More bad news from the land of the rising sun.  Deflation in Japan continues across a wide swath of goods and services, even while the country sees some of its highest economic growth rates in years.  Consider this recent Bloomberg post:  Japan Deflation Concern Rises Even as Growth Quickens

Bloomberg writes,

The domestic demand deflator, a measure of price levels that excludes the cost of imports, fell 2.6 percent in the third quarter from a year earlier, the most since 1958, Cabinet Office figures showed yesterday in Tokyo. At the same time, gross domestic product jumped 4.8 percent, the most since early 2007.

Sustained price declines threaten to curtail a corporate- profit rebound that’s already been insufficient to spur a rally in Japan’s shares this quarter.

Here are some other downright scary points in the article:

• Consumer prices have fallen for seven straight months.
• Even after seven months of gains in factory output, about one third of Japan’s factories sit idle.

It is our view, as we have written in other posts, that Japan is quickly approaching meltdown.  The country has had the loosest monetary policy in the world for nearly two decades, and fiscal spending that has been so out of control that it almost makes Presidents Bush and Obama seem prudent and responsible by comparison.

Once you enter a deflationary spiral, it is nearly impossible to get out of it.  It took World War II and the ensuing Baby Boom to get the United States out of its last period of prolonged deflation.  What could possibly pull Japan out of its current malaise?

Look at the bullet points again: prices have fallen for seven straight months and fully one third of Japans factory capacity is idle — and this is one of the premier manufacturing countries in the world!

At this point, it would appear to us that the only thing that could make prices rise again in Japan would be a massive currency crisis — and we believe that it is highly likely we will see one of those in the coming years.

All of the gold bugs and fanatical dollar bears might want to take a look across the Pacific to see what the real conditions for currency collapse look like.

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

Earlier this week, we wrote of the “Sinking Ship That Is Japan.”  Today, we’re going to take a look at what the bond market has to say about the Land of the Rising (or perhaps “Setting”?) Sun.

In an almost unfathomable vote of confidence in Japan’s credit worthiness given the county’s debt load and horrendous demographic picture, bond investors have priced the ten-year Japanese treasury at a yield of only 1.4%.  Investors are willing to accept a paltry return of less than a percent and a half from a borrower with the state finances of a banana republic — with government debt now closing in on 200% of GDP!

This prompts the question:  WHY?

The standard answer has been that,

1. Since Japan in experiencing deflation the real interest rate is higher, making the bonds more attractive, and
2. Japan’s domestic population, with its high savings rate, has a voracious appetite for “safe” fixed income, essentially willing to buy at any price.

Of course, for a lot of Japanese, the yield is not sufficient, and a fair number invest their savings in foreign stocks, bonds, and currencies.  They will almost certainly be happy that they did, as we view the likelihood of a full-blow currency crisis in the yen being very high within the next decade.

At any rate, international investors may not be as sanguine on Japan’s credit risk.   Consider the chart below, from Bloomberg Read the rest of this entry »

Once in a while, you have a “me too” moment when you see an article that you wish you had written.  Barry Ritholtz posted on of those today: “Worry About Japan, Not America.”

Ritholtz, though he doesn’t cover the demographic angle, is one of the few analysts out there who understands debt deflation and why the effective insolvency of America’s large banks is such a big deal.  The decisions being made today in Washington are, unfortunately, the same that have been made by Japan for nearly two decades now.  Finally, it appears that Japan is reaching the end of the line.  The country may already be to the point where its sovereign debts are unpayable.  What happens when this realization sets in?  What will happen to the yen?  Or to the “carry trade”?  What will happen when the second largest economy in the world “blows up” like a banana republic?

Honestly, we don’t know.  But we may be much closer to finding out than most analysts think.

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

Barron’s relates a description of Japan’s future by a hedge fund manager familiar with the country:

Within 50 years or so…high-tech aircraft will be taking Chinese and American tourists on fly-overs there to view the dilapidated remains of what was once the world’s second-largest economy.  By then, all that survives will be blighted metropolises like Tokyo, populated mostly by the elderly, and decaying, weed-choked highways, bridges and bullet-train right-of-ways, spectral reminders of a once-vibrant society that lost its way.  (From “Is the Sun Setting On Japan?“)

This is a theme that HS Dent has been covering for years, and for good reason.  We see something along these lines befalling parts of Europe and, to a lesser extent, even the United States. (The U.S. will get older, though it will not actually shrink any time soon).  As Barron’s continues, “The old saw about demographics being destiny certainly applies to Japan, which is graying at an alarming rate because of longtime low fertility rates; its post-World War II baby boom petered out almost a decade before America’s ended in the mid-1960s.”

Demographics certainly are destiny; they are the future that has already been written.  And this future, as Japan has proved, is one of less consumer spending and a higher rate of savings.  This — combined with the hangover from a bursting debt bubble — should insure that the U.S. economy will grow at more modest rates in the decade ahead.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

You have to love the Japanese language — they have a word for pretty much everything.

A fine example is choiwaru oyaji — defined as a middle-aged man who is “slightly bad,” in a recent article.

Everyone knows the type: the naughty old guy in the office who likes to flirt with the receptionist and tell the occasional off-color joke at the water cooler.  He’s not a “dirty old man” per se, but more of a rascally little boy who never fully grew up.  He’s in his 50s but still young at heart, and he takes care of himself — he usually has a good haircut and will generally not be seen in public without a sports jacket and a classy pair of shoes.  He’s certainly no beaten-down, everyman slob like Al Bundy (or Al’s Japanese equivalent).

