Today's stock market saw a sharp decline in the Nikkei Index. Well actually this decrease is just the beginning. We will explain why in the lines below.
According to the US Central Intelligence Agency (CIA) Japan's public debt is about 214% of the GDP (see HERE), according to the International Monetary Fund (IMF) it is 229% of GDP (see HERE) and according to CNN it is expected to reach 230% of GDP next year (see HERE). I do not know the truth but let us simply assume an estimate of 220% of GDP, which is safe and simple for calculations.
As the government yields of JAPAN are at about 1%, it means that to serve this debt the government of Japan needs to pay in annual interest a amount equivalent to 1%x220% of GDP = 2.2% of GDP.
But Japan's economy is not really growing (negative GDP growth in the past years as seen on the World Bank chart HERE), so it is not very easy to find these 2.2% of GDP to pay for the interest rates. If the Japanese government raises new taxes, it will be equivalent to taking 2.2% of GDP growth from the econnomy, which for Japan means destroying growth, and you can be sure that this is not going to happen since the government wants to be re-elected some day. Finding savings by cutting the government budget is also hardly feasible: the Japanese government is already running deficits year in and year out to create massive stimulus packages to keep the economy working. So the Japanese government is not able to increase taxes or savings to pay interests on its debt, let alone reimbursing this debt.
The only way to keep the system going is to borrow more every year. Which explains that the Japanese government increases its debt with 5%-10% of GDP every year. There is a simple lesson to learn from this: they are not able to pay this back !
What will happen in a couple of years? It will be more and more difficult for the Japanese to find people willing to lend them money at a 1% rate since people start now to understand that the Japanese cannot pay back. So investors will ask for higher risk-adjusted returns. Investors can very soon start to ask for 5% or 8% rates to the Japanese Governement. As a benchmark Greece's10-y Govt Bond Yields is 8.6% at the time I write this article and Greece is actually better off than Japan since it has a lower ratio DEBT/GDP than Japan and is backed by rich EU countries. If the interest rate that Japan needs to pay raises and reaches 5%, then the government will need to pay annually 5%x220% of GDP = 11% of GDP each year just in interest rates. This is too much to bear for any government or country.
In essence the Japanese government will default on its debt within a few years, which will result in a massive devaluation of the Japanese currency and will lead to a dreadful economic crisis in the archipelago. So you can expect most established Japanese firms to either go bankrupt or take a very severe hit in a few years from now.
DON'T INVEST IN JAPAN!
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17 countries in Europe are sharing a common currency: the Euro. This currency binds their economies very tightly and those countries form the most integrated part on the European Union, but there are huge disparities among them which poses very serious risks to this union. Eastern Europe countries such as Estonia, Poland, Bulgaria or Romania can still be considered developing economies as they joined the union only 10-15 years ago fairly shortly after the end of the Soviet Era . You also find mature post-industrial Economies, with France and Germany that are the regional heavyweights and with five smaller prosperous countries: Luxembourg, Netherlands, Belgium, Austria or Finland. Last but not least, there is the southern part of the Eurozone, with many countries in big trouble: Spain, Italy, Greece and Cyprus are now going through the worst economic crisis since the 1930s. They all have public debt exceeding 120% of their GDP and they all have unemployment rates in the range of 20% or more of the workforce (see link HERE) . Italy is a little better off than its Southern neighbors but the country’s long-term economic stability is questionable as its ratio debt to GDP is about 126% for 2012, the servicing of the debt leaving little to no freedom of maneuver to the newly elected government.
France and Germany have been the motor of the European construction and they shared most of the economic burden to support the Southern and Eastern Europe since the 1980s. But we think they will not be able to go on much more subsidizing Southern Europe, which will lead to a big fracture inside the Eurozone. The reason is that France’s economy itself seems to be going nowhere. This week’s official figures are showing, again, a recession with a 0.2% contraction of the French GDP (see Bloomberg article HERE). At the same time the French unemployment is growing to a staggering 10.6%. With regards to public national debt, the evolution has been similar: France’s national public debt was 64% of the national GDP in 2006 but it reached a staggering 90.2% in march 2013 according to the Insee, French National Institute of Statistics and Economic Studies (see link HERE). Another interesting indicator to look at is the French National Index CAC40, and this index is 28% lower in May 2013 than it was in January 2000. So we are talking about deeply negative returns over a 13-year period, which is a complete disaster from an investor standpoint, as you can see below in the graph below (click on the graph to be redirected to CAC40 page on Yahoo finance).
This long-term degradation of France’s economy and public finances is symptomatic of a country that has shown complete inability to adapt to a changing world, and the current government shows not capacity to change things. The French state is huge and malfunctioning, with annual spending now stable at 56% of the country's GDP. Most of this huge budget is allocated to non-productive expenses such as serving interests of the public debt, pensions, unemployment benefits, health-care and keeping afloat many inefficient loss-making and state-owned companies. Instead of reforming this malfunctioning machine, the current socialist government is desperately trying to increase taxes to balance its budget. The government’s main targets being wealthy entrepreneurs and large US companies such as Yahoo, Google and Apple. Funny enough the government’s budget secretary who was leading the initiative against tax evasion has himself been accused in April of massive tax evasion and is now risking 5 years of prison (see full story HERE). So as you can see, France's economy is going nowhere right now.
We are now reaching a tipping point. France has so many problems of its own to solve that it cannot afford much longer to keep its leading role in the EU. Germany remains a motor and a big lender but it cannot bear alone the burden to support economically the failing southern Europe and most of the smaller European economies have neither the will nor the critical mass that is required to provide this support. The last major European economy is the UK, but it will not help as the Brits are actually trying to leave the European Union! The Conservatives which are the ruling political majority presented two days ago the terms of a referendum to be held within a couple of years to ratify UK leaving the EU (see full story HERE).
So beware of the Eurozone, they are running into many years of trouble and nobody can tell today how this chaos is going to end.
Nonetheless not all is dark and bleak in Europe. Some smaller countries with the coldest climates of the continent have managed not only to stay away from this EU chaos but to position themselves extremely well in world economic rankings so they are thriving economically and can very well be regarded as very attracting for long-term investors:
The conclusion is that the current outlook for Eurozone is bleak right now, and it is not going to be any better in the years to come, but the cold, or rather cool, countries of Norway, Sweden, Denmark and Switzerland remain very interesting for an investor. We therefore advise you to invest in Exchange Traded Funds (ETFs) to get exposure to these specific countries. Below is a list of funds that can be traded from the US markets and that will do the job: