If you think that Fed Chairman Ben Bernanke is unpopular, consider the tragic case of Takahashi Korekiyo, who served as Bank of Japan governor from 1911-1913 and as finance minister and prime minister in the 1920s and 1930s.  Gillian Tett recounts his story in today’s Financial Times.

In the first decades of the 20th century, Japan was an emerging markets growth story not too unlike China in the early decades of Deng Xiaoping’s reforms.  The US stock market crash of 1929 and the global recession that followed hit Japan hard.  Japan experienced bank failures, a credit crunch, and a deep recession…until Mr. Takahashi came to the rescue. As Tett tells the story,

In December 1931, Takahashi returned to the job of finance minister and fought recession with stimulus: he abandoned the gold standard, loosened credit conditions and raised public spending, financed with new debt.

In some ways, it worked. As the yen lost 40 per cent of its value, exports boomed. Then, as annual public spending rose above 50 per cent of GDP, or almost double the 1929 level, Japan’s economy stabilised, even as the US continued to ail.

But Takahashi encountered two problems.

First, the stimulus did not stop Japan from becoming marked by social fracture, political unrest and nationalism. On the contrary, tensions continued to rise, partly as the large conglomerates, or zaibatsu, were the biggest winners from stimulus.  That sparked resentment, not unlike what has happened in the US as Wall Street banks have made profits from quantitative easing.

Second, and unsurprisingly, the spending bonanza undermined confidence in Japan’s government debt and its currency, creating fragility. So in 1936, Takahashi embarked on an exit strategy, cutting public spending and tightening monetary policy. From a macroeconomic perspective, it made sense. But it cost Takahashi his life. As political tensions exploded, he was assassinated by rogue army officers who were furious at - among other things - the military spending cuts. That triggered a slide towards militarism, wild public spending and hyperinflation.  (Link to article)

Tett postulates that the experience of the unfortunate Mr. Takahashi is one of the reasons for Japan’s current reluctance to end its fiscal and monetary stimulus programs, which have now dragged on for nearly 20 years.   Possibly.  Or, it could simply be that in a democratic society, politicians do not have the stomach for austerity, choosing instead to push the problems indefinitely into the future.

Whether Japan chooses stimulus or austerity, it is not likely to matter much.  The country’s demographics are in what appears to be terminal decline, which in turn drags the Japanese economy into  terminal decline.

Will Japan fall into the grips of nationalism and military rule again?  I would find this to be doubtful.  It’s hard to imagine a country as elderly as Japan rediscovering the joys of militarism, though this is exactly what George Friedman of Stratfor forecasts in his recent book, The Next 100 Years: A Forecast for the 21st Century.

It remains to be seen.  In any event, whenever Ben Bernanke has one of those “why did I take this job…” moment, at least he can take solace in the fact that he’s unlikely to meet the end of the unfortunate Mr. Takahashi.

Charles Lewis Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

“Individual investors are fed up with the stock market,” writes TechTicker. “Burnt by 10 years of negative returns, two crashes, and a current economy mired with high unemployment and lackluster growth, many are throwing in the towel.”

Perhaps not surprisingly, retail investors have instead poured their funds into bonds in record numbers, helping to send yields to new lows.

Treasury yields are near record lows even while the fiscal position of the United States is the worst its been since the Great Depression–and arguably worse given the looming Social Security and Medicare solvency crises that will boil over with the retirement of the Baby Boomers.

It might seem almost silly to ask. But is there an irrational bubble in bonds?

The short answer, which will be controversial to many, is “no.”

This does not mean, of course, that bonds are an attractive investment at current prices. Unless you are an institutional investor whose investment mandate requires an allocation to longer-term bonds, yields are currently so low as to make Treasuries not worth owning.

But “unattractively priced” does not necessarily mean “bubble.”

This is not just a matter of semantics. There are some real differences here that do matter, and tossing the word “bubble” around indiscriminately can lead you to draw the wrong conclusions.

There is no precise definition of a speculative bubble, though Hyman Minsky gives us a good outline of what to look for. In Minsky’s model, a speculative mania tends to follow five stages, summarized below by Investopedia:

1. Displacement: A displacement occurs when investors get enamored by a new paradigm, such as an innovative new technology or interest rates that are historically low.
2. Boom: Prices rise slowly at first, following a displacement, but then gain momentum as more and more participants enter the market, setting the stage for the boom phase. During this phase, the asset in question attracts widespread media coverage. Fear of missing out on what could be an once-in-a-lifetime opportunity spurs more speculation, drawing an increasing number of participants into the fold.
3. Euphoria: During this phase,caution is thrown to the wind, as asset prices skyrocket. The “greater fool” theory plays out everywhere. Valuations reach extreme levels during this phase. During the euphoric phase, new valuation measures and metrics are touted to justify the relentless rise in asset prices.
4. Profit Taking: By this time, the smart money – heeding the warning signs – is generally selling out positions and taking profits. Note that it only takes a relatively minor event to prick a bubble, but once it is pricked, the bubble cannot “inflate” again.
5. Panic: In the panic stage, asset prices reverse course and descend as rapidly as they had ascended. Investors and speculators, faced with margin calls and plunging values of their holdings, now want to liquidate them at any price. As supply overwhelms demand, asset prices slide sharply.

