In today’s Exponential Investor

  • Heroin addicts on the doorstep
  • Forget stubborn inflation. What about deflation?
  • Lessons to be learned

On Friday in the Exponential Investor Podcast, we spoke with our colleague and friend, Nickolai Hubble from Fortune & Freedom.

If you missed that episode, you can catch it here.

We first met Nickolai nine years ago in a tiny bolt-hole office in Fitzroy Street, St Kilda, a bay-side inner-city suburb of Melbourne.

To get into that office on a Monday, you’d usually have to either navigate the passed out local heroin addict on the front step or a few empty “tinnies” of Carlton Draught and some pizza boxes from the Sunday evening before.

It was the kind of area that certainly showed you the realities of the world, warts and all.

Nonetheless, from those early days of editorial discussion and debate in Melbourne, to our time working together in the London offices of Southbank Investment Research, and beyond, I find it a delight to catch up with Nickolai.

He has lived and worked all over the world. He knows the ins and outs of how the world really works. He understands aspects of it that most investors never think about, and he gets how to navigate the pitfalls and perils of the markets as well as anyone else we know.

Today, Nickolai lives in Japan. And to be honest, we’re a little jealous. We love Japan. It’s a corner of the world that very much sticks to its guns (metaphorically rather than literally). It’s a country that is deeply rooted in tradition (with a liberal sprinkling of high-tech modernisation), family and a culture. That culture contributes to Japan’s soft power globally.

Nickolai has chosen to live in a country that is on a strange economic journey. That journey is one which raises interesting questions for those of us in the rest of the world…

Japanese spirals

Japan has been caught up in a spiral of falling prices ever since the early 1990s. An economic bubble, spurred by an extortionate stock market and property market speculation burst, led to tumbling asset prices in its aftermath.

A lack of demand stemming from demographic factors such as an ageing population and absence of immigration has also compounded the situation.

For example, Japan’s inflation rate hit MINUS 1.35% in 2009, its lowest recorded figure.

This negative rate of inflation is otherwise known as deflation. In other words, a fall in prices of goods and services.

It might sound like a good thing, and something that we are all longing for given the current economic climate.

However, deflation can bring its own problems.

Deflation can create a spiral of falling prices and economic growth.

For example, consumers know prices are likely to continue falling, so they wait for even cheaper prices before spending on goods and services.

This waiting game for lower prices leaves an economic vacuum of depleted demand and suppresses economic growth.

Deflation increases the real value of government debt too.

You mean, it costs me money to deposit cash at the bank?

In response to all this, Japanese policy-makers have pumped vast sums of monetary stimulus into the economy through bond buying programmes.

For example, since 2014, the Bank of Japan (BoJ, Japan’s central bank) has pledged to buying $740 billion in government bonds every year. This policy has become well known globally as quantitative easing (QE).

Meanwhile, the BoJ has kept official interest rates at rock bottom (or negative) levels.

The aim has been to encourage spending, because the incentive to save is reduced due to lower rates. Lower bond yields (and higher bond prices) should contribute to lower long-term borrowing costs and should encourage business investment.

However, inflation hasn’t budged.

Japan’s current inflation rate is still negative, sitting at MINUS 0.03% (2020, year on year). The official rate of inflation from 2021 is yet to be released. However, projections are anticipating Japan’s inflation rate to sink further to MINUS 0.17%.

The BoJ’s policy interest rates are also negative at MINUS 0.1%. So, it actually costs Japanese citizens money to deposit their cash at the bank. It also means that borrowers, rather than lenders, are paid interest when taking out a loan for example.

Japan is an unusual country for a lot of reasons. In terms of its financial and economic situation, what are the lessons from Japan that are relevant for the rest of the world?

Why it isn’t all gloom and doom

Cash held as notes and coin pays a zero interest rate. If you live in a country where crime is low and where you can literally store banknotes under your mattress (or, in the case of Japan, futon), those banknotes will be an attractive asset.

As discussed, depositing the money at a bank will actually cost you if the interest rate is negative.

In a country like Japan, the absolute amounts of money that can be moved quickly into other asset classes such as equities (or crypto) are huge.

As of November 2021, the average amount of cash circulating in the Japanese economy hit a record high of $10.34 trillion, offering abundant liquidity for asset purchases.

If you live in a country with inflation, though, the issues are different. Keeping banknotes under your mattress is almost never a good idea. You need to be invested, to be active, and to always consider what are the implications of rising prices for everything.

The good news is that there are things that you can do to preserve your wealth in real (after inflation) terms.

On Wednesday we’re going to show you some simple and effective ways in which you can do that using the world’s new, alternative financial system…

Until then…

Sam Volkering
Editor, Exponential Investor

Elliott Playle
Junior Analyst, Exponential Investor