Category Archives: Japanese development

Japan’s prime minister, Yukio Hatoyama, resigns. Impact?

June 3, 2010 By in Asian economic development, economics, Japanese development, Recent Market Action, Stock ideas, Strategy Tags: , , , , , Leave a comment

I’ve read somewhere that salesmen of used cars change jobs about every sixteen months.  I’ve never tried my had at it, but I imagine the rapid turnover comes from the job’s high pressure, low status and low income.

If you were a Japanese prime minister, used car sales must be looking like pretty steady work.  The country that once called itself the land of Wa (harmonious balance) is looking for its fifth PM in four years.  The last PM to hold onto his job for any length of time was Junichiro Koizumi, a Kennedy-esque political reformer who left office in late 2006 when his own party, the Liberal Democrats (LDP), thwarted the continuation of Koizumi’s modernization and anti-corruption agenda.

the current mess

I can’t say that it comes as a big surprise that Yukio Hatoyama would be forced to resign less than a year after the landslide election victory of the Democratic Party ousted the LDP from power.  As I pointed out in January, signs of potential trouble were already surfacing late last year, when outspoken finance minister Hirohisa Fujii left his post and was replaced by Naoto Kan, a man who had no financial experience.

Mr. Kan’s chief qualification for the job appeared to be the approval of the Secretary General of the DP, Ichiro Ozawa.  Although Mr. Ozawa has been a powerful politician in Japan for many years, persistent rumors of corruption have prevented him from attaining high national office himself.  The suggestion that Mr. Ozawa was controlling the DP from the shadows clashed sharply with the anti-corruption platform the DP was elected on.

As it turns out, both Mr. Ozawa and Mr. Hatoyama have been embroiled in a recent bribery scandal.  Neither has been indicted so far, but, according to the Financial Times, a civilian review board has characterized prosecutors’ failure to charge Mr. Ozawa as “extremely illogical, unnatural and thus unbelievable”  and has returned the case to the prosecutors for further consideration.

Apparent lack of leadership, a weak economy, scandal, and furor over US troops stationed in Japan have all contributed to the plunge in approval ratings–in advance of an upper house election expected next month–that sealed Mr. Hatoyama’s doom.

what comes next?

I don’t know what I’d do if I were a Japanese citizen.  The DP has been voted in on a reform platform twice in the past twenty years or so (they were the Socialists last time around) and proved a disappointment.  The third attempt at structural change by the electorate, the Koizumi election, also succumbed to the power of the status quo.

From a stock market perspective, my view remains unchanged from January.  Tokyo has marginalized itself as a world stock market.  The best strategy is still to look for entrepreneurial, niche companies.  Ideally, these will be raising money in Japan and exporting their expertise to countries like China or Korea.

It’s hard to believe that this is the same Japan that was touted to dominate the world in the late Eighties.

Martin Wolf: the ants and the grasshoppers

May 28, 2010 By in Asian economic development, Balance of Payments, China, currency effects, economics, Hong Kong, Japanese development, reserve currency, Strategy Tags: , , , , , , , , , Leave a comment

Martin Wolf, one of my favorite economic commentators, recently wrote an update of the fable of the ant and the grasshopper (actually a cicada, but…) in the Financial Times.

Aesop

In the original story, attributed to Aesop, the ant works all summer to store up food for the winter while the grasshopper plays.  When the weather turns bad, the grasshopper asks the ant for aid.  He is rebuked for his idleness and left to die.

Wolf

In the Wolf version, there are industrious “ant” countries (China, Germany and Japan), which produce goods and export them to lazy “grasshopper” countries (like the US, UK and the PIGS) who dabble in activities like real estate, which by and large generate no economic return.  (that is:  if you build a factory, you can make stuff in it that you can sell at a profit.  If you build a beach house, it just sits there.  It’s like buying a very expensive home entertainment system.)

The grasshoppers get the money to do this by borrowing from the ants’ banks, using their real estate as collateral.

