The Demise of Japan as an Economic Power?

In the Land of the Rising Sun, the financial sun is apparently setting. I have zero investments today in Japan for the reasons outlined in the story linked below. Credit Default Swaps (CDS) are showing the Japanese banks are under great stress. Those bank debt insurance policies are at levels close to where American banks were in September 2008 before the big crash and bank implosion.

I have business associates in Japan, and the economy has been in virtual depression for many years. They have a homeless problem like you would not believe with tent villages on public grounds in the cities, especially around the old castles (but being Japanese, they are very tidy tent villages).

From my take on the Japanese people, the problem is mostly to do with their domestic reluctance to consume. They have a domestic consumption economy much too small for the size of the country (by population). The older generation that came of age post WW2, was reluctant to spend on anything, understandably so given what they went through in the years after 1945. Even the business leaders who make a very nice income by American standards, are very frugal in how they live. The wages for the workers among the younger generations are very modest.

I was able to determine that a sales person selling the same products as me, with the same skill set and experience, was making half the wage. The Japanese I know can’t believe how well we live here in America and some consider us wasteful and decadent (though they enjoy participating in the decadence when they visit).

And with the WW2 generation being very conservative about their own future, they had small families with birth rates below the "replacement rate" of about 2.2 children per family. This, along with virtually no immigration, leads to the well known problem of Japan’s aging population. Who is going to take care of all the older people on government pension and healthcare?

And now Japan has lost the one thing that kept it going and growing the past 40-50 years: a leading global position in manufacture and export of consumer goods. China and its siblings (Taiwan, Singapore, Thailand, Vietnam, etc) are taking over this role on the world stage. Japan is left to try and export capital goods and engineering know-how to China and siblings, much like America. But America has a population that always expands from immigration (a reason I am very pro-immigration) and an established consumer psychology that will recover within the next few years, Bill Gross’ proclamations not withstanding. Our desire to consume is genetic. It is the source of the proverbial "American Dream".

A second significant problem for Japan is that Japan has no natural resources to export. So, they have lost their consumables export leadership and have nothing left to sell the rest of the world to drive their economy. Japan does not consume enough as a nation to fully utilize its own productive capacity for domestic demand and to keep its younger workers employed to pay for the retirements of the older workers. This endemic factory "utilization gap" is the source of Japanese deflation.

I think Japan will either evolve out of necessity into a consumer nation over the next 20 years as the younger generations with Western ideals take over management of the country, or Japan's financial system will go into default. In October last year, the world financial system came to the rescue of America with its heavy importation of manufactured products and its reserve currency. The world had to save American banks in order to save itself. But for Japan, there will be no such salvation. Its banks will be allowed to fail and the Japanese people will have to build the country all over.

If Japan defaults, it will be very ugly (Iceland times 100). So, I expect global financial interests to push the Japanese to avoid that fate before it happens. Ironically, the Japanese need to spend their savings (those infamous Postal accounts). That is their one chance to save themselves and the rest of the planet a lot of pain. Strange as it seems for Americans with our low national savings rate, it is possible for a nation to be too thrifty (called "The Paradox of Thrift"). There is a need for balance in a sustainable economy: not too little savings, but not too much; not too little social security, but not too much (Obamacare for example); not too little immigration, and not too much. And so on.

Just be glad this is happening now and not in 1990. The Japanese economy (including real estate and stock market) has already deflated by 80%. The crash if it happens, will not be as precipitous from these levels as it could have been. But it is shocking to contemplate. I think the weakness of Japan's economic system, its lack of domestic consumption and its long term social liabilities, is the reason the Yen will never become the world reserve currency. The dollar remains safe in that role for some time to come.

Here is a link to the article that inspired this post published in the UK Telegraph on Sunday. It is somewhat frightening reading. But as mentioned, I don't think the Japanese economy has a great deal of direct influence on the Rest of the World. Besides, as Warren Buffett says (quoting someone like Ben Graham I believe), "Buy when everyone is Fearful and Sell when everyone is Greedy". He did that when he acquired all of Burlington Northern Santa Fe rail (BNI) for $44B.

