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Zero interest rates: what UK investors can learn from Japan

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The glossy Tokyo branches of Japan’s big trust banks offer a startling menagerie of investment options. You can open deposits in sterling, dollars and euros. There are investment trusts themed on sustainability, fintech and driverless cars.

For the properly adventurous there is a fund that invests in Turkish bonds, which offers a tempting interest rate and a five-year return history of minus 54 per cent.

What is almost completely absent is any suggestion that the customers might want to deposit money in yen. The interest rates on offer, which a determined customer can track down via the web, suggest why: for a term deposit of any size, over any period of up to five years, with a fixed or a floating interest rate, the banks will pay 0.002 per cent. Deposit enough money to buy a house and the annual interest should be enough for a cup of coffee.

While low or negative interest rates are still relatively new in the UK and Europe, Japanese savers have been wrestling with the phenomenon for more than two decades, since rates first hit zero in 1999.

In that time, they have experimented with all sorts of investments, and while they have found few good answers, they have learned a number of bitter lessons about what does not work — lessons that may now be relevant to their British counterparts. When the best available savings rates are around 1 per cent for a two-year fixed deposit, it is really time to consider seriously the Japanese experience.

“When interest rates are low is when you really need to invest carefully or you will lose your capital,” says Taichi Matsuda, who instructs financial advisers at Mitsubishi UFJ Trust, one of Japan’s largest investment managers. Those lessons include the potential for decades of low interest rates, the seductive lure of higher rates overseas and the need to take on and manage risk actively rather than pining for a past era of safe returns.

The simplest lesson — that low interest rates are here to stay — is one that took many years to sink in. When Japanese interest rates first hit zero in 1999, it was regarded as an oddity, trapped by unique circumstances. The world economy was in good shape and working itself towards the peak of the internet bubble. Many investors expected that Japanese rates would rise back to the levels of other developed nations and its large public debt would cause a crisis.

Rather than a debt crisis, however, Japan showed that low interest rates can go still lower. The nation’s ageing demographics — which are shared to a lesser degree by most advanced economies — meant a growing multitude of elderly savers, with 29 per cent of Japanese aged 65 and over.

Meanwhile, Japanese corporations that once gorged on bank credit, have lost the drive of their heyday in the 1970s and 1980s; they are reluctant to borrow and invest in a declining domestic market. No matter how low rates go, saving and borrowing have struggled to find an equilibrium.

In the mid-2000s, when Japanese 10-year bond yields hovered around 1.5 per cent, some strategists said they could not go lower and urged investors to sell bonds. But the trade of shorting Japanese government bonds in anticipation of a debt crisis became known as the “widow-maker” for its harvest of investment victims. Today, the Bank of Japan now targets a 10-year bond yield of around zero, while 30-year bonds yield just 0.65 per cent.

During the Covid-19 crisis, US and UK government yields have fallen close to those levels. Though British savers can still make some kind of a return on term deposits, Japan suggests a return to positive overnight rates may be a long time in coming.

“One thing you can say for sure is that low rates have become long-term,” says Takashi Abe, the chief executive of Ales Investment Advisors, a firm of financial advisers based in Tokyo. “Even massive quantitative easing hasn’t generated inflation.”

The rise of the yen carry trade

Because Japan was the first country to reach ultra-low interest rates, and it was so unusual at the time, there was an obvious temptation for Japanese investors. While their own interest rates were zero, US interest rates peaked at 6.5 per cent in the summer of 2000. By holding their savings in a different currency, a yen-based investor could earn vastly more interest.

That led to the early 2000s heyday of the yen carry trade and “Mrs Watanabe”, the archetypal Japanese housewife-turned currency investor. Most high street banks in Japan began to offer foreign currency deposits, with displays in their windows showing interest rates in dollars, euros, Swiss francs, sterling and other currencies. “Japanese investors targeted high interest rate currencies such as the Australian or New Zealand dollar,” says Yoshihiko Kobayashi, president of the retail currency brokerage JFX.

The constant selling of yen by retail investors, as well as hedge funds, helped to keep the currency weak and for a time the currency investment strategy did well. For example, a Japanese investor who deposited their cash in sterling in 2000 not only enjoyed British interest rates of 4 or 5 per cent a year, but a decline in the yen from around ¥150 to ¥250 against the pound between the summer of 2000 and 2007, giving them a double-digit return. That was vastly better than the zero they would have earned from yen deposits — until it all went wrong.

