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 »

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 »