At some point, the ants figure out what’s going on and realize they’ve made a very bad deal.  The grasshoppers are never going to repay and the collateral is not particularly useful.  On occasion, the grasshopper economies weaken as real estate prices wobble and then fall.  Does the grasshopper government learn the folly of its ways?  No.  It simply lowers interest rates and borrows more from the ants to pump up the real estate market and keep the party going a while longer.

The ants help out because they don’t want to admit that they’ve made all these horrible loans.  So they end up throwing good money after bad.

In the Wolf fable, there are two sets of ants/grasshoppers:  Germany/rest of the EU, and China/EU + US.

me

I think the grasshopper/ant metaphor is a very useful way of framing the structural problems that the US and Europe face today.  In particular, it highlights the fact the Europe is in double trouble:  it’s China’s largest trading partner, and the EU faces the internal Germany/Greece dilemma as well.

I think the story needs a couple of nuances to make it a better reflection of today’s global economic situation, though.  For instance:

a post-WWII phenomenon

The first “grasshopper” was the US and the first “ants” were Japan and Europe.   The original relationship benefitted the US, of course, but it was also essential in enabling the rest of the developed world to rebuild after the destruction of their industrial infrastructure during WWII.  Two of todays ants were the initiators of this devastation.

After the fall of the Berlin Wall and the reunion of the two Germanys, that country faced enormous economic difficulties:  the west’s outdated plant and high-cost labor, the pitiful state of the east after almost a half-century of Soviet rule, and the consequences of the inflated exchange rate at which the merger was done.  So Germany really needed grasshopper counterparts to alleviate what would otherwise have been a decade of even greater misery.

not just good and evil

There’s a wider point.  Like the sadist and the masochist (maybe not the best analogy, but the only one I can come up with at the moment), the relationship may not be healthy but both sides do get something out of it.  The ants get technology transfer and the opportunity to radically raise their standard of living.  The grasshoppers get a chance to invest directly in the fast-growing ant economy.  They also get cheaper foreign-made goods.

China is a very unusual ant

For one thing, it’s much larger than any of the others.

It also doesn’t have the hangups of its fellow ants:  Germany’s commitment to make the one-Europe project work, and Japan’s history of extreme deference to the wishes of the US as a result of having lost WWII.

China gets what’s going on.

To me, it gives every indication that it thinks it has gotten all the value it can out of the grasshopper/ant dynamic and is determined to move on.  It has already started to convert its dollar foreign currency reserves into physical assets through foreign acquisitions by state-controlled companies.  Unlike Japan, which has never wanted the yen to be a world currency, China is taking steps to make the renminbi a vehicle of exchange among emerging countries.  It is also trying to grow its way out of its grasshopper problem by strengthening economic ties with other emerging nations.  China won’t thereby reduce the size of its problem of being a creditor to grasshoppers, but it may be able to reduce the significance of these liabilities if it can expand its trade in a healthier way with non-grasshopper nations.

Paul Krugman: we’re not Greece in the making, we’re Japan–is this likely?

May 24, 2010 By in Asian economic development, Current Market Thoughts, economics, emerging markets, Japanese development, Stock ideas, Strategy Tags: , , , , , , , , , , Leave a comment

Paul Krugman, Nobel prize winner in economics and professor at Princeton, gave his view of the coming shape of the US economy yesterday in one of his regular opinion columns in the New York Times.

According to Krugman, the idea that Greece, a country which has maxed out its ability to borrow from the rest of the world, and whose major problems are a gigantic government deficit, non-competitive labor and the threat of devaluation/inflation, is in effect a crystal ball in whose interior we can see the destiny of the US, is very wide of the mark.

Instead, he sees the US of the next ten years as paralleling the “lost decade” of Japan in the 1990s–exhibiting very sluggish economic growth and persistent high unemployment.  In support of this thesis, he cites the high unemployment the US is showing now, as well as the continuance of extremely low interest rates–signaling that deflation, not inflation is the malady we should fear the most.  He also sees recent falls on Wall Street as evidence that the stock market is beginning to factor in the likelihood that his view will prove correct.

