Field Reporter: Are they slow-moving, chief?
Sheriff McClelland: Yeah, they're dead. They're all messed up.
– Night of the Living Dead (1968)
In B-grade horror movie lore, Tokyo has to fend off attacks from rampaging monsters like Mothra and Godzilla. If the cinema were more true-to-life, however, Japan would be less worried about overgrown fire-breathing lizards... and more terrified of zombies instead.
In response to a recent Taipan Daily asking what brought us out of the Great Depression, a number of you responded with a good question. “What about Japan?” Or rather, “What about Japan’s extraordinary rate of consumer savings – and why hasn’t it helped?”
After putting in a massive blowoff top to cap a truly insane 1980s bull market, Japanese stocks proceeded to head lower... for the next twenty years. The Nikkei is now less than a quarter of its value at the 1990 peak – a 75% decline over two decades in which the rest of the world boomed. Meanwhile Japanese real estate, depending on location, is down anywhere from 50%-80% from the 1990 peak. And depending on how things play out, prices might fall lower still before all is said and done.
(By the way, just as an aside – the next time someone extols the virtue of passive index funds and “stocks for the long run,” consider showing them this chart. As legendary natural resource investor Rick Rule likes to say, “You’re either a contrarian or a victim.” Few markets showcase the brutal truth of this statement like Japan.)
How in the World...?
So how in the world did this happen? How did the second largest economy in the world – and the benchmark index for one of the richest, most prosperous countries in the world – wind up in a two-decade slump?
In a word, “zombies.”
George Romero’s zombies liked to eat brains. Japan’s zombies prefer to eat wealth. In the past 20 years, as the Nikkei outlook went from ugly to bad to worse, Japan proved itself to be a world champion wealth destroyer...
The Rise and Fall of Japan Inc.
Japan first established itself as an economic powerhouse in the aftermath of World War II. Once known for shoddy, low-quality, knock-off type goods, Japan eventually morphed into a juggernaut in high-tech areas like robotics, electronics and automobiles. Today, companies like Toyota and Honda remain the standard for cutting-edge efficiency, quality control and incremental innovation.
In the 1980s, when the country reached the pinnacle of economic might, Americans feared that “Japan Inc.” would soon dominate the West – and perhaps even own the United States outright. Television programs like “Lifestyles of the Rich and Famous” spoke breathlessly of unknown Japanese businessmen worth untold billions (back when “billion” was still a big number). Western minds were concentrated by the spectacle of Japanese buyers snapping up real estate icons like Rockefeller Center. The Japan Inc. juggernaut looked unstoppable.
And what exactly is “Japan Inc.,” you ask? Investopedia defines it as “a nickname for the corporate world that came about during the 1980s boom, when Western business people saw how closely the Japanese government worked with its nation’s business sector.”
On the whole, one could think of Japan like a giant aircraft carrier. In the 1980s, the aircraft carrier was chugging along in exactly the right direction, with MITI (Japan’s Ministry of International Trade and Industry) plotting the course.
The trade-off for running such a concentrated top-down plan, however, is an utter lack of flexibility. An aircraft carrier can’t turn on a dime. It can’t even turn on a football field. It has to go miles and miles out of its way just to make a small adjustment in course.
By the end of the 1980s, the global economic landscape (or seascape rather) had shifted. For the first time in years, flexibility was once again at a premium over relentless focus. Given this sea change, the “Japan Inc.” mindset turned from blessing into curse. The country lost its way.
Mega-Boom and Mega-Bust
In the go-go 1980s, Japan also experienced a fantastically epic stock market and real estate bubble. At the height of this bubble, Japanese companies were trading at 60 or 70 times earnings as the Nikkei climbed towards 40,000. The real estate situation got so out of hand, the patch of land under the Imperial Palace in Tokyo was at one point deemed more valuable than all the real estate in California.
This insane mega-boom led to an equally insane mega-bust. And this is where Japan’s problems really began. When market forces turned against it, the country didn’t know how to handle it.
There is a saying (attributed to various sources) that “capitalism without bankruptcy is like Christianity without hell.” That is to say, it just doesn’t work. Without the threat of punishment, sinners have no reason to repent from their wicked ways. And without the discipline of bankruptcy, a market has no means of cleansing and renewing itself.
One of the major problems Japan has wrestled with these past 20 years is the need to liquidate and start fresh – and the consistent refusal to do so. The Japanese “zombies” mentioned earlier in the piece are zombie banks and zombie corporations... “living dead” type organizations that shamble on aimlessly, gobbling up manpower and resources, kept from their natural graves by routine capital injections from the state.
The Nail That Sticks Up Gets Hammered
Part of the problem, it seems, is the distinctly Japanese preference for unity and harmony over diversity and discord. I am no expert on Japan, but everything I have seen, heard and read seems to emphasize this preference.
