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Japan: Land of the Rising Debt
I promised to forward an article I wrote on Japan for Institutional Investor, and here it is. I also wanted to share pictures with you from the Value Investing Seminar in Italy (follow links to see pictures). I went to Italy with my brother Alex. We spent a few days in Rome, then took a train to Naples (from where we took a day trip to Capri, Pompeii and Sorrento), and finally ended up in Trani – a small town on the Adriatic Sea where the conference was held. Trani is a little gem. The people were warm, there were very few tourists, and the food was incredible. Few people spoke English; but unlike Parisians, who may well speak English, but refuse to do so, I got along fine with Italians, maybe because they speak with their hands (I do too). The seminar was an amazing experience. Ciccio Azzollini, who organized it with Whitney Tilson, is a terrific host and a wonderful human being, and he is solely responsible for me gaining five pounds. I cannot wait to go back next year!
Japan: Land of the Rising Debt
Investors are understandably scared of the sovereign debt crisis unfolding in Europe. Amid their angst, however, they are ignoring a more likely, and significantly larger, debt catastrophe that is about to hit the nation with the second-largest economy in the world — Japan. Two decades of stimulative, low-interest-rate fiscal policy have made Japan the most indebted nation in the developed world, and as new Prime Minister Naoto Kan recently said, in his first address to Parliament, that situation is not sustainable. Japan has little choice but to raise interest rates substantially, with dire consequences far beyond its shores.
The prelude to the current crisis began in the early 1990s, after Japan’s housing and stock market bubbles burst and its economy slipped into recession. For the next 20 years, using flashy names like Fiscal Structural Reform Act, Emergency Employment Measures and Policy Measures of Economic Rebirth, the government cut taxes, increased spending and borrowed money to finance itself. Today, Japan’s ratio of debt to gross domestic product stands at almost 200 percent, more than twice that of the U.S. and Germany and second only to Zimbabwe.
A country with ballooning debt needs to have an expanding economy to outgrow the burden. Economic growth is driven by two factors: productivity and population growth. Although the Japanese economy may continue to reap the benefits of productivity gains, population growth is not in the cards.
Japan has one of the oldest populations in the developed world — every fourth person is 65 or older — and its number is on the decline. The Japanese birth rate is one of the lowest in the world, a meager 1.2 children per woman. To maintain its current population level, the average woman in Japan would need to give birth to 2.1 children. (Of course, only economists know how a woman can give birth to a fractional child.)
The severity of the debt problem in Japan has been masked by the fact that government spending on interest payments has not changed over the past two decades, as the average interest rate paid on the country’s debt declined to 1.4 percent in 2009 from more than 6 percent in the 1990s. This is about to change. Historically, more than 90 percent of Japan’s government-issued debt has been consumed internally by its citizens, directly or through its pension system. But the savings rate in Japan, which was in the midteens in the 1990s, today is approaching zero and will likely go negative in the not-so-distant future.
The Japanese economy operates on the assumption, soon to be proved false, that the government will always be able to borrow at low interest rates. As internal demand evaporates, the government will have to start hawking its debt outside Japan — in a more realistic world, where interest rates are a lot higher. Japanese ten-year Treasuries currently yielding 1.3 percent will not stand a chance against U.S. or German bonds of the same maturity, which yield 3.5 percent and 3 percent, respectively. Japan will have to offer rates far in excess of its U.S. and German counterparts. Although they have their own set of problems, the U.S. and Germany still have much lower indebtedness and superior demographic growth profiles.
Higher taxes and the austerity measures that undoubtedly will follow, combined with higher interest rates, will further slow Japan’s economy and drive the country toward insolvency. Unlike Greece, which because of its size could be bailed out by Germany and friends — with a little help from the ever-willing International Monetary Fund — Japan is too big to be bailed out. Defaulting on its debt, especially when the majority of it is held by its own citizens, is a political impossibility. But unlike European nations that socialized their currencies and cannot print euros on their own, Japan has complete control over its currency printing press. And print it will! Decades of deflation will turn into hyperinflation, which will destroy the purchasing power of Japanese citizens’ savings and collapse the yen.
The consequences of the economy’s slow but sure unraveling in Japan will spill over to the rest of the world. Japan is the second-largest holder of U.S. government debt, and most likely it will start selling Treasuries. To make matters worse, Japan will start competing with the U.S., not just in cars and electronics but for buyers of sovereign debt. As Japan exports inflation, interest rates around the globe undoubtedly will rise.
Timing bubbles — and Japan is in the late stages of an enormous debt bubble — is very difficult. They tend to last longer than rational observers expect. But as Japan’s debt continues to swell, the eventual bursting of the bubble grows more catastrophic.