In the wake of the global financial crisis and the collapse of Lehman Brothers, the yen soared above ¥80 to the dollar and reached a peak of ¥120 against the pound, wiping out years of accumulated interest for those who got in early or imposing capital losses on those investors who entered the market late. “The outcome depended on their entry level,” says Mr Kobayashi. “Buy-and-hold in a high interest rate country is extremely risky.”

Japan’s largest banks still offer deposits in the main G7 currencies, but they now have zero interest rates too. Some smaller banks have moved on to a wider range of currencies: for example, Daiwa Next Bank, a banking arm of the Daiwa Securities group, is advertising interest of 1 per cent in South African rand, 1.5 per cent in Turkish lira, 1 per cent in Mexican pesos or 0.2 per cent in Chinese renminbi.

At some point, British banks may try the same ploy of luring customers with temptingly high interest rates in a foreign currency, but Japan’s experience — as well as standard economic theory — suggests they involve a lot of risk for dubious returns. High interest rates often reflect high inflation and a falling exchange rate.

“The yen is stable at the moment. There’s no volatility in currencies or bonds,” says Mr Abe. “People who trade currencies have moved towards the domestic stock market.”

Real estate woes

In Britain, the most popular asset is property, with low interest rates accompanied by a dramatic rise in house prices. Japanese real estate has shown strikingly different behaviour, however. After rising fivefold or more during the 1980s bubble, property prices slumped during the 1990s, and even after interest rates hit zero in 1999 there were only modest rises in real estate prices or investment.

Several factors help explain why Japanese property prices have behaved this way. Japan’s population is declining and shifting to Tokyo, which has meant reduced demand and high vacancy rates in many regional cities, holding down prices. Structures in Japan tend to be knocked down and rebuilt every 40 or 50 years, so investors need to reckon with a high rate of depreciation.

Perhaps most importantly, new construction is relatively easy in Japan — including in Tokyo — so property does not have the extreme scarcity value that it does in London, Paris or Hong Kong. Huge apartment building on reclaimed land around Tokyo Bay is a case in point.

Several areas of the property market have prospered: expensive apartments on the high floors of Tokyo tower blocks have done particularly well thanks to a quirk in inheritance tax law.

Various schemes have sought to lure private investors into the property market. One notable scandal involved loans to buy “shared houses” with communal facilities, aimed at single, low-income women moving to work in Tokyo and other big cities — the supply soon vastly exceeded demand and the investors lost money.

How the UK and Japan compare

UK

Total population: 66.8m

Population aged 65 and over: 19%

Population growth rate: 0.6%

GDP average growth rate (2009-2019): 1.87%

Forecast GDP growth rate 2020: -5.27% GDP per head: $44,287

Household savings as a percentage of disposable income: 0.74%

Currency/deposits as percentage of household financial assets: 25.1%

Household debt as percentage of net disposable income: 142%

Source: IMF, World Bank, OECD

JAPAN

Total population: 126.3m

Population aged 65 and over: 28%

Population growth rate: -0.2%

GDP average growth rate (2009-2019): 1.27%

Forecast GDP growth rate 2020: -9.76%GDP per head: $41,636

Household savings as a percentage of disposable income: 4.29%*

Currency/deposits as percentage of household financial assets: 52.8%**

Household debt as percentage of net disposable income: 107%***

*2016 data; **2017 data; ***2018 data

But on the whole, Japanese investors have not turned to property as a place to park their money in the low interest rate environment. The investment market for apartments is growing but constrained by a lack of credit, says Keiichi Kurauchi, president of the brokerage website Kenbiya. “Japan has lots of wooden structures and it’s hard to borrow on them,” he says. Without easy access to leverage, or the lure of big capital gains, property has not become a retail investor obsession.

Such differences in market structure help to explain why British investors have had a different experience. But Japan also shows that low interest rates do not guarantee eternally rising house prices. Much depends on population growth in the UK and whether British planners permit new houses or force residents to compete for the existing stock.

That leaves the options for Japanese investors narrowing down to one simple choice: put their money to work in the stock market or leave it in the bank. Historically, Japanese savers have been wedded to bank deposits, and the experience of the 1980s bubble and the devastating 1990 stock market crash, when the Nikkei index ultimately fell by more than 80 per cent from its all-time peak, reinforced that conservatism. But the past 30 years have been one long campaign to force a rethink.