In looking at the Treasury market today, we cannot credibly say that we are following this model. Perhaps it could be argued that the housing and credit market collapse of 2007-2009 qualifies as a “displacement.” But what we are seeing in the market hardly qualifies as a “boom” and certainly doesn’t qualify as “euphoria.”

In judging the temperament of those currently buying Treasuries, it should be obvious that these are not greedy speculators chasing returns. They are shell-shocked investors who have lost their tolerance for risk taking.

No one likes Treasuries. No one is quitting their job to day-trade bonds like they did tech stocks in 1999. No one is taking out a liar loan to “flip” Treasuries like Miami condos in 2004.

It is an entirely different mentality. Retail investors buy them for the simple reason that they are not stocks.

Furthermore, in nearly all examples of bubbles–and in the recent housing and financial bubble in particular–leverage plays a major role in inflating prices. Miami condos would have never reached the absurd prices they did without the loose mortgage financing that was available. You could argue that the Fed’s loose policies are creating the leverage that is being used to buy Treasuries (thus keeping the prices high and the yields low), but this is not entirely accurate either. All else equal, loose monetary policy causes longer-term yields to rise, not fall. The Federal Reserve does not buy every bond put out by the Treasury and cannot mandate what market rates will be at all maturities of the yield curve. The Fed, though powerful, is not omnipotent. And total leverage in the U.S. financial system is continuing to shrink as the private sector deleverages faster than the Treasury can issue new debt (see Figures 1 and 2).

Figure 1: Total Debt Outstanding

 Figure 2: Total Debt Outstanding–Federal vs. “Everything Else”

It would seem unlikely that we would have a bona fide “bubble” in anything during a period of financial system deleveraging.

So, while I have established that there is no “bubble,” per se, in Treasuries, I want to reiterate that this does not mean that the current price is attractive or that yields can continue to fall forever. At this point the potential upside to bonds is small while the potential downside is quite large.

Bonds, unlike stocks, commodities, or other assets, do have a theoretical maximum price. Except during a period of extreme volatility, yields can never fall below zero. In a world in which discount rates across all maturities fell to zero, the theoretical value of a bond would be its face value plus the cash value of any unpaid coupon payments. We’re not to that level of pricing yet, and it would be highly unlikely that we will ever get there. But as Japan’s experience in the 1990s and 2000s proved, yields can stay lower than anyone thinks possible for longer than anyone thinks possible.

I’ll wrap this up with some fairly straightforward trading advice. Given their current yields, Treasuries are not attractive as a “buy” right now. But given the deflationary forces still plaguing the economy, I wouldn’t be shorting them either. It might be best to simply avoid them altogether.

Charles Lewis Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Neil Howe, who previously co-wrote several groundbreaking books on demographic trends with William Strauss (Generations, The Fourth Turning, Millennials Rising), published a new book in 2008 with Richard Jackson: The Graying of the Great Powers: Demography and Geopolitics in the 21st Century.
We consider Howe’s prior work with Strauss to be required reading for anyone wanting to understand the role that demographics have played in recent history, particular the interplay between the major generations (Baby Boomers, Echo Boomers, etc.). We would say the same Howe and Jackson’s new book, though readers who are already familiar with Philip Longman’s work, particularly The Empty Cradle, might find it to be somewhat redundant.

Graying covers many of the same themes covered by Longman and others — the usual doomsday (though completely accurate) scare statistics about Europe’s demographic decline, the coming pension and health funding crises and probable wave of national bankruptcies — and combines them with some of the geopolitical themes discussed by Mark Steyn in America Alone and Patrick Buchannan in The Death of the West (though without Steyn and Buchanan’s abrasiveness and charged ideology) and to a lesser extent those covered by George Friedman in The Next 100 Years.
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Here’s a cheery headline from today’s Financial Times: “Japan looks for positives as it succumbs to the inevitable.”

The article was in reference to China’s recent overtaking of Japan to become the second largest economy in the world after the United States.  But given our research at HS Dent, it could be taken to mean so much more.

Japan is the oldest country in the world by median age of population, and this is only going to get worse.  The population is already shrinking.  The country desperately needs new babies for its future, but young Japanese do not have the means or perhaps the desire to have them.  But even Japan commenced a new baby boom today, the damage has already been done by 30+ years of low birthrates.