Comments

[Mad Hedge F...:]

poa ) As much as I want to find a trade in Japan and therefore have an excuse to go there again, my searches have recently come up empty. With America maintaining its lead in innovation and the creation of new business models, and China taking over the world’s low end manufacturing, it is hard to see a future for Japan. Can a country of 127 million live only off of the high end manufacturing of luxury cars, video games, and electronics? The country is increasingly looking like a “has been” emerging market. During my career, I watched GDP growth rates fall from a white hot 10% in the sixties, to 4% in the seventies and eighties, to 1% in the nineties and the early 21st century. Are we flat lining at 0% in the teens? That leaves fertile ground only for stock pickers who are willing to do the local spade work to find one hit wonders like Toyota and Fast Retail. That is a job best left to country specialists, like my old friend, 40 year veteran Ed Merner, who runs the Atlantis Japan Growth Fund (LSE-AJG) traded in London, which has shot up a sizzling 80% in six months.

Nov 04 06:12 AM

[Salacious:]

I am curious about the Postal savings accounts in which the Japanese place their money. Are the interest rates at all attractive, or is stability the one and only goal? Also, does anyone know how much exposure Japanese investors have to the rest of the world? It seems such a waste to have money locked away when it could be put to work.

Nov 04 09:54 PM

[ETFdesk.com:]

interesting read on Japan: “currency death spiral” Japan, Einhorn and ‘tontine’ fantasies www.etfdesk.com/headli...

Nov 05 10:28 AM

[Asia Hand:]

Thank you for your insightful article.

Pretty much succinctly sums up the social, cultural, generational and economic factors and challenges.

The one potential counterpoint is that Japan needs to have a population implosion as it was already overpopulated and this is just a phase in a cycle of regrowth.

Anyways, Kudos.

Nov 05 11:07 AM

[Alex Filonov:]

Maybe Japan is waking up now? Last elections result means something, IMHO.

Nov 05 12:12 PM

[spald_fr:]

Thank you for your article. I conduct business in Japan often and agree with everything you write.

You may also want to further explore the Japanese agricultural base. As many younger people (read men) gravitate into the cities for opportunity, the farms are losing manpower and are ageing quickly. Increasing hybrid yields are masking this personnel effect.

Immigration of Korean men into the farming communities is becoming common, with Japanese women taking Korean men as spouses.

Nov 05 12:21 PM

[zagrebzagreb:]

The major problem with Japan is their reluctance to consume?

Nope... You would then find the same issue with all northern European and Scandinavian countries, which operate with large trade surpluses and conservative domestic consumer behaviors. These are the most robust economies in the world.

Look instead to the way Japan subsidizes the largest businesses at the expense of the population in general. Japan has macro economic issues stemming largely from an economy geared to provide cheap capital and vast structural support to entrenched multi-nationals... This short changes roughly 80% of the remaining business activity, including consumer spending.

Capital at roughly zero percent interest, for decades and decades? Yes, but only if you are part of a keiretsu (part of a chain of interlocking businesses, often with banking and heavy industry at the center). These include all Japanese companies with household names - Sony, Mitsubishi, Komatsu, etc.

Recently, we have seen the devastating effects of giving away money with almost no oversight and bogus expectations for returns... try doing that for years and years, and you'll end any forward momentum an economy might have.

Nov 05 02:07 PM

[Nagano Jim:]

I disagree with the premise of the article. The problem is not that the Japanese don't spend enough. Nations do not become wealthy because simply because their people spend a lot. This is kind of like saying a child becomes tall because he eats a lot. If the child is not growing, eating a lot will just make him fat. What makes the child taller is growth. That Japan's citizens don't spend a lot is a symptom, not the disease.
To generate growth, the private enterprise in a nation must create new and better products and services. What made Japan flourish in the 1970s and 1980s was primarily that its manufacturing might was constantly finding new ways to produce high quality products that people wanted faster, cheaper, and at better quality.
What Japan needs now is a major injection of entrepreneurship. I read a statistic somewhere recently that as much as 80% of all the companies in Japan date from the Meiji period (starting in the 1860s). Japan needs to unleash its creative minds to generate the new items and services that will capture the world's imagination. It needs to remove the barriers in its legal and economic system that are strangling entrepreneurship. Entrepreneurship is risk taking, and the Japanese are highly risk averse. Therefore, there needs to be a concerted push to come from the top to get people to try to make their ideas into reality. Only then will Japan be able to create value and start to significantly grow again.