On the one hand, Japan’s long years of ultra-low interest rates damped any desire to take risk. Pervasive gloom about the future and the stagnation of Japan’s stock market throughout the 2000s led many to conclude that while the bank might pay zero interest, the stock market was not much better — and risky to boot.

This year’s economic downturn has had a similar effect on risk appetite. “Japan has had a long experience with low interest rates so the coronavirus environment isn’t really new for people,” says Mr Abe. “It’s more that the shock puts them off investing at all.”

In a world with low returns, as well as growing job insecurity and uncertainty about the future of public pensions, potential savers wanted to hold on to what they have rather than take risks in pursuit of high returns. “Many of our customers are older and rather than aggressive investments they want to preserve their capital,” says Mr Matsuda.

But in recent years there has been a gradual change in attitude. Shinzo Abe, the prime minister from 2012-2020, made a determined effort to increase investment in stocks. One part of that was a new governance and stewardship code, aimed at making Japanese companies more shareholder friendly, and increasing their return on capital.

FT series: Lessons from Japan

The Abe administration also changed the investment portfolio of the Government Pension Investment Fund, the world’s biggest pension fund, with ¥167.5tn ($1.6tn) in assets under management. A large part of its holdings in Japanese government bonds was switched into domestic stocks, foreign bonds and foreign equities. That set a clear benchmark for other Japanese savers to follow.

“If we have a study group or a seminar then I notice that participation from a younger age group has really increased,” says Takashi Abe. “They are more concerned about the future and feel like they have to invest. People realise that their bank deposits aren’t going to increase.”

Throughout the 2000s and 2010s, the Japanese stock market relied on inflows from foreign investors for much of its activity, but in the past 18 months that has begun to change. The Nikkei 225 has reached levels not seen for almost three decades, with the activity driven by local investors. Even at around 26,800, as it was this week, it still is well short of its 1989 record of 38,916.

Compared with the strength of the US market, Japan looks a bit cheaper, according to strategists, especially given a much greater latent potential for companies to restructure and increase their returns. Japanese equities now trade on a forward price/earnings ratio of 20.5, versus 21.8 for the US. Depressed by Brexit uncertainty, the UK market is on a lowly 14.9.

Mr Abe advises his clients to assemble a portfolio of Japanese equities. “There’s no escape from low interest rates. In that case, the only thing you can do is invest in stocks,” he says. “Taking a risk on stocks is less risky than not investing.”

With interest rates now low across the developed world, British investors may come to the same conclusion.



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Why it might be good for China if foreign investors are wary

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Chinese economy updates

The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center for Global Policy

The chaos in Chinese stock markets last week was exacerbated by foreign investors selling Chinese shares, leaving Beijing’s regulators scrambling to regain their confidence while they tried to stabilise domestic markets. But if foreign funds become more cautious about investing in Chinese stocks, this may in fact be a good thing for China.

In the past two years, inflows into China have soared by more than $30bn a month. This is partly because of a $10bn-a-month increase in the country’s monthly trade surplus and a $20bn-a-month rise in financial inflows. The trend is expected to continue. Although Beijing has an excess of domestic savings, it has opened up its financial markets in recent years to unfettered foreign inflows. This is mainly to gain international prestige for those markets and to promote global use of the renminbi.

But there is a price for this prestige. As long as it refuses to reimpose capital controls — something that would undermine many years of gradual opening up — Beijing can only adjust to these inflows in three ways. Each brings its own cost that is magnified as foreign inflows increase.

One way is to allow rising foreign demand for the renminbi to push up its value. The problem, of course, is that this would undermine China’s export sector and would encourage further inflows, which would in turn push China’s huge trade surplus into deficit. If this happened, China would have to reduce the total amount of stuff it produces (and so reduce gross domestic product growth).

The second way is for China to intervene to stabilise the renminbi’s value. During the past four years China’s currency intervention has occurred not directly through the People’s Bank of China but indirectly through the state banks. They have accumulated more than $1tn of net foreign assets, mostly in the past two years.

Huge currency intervention, however, is incompatible with domestic monetary control because China must create the renminbi with which it purchases foreign currency. The consequence, as the PBoC has already warned several times this year, would be a too-rapid expansion of domestic credit and the worsening of domestic asset bubbles. 

Many readers will recognise that these are simply versions of the central bank trilemma: if China wants open capital markets, it must give up control either of the currency or of the domestic money supply. There is, however, a third way Beijing can react to these inflows, and that is by encouraging Chinese to invest more abroad, so that net inflows are reduced by higher outflows.

