The period from around 1991 to about 2001 is often referred to as the “Lost Decade” in Japan. The period was marked by near-zero interest rates and negative economic growth. From 1995 to 2007, Japan’s GDP fell from $5.3 trillion to $4.3 trillion and wages dropped about 5 percent. At the same time, Japan’s government operated at a massive deficit in an attempt to stimulate the economy.

As a result, Japan’s debt-to-GDP ratio is now 238 percent, higher than any other country in the world by a wide margin. The U.S. debt-to-GDP ratio is around 103 percent.

“Last year, Japan’s debt-to-GDP ratio stood at 238 percent, and since 1994, headline inflation has been negative for almost half of the time. This trend has also emerging in the eurozone in recent years,” ING economist Carsten Brzeski wrote last week.

Brzeski said eurozone trends in economic growth, inflation, interest rates and demographics since 2008 have lined up closely with trends in Japan starting in 1991.

What’s Next?

Fortunately for European investors, up to this point, the eurozone economy is still much better off than Japan. Interest rates are higher, growth is positive and debt levels are lower.

Yet after the ECB cut its near-term growth forecast to just 1.1 percent and announced a third round of post-crisis bank stimulus last week, investors will be watching debt levels and growth numbers closely.

The next ECB monetary policy meeting is scheduled for April 10.

While investors may be concerned, they certainly aren’t shying away from eurozone stocks. Year-to-date, the SPDR S&P 500 ETF Trust (NYSE: SPY) is up 11.1 percent and the Vanguard FTSE Europe ETF (NYSE: VGK) is up 9 percent. The iShares MSCI United Kingdom Index (NYSE: EWU) is up 11 percent.

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