By David Sterman
Even as the S&P 500 has risen 20% over the past 12 months, the champagne is really flowing in Japan, where the Nikkei index is up a stunning 60%. But it's time to put the cork back in the bottle. As my colleague Joseph Hogue recently noted, the Japanese economy holds the risk of a deep blowup. He focused on Japan's potentially ruinous debt load and didn't even touch on two other major concerns.
First, Japan's decision to end its use of nuclear power is leading to a massive spike in fossil fuel imports. Japan now looks set to run massive trade deficits far into the future. Second, Japan is aging fast. Consider these stats:
- Roughly 23% of Japan's citizens are now over 65, up from 11.6% in 1989. This figure is set to keep rising. (As a point of reference, roughly 14% of all Americans are over 65, and this percentage is expected to rise to 20% by 2030, according to the U.S. Administration on Aging.)
- Japan's population is set to shrink 24% to 95 million by 2050, and a rising percentage of the population will be elderly, according to the Japanese Health Ministry.
But the primary near-term concern for the Japanese economy, as Hogue discussed, is the high debt-to-GDP ratio. Unless the Japanese economy starts to grow at a faster pace, look for global investors to again focus on this ticking time bomb. But Japan isn't alone. Here are the 10 major economies with the highest-debt-to-GDP ratio:
Even the typically cautious Germans sport an 80% debt-to-GDP ratio, higher than the United States' 72%. It's an issue that will likely dog all of Europe for many years to come. Smaller economies such as Greece and Iceland could eventually seek to wave the white flag and welch on their debts, as Argentina did a decade ago. But larger economies can't explore that option without risking blowing up the global financial system.
Besides Japan, here are three other major economies that could implode in coming years.
1. France: World's Fifth Largest Economy
While German policy makers seek ways to help businesses be productive (through strong investments in infrastructure and flexible labor policies), French policy makes life difficult for business at every turn and will make the economy ever-less competitive. For example, in the face of mounting government debt and an aging population, France had the chance to raise its retirement age from 62, but recently chose keep that age in place. And France's 35-hour work week is still a third rail for politicians. Any move to discuss boosting the work week to 40 hours is quickly silenced. French unemployment benefits, which can approach the equivalent of $8,000 per month for some workers, have also remain untouched.
Meanwhile, even as other European economies are starting to generate slightly better economic trends, France's industrial production continues to fall (dropping 1.4% from May to June) and its unemployment remains at a 14-year high. Germany's Der Spiegel recently took note of France's ineffectual government policies. As per Mathieu von Rohr:
The French economy has been in gradual decline for years, without any president or administration having done anything decisive about it. But now, ignoring the problems is no longer an option. The economy hasn't grown in five years and will even contract slightly this year. A record 3.26 million Frenchmen are unemployed, youth unemployment is at 26.5 percent, consumer purchasing power has declined, and consumption, which drives the French economy, is beginning to slow down, as well.
Simply put, the only way for France to chip away at its high debt-to-GDP ratio is to boost GDP, especially considering the country's persistent budget deficits. Meanwhile, French corporations, which compete on the global stage, are becoming less competitive due to high labor costs and onerous regulations. And French voters may seek to elect politicians that further hamstring business by protecting one of the world's strongest social safety nets.
2. Italy: World's Eighth Largest Economy
Many of the issues affecting France are also in place in Italy, where the economy is now 7% smaller than it was in 2007. The Italian government recently predicted the economy will shrink a further 1.3% in 2014, as the downward spiral shows no signs of letting up. (That view may be optimistic: Italy's Central Bank anticipates a 1.9% contraction.)
Italy was once known as a leading manufacturer, and its small companies produced a wide range of hand-crafted products such as clothes, footwear and electronics. But in recent years, countries such as Turkey have started to supplant Italy, thanks in large part to lower wage rates. And ever since it adopted the Euro, Italy no longer has the luxury of devaluing its currency to make its exports more competitive. Der Speigel's Hans-Jürgen Schlamp took a fresh look at the Italian economy and noted that "one in two small businesses was only able to pay its employees in installments. Three out of five companies are forced to take out loans to pay their high tax bills."
For countries like France and Italy, it may appears as if these steady declines are being taken in stride and their economies and societies can muddle through this period of extended stagnation. Yet at what point might they reach a tipping point, where massive debt loads, declining output and rising social strife boil over into a full-blown crisis? In that context, it's hard to fathom why investors are bidding up stocks in these markets.
3. China: World's Second Largest Economy
To be sure, China possesses a range of virtues that countries like France and Italy can only dream of, including rising consumer demand, a world-class infrastructure and pro-business policies. But China also faces one major problem that is beyond the realm of any policy maker: Its working-age population is shrinking. According to China's National Bureau of Statistics, the amount of eligible workers shrank by 3.45 million in 2012. That spells the end of an ever-expanding work force that had been driving China's economy for more than three decades.
Clint Laurent, who works at research firm Global Economics, recently told the Economist magazine that the number of 15 to 24 year olds will shrink particularly quickly, dropping by 38 million (21%) over the next 10 years. And fewer young workers means employers will have to boost wages to fill jobs, which may set off a cycle of uncompetitiveness where factories in China close and reopen elsewhere in lower-cost Asian nations.
If this demographic shift indeed leads to a sharper slowdown in the Chinese economy, then sociologists predict a period of rising social unrest, as Chinese consumers have tolerated massive environmental degradation and a yawning gap between rich and poor. That could trigger deeper strains on the world's second-largest economy.
Risks to Consider
As an upside risk, a resurgent U.S. economy could help spark firmer global economic activity, that could reverse the spiral being seen in Europe and elsewhere. As noted, European stocks have been rising at a solid clip in recent years. As a result, investors should closely monitor these potentially troubling trends.