And this is exactly what the regulators have been trying to do. Since October of last year they have implemented a series of policies to encourage Chinese to invest more abroad, not just institutional investors and businesses but also households.

But even if these policies were successful (and so far they haven’t been), this would bring its own set of risks. In this case, foreign institutional investors bringing hot money into liquid Chinese securities are balanced by various Chinese entities investing abroad in a variety of assets for a range of purposes.

This would leave China with a classic developing-country problem: a mismatched international balance sheet. This raises the risk that foreign investors in China could suddenly exit at a time when Chinese investors are unwilling — or unable — to repatriate their foreign investments quickly enough. We’ve seen this many times before: a rickety financial system held together by the moral hazard of state support is forced to adjust to a surge in hot-money inflows, but cannot adjust quickly enough when these turn into outflows.

As long as Beijing wants to maintain open capital markets, it can only respond to inflows with some combination of the three: a disruptive appreciation in the currency, a too-rapid rise in domestic money and credit, or a risky international balance sheet. There are no other options.

That is why the current stock market turmoil may be a blessing in disguise. To the extent that it makes foreign investors more cautious about rushing into Chinese securities, it will reduce foreign hot-money inflows and so relieve pressure on the financial authorities to choose among these three bad options.

Until it substantially cleans up and transforms its financial system, in other words, China’s regulators should be more worried by too much foreign buying of its stocks and bonds than by too little.



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Square to acquire Afterpay for $29bn as ‘buy now, pay later’ booms

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Square Inc updates

Payments company Square has reached a deal to acquire Australian “buy now, pay later” provider Afterpay in a $29bn all-stock transaction that would be the largest takeover in Australian history.

Square, whose chief executive Jack Dorsey is also Twitter’s CEO, is offering Afterpay shareholders 0.375 shares of Square stock for every share they own — a 30 per cent premium based on the most recent closing prices for both companies.

Melbourne-based Afterpay allows retailers to offer customers the option of paying for products in four instalments without interest if the payments are made on time.

The deal’s size would exceed the record set by Unibail-Rodamco’s takeover of shopping centre group Westfield at an enterprise value of $24.7bn in 2017.

The transaction, which was announced in a joint statement from the companies on Monday, is expected to be completed in the first quarter of 2022.

Afterpay said its 16m users regard the service as a more responsible way to borrow than using a credit card. Merchants pay Afterpay a fixed fee, plus a percentage of each order.

The deal underscored the huge appetite for buy now, pay later providers, which have boomed during the coronavirus pandemic.

“Square and Afterpay have a shared purpose,” said Dorsey. “We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles.”

Adoption of buy now, pay later services had tripled by early this year compared with pre-pandemic volumes, according to data from Adobe Analytics, and were particularly popular with younger consumers.

Rivalling Afterpay is Sweden’s Klarna, which doubled its valuation in three months to $45.6bn, after receiving investment from SoftBank’s Vision Fund 2 in June. PayPal offers its own service, Pay in 4, while it was reported last month that Apple was looking to partner with Goldman Sachs to offer buy now, pay later facilities to Apple Pay users.

Steven Ng, a portfolio manager at Afterpay investor Ophir Asset Management, said the deal validated the buy, now pay later business model and could be the catalyst for mergers activity in the sector. “Given the tie-up with Square, it could kick off a round of consolidation with other payment providers where buy now, pay later becomes another payment method offered to their customers,” he said.

Over the past two years Afterpay has expanded rapidly in the US and Europe, which now account for more than three-quarters of its 16.3m active customers and a third of merchants on its platform. Afterpay said its services are used by more than 100,000 merchants across the US, Australia, Canada and New Zealand as well as in the UK, France, Italy and Spain, where it is known as Clearpay.

Square intends to offer the facility to its merchants and users of its Cash App, a fast money transfer service popular with small businesses and a competitor to PayPal’s Venmo.

“It’s an expensive purchase, but the buy now, pay later market is growing very rapidly and it makes a lot of sense for Square to have a solid stake in it,” said retail analyst Neil Saunders.

“For some, especially younger generations, buy now, pay later is a favoured form of credit. Afterpay has already had some success with its US expansion, but Square will be able to accelerate that by integrating it into its platforms and payment infrastructure — that’s probably one of the justifications for the relatively toppy price tag of the deal.”