Nov 05 04:35 PM

[GeminiAtlas:]

I will have to agree with Nagano Jim here.
The role that the Japanese goverment has played in the business affairs has created more or less a state capitalist society ( i.e. Japan, Inc.) or neo-mercantalist policies to produce an export driven economy. Basically the investment decisions are driven by high level industrial policy of the government. So investments haven't gone to what the Japanese domestic population would want to buy. Also, would add to Jim's comment that the high level of government intervention also produced risk averse enterprises, or at least 'zombie' entities that produce less value than they are worth.


On Nov 05 04:35 PM Nagano Jim wrote:

> I disagree with the premise of the article. The problem is not that
> the Japanese don't spend enough. Nations do not become wealthy because
> simply because their people spend a lot. This is kind of like saying
> a child becomes tall because he eats a lot. If the child is not growing,
> eating a lot will just make him fat. What makes the child taller
> is growth. That Japan's citizens don't spend a lot is a symptom,
> not the disease.
> To generate growth, the private enterprise in a nation must create
> new and better products and services. What made Japan flourish in
> the 1970s and 1980s was primarily that its manufacturing might was
> constantly finding new ways to produce high quality products that
> people wanted faster, cheaper, and at better quality.
> What Japan needs now is a major injection of entrepreneurship. I
> read a statistic somewhere recently that as much as 80% of all the
> companies in Japan date from the Meiji period (starting in the 1860s).
> Japan needs to unleash its creative minds to generate the new items
> and services that will capture the world's imagination. It needs
> to remove the barriers in its legal and economic system that are
> strangling entrepreneurship. Entrepreneurship is risk taking, and
> the Japanese are highly risk averse. Therefore, there needs to be
> a concerted push to come from the top to get people to try to make
> their ideas into reality. Only then will Japan be able to create
> value and start to significantly grow again.

Nov 05 05:18 PM

[jse17:]

If one were truly a contrarian in context of the abundance of bad news presented here and elsewhere, one would likely buy the Japanese ETFs and CEFs. Additionally, the Japanese indexes are the least expensive of any major market according to First Eagle Fund’s manager.

As the E*TRADE baby so eloquently states, do some analytics and basic research Shankopotamus …… !

Nov 05 11:20 PM

[JudeJin:]

the real problem underpinning any economic problem is there's not enough work for everyone because the labor can't clear on the current price! japanese are working hard on after hour drinking binges and spent a lot in "snacku". the government intervention has kept the real economy from adjusting to the new labor supply demand equation after china joined the global competition. same problem with the USA.

when i was a teenage in shanghai, my parents was making less than 1000 dollars a year. but once china joined the global trade, hey, a lot of people are making 50K USD a year now, or even more.

in order for the japanese and the americans to compete, the labor market has to clear on market price without any intervention. intervention to keep the wages artificially high will result in higher unemployment. that's a rule of thumb!

Nov 06 01:07 AM

[JudeJin:]

or put in another way, the japanese miracle was a great hallucination resulted from structural lack of competition when the chinese were shut away from the competition.

when the japanese wake up to the reality, things probably will be very very dire. bankcrupt government, failing economy and currency.

Nov 06 01:12 AM

[Gary A:]

If Japan defaults I hope they take Goldman Sachs with them. And you don't know if the government spending figures in the US. are even valid. I don't believe, that with sales receipts down, spending isn't also down a lot more than reported. I think we could end up like Japan. I think we cannot afford inflation because our people cannot buy the higher priced products. hubpages.com/hub/The-R...

Nov 06 03:35 AM

[jse17:]

www.trustnet.com/News/...

Nov 06 08:27 AM

[chap08:]

In my experience the comment below isn't true. There are (and have been) plenty of entrepreneurial Japanese businesses. It is true as you and others say that the keiretsu get an effective subsidy, but I have seen plenty of innovation coming out of Japan.

I don't think that you can pin the blame on one single factor. But that one thing that hasn't been mentioned is deflation itself. Those who like a bit of deflation won't like me saying it, but my experience of the Japanese people is that they factor in deflation. Why spend when you expect things to just keep getting cheaper? A form of money illusion - maybe, but reality - definitely. A dose of inflation would sure get those postal savings moving.