Is there any way we can avoid this fate?  Yes.  Fiscal policy in Washington has been unduly restrictive so far.  Congress, too, has bought into the Greek model and is trying to avoiding (non-existent) inflation that it thinks additional spending would induce.  What the economy in reality desperately needs, though, is more fiscal stimulation.  But even if legislation to do so were proposed, it would stand no chance of passing, given the national mood and the posturing of (mis-guided) deficit hawks.

There is some chance that a self-sustaining economic recovery will emerge in the US, despite inadequate fiscal stimulus.  But it’s by no means a sure thing.

I think that Krugman is directionally correct.  His conclusion is grim news for investors seeking to support themselves on interest income from cash or bonds, because it implies that interest rates will stay low for a l-o-n-g time.  But, shock value aside, I think the comparison with Japan is a big stretch.  But even if Japan is an indication of the future for the US, this is not as bad as it sounds for holders of stocks.

maybe it’s nitpicking but the US isn’t Japan

There are lots of points of difference between the US now and Japan back then.  For example,

1.  The median age of the Japanese population is much higher than that of the US.  Japan allows virtually no immigration.  As a result, as the “lost decade” unfolded Japan’s work force began to flatten out in size and then shrink–meaning the country began to depend on solely increasing worker output to produce economic growth.  That’s bad.  Absent productivity gains, the trend will be for GDP to contract!

2.  Japanese companies spent heavily on new plant and equipment during the second half of the Eighties, knowing the demographic story meant they would have to become more capital intensive to make their workers more productive.  Unfortunately, rather than buy more advanced machines or invest in R&D, they seem to have somehow just duplicated what they had already–meaning their costs went up but productivity didn’t.

3.   Japan had (and still has) no effective mechanism for dealing with failing companies.  Change from within is culturally very difficult to achieve.  In addition, government policy actively discourages replacement of even the most ineffective management, as many value investors have learned to their sorrow.  On top of that, for many years banks were pressured to prop up otherwise-bankrupt companies through new lending–thereby eviscerating the profits of better-managed rivals.  Foreign takeover of Japanese firms is virtually impossible.  Prospects for domestic entrepreneurs to do the same are almost equally dim.

The result of policies that preserve a traditional lifestyle at the expense of economic growth mean that in Japan there is little of the “creative destruction” that spawns new businesses.  Loads of economic resources are perpetually tied up doing nothing.

possible commonalities are political

1.  Japan did have a number of big fiscal stimulus packages during the Nineties.  But they were focused mainly on pork barrel public works projects for the rural constituencies of powerful members of the Diet.  These roads and bridges to nowhere did provide temporary jobs for construction workers, but they had virtually no multiplier effect and thus no lasting positive impact on the economy.

One of the goals of prime minister Junichiro Koizumi (2000-2006) was to redirect public works spending toward urban areas to promote productivity in service industries.  But he was only partially successful.  And one of his signature achievements–privatization of the national postal service, which had long been a source of funding for pork–is now in the process of being reversed.

2.  Japanese voters have from time to time elected “reform” slates to the Diet.  But, at least so far as I can see, although the names have changed, the policies haven’t.  PM Koizumi managed to clean up the bad debt problems of the major banks, and a previous Socialist government made the election process more democratic.  Otherwise, though, a case of “same old, same old.”

what about stocks?

For the stock market in Japan, the “lost decade” began with two+ years in which everything went down.  With even such mundane companies as cement plants trading at 100x earnings, this is not surprising.  The market then stabilized, and traded in a wide range for the rest of the decade, ending the next seven+ years basically unchanged.

There were two types of stocks that did particularly well during the decade.  The first were companies with substantial operations outside Japan, many of them global brand names like Canon, Honda, Toyota or Nintendo.  The second were smaller, domestically oriented, niche firms that benefitted from the unresponsiveness of their larger, hide-bound rivals to customer needs.  Some of these rising stars were discount retailers.  Others were service companies, many related to mobile phones and/or the internet.

For a while, foreign investors were intrigued by the extremely low valuations of badly run, but asset-rich, firms.  Gradually, it became clear that Japan had no desire to allow incumbent management to be replaced, whether by new ethnic Japanese executives or by foreigners.  My impression is that there are still a few hard-core activists trying to make social change, but that most have lost interest in this class of companies.

implications for the US?