Square handled $42.8bn in payments in the second quarter, with Cash App transactions making up about 10 per cent, according to figures released on Sunday. The company posted a $204m profit on revenues of $4.7bn.

Once the acquisition is completed, Afterpay shareholders will own about 18.5 per cent of Square, the companies said. The deal has been approved by both companies’ boards of directors but will also need to be backed by Afterpay shareholders.

As part of the deal, Square will establish a secondary listing on the Australian Securities Exchange to provide Afterpay shareholders with an option to receive Square shares listed on the New York Stock Exchange or the ASX. Square may elect to pay 1 per cent of the purchase price in cash.

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Biden puts workers ahead of consumers

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US economy updates

For the past 40 years in America, competition policy has revolved around the consumer. This is in part the legacy of legal scholar Robert Bork, whose 1978 book The Antitrust Paradox held that the major goal of antitrust policy should be to promote “business efficiency”, which from the 1980s onwards came to be measured in consumer prices. These were considered the fundamental measure of consumer wellbeing, which was in turn the centre of economic wellbeing.

But things are changing. A White House executive order on competition policy, signed last month, contains some 72 discreet measures designed to stamp out anti-competitive practices across nearly every part of the US economy. But it isn’t about low prices as much as it is about higher wages.

Like the Reagan-Thatcher revolution, which took power from unions and unleashed markets and corporations, Biden’s executive order may well be remembered as a major economic turning point — this time, away from neoliberalism with its focus on consumers, and towards workers as the primary interest group in the US economy.

In some ways, this matters more than the details of particular parts of the order. Many commentators have suggested that these measures, on their own, won’t achieve much. But executive orders aren’t necessarily about the details — they are about the direction of a government. And this one takes us completely away from the Bork era by focusing on the connection between market power and wages, which no president over the past century has acknowledged so explicitly.

“When there are only a few employers in town, workers have less opportunity to bargain for a higher wage,” Biden said in his announcement of the order. It noted that, in more than 75 per cent of US industries, a smaller number of large companies now control more business than they did 20 years ago.

His solutions include everything from cutting burdensome licensing requirements across half the private sector to banning and/or limiting non-compete agreements. Firms in many industries have used such agreements to hinder top employees from working for competitors, as well as to make it tougher for employees to share wage and benefit information with each other — something that Silicon Valley has done in nefarious ways.  

This gets to the heart of the American myth that employees and employers stand on an equal footing, a falsehood that is reflected in such Orwellian labour market terms as the “right to work”. In the US this refers not to any sort of workplace equality, but rather to the ability of certain states to prevent unions from representing all workers in a given company.

But beyond the explicitly labour-related measures, the president’s order also gets to the bigger connection between not just monopoly power and prices, but corporate concentration and the labour share.

As economist Jan Eeckhout lays out in his new book The Profit Paradox, rapid technological change since the 1980s has improved business efficiency and dramatically increased corporate profitability. But it has also led to an increase in market power that is detrimental for people in work.

As his research shows, firms in the 1980s made average profits that were a tenth of payroll costs. By the mid 2000s that ratio had jumped to 30 per cent and it went as high as 43 per cent in 2012. Meanwhile, “mark-ups” in profit margins due to market power have also risen dramatically (though it can be difficult to see this in parts of the digital economy that run not on dollars but on barter transactions of personal data).

While technology can ultimately lower prices and thus benefit everyone, this “only works well if markets are competitive. That is the profit paradox,” says Eeckhout. He argues that when firms have market power, they can keep out competitors that might offer better products and services. They can also pay workers less than they can afford to, since there are fewer and fewer employers doing the hiring.

The latter issue is called monopsony power, and it is something that the White House is paying particularly close attention to.

“What’s happening to workers with the rise in [corporate] concentration, and what that means in an era without as much union power, is something that I think we need to hear more about,” says Heather Boushey, a member of the president’s Council of Economic Advisors, who spoke to the Financial Times recently about how the White House sees the country’s economic challenges. 

The key challenge, according to the Biden administration, is that of shifting the balance of power between capital and labour. This accounts for the emerging ideas on how to tackle competition policy. There are many who regard the move away from consumer interests as the focus of antitrust policy as dangerously socialist — a reflection of the Marxian contention that demand shortages are inevitable when the power of labour falls.

But one might equally look at the approach as a return to the origins of modern capitalism. As Adam Smith observed two centuries ago, “Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased.” Reprioritising it is a good thing.

rana.foroohar@ft.com



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