I’ve been VERY wrong about the Japanese stock market

The Liberal Democratic Party retook control of the national government in Japan late last year on a platform of massive monetary stimulation aimed at shocking the economy out of its quarter-century of torpor.

Most economic effects have been as expected.  The ¥ has lost about a quarter of its value.  This has given export-oriented industries a big boost.  The price of imports has risen by enough, however, that the overall effect of devaluation on Japan has been slightly negative so far.  The trade balance will doubtless improve as Japanese citizens adjust to the tremendous drop in their standard of living that the devaluation has brought about.

Where I’ve been wrong has been in handicapping the behavior of the Japanese stock market.  In the only other recent episode of a big fall in the ¥, the Topix index (Tokyo large caps, the index professional investors use) rose as the currency declined, but only by enough to keep a dollar-oriented investor from losing money.  Yes, export-oriented stocks did better than Topix, but the overall index was unchanged in dollar terms.  I thought something similar would happen again.

Not this time, though.

Since the Abe administration took office and made it clear it would carry out its campaign promise, the Topix is up by 66% in local currency terms, meaning a dollar-oriented investor in the index has made a 25% gain.  Buyers of down-and-out consumer electronics firms like Sony have made twice that.  The long-Topix, short-¥ trade has made a killing.

As I see it, the rise in the Topix has been driven by foreigners.  Locals–never, in my experience, the canniest of investors–have  been mostly using the opportunity offered by devaluation to declare victory in their foreign investing forays and are bringing money home to put into things like real estate.

Press reports indicate new investors in Japanese stocks, including high-profile Western hedge funds, believe very strongly that the change in money policy also heralds a new era of openness to structural economic reform by Tokyo, and that foreigners will be allowed to play a significant role in the latter process.

My view, based on almost 30 years of watching Japan, is that Tokyo insiders regard devaluation as a substitute for reform, not a precursor.  I’d point to the experience of former Prime Minister, Junichiro Koizumi, who was given an overwhelming electoral mandate for reform but who resigned as PM after five mostly fruitless years (2001-2006) of trying to effect change.  As soon as he left, the Diet immediately began to reverse the progress he was able to make.

For Japan’s sake, I hope I’m wrong again.  But I’m not willing to bet on the possibility.  As for the new wave of foreigners, I find it hard to figure whether they have a much more sophisticated read on the political process in Tokyo than I do or whether they’re completely clueless.  Given that reversal of the deep social/political aversion to disruptive change should make me wildly bullish about Japan, in some sense I must think the latter is more probable.  My official position, though, is that I don’t choose to bet.



parity party on the calendar–the yen and the penny?


Two days ago the Japanese yen reached a low where US$1 could buy ¥99 in the foreign exchange markets.  That’s extremely close to parity between the US penny and the yen.

What makes this level shocking is that last September, one greenback would only get you ¥77.  So the exchange value of the yen has dropped against the US$ by 22%+ in a little over half a year.  Stuff like this doesn’t usually happen with the national currencies of large developed world economies.

On the other hand, there aren’t normal times in the Land of Wa.

Japan’s problem

Japan has been struggling economically for almost a quarter century, plagued by a toxic combination of next to zero real economic growth + Deflation.  A falling price level means takes more of your income to repay debt, so no one borrows.  Things will always be cheaper tomorrow, so everyone postpones spending.

This stagnation is not an accidental occurrence, as I see it.  It’s the result of deliberate policy decisions by Tokyo aimed at preserving the social and cultural milieu of the 1970s-1980s–as well as the power of the aging and hidebound executives/bureaucrats/ politicians who came to power in that era.

How so?      The Japanese workforce is shrinking as the population ages, but immigration to replace those workers is not allowed.  Moribund companies are not permitted to die.  Instead, they’re kept alive by financial infusions from suppliers, customers and local financial institutions.  Nor are such firms encouraged to streamline or refocus so they can make money again.  Quite the opposite.  The government even protects inept or indifferent managements from any shareholder attempts to compel them to do so.  In many cases–the auto companies are one shining exception–zombie-like firms destroy the profitability of entire industries.

the inflation “solution”

Faced with severe voter discontent, the recently-elected new government has decided to “cure” the economic malaise by increasing the money supply until doing so creates inflation.  That’s the main economic plank the Liberal Democratic Party ran on, so arguably the ballot box shows the measure has popular approval.  Unfortunately for Japanese citizens, however,…

…there’s little reason to think that this will do lasting good

Textbook theory says an acceleration in money growth will lower interest rates and weaken the currency.  That gives the economy a temporary boost, which will gradually subside–leaving the country with the same real growth rate as before but with higher inflation.

A whiff of inflation is nothing too horrible in Japan’s case, since the country is suffering the ills of deflation–except for the risk that domestic interest rates will rise.  That could make it far more difficult for the government to finance the country’s huge debt burden.

In some ways, we’re in uncharted waters here, however.  Textbook theory is formulated from general economic principles buttressed by observations from practical experience.  Most of that experience comes either from small economies or from a much simpler pre-globalization (no BRICs) world, however.

So far, the announcement of Tokyo’s intention to create inflation has weakened the yen by a (to me) startling 22.5%.  That represents an extraordinary loss in national wealth.  It also means that dollar-denominated items–like food, clothing, fuel–that Japanese consumers buy on a regular basis now cost almost 30% more in yen than they did six months ago.  Yes, this is inflation, but not the healthy kind–wage increases driven by rising industrial productivity;  rather, this is a substantial fall in the Japanese standard of living.

Will the loosening of money policy lead to improvement in profits for Japanese industry?  In the case of commodity-like machinery output, the short-term answer is “Yes.”  Both the EU and the US have recently expressed strong concern that Japan is attempting to export its industrial woes through hostile currency devaluation.  This means that basic industry in both areas is already being hurt by Japan’s move.

On the other hand, will you now pick a Sharp TV over a Samsung, or a Sony smartphone over an iPhone/Galaxy S4 just because the price of the former has gone down a bit?  How many more boomboxes or Walkmen will you buy?

Perhaps most distressingly, for much of Japanese industry a lower currency will only make it easier to ignore their lack of innovation and their weak general management for a while longer.

The damage done to Japanese consumers is real and it’s today.  An industrial renaissance due to looser money is unlikely, in my view, while the government defends the status quo.  As the White Queen in Through the Looking Glass said, it’s “jam tomorrow.”