Even under political and cultural conditions so adverse for investors as Japan has been, it has still been possible to make money in the stock market there.  The situation in the US will without doubt be far more supportive for stocks, even if Mr. Krugman is completely right in his analysis.  After all, the US continues to be a hotbed of internet and other technology innovation.  Washington, for all its faults, is infinitely more business friendly than Tokyo.

The key to outperformance, even in the weak economic environment Krugman envisions, will be the same as it was in the lost decade in Japan:  focus on two areas–the strongest companies domestically, and firms that cater to customers in regions of the world that are growing quickly (in this case, meaning emerging markets generally and the Pacific in particular).

Russell Napier on the future of the US?

April 16, 2010 By in Asian economic development, China, Current Market Thoughts, economics, Japanese development, Portfolio management, Strategy Tags: , , , , , , , , , , Leave a comment

Who is Russell Napier?

Russell Napier of CLSA wrote the Market Insight column that appeared on Wednesday in the Financial Times.

Mr. Napier is a highly skilled, very thorough financial analyst.  He also has a bearish temperament.  I started to write that he’s a “professional bear,” but that’s not right.  Unlike doomsayers who are always available with a quote about how the world is about to go to hell in a handbasket–usually the same sentiment they have been furnishing to reporters for the past twenty-five years (think: Marc Faber or Andrew Smithers), Mr. Napier is not a publicity hound.

That makes his analysis of the future for the US and European economies, which I find eerie, even more disturbing.

His argument:

1.  The US and Europe have already saddled themselves with so much government debt that they are incapable of lowering it in any meaningful way.  At the very least, there is no political leadership (Germany possibly excepted, and they’re stuck with the rest of Euroland) willing to address the problem.  It may also be that there is no national political will among citizens to pay the money back.

2.  Simply servicing the existing debt will end up with new government debt issues crowding out private capital-raising activities.  To raise more funds, as well as to make government securities look more attractive, governments will levy new taxes that reduce the earning power of private securities.

3.  Private capital will respond by trying to leave the country, but will be prevented from doing so by newly-legislated capital controls.

4.  Mr. Napier concludes his article with the statement that “The ‘new normal” is not sub par economic growth.  The new normal is the roll back of the free markets.”

I’d add a #5.  Assuming #1-4 come to pass, our children will emigrate to countries that offer better economic prospects, much as Europeans came to the US after WWII or as high taxes and limited opportunities caused educated Australians and New Zealanders to seek foreign jobs a generation ago.

What caused our present sorry state?

–in Napier’s opinion, the “North Asian” economic growth model with its emphasis on overproduction in manufacturing made us the parasite to their host.  (I don’t believe this, but that’s what he said.  In any event, I’m not sure diagnosing the cause of our heavy indebtedness is that important.)

too bleak?

What a bleak outlook!

Is the “fall” of the West already written in stone?  I don’t think so.

Certainly, many in the Pacific and Latin America already look at the US in the same way many Americans regard the UK–as a place that time has passed by, whose citizens console themselves in dreams of their past glory.  But that’s just the inevitable consequence of their recent rise to world economic prominence.

One thing has changed, though, in my opinion.    Sixty years ago, Wall Street figured that Republicans were good for business and Democrats were bad, but that perception has long since been relegated to the junk pile.  It has been replaced by what my thirty+ years as an investor have taught me–that Washington is basically like Disneyworld, a collection of strange characters, an interesting and entertaining place to visit that’s largely irrelevant to the running of the economy, and therefore to the rise and fall of stock prices.  Gridlock is the optimal political state, since that minimizes the possibility of bizarre government ideas messing up commerce.

We now know that picture isn’t right, either.  Somehow, with the tacit approval of voters, professional politicians have succeeded in pretty much maxing out our national credit cards.  And for what?–McMansions in Miami and Las Vegas, Vietnam-like wars in the Middle East, and entitlements.  The lightbulb is just starting to come on about how deeply in debt–both through outstanding Treasury bond issues and promises of future retirement and medical benefits–we are.