There is a phrase that encapsulates Japanese corporate culture: “The nail that sticks up gets hammered.” In other words, it’s better not to make waves... to keep your head down and stay loyal to the organization.
For a long time the unofficial mascot of Japan was the sarariman, or “salaried man” – the white collar Japanese worker who rose through the ranks of a single company and stayed with that company for life.
The deep desire to remain loyal and not make waves influences Japanese corporate culture at the higher levels too. Another distinctly Japanese concept is the keiretsu, which Wikipedia defines as “a set of companies with interlocking business relationships and shareholdings.”
For many decades – from the post-World War II renaissance through the end of the 1980s – the “Japan Inc.” system worked and worked well. The loyal sarariman found lifetime employment with his parent corporation, which in turn strengthened its business ties via the keiretsu. And the Japanese government coordinated the efforts of the keiretsu through MITI (which has since been replaced by METI, the Ministry of Economy, Trade and Industry).
Here Come the Zombies
The “zombies” arose from Japan’s desperate need to preserve not just a way of doing business that had long worked well, but also a culture and a way of life. To let loose the raging forces of creative destruction would be an uncouth, uncivil, unloyal thing to do in the Land of the Rising Sun. It was simply not the Japanese way.
And so Japanese corporations held on to their workers as long as they could. It was not an unheard of thing for a hapless sarariman, no longer with work to do but still supported by his employer, to come in and sit at an empty desk for eight hours, then go home.
The Japanese government kept exactly the same mindset. Banks and corporations were to be rescued, not liquidated. Meanwhile, in the hopes of stimulating the Japanese economy back to growth, staggering sums were plowed into useless construction projects – highways, roads, tunnels, “bridges to nowhere” all over the country. None of it worked.
Paradoxically, Japan’s wealth worked against it in this case. The country was able to afford such expensive measures – in effect, to pour money down a huge rathole for 20 years – because Japan was (and still is) rich.
A Vicious Deflationary Circle
Now we can circle back to the original inquiry, as to why accumulated Japanese consumer savings couldn’t break the two-decade slump.
As best as this observer can tell, the problem was something of a vicious circle that kept Japan’s economy in the dumps. This bogged-down state of affairs was created by wealth-destroying government policy and enabled by a wealth-destroying corporate mindset.
Japan is unique in that something like 95% of Japanese government bonds are domestically owned by Japanese institutions with ties to the government. Unlike America, which has borrowed staggering sums from the rest of the world, Japan has more or less borrowed staggering sums from itself.
This habit of borrowing huge sums, pouring them into the maw of zombie banks and corporations, and then repeating the process all over again, has managed to keep Japan’s domestic economy in an almost permanent state of funk. No liquidation of zombie companies means no room for vital new growth. An overhang of stagnant bureaucracy means a lousy employment situation, which in turns encourages Japanese consumers and companies to save.
Consumer and company savings then go into JGBs (Japanese Government Bonds), which pay painfully low interest rates, because there are few better places for it to go. Meanwhile, when Ms. Watanabe looks around she sees prices gradually falling, not rising... and so the Japanese economy gets saddled with a deflationary mindset on top of everything else.
A Cautionary Tale
All in all, Japan presents a cautionary tale. Without a vital center of “creative destruction,” capitalism simply cannot work.
In a forest, dead trees eventually fall to the ground and decompose. This natural birth-death process gives nutrients to the soil and opens up the leafy canopy to sunshine and new growth. But without death you don’t get rebirth... you just get stagnation.
Interestingly, too, people forget that 20 years is not the same as forever. Japan has been able to go on for decades as it has precisely because the country is so rich. Via issuance of JGBs and the propping up of unproductive enterprises, the government has been able to squander wealth on an epic scale because Japan had so much stored wealth to squander in the first place.
But there will come a day – perhaps not all that far off – when Japan runs out of capacity to borrow. At some point, no one will lend more money to debt-laden, zombie-prone Japan... not even the citizens and corporations of the country itself.
When that happens, we may well see a “big bang” of supernova-style proportions as the Japanese government is forced to do something drastic. Wouldn’t it be ironic if, after 20 years of fearing inflation and pursuing muddy stagnation-type policies, the Japanese Central Bank were forced to bring about one of the most explosive currency devaluations of all time?
Thankfully, there are reasons why America will not automatically be consigned to Japan’s interminable fate. A taste for creative destruction, a diehard entrepreneurial spirit, and the opportunity to benefit from breakthrough technology are three possible “escape hatches” that come to mind.
The pressing lessons for Western policy makers (currently hoping to circumvent the Japan experience) are ominous: Do not assume that a fat checkbook is the answer. Beware the politics of consensus and the grasping hand of bureaucracy. Short-circuit creative destruction at your peril.
Will they get it right? Guess we’ll see...