Give credit to the Japanese for inventing a phrase that encapsulates this mental image! Read the rest of this entry »

In a lot of our writing, we fall into the trap of talking about Japanese deflation as if it were in the past, something in dusty history books.  The truth is, it’s still here and is actually getting worse!

Japan has spent much of the past two decades fighting on-again / off-again deflation.  But in 2009, Japan faced some serious setbacks in this war of attrition.  Forbes reported that Japanese wholesale prices fell a record 8.5 percent in the year to July, and final goods prices dropped an annual 3.3 percent — accelerating from June’s 2.6 percent fall.  Nearly 20 years after the onset of Japan’s financial crisis and the country remains mired in a deflationary funk…while the population shrinks and grows older.  So much for the argument proposed by professor Jeremy Siegel and others that an aging society is inflationary.

It has been HS Dent’s position that the aging of a society — and the cash hoarding that generally goes with this trend — is highly deflationary.  We stand by this claim, and we believe that Japan is vindicating our position today.  

Europe and the US too should continue to experience lingering (though initially quite mild) deflation in the years ahead.   And all the government stimulus in the world is unlikely to change that.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Henry Blodget recently interviewed popular financial writer John Mauldin and geopolitical analyst George Friedman (See video).  It is George Friedman’s comments that we find implausible.  We should start by saying that, in general, we like Friedman’s work.  His Stratfor is a fine resource for geopolitical analysis, and he is simply one of the best in the business for what he does.  We’ve quoted Friedman before in the HS Dent Forecast (see March 2009 issue), and even recommended his latest book.

So, we’re going to have to chalk up his recent Japan comments to temporary insanity.  Friedman believes that a debt crisis in Japan will lead to a fundamental shift in the character of the Japanese state.   The pacifist and democratic Japan of the post-WWII era will be replaced with militantly aggressive Japan — essentially a return to Japan’s WWII fascistic past.   In this view, Friedman has drawn the wrong conclusions from history and has in the process absolutely divorced himself from reality.

Yes, the financial crisis of Wiemar Germany led to a new German militarism and to the rise of Adolf Hitler.  All around the world, authoritarian and totalitarian governments rose to power in a similar fashion.  Even recently, in Argentina, the financial crisis led to the rise of Kirchners — hard leftists with an authoritarian bent who are allied to the radical Hugo Chavez.   So, the historical precedent is there.

But where would Hitler have been without his “Brown Shirts,” his young ideological thugs?  It’s difficult to have a militaristic society without a large pool of aggressive young men.   And this is something that Japan is sorely lacking.

Are we to believe that a country in which the median age will be over 50 will take up arms and conquer its neighbors?  According to UN estimates,  Japan’s median age will be 50.6 by 2025.  It’s already 44.7 — nearly a decade older than the United States.

Furthermore, Japan’s population is shrinking!  How can Japan possibly field an army with a population that is greying and shrinking faster than any society in history?  Moreover, given that Japan is largely a country of only children…what parent or grandparent would want to see their only son fight and die in a war?

Had George Friedman asked himself any of these questions, we would hope that he would have reached very different conclusions.  If demographics are destiny, then Japan’s future will not be militarism.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

We always look forward to reading Foreign Affairs.  It is arguably the authoritative foreign policy publication, and there is almost always plenty of food for thought in every issue.  Once in a while, however, a contributor will swing and miss.  

Richard Katz, a noted expert on Japan, penned an article titled “The Japan Fallacy.”  Katz writes, “In periods of crisis, pundits and policymakers tend to scramble for historical analogies.  This time, many have seized on Japan’s notorious ‘lost decade,’ the decade of stagnation that followed a mammoth property bubble in the late 1980s.  But this comparison is wrong.” Read the rest of this entry »

In today’s Gartman Letter, Dennis Gartman continued his discussion of the Japanese demographic nightmare that we mentioned in a prior post.  We will discuss his comments shortly, but a little background is necessary first.   

It’s hard to believe this, given Japan’s reputation as an exporting powerhouse, but Japan actually ran trade deficits for the five months leading up to February.  Some commentators tried to explain Japan’s shift into trade deficit with a demographic explanation: the growing legions of retired Japanese do not produce, but they do consume.  Therefore, as Japan’s retirees work through their savings, it is natural that Japan run a trade deficit, as the shrinking domestic workforce will simply not be able to support the needs of a growing population of retirees.   

This explanation—a version of which Jeremy Siegel proposed in his otherwise excellent book The Future for Investors—sounds intriguing.  But it is patently false.   Read the rest of this entry »

Dennis Gartman, of Gartman Letter fame, had some good commentary on Japan’s demographics in his March 20 issue that are worth repeating here.  The Japanese demographic implosion is a topic that we find particularly fascinating.  Here before us, we see a real-time case study in what happens to a modern country with a shrinking and aging population.   In a pre-industrial agrarian society, a shrinking population means fewer mouths to feed and is a boon to those who remain.  But in a modern, consumer-focused economy, population growth is a necessity.  Fewer, increasingly older consumers mean fewer sales.  Fewer workers means fewer people paying income taxes.  A shrinking population also quickly exposes pay-as-you-go social security systems as the Ponzi schemes that they are.   Let us now take a look at Gartman’s interpretation of events: 

We have long argued that Japan has put itself into a horrid place demographically as her birth rate keeps on plunging and as Japan is no longer replicating itself. Things have gotten so bad demographically that the government itself says that Japan’s population shall halve in another 50 years…. At this point, little… indeed it appears nothing… can be done to stop this terrible demographic collapse. We are watching a demographic train wreck happen in very slow, but inexorable motion.

Read the rest of this entry »