In 2006 Steven Drobny published a book on global macro hedge funds called "Inside the House of Money". It is by far my favorite biographical style investment book. Although the market views expressed in the book are becoming outdated, I still find that I learn something new any time I thumb through the pages. However, I am not writing for the purposes of a book review.
I am writing because in Chapter 8, Drobny interviews a central banker turned hedge fund manager named Dr. Sushil Wadwhani. Wadwhani received his PhD from the London School of Economics. He has also worked for Goldman Sachs (NYSE:GS), the famous trader Paul Tudor Jones, the Bank of England, and has managed his own fund.
In 2006 Dr. Wadwhani argued, via Drobny's book, that "because...so-called 'modern' central banking is focused on consumer price inflation and not so much on asset price inflation, the result in a number of these places has been that huge imbalances have built up." He goes on to argue that "an obvious imbalance is the U.S. current account deficit leaving the U.S. dollar overvalued...". He also highlighted "other imbalances everywhere: the housing market in Australia, New Zealand, the United Kingdom." He did forecast that all of these things would go through a substantial correction but noted, as an ardent believer in Keynesian economics, "that it is extremely difficult to know when a bubble is bursting".
Fast forward to 2011....
I am not too familiar with housing prices in Australia or New Zealand, but anyone in the U.S. is all too aware that there has been a MAJOR correction, of sorts, in the form of a full out balance sheet recession. The Financial Times recently posted an interesting article in which they discuss the "Japanization" of the United States and Europe. The more I think, read, and learn about this comparison it is becoming harder and harder for me to see any better description for the path the United States is heading down than the term "Japanization". The FT succinctly asks, "the big question for many investors these days is one that could scarcely have been thought about a few years ago: is the west turning into Japan?"
Among the people quoted in the FT article, Sushil Wadwhani is on record arguing, "this is looking like a Japan-style scenario. I am more nervous than I have ever been before about it,” says Sushil Wadhwani, founder of the eponymous hedge fund and a former member of the Bank of England’s rate-setting monetary policy committee."
According to Dr. Wadwhani, "the most striking example of the “Japanisation” of countries such as the U.S., UK and Germany is in their benchmark borrowing costs. If you take 15 years off 10-year Treasury, gilt and Bund yields there is a remarkable similarity with Japan’s performance from 1988 to 1996."
The article goes on to say, "Mr Wadhwani believes that the stock market reaction to any future stimulus by the U.S. Federal Reserve will be crucial. 'How long the rally lasts will be dependent on if the economic data pick up. If they don’t, that would be like Japan and a very bearish signal'."
The FT article is a quick read and well worth it. It does an excellent job framing the importance of comparisons between the West and Japan. "The response to [the comparisons] will determine the future direction of western economies as well as of shares and bonds. To date, the tentative answer has been that the developed world is heading Japan’s way as government bonds have far outperformed equities."
As the evidence continues to mount regarding the outcome to this question, it is best to keep an open mind. With any luck there will be some positive developments in the political scene in the U.S. (read: new politicians) who will draw on comparisons between the U.S. and Japan to make careful, well thought out, pragmatic, balanced decisions about how to tackle our fiscal problems so as to avoid becoming quite simply, Japan. But as Keynes famously said, "when the facts change, I change my mind..." and I would simply add "and not before such time".