4 Points to Consider Before Placing Your Bet on Japan

by: The PolyCapitalist

Predicting the Land of the Rising Sun's future is a complex undertaking, and many a financier has had both their belt and suspenders handed to them from betting on Japan's economic implosion.

If you're interested in going long or short Japan, here are some of the key macro elements to keep in mind:

1) Japan (ETF: EWJ) is a major surplus country, meaning it produces and sells much more than it consumes. Much of the savings the country generates, which have to go somewhere, have been invested at home in Japanese Government Bonds (JGBs) and abroad in U.S. dollar denominated assets. Alongside China, Japan is the second largest holder of U.S. treasury debt with as almost $1 trillion in holdings.

2) While Japan has a breathtaking 200%+ public debt/GDP ratio (the highest in the developed world), 94% of that debt is Japanese owned. What this means, basically, is that so long as the Japanese keep buying JGBs then Japan's fiscal future is in its own hands. In contrast, the U.S. depends on foreigners to finance a large portion of its federal deficit. The thrifty Japanese save enough to finance their Keynesian stimulus policies all by themselves and still have plenty left over to spot Uncle Sam!

Now, the Japanese savings rate has been steadily declining to what would seem an unsustainable level in terms of maintaining the current fiscal course:

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But if the government gets into trouble it can always expropriate its rentiers through taxes, inflation, financial repression, or some combination of these. U.S. bondholders, like PIMCO's Bill Gross who recently liquidated his U.S. Treasury holdings, won't stand for this type of financial subterfuge. Bottom line: I think the U.S. has a potentially more problematic fiscal situation than Japan due to the dependence on an international bond market whose tastes, as Greece learned the hard way last year, can shift swiftly.

3) In terms of work ethic and cultural solidarity, few countries can compete with Japan. Put another way, if the Japanese people make up their minds to pursue an economic objective, and that objective is economically sound, then I would not want to bet against them.

4) But the potentially big long-term negative for Japan is demographics. Not only is the country's birth rate declining, but the population is rapidly aging with 21% of the population over the age of 65, making Japan the world's most elderly nation. Japan also has very low immigration. Japan is certainly not alone on aging and demographic problems (see China). Overall, demographics is an area where the U.S. clearly has a big advantage, and the demographic card may prove an ace longer-term.

Some investors, such as Hugh Hendry, have been using Japan as a synthetic/derivative China short. This video is from awhile back, but here are Warren Buffett's still relevant thoughts on Japan.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.