Meanwhile, Japan’s debts continue to mount and today total more than 200% 0f GDP.  How will these debts be paid?  Who is going to care for Japan’s elderly in the years ahead?  And what happens to a country that slowly grows old and dies?

These are unanswerable questions.  But they point to an inevitable decline–and possible collapse.

Related post

Charles Lewis Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

With the mobile phone market already saturated in the developed world (see past HS Dent discussions of S-Curves), operators and manufacturers alike have looked to the smartphone “trade up” market for growth. Just as there were winners and losers in the original race for mobile phone supremacy, there will be winners and losers in the smartphone race as well.

Nokia, the Finnish company that emerged as the biggest seller of traditional phones, jumped out to an early lead in the smartphone market. But that lead is being chipped away at an alarming rate by upstarts like the Apple iPhone and the various phones that use Google’s Android system.

While the iPhone gets most of the headlines, it’s days in the sun might be limited.  Android, almost overnight, has surged past Apple to become the number three global smartphone operating system and number one in the United States!

The parallels to the 1980s personal computer wars between Apple and IBM are obvious.  Most techies agreed that Apple made a better product than IBM.  But while Apple kept tight control over the manufacture and sale of computers that used its architecture and software, IBM opened its own to cloning.  The result was an explosion in the IBM compatible “Wintel” standard and a long period of comparatively slower growth for Apple.  This is why it is Bill Gates, not Steve Jobs, who was the richest man in the world for most of the 1990s and 2000s.

Is Apple making the same mistake again?  It would appear so.  Given the number of handset makers currently making phones to world with Android, its hard to see how Apple can maintain technological superiority at an affordable price.  But it’s not just Apple.  Nokia too is being rather pigheaded by insisting on using its own Symbian system.  Perhaps the company’s management is too proud to discard a project that they have invested so much time and money developing.

At any rate, as students of economic history, all of this will be fun to watch.  In the world of mobile communications, we’re watching the creative destruction process happen before our eyes.  In the end, we’ll all have better–and cheaper–phones to show for it.

Charles Lewis Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

I came across two pieces of news today, one that made me optimistic about the future and one that made me see red with rage.  We’ll start with the good news:  Skype announced that it will be launching an initial public offering.  It’s shares will be traded on the Nasdaq.

Long-suffering readers have had to endure my pontifications on the virtues of Skype for years now. (Click here to view past posts on Skype.)  More than just a product, I view Skype as an embodiment of the creative destruction process.  Skype has lowered the cost of international calls to free in many cases and significantly cut costs in others.  This is painful for legacy telecom companies, but it is a boon to the consumer and to globalization itself.

Skype is already the biggest carrier of international  calls, and the initial public offering will only help it to expand.  This is great news.  (My only residual gripe is that I cannot use Skype on my AT&T Blackberry; currently, only Verizon customers have this privilege…not that I am bitter…)

Now for the bad news:  in an act of technophobia and luddism that is almost shocking, the Obama Administration’s Justice Department has threatened legal action against several American universities.  Their alleged crime?  Trying to help their students save money by offering their textbooks in electronic format on the Amazon Kindle rather than in hard copy!

The Justice Department’s  stated rationale is that e-readers discriminate against the blind, thus depriving blind students of their civil rights under the Americans With Disabilities Act.  (See article.)

I try to keep my blog posts apolitical; my beat is the financial markets, not Washington DC.  But the cynic in me can’t help but wonder if Obama’s Justice Department has ulterior motives.   Much like the original Luddites attempted to derail the Industrial Revolution by destroying factory equipment–all in an attempt to save obsolete craftsman jobs–could it be that the Obama Administration is retarding the Information Revolution as a way of paying back its supporters in academia?  Professors and college bookstores alike make a lot of money gouging their students with expensive text books.  Amazon’s ebooks cut into those fat margin, much to the benefit of the students that the universities are ostensibly there to educate.

It’s hard to believe that a move this heavy handed could really be about helping the blind. Surely, liberal-minded universities could find other ways to help their vision-impaired students.

At any rate, this just goes to show that every economic revolution has reactionary forces that try to hold it back.  In the end, new technology will win.  Obama’s Justice Department’s idiotic moves will be no more effective that King Canute’s attempts to command the tides.  EBooks will persevere.  Amazon, Apple and other sellers will make their products accessible to the vision impaired, or whatever disadvantaged group Obama’s Justice Department decides to champion next week.  It will make the products more expensive for the rest of us, of course.  But the end result will be falling costs and a wider spread of information.

