Chart of the week – Bund yields turn Japanese

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German + Japanese sovereign bond yields

Source: BNP Paribas Asset Management, Bloomberg as of 10/02/2015

3 February 2015 will go down in history for bond buffs as the the day when yields of Germany’s 10-year government bonds fell below Japan’s (JGBs) for the first time on record (10-year Bunds had a yield of 0.34% versus 0.36% for 10-year JGBs – source: Bloomberg). This development arguably gives credence to the view that the eurozone economy, like Japan’s, is afflicted by secular stagnation – whereby weak demand and excess savings render short-term interest rates ineffective as a means of stimulating growth.

The best way to get out of deflationary troubles is not to get into them in the first place. This was the advice given by (the then) Governor Ben S. Bernanke in 2002 in a now famous speech entitled “Deflation: Making sure “It” doesn’t happen here”

The fact that Germany can borrow at a lower rate than Japan is therefore probably not a good sign. There are indeed grounds for believing that bond yields this low are a sign of the “Japonification” of the eurozone – in reference to the Japan’s struggle since the early 1990s to overcome a weak growth paradigm.

“Japanification” is an amusing word, but what Japan and Germany really have in common is that they are both particularly subject to population decline and ageing. They are not the only countries affected by a sudden reversal from demograhic expansion to decline, but “they do appear to be  leading the way to a new population dynamic in the industralised world.” In both countries, the working-age population has been shrinking for more than a decade, and the rate of decline will accelerate in coming years.

An ageing population could hold down growth and interest rates in several ways:

– The most direct being the supply of labour. An economy’s potential output depends on the number of workers and their productivity. The working-age populations of both Japan and Germany have been declining for over ten years and the rate of decline is set to accelerate in coming years.

There is an erroneous perception that the Japanese economy has performed badly in recent years. If, however, allowance is made for the fact that Japan has an ageing and declining population, then Japan has been the most successful of G5 economies. That is to say it is the country whose GDP at constant prices per person of working age has grown most rapidly, at least since 1999. The problem is there are fewer and fewer workers in Japan.

– A falling population lowers the number of potential clients and workers available to business. Companies will also tend to buy less equipment (invest less) if there are fewer workers to operate machinery. Researchers at the Federal Reserve published a research note last year in which they noted that “an important reason why businesses are accumulating capital goods at a slower pace than two or three decades ago is likely that the effective labor force that will use that capital (i.e. the labor force adjusted for technical progress that enhances productive efficiency) is also expanding less rapidly.” 

Exhibit 1: Decline in the working age population in the eurozone (% change from one year previously).

working age pop

Source: Secular Stagnation: Facts, Causes and Cures. CEPR press – A Book published 2014

– Older, declining populations with longer spells of retirement are reckoned to require higher savings rates than younger, growing populations. Simultaneous saving efforts in ageing, developed countries may act to drag down the rate of equilibrium interest that brings investment and savings into balance.

In 2011 a book was published entitled “Imploding Populations in Japan and Germany, A Comparison” (published by Brill). This work suggests that population implosion “opens a new chapter in history.” This may well include a new era in the functioning of sovereign bond markets.

Andrew C. Craig

Head of Financial Market Analysis & Publications

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