US is following Japanese road to ruin

Paul Chesson, fund manager, Japanese equities, at Invesco, tells MoneyWeek where he'd put his money now.

Investment-grade income investments, be they corporate or sovereign, seem to be among the best bets around, given the current precarious global economic environment. As a fund manager specialising in Japan, it looks to me as though the US has been trying out the same experiment as Japan in the early 1990s; namely, attempting to avoid the hangover from the bubble by opening another bottle of whisky (with loose fiscal and monetary policy).

But when the second bottle has gone, the hangover will, of course, be that much worse. Such an approach didn't work in Japan, and it won't work in the US. And while the fallout in America won't be as bad as it has been in Japan, that's not saying much - after all, Japan is to this day feeling the repercussions of the 1980s bubble.

My comparison between Japan in the early 1990s and the present-day US is pooh-poohed whenever I mention it, and always for the same reason. "But Paul, Japan is totally different from the States in every respect." Not quite. Granted, Japan doesn't have a capitalist culture. Companies don't respond to stimuli in the same way as they do in America, which is the main reason why Japan's post-bubble clean-up has been so drawn-out. There is, nevertheless, real common ground between the two countries, in so far as America, too, has experienced a bubble.

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A bubble is usually an increase in supply (whether of buildings or technology) that is based on unrealistic expectations of future demand. When the demand fails to materialise, things get nasty. In Japan's case, the authorities postponed the nastiness to the late 1990s by trying unsuccessfully to pump up demand - primarily by fiscal means - in order to meet supply. Faced with the same circumstances, America's powers-that-be acted at once more swiftly and more aggressively. Yet in the end, they too opted to use monetary and fiscal stimulus to manufacture additional demand and thereby mitigate fallout from the bubble.

The present consensus seems to be that this tactic has proved a success. But that is exactly what everyone said about Japan ten years ago, when construction firms were busy building bridges to nowhere. The fact that recent US growth has been achieved by debt creation in the all-important consumer sector means that this isn't healthy growth, and nor, in my opinion, is it sustainable.

As for the much-vaunted US recovery, it is far too early to assume the American economy is out of the woods. Economic imbalances have not gone away, but have got worse; the US consumer, who accounts for a quarter of global demand, has shown an appetite for debt that even the optimists could not have imagined.

Sadly, America's misguided attempt to postpone fallout from its bubble has helped create an investment bubble in China. Asia provides the finance to fund the US deficit so that American consumers can borrow heaps of dollars to buy Asian-made goods. True, China is a great long-term story for the global economy. But when growth in capital formation is as strong as it has been (representing more than 40% of the Chinese economy and growing at more than 40% a year at the recent peak), demand can't hope to catch up with supply in the short term.

And when even conservative estimates show a major bad-debt problem brewing at Chinese banks, you can see how global growth engines could slow substantially. With Chinese supply meeting with diminishing demand from the West, we'll soon be talking about deflation again - in which case there'll be little need to raise rates anywhere. And as investment grade corporate bonds are a real winner when rates are low, I'd recommend tucking some away for when things really get tough.