Suddenly, what Washington does is important.  The picture Mr. Napier paints is what happens if we stick with business as usual.

investment implications

There are investment implications.  The most obvious, and the most important for us today, are that diminishing economic growth prospects in the US and Europe imply emerging markets will do relatively well and that in developed markets multinationals will be better performers than their Europe- or US-centric peers.  This is the strategy I see most investors following anyway.

The next thing to monitor is whether, as Mr. Bernanke has been calling for repeatedly, Washington is able to come up with a credible medium-term roadmap for reducing the government deficit.  If not, as crazy as it sounds to an American, the beginnings of capital flight may not be far behind.

Stay tuned.

Renminbi revaluation appears imminent

April 7, 2010 By in Asian economic development, China, economics, emerging markets, Hong Kong, Japanese development Tags: , , , , , , Leave a comment

The renminbi is about to appreciate

All signs are pointing to a decision by Beijing to allow its currency to rise in value vs. the US dollar.  In fact, the Financial Times reports today that a high-level Chinese government economist confirmed at a press conference that the trading band for the renminbi will be widened and subsequently the currency will be allowed to appreciate (an earlier FT article addresses the differing positions of Chinese government ministries on the issue).

It will be interesting to see the result.  The Chinese announcement yesterday suggests the resumption of a crawling peg that will have the renminbi appreciate against the US dollar by around 5% a year.  The biggest unknown is how long the appreciating trend will continue.

The fact that the administration said last week that it was delaying a report that might have labelled China as a currency “manipulator” was a clear suggestion that a change in currency policy in China might be in the works.  One might read the increased anti-China rhetoric in Congress as a second indicator–legislators playing to a home audience with draconian legislative proposals that would never be put to a vote.  That would be reminiscent of Congressional behavior years ago when the issue of renewing China’s most favored nation trading status would come up for its yearly review.

Why revalue?

Even before the financial crisis, China was beginning to realize it was coming to the end of the period when it could achieve strong economic growth through exporting to the US while pegging its currency to the dollar.  The question has not been whether to reorient the country toward developing domestic demand, as well as cultivating higher value-added manufacturing.  Rather, it has been how to do this while minimizing economic disruption and potentially destabilizing social effects.  Beijing has also clearly signaled that about the last thing it thinks it needs is a larger hoard of US Treasury bonds, which it assumes Washington will try to evade repaying in full.

Congressional saber-rattling always helped with Japan…

A generation of politicians in Tokyo, now mostly retired, were remarkably receptive to economic demands/threats emanating from Washington.  I think there were two reasons for this.  Japan welcomed “foreign arm-twisting,” which allowed it to shift the responsibility for difficult decisions away from itself.  Blame would accrue to the other government “forcing” Japan to act in a certain way.   Also, government officials who felt social responsibility for losing WWII also felt an obligation to defer to the wishes of the victors.

…but not with China

The social myth is different.  For China, relations with the West are more frequently seen through the lens of the Boxer Rebellion or the Opium Wars, where foreigners invaded China and seized territory.  In the case of the Opium Wars, Britain compelled China to reopen its borders to the British addictive drugs that China was trying to keep away from its citizens.  Not a pretty picture.  Political grandstanding of the Senator Schumer type (a man not noted for his deep knowledge of economic issues) simply does harm.  It reawakens these nineteenth-century memories and causes China to oppose even the most reasonable proposals because they are linked with threats.

Twenty years ago, as China was taking its turn toward capitalism, it needed the West, and the US in particular, as a market for its exports.  It doesn’t think it needs the US now.  Even if it did, it worries that our IOUs may not be any good.  This implies that China doesn’t see the necessity of going to extremes to placate the US any more.

Two other items to note

By all accounts, and in contrast to past behavior, there has only been a muted defense of China by its big customers in the US.  This may well be a result of other changes in China–witness the Google affair–that have tended to block the expansion of US firms into China’s domestic market.

Also, China has explicitly linked its currency policy to the US political stance on Taiwan and Tibet.

It seems to me that China feels the US is dealing from a position of weakness and that, as such, it need not be as indirect in expression its opinions as it has in the past.