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

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

The Japanese government has taken a novel approach to selling its bonds: questioning the masculinity of any Japanese man who doesn’t buy them.

“The name is Bond, Japanese Government Bond.”

You could be forgiven for mistaking Lindsay Whipp’s recent Financial Times column for a spoof from The Onion: The best a man can get: Japan’s government bonds given hard sell

As Whipp continues,

Stuck with the tricky job of making debt issued by the world’s most indebted government an attractive investment prospect, Japan’s ministry of finance has hit upon a novel sales pitch.  A high-profile advertising campaign to persuade millions of small-time investors to buy the country’s sovereign debt has gone for raw sex appeal: “Women have a thing for men who own [Japanese Government Bonds]!! . . . right!?”

Owning bonds might not be everyone’s idea of the way to a woman’s heart but, according to the finance ministry advert, women prefer men who invest in solid government debt because they are sensible investors.

The advert in the free commuter magazine R25 features five women who say they would choose husbands who are “serious about money” and invest for “stability”.

I’m not sure whether to laugh or cry at this.  With the country’s debt at 200% of GDP–the highest debt levels in the world outside of Africa–Japan’s government bonds have become so unattractive that the government is attempting to entice men to buy them with promises of female affection.

What’s next, bond coupons that are redeemable at gentlemen’s clubs?

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

 We read on Bloomberg this morning that “Japan’s household sentiment rose for a second month in February as the economic recovery began to generate jobs… Japan’s export-led revival is beginning to stabilize the labor market, helping build the base for a broader recovery that includes households. Spending by consumers accounts for more than half of the world’s second-largest economy.”   Link to Bloomberg article.

We’ll see about that “broader recovery.”  At HS Dent, we have held out hope for quite some time that the rise of Japan’s small Echo Boom generation (the children of the Baby Boomers) would allow Japan to enjoy a mini-boom, of sorts.   While we viewed a return to Japan’s heyday of the 1970s and 80s as out of the question, we did expect at least a mild improvement in the economic malaise that has come to define Japan.  That mini-boom might still come; hope springs eternal.  But given all of Japan’s other problems, we expect any boom to be VERY small.  It might be more of a pause in the decline rather than a bona fide boom.  We shall see.  But we wouldn’t hold our breath on that.  “Mini boom” or not, Japan may be headed to the largest sovereign debt crisis in world history.  (see “Japan, the perpetual crisis tease“)

This won’t end well.

Charles Sizemore, CFA

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

“Cassandra’s curse was that her warnings would never be believed,” writes the Economist. “Doom-mongers in the Japanese government-bond market have suffered a milder fate: they were just far, far too early.”

At HS Dent, we’ve been firmly in the Japan “doom-monger” camp for quite some time.  We’ve hesitated to take active bets against the Japanese bond market (believing that deflationary forces would keep bond yields low), and have even held out hope that the country might enjoy a mild “mini boom” with the maturing of that country’s small Echo Boomer generation.  But our long-term view has remained unchanged — that Japan, as a country and economy, was on a slow, steady track to oblivion.

The Economist largely agrees though thinks that Japans day of reckoning could be at least a few years off.  But come it will:

It certainly seems likely that at some point the worst fears of the bears will come to pass. Debt servicing already uses up some 35% of government revenues. Imagine what that figure would look like if Japan paid the same level of yields as Germany (or worse still, Greece). A fair chunk of Japanese debt is owned by government agencies, a financing pyramid that will eventually collapse. Historically countries with very high levels of government debt have defaulted or, more usually, inflated the problem away.

From “Apocalypse, Not Now“

It remains to be seen how the Japan saga will end.   It’s hard to imagine a good ending for the country’s bondholders, however.