On Nov 05 04:35 PM Nagano Jim wrote:

> I disagree with the premise of the article. The problem is not that
> the Japanese don't spend enough. Nations do not become wealthy because
> simply because their people spend a lot. This is kind of like saying
> a child becomes tall because he eats a lot. If the child is not
> growing, eating a lot will just make him fat. What makes the child
> taller is growth. That Japan's citizens don't spend a lot is a symptom,
> not the disease.
> To generate growth, the private enterprise in a nation must create
> new and better products and services. What made Japan flourish in
> the 1970s and 1980s was primarily that its manufacturing might was
> constantly finding new ways to produce high quality products that
> people wanted faster, cheaper, and at better quality.
> What Japan needs now is a major injection of entrepreneurship. I
> read a statistic somewhere recently that as much as 80% of all the
> companies in Japan date from the Meiji period (starting in the 1860s).
> Japan needs to unleash its creative minds to generate the new items
> and services that will capture the world's imagination. It needs
> to remove the barriers in its legal and economic system that are
> strangling entrepreneurship. Entrepreneurship is risk taking, and
> the Japanese are highly risk averse. Therefore, there needs to be
> a concerted push to come from the top to get people to try to make
> their ideas into reality. Only then will Japan be able to create
> value and start to significantly grow again.

Nov 06 08:36 AM

[tripleblack:]

[quote] If Japan defaults, it will be very ugly (Iceland times 100). [quote]

Just a quibble, but the ratio would be more like "Iceland times 1000", particularly in terms of the global impact.

The recent devaluing of the Yen (particularly against the Euro, but also against the dollar) is something that I would expect more of as the new government in Tokyo loses their naive ideas and learns the truth.

Nov 06 12:12 PM

[Brian McM:]

The Japanese consider the Koreans to be racial brethren, so Koreans are embraced in Japanese society. There is of course a racial bridge. The ancestral majorities of both countries came from the Chinese mainland and both countries have had to defend themselves against much larger China (and its allies) through the centuries. (there is an aboriginal race in Japan, the Ainu, mostly on the northern island of Hokkaido, that do not share the racial characteristics of the majority Japanese).

But I don't think the limited immigration between Korea and Japan is sufficient ot infuse Japan with the youth and alternate thinking needed for economic success in the 21st century. This will be their greatest challenge.

On Nov 05 12:21 PM spald_fr wrote:

> Thank you for your article. I conduct business in Japan often and
> agree with everything you write.
>
> You may also want to further explore the Japanese agricultural base.
> As many younger people (read men) gravitate into the cities for opportunity,
> the farms are losing manpower and are ageing quickly. Increasing
> hybrid yields are masking this personnel effect.
>
> Immigration of Korean men into the farming communities is becoming
> common, with Japanese women taking Korean men as spouses.

Nov 06 07:40 PM

[Brian McM:]

I agree with this analysis. It is the other side of the same coin. In Japan, the group is more important than the individual which creates the organizational dynamics you describe, but also discourages consumption as selfish. The individual who consumes is taking capital from the larger entity and the common good.

The rugged individualism of America is a product of generations of immigrants escaping some tyranny and wanting to lead an life indepedent of rule or oppression. This individualism is expressed as selfishness or greed by the outliers of the population distribution. They may also be the most successful as this greed in the American society can result in great wealth. But there is a bell curve and most people are in the middle, both indvidualistic but at the same time concerned about society. Japan lacks that balance from my perspective. And because it is so insular, it has no way to import an individualism ethos.

Nagano Jim is in the same camp as ZagrebZagreb. And I definitely agree that state managed business has this downside. This is really the lesson for American politicians. Limit entrepreneurship and control major industries with a heavily socialized economic system and you get Japan. And I doubt American society can do this form of economy nearly as well as the Japanese. So, a socialized and centrally controlled economy in America would be a complete disaster. But consumerism is very important in an entrepreurial economy. America needs consumerism to drive innovation.


On Nov 05 02:07 PM zagrebzagreb wrote:

> The major problem with Japan is their reluctance to consume?
>
> Nope... You would then find the same issue with all northern European
> and Scandinavian countries, which operate with large trade surpluses
> and conservative domestic consumer behaviors. These are the most
> robust economies in the world.......
>

Nov 06 07:46 PM

[Brian McM:]

Well said JudeJin. You must have some personal experience in Japan. the Snacku did not go unnoticed. You are right, America must be able to compete on labor cost with other countries to be effective in the world. Now I ask a question that I don't mean to offend my Chinese friends: how do you feel about the Chinese Yuan indexed to the dollar? This will create inflation in China while it attempts to keep American labor from becoming more competitive with Chinese.

On Nov 06 01:07 AM JudeJin wrote:

> the real problem underpinning any economic problem is there's not
> enough work for everyone because the labor can't clear on the current
> price! !

Nov 06 08:00 PM