Charles Lewis Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

In the 1998 movie Waking Ned Devine, an elderly Irish pensioner wins the lottery and instantly dies, ticket in hand, of a heart attack.  The townspeople concoct a scheme whereby one of them will pretend to be Mr. Devine in order to collect the lottery winnings, which will then be shared by all the inhabitants of the town.

Why do I bring up an obscure movie from 12 years ago?  Because an article I read in the Financial Times reminded me of it. After nearly 20 years of economic malaise in which Japanese citizens have seen their wealth slowly seep away, there has been a large increase in pension fraud.  The Japanese have one of the longest average life expectancies in the world.  But perhaps their census takers should take a closer look at some of the 100+ crowd.  The FT writes,

Next week marks the start of Japan’s Obon holiday in which families take time off to pay respects to their ancestors, a tradition conveying the importance Japanese families attach to their deceased relatives. But some have been clinging on to their ancestors’ memories and pensions rather too assiduously.

In one case, the corpse of a man who would be 111 years old was kept in a Tokyo house for nearly 30 years. The authorities are reportedly investigating his family on suspicion of pensions fraud and negligence.

The Japanese press has since tallied nearly 60 instances of centenarians registered with local authorities to receive pensions but whose whereabouts is unknown. The macabre findings have refocused attention on the ability of the Japanese government to cope with its ageing population, particularly its capacity to pay their pensions.

From “Respect Your Elders,” The Financial Times, August 6, 2010

Desperate times call for desperate measures.  Traditional Japanese religions involve ceremonies of ancestor worship, and even as the traditions have waned the respect has remained.  So, it’s telling of how truly bad the situation in Japan has gotten when normally respectful Japanese engage in this kind of behavior.

Around the world, as Baby Boomers enter their retirement years with insufficient funds, the temptation will be there to engage in similar forms of Social Security and pension fraud.  Don’t be surprised to see stories like these in Japan pop up in  your local newspapers.

Charles Lewis Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Changing Global Demographics are an ongoing theme at HS Dent.  Yesterday, I got a first-hand look at Changing Local Demographics.

Driving through the old neighborhood in suburban Dallas where I grew up, I noticed that the batting cages where I spent many a summer day swinging (and often missing) at cheap rubber baseballs was no longer standing.  In its place was a brand-new retirement community!

There is something symbolic here, and it is playing out in cities across the country.  This is not to say that the United States is facing a dearth of young people.  Nothing could be further from the truth, as birthrates are near all-time highs.  But the distribution of where the young people are located is different.  As the parents  that raised my generation are now empty nesters, there is a noticeable lack of youth in their neighborhoods, except when the grandkids come to visit.  But, in the case of my old neighborhood, drive 15 miles north, and you see children everywhere.

As investors and small business owners, we need to keep an eye on these trends.  Changing demographics are neither good nor bad; they just “are.”  And by understanding them, we can better position ourselves to  profit from them.  As the owners of my old baseball haunt can attest, an area that was good for kids yesterday might be better for seniors tomorrow.

Charles Lewis Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

“The Internet’s sheer scale means that listening to all of the noise would result in information overload. Before it can be understood effectively, it needs to be harnessed into usable data.”

–Dalrymple and Chrysafis, 2010

The quote above is particular true in the financial markets, where we at HS Dent operate.  The Information Revolution of the 1990s unleashed incredible, exponential amounts of new information.  The rise of social media and standardized blogging platforms ten years later has kicked this revolution into overdrive.

Here at HS Dent, we are voracious readers. Our office consumes a mind-boggling amount of written material.  In print, we get the Financial Times, Wall Street Journal, New York Times, Barron’s, the Economist, Foreign Affairs, the Harvard Business Review…and the list goes on.  Our online reading consumption is even bigger. (Not shockingly, the HS Dent Forecast tends to get a bit lengthy.) Read the rest of this entry »

I originally penned this article for the August 2007 issue of the HS Dent Forecast–nearly three years ago.  HS Dent’s research on deflation and consumer spending proved to be right on the mark.

The late Milton Friedman may be the most accomplished economist of his generation. Just as his predecessor John Maynard Keynes influenced every aspect of economic thinking and policy in the 1930s, 40s, and 50s, virtually every significant development in recent decades towards free and open markets bears Friedman’s mark. Friedman’s Chicago School provided much of the intellectual fuel for the Reagan and Thatcher Revolutions in America and Britain. Even Augusto Pinochet, the Chilean military dictator, staffed his government with “Chicago Boys” who eventually gave Chile one of the most competitive economies in the developing world. Milton Friedman was a revolutionary who truly changed the world, though this piece is not about his intellectual exploits. Rather, it explains the economist’s theories on consumer behavior and relates them to our own research. We will attempt to add demographic insights into the venerable Milton Friedman’s work and discuss the implications for the next economic season.
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