Why Japan Might Find It Hard To Ease Out Of This One

Includes: EWJ, FXY
by: Rahul Garga

In February 2013, ailing electronics company Sony (SNE) just announced the launch of the PS4, a relatively uninspiring upgrade of its previous flagship model with no new innovation ... just more of the same.

It seems strong parallels can be drawn between the decline of Japanese industry and the lack of creative policy management in the government.

Running out of Steam

Perhaps it is no coincidence that as the Japanese population ages, it is reflected in the decline of youthfulness and energy that Japanese industry once exuded.

Japan once held a major competitive advantage in the field of manufacturing, which it successfully used to dethrone major Western industrialized countries in many different areas. For example, in 1980, Japan held over 50% of the shipbuilding market share and this fell to less than 10% in 2013. The single biggest reason for their advantage was the "lean" manufacturing process that made them super efficient. This "trade secret" however is no longer a secret in so much as it has become a standard operating procedure in manufacturing plants around the world. Factories from Shenzhen to Bangladesh use Kaizen principles just as any plant in Osaka would.

In terms of product differentiation, "Made in Japan" was synonymous with quality, however because of the increasing standardization of production and global nature of business, quality has now become a requirement rather than a distinguishing feature. In some industries, arguably car manufacturing, it still enjoys somewhat of a lead, however this has also been severely dented because of the recall saga of late. There is no doubt that the spread between perceived superiority of Japanese products vs. its Asian competitors is rapidly narrowing at an exponential pace.

In the electronics space, where Japan once reigned supreme, it has become a laggard as its corporations struggle to maintain a competitive edge. Perhaps the fact Samsung Electronics (OTC:SSNLF) has an operating profit 2.5 times more than 9 of Japan's largest electronics corporations sums up its predicament the best.

In today's economic landscape, ideas have become the biggest competitive advantage as technology continues to diffuse at a rapid pace and replication of a product's specification becomes demystified. There are plenty of iPhone look-alikes floating around in China that can do the same job, but Apple's (NASDAQ:AAPL) soon to be biggest market is still China.

The Japanese government like its corporations is struggling to find an innovative way of fighting the demon of deflation.

What is this new round of QE trying to achieve?

Japanese financial institutions don't really have an acute liquidity program as they have been awash with support since the beginning of the decade.

One of the primary objectives of a Quantitative Easing program is to depress long term rates to stimulate borrowing. However, the Japanese economy has been in a zero rate environment for the past decade and as you can see below, Japanese 10 year sovereign yields have been below 2% for quite some time already.

Japanese 10 Year Government Bond Yield
(Click to enlarge)

Yield starved Japanese investors have already begun to park their money in higher yielding assets which in turn help to boost the global economy, but this still doesn't help raising the level of inflation at home.

The intended effect of lowering rates will be marginal at best.

Rather than the direct effects of QE, it seems the real objective is to indirectly create conditions for the depreciation of the yen.

While it is true that Japanese firms have been buckling under the pressure of a strong yen due to the largely Risk-Off sentiment over the past few years, depreciation alone is not going to solve the structural problems of the Japanese economy.

They are going to have to do more than "more of the same" if they are to break this economic rut.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.