The Henley Group

THE WEALTH MANAGEMENT PROFESSIONALSHong Kong Singapore Shanghai London

For more information, please contact:Martin W. Hennecke, Chief EconomistT: +852 2824 1083 E: mwh@thehenleygroup.com.hkwww.thehenleygroup.com.hk

“Looking tough on inflation is part of any central banker’s job description: if investors believe that inflation is going to get out of control, you end up with higher interest rates and capital flight, and a vicious circle quickly ensues.”

James Michael Surowiecki, American journalist and writer at ‘The New Yorker’

It has been another eventful three months, with equity markets generally doing well despite geo-political turmoil not only in the Ukraine but also in much of the Middle East.

Europe in particular though may be facing a tougher time going forward, as highly indebted Italy has slipped back into recession, France announced it will be missing its deficit target and even economic powerhouse and EU paymaster Germany is finally seeing negative growth, as Russian sanctions start to bite. Hungarian Prime Minister Viktor Orban probably expressed it best when noting that “the sanctions policy pursued by the West, that is, ourselves… causes more harm to us than to Russia. In politics, this is called shooting oneself in the foot.”

The United States meanwhile may have shot itself in the foot too, not that it has much trade with Russia, but it relies on the use of the USD in international trade in order to maintain global influence

and, perhaps more importantly, to be able to inflate and finance ever growing deficits without causing its currency to decline in value. Yet recent events appear to have brought the BRICS nations plus a number of other developing markets only closer together, resulting in the USD100bn BRICS development bank launch, as well as increased use of local currencies in the respective countries’ bi-lateral trade.

The Chinese yuan in particular may benefit in this regard, as China overtook the United States as the world’s largest trading nation last year, and it is not just the BRICS nations that are expanding

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Land of the rising sun debt

The Henley Group | Land of the rising sun debt September 2014

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One way to benefit from this scenario can be to seek a safe haven in the time-honoured default- and inflation-proof precious metals, led by gold, which happen to be trading at very attractive prices presently after having witnessed a sharp drawdown over the past several years.

However, the majority of ordinary Japanese citizens are likely to be less familiar with gold than with bricks and mortar, i.e. property, which may come to their mind first when thinking about how to achieve better inflation protection (and positive real yield) compared with holding cash in the bank or in bonds.

Japanese property is not really cheap in nominal prices compared with global averages, but then it never really is because of the limited land size. When looking at price-to-income and price-to-rent ratios relative to long term averages though, Japan currently happens to be the world’s most undervalued property market.

Therefore, a limited exposure to this asset class, as part of a diversified portfolio, may be an attractive contrarian bet on Japanese citizens moving a good part of their cash back into real assets on the expected rising inflationary risks associated with the country’s debt problem.

Martin W. Hennecke Group Chief Economist

the use of this currency, but yuan clearing banks have been set up recently in a number of European countries as well. Commenting on the establishment of the ECB/PBOC euro/renminbi currency swap, Christian Noyer, governor of the French National Bank and member of the ECB, noted that “China has decided to develop the renminbi as a settlement currency” and “trade between Europe and China does not need to use the dollar”.

Another interesting development has been taking place recently in Japan. Although “Abenomics” does not appear to be succeeding in improving the country’s economy or trade balance, it sure has “succeeded” to bring up inflation, as Japan’s core CPI has moved decisively from deflation into inflation, even when excluding the recent consumption tax hike.

Accordingly, it appears to be only a matter of time before the Japanese (which presently keep the majority of their savings in cash and bonds after having gotten burnt by a nearly 30 years long equity and property bear market) awake from their slumber to realise that a 0.5% “yield” on 10-year Japanese sovereign bonds (JGBs) is not exactly a very profitable strategy when inflation is notably higher and rising.

What’s more, inflation may potentially get much worse going forward due the country’s unsustainable debt burden, which presumably will necessitate a substantial expansion of quantitative easing (money printing) policies to prevent a debt crisis.

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