Charles Sizemore, CFA

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

Concerned about the level the country’s borrowing, S&P has threatened to downgrade the Japan’s sovereign debt.  The Wall Street Journal writes,

The statement from Standard & Poor’s on Tuesday was the first formal declaration of concern from a ratings company about Japanese borrowing in the months since investors began to raise questions about the sustainability of government debt, estimated to have reached the size of the country’s entire economic output for the year ending in March—the highest level in the industrialized world. (Link to article)

Our only question is “what took them so long?”   Japan should have been downgraded ages ago.  The country has amassed debts that it is unlikely to ever repay.  Who in their right mind would lend long term to the Japanese government given the country’s fiscal position?  It’s about time someone acknowledged the obvious.

Charles Sizemore, CFA

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

Cool graphic from the Economist comparing China and Japan:

It’s telling to watch Japan’s relative importance in the world economy (measured here as its GDP as a share of US GDP) fall over the past two decades.  Japan, as an industrial society, is a country in inexorable decline.  And with an aging and shrinking population, there is no reason to believe this can be reversed.

In 2010, China should surpass Japan to become the world’s second-largest economy. This is a major accomplishment for a country that only a few decades ago was among the poorest in the world.  But will the success last?  Or will China follow Japan’s recent history and suffer a bubble burst followed by a decade or more of debt deflation?

The Economist would argue “no,” writing:

China is still far poorer than Japan was at its peak, and thus has more room to improve productivity. A transition of surplus labour from agriculture to industry and services would increase efficiency and bring its economy more in line with the developed world…  But in the long run, a shift away from investment and exports towards domestic consumption would make China’s output more sustainable, and help it to avoid experiencing a bubble like Japan’s.

Unfortunately, the Economist is ignoring the proverbial elephant in the room — demographics.  China’s current economic model relies on an endless stream of young migrant workers from the countryside.   This simply cannot and will not continue indefinitely.  China is one of the fastest-aging countries in the world due to the effects of the One Child Policy over the past three decades.  The number of young Chinese who are in their prime moving years is set to begin a long, multi-decade decline in 2010.  This could mean that China will be facing serious issues with overcapacity in the years ahead, as infrastructure was built for people that might never migrate.  And with overcapacity comes…you guessed it…deflation.

Related post: A Christmas Carol of Sorts, Starring China as Ebanezer Scrooge

This wraps up 2009 for the HS Dent Blog.  Here’s to a prosperous 2010! 

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

One of our Demographics School attendees forwarded us two articles we thought we’d pass on:

“The American Who Manages the Decline of a Japanese Hamlet“  Wall Street Journal

“In Aging China, A Change of Course” Washington Post

It’s a week before Christmas, and we can’t help making a comparison here to Charles Dickens’s A Christmas Carol.  In this case, China is Scrooge and Japan is the Ghost of Christmas Yet to Come.

The difference is, unlike Ebenezer Scrooge — who had the ability to change his ways and avoid his unfortunate fate –China’s future cannot be changed.

In comparing China to Scrooge, we are not referring to Chinese labor practices or implying that China’s labor force consists of millions of unfortunate and underpaid Bob Cratchits.   It’s not China’s wages that we consider misery, but rather its birthrate.

Demographics are the future that has already been written, and China’s future looks bleak indeed. But first,let’s look at Japan.  The Wall Street Journal article above tells the story of an American whose job it is to manage the slow death of a small Japanese village.  While one village might not be particularly significant in the grand scheme of things, the same is occurring throughout Japan.  The island, with the exception of a small number of large cities, is slowly being depopulated.  Falling birthrates throughout the post-WWII era have insured that Japan will continue to shrink for the foreseeable, with serious consequences for the stability of the country.

China isn’t to this stage yet.  But after 30 years of the One Child Policy, it is only a matter of time before the day comes.  Even if China were to suddenly reverse the policy — which is unlikely — the damage has already been done.  And, as the Washington Post article recounts, Chinese families have become accustomed to the One Child Policy.  Many simply cannot afford to have a second child even if they wanted one.

So again, unlike Ebenezer Scrooge, it is almost certainly too late for China to change its ways.

Related post: “Some Geopolitical Musings”

Charles Sizemore, CFA

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

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.

Read the rest of this entry »

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 »