Carl Tannenbaum says Japan fears should be kept in perspective
“Abenomics”, the programme pushed by Japanese prime minister Shinzo Abe to reflate the economy, should ultimately help the country's banks, even if they are suffering lost business from trading government bonds, says Carl Tannenbaum, Chicago-based chief economist at Northern Trust.
Speaking yesterday at AsianInvestor’s eighth annual Asia Investment Summit in Hong Kong, Tannenbaum says market fears and scepticism about Japanese monetary and fiscal policy should be kept in perspective. “This is what the market has been clamouring for: a bold response by Japan to get out of deflation.”
So no whining.
His thesis is that the health of banking sectors is what now differentiates regions, both in terms of economic prospects as well as overall opportunities for investors.
The US has the brightest picture for its banks, thanks to swift government action to force them to recapitalise. Europe has the dimmest. Asia and emerging markets is a mixed picture, but Tannenbaum is bullish on Japan’s banking sector.
“If any sector benefits from Abenomics, it’s banks,” he says. Low interest rates are a challenge for the sector’s profitability, and that hurdle is going to be in place for a long time under Bank of Japan quantitative easing.
But it is nothing new, and explains why banks have been so conservative for so long. Demographics have also been at play, with aging savers continuing to build up huge deposits that banks have struggled to put to work.
Yet the first pillar of Abenomics, the monetary piece, is having a positive effect. The psychology of the market is changing, expectations of growth are shifting, and banks are starting to lend.
Japanese banks have not reformed as quickly as the American ones did, but they have been gradually eating away at money-losing real-estate portfolios over the past two decades. Finally, they seem to be turning a corner on dud loans, and Abenomics should help banks further if property values rise.
“Ultimately banks benefit from Abenomics, and that will support Japan as a destination for investment,” Tannenbaum says.
The challenge involves the other aspects of Abenomics, a fiscal stimulus through increased borrowing, and economic restructuring. These are necessary in order to stimulate demand for credit. Abe is expected to propose measures to the Diet this summer meant to encourage companies to raise wages, and to help ease more women into the workforce.
Another challenge is political. Tannenbaum notes that a side effect of the BoJ asset purchase programme is a weaker yen, and Japan’s exporters are meant to be big gainers. But relations with China and the increased militarist rhetoric from some Japanese government officials are poisoning the opportunity to sell Japanese goods and services to China.
China’s own banking picture is murkier. Given government support and its ability to prop up the banks, it is unlikely that fragilities in China’s banking sector would lead to a collapse along Lehman Brothers-like proportions, at least not one that would have repercussions overseas.
However, Tannenbaum says bad credit is going to be a problem. The only way for banks to strengthen their balance sheets, in the form of conserving credit and boosting liquidity, is by withdrawing credit. But credit underpins GDP expansion, particularly since 2008.
This leaves China with unpleasant options: bite the bullet and risk a hard landing for the economy, or engage in a Japan-style, drawn-out slog involving zombie lenders and zombie borrowers. Given the incentives among bank CEOs – which to date involve rewards for following government edicts to lend, rather than rewards for prudent commercial decision-making – Tannenbaum suspects the zombie scenario is more likely.
Ultimately, that will slow China’s quest to internationalise the renminbi and turn it into a widely accepted currency. Tannenbaum says he admires the way China has advanced the RMB internationally, but that the government has to eventually take difficult steps if it wants the currency to realise its potential role. This includes putting the banks on a commercial footing, improving credit and corporate governance, lifting controls on the flow of information, bolstering property and contract protections, and making accounts more transparent.
“China has already come so far,” Tannenbaum says of the renminbi. “When do they take the plunge?”
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