Japan is proof that a country cannot borrow itself to prosperity. The U.S. and other developed nations still have a chance to make the politically difficult but right decision to cut fiscal spending and stop looking for government to be the source of sustainable growth — which it never is.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of "Active Value Investing: Making Money in Range-Bound Markets" (Wiley 2007). To receive Vitaliy's future articles my email, click here.
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As someone who lives in Japan, I too have to agree with the paper and not at all with pitz.
You can't be serious. Housewives often stay at home because companies aren't hiring, and removing themselves from the workforce for childbirth often permanently impairs career prospects. And then there's corporate culture: have you ever been out with Japanese colleagues and seen bright, hard-working, positive young women reduced to refilling drinks and cleaning tables? Ever seen a young woman interpret during a meeting while the young men are allowed to discuss business? How about serving tea (chakumi)? It's degrading, and companies get away with it because there are no jobs.
Further, when I say female careers are few, combine that with the reality that the female labor force participation is high after infant-rearing years (around 75%). They just work in low-wage service sectors.
Birth rates that fall to sustainability are. Many families I talk to would like to have another child, but are worried about the cost of clothing, shelther, education, etc. They can't afford to move out of their 10-jo place. Women don't want to get married because they'll have to leave their careers to raise a child. These tradeoffs do not exist in many countries.
Japan's low birth rate is driven by high cost of living amid wage deflation and a tightened job market, period. Furthermore, there are consequences of this "prosperity"-driven aging: Japan will have to heavily raise the retirement age for the national pension, raise payroll taxes, or admit millions of immigrants.
First off, Mrs. Watanabes aren't that major a force. Second of all, what are they doing? They're scraping to find yield outside of Japan, where deposits earn only a few bps. Last I checked, a 10-year CD at MUFJ or Mizuho would get you around 0.60%. It's a job with very small returns, if any (last I checked, they were getting burned on PRDCs.) The only people doing it are those with few other options. A large population of DIY day traders and currency speculators is not desirable for any country.
In other words, you haven't been paying attention to Japanese politics. We're on our fifth prime minister in four years, just had the DPJ lose massively in the upper house after the LDP lost massively in the previous election, have had several ministers (notably in Agriculture) kill themselves, finally got through the public humiliation of Ozawa's money handling, etc. There's no polarization only in that the population knows the system is broken.
Circumspice, the indiginities you list are minor compared to the indignities American workers are forced to suffer on a daily basis, including, more recently, being forced to train their H1-B guest worker replacements, particularly in the IT sector, before they are laid off themselves.
American firms are rife with females hired by male managers for what's between their legs, and not what's between their ears.
Having many Prime Ministers shows the vibrance of the Japanese political system and the Japanese population's propensity for change. Whereas America re-elected GWB even after the problems with him were extremely well documented.
Don't know why Japanese housewives would care about picking up a few extra basis points, and interest rates are not an indication of the ability of an investment to preserve its purchasing power. The Yen continues to buy more goods than it did in the past, so even a 0% nominal return has been a positive real return.
Japan can look forward to increasing productivity, and heaven forbid, employing some of those Japanese females who you claim are unhappy and indignantly treated, in response to its population challenges. Large numbers of unskilled immigrants are not needed. Japan hopefully will not destroy itself and its limited ecosystem by importing millions of immigrants like did the United States.
No way Pitz lives in Japan. He must live in a Utopian worker fog, oblivious of the outside world, unable to see the confluence of events that will hit Japan in the next 20 years. Keep smoking the bud, my friend.
The exception to the rule. Most female managers I've met in any country have gotten there by being more results-driven than their male colleagues, simply because of the culture they've had to fight through to get there.
In the US, "diversity" is often taken to be a joke, but when you sit in on a bunch of 55 year-old lifers nodding in quiet agreement with what the 65 year-old lifer is saying (all men, often from national universities), you really understand how important it is. Japan's companies don't, and they don't because their bottom line is often not profit: it's personal relations and, at the highest ranks, executive ambition for status. Activist investing is frowned upon and there is much cross-shareholding, and thus you have an entrenched management and corporate culture. I'm optimistic for changes in global and future companies in Japan, but that precludes many manufacturers. It is a very serious issue for women here.
Hot damn is that some spin. No, it's evidence of poor leadership. Look at how quickly their approval ratings drop. This is not because Japanese people love change--a laughable assertion in itself--much less love it every year, but because their leaders continually fail to meet expectations. Seriously, ask a Japanese person whether they preferred the Koizumi era or the Abe-Fukuda-Aso-Hatoyama-Kan era (both 4-5 years). You're probably the first person I've heard, living in a sea of Japanese, who's spoken favorably about the high vacancy rate at the Kantei.
As for immigration, the point that I'm making is that pension obligations are very high. Women are employed, but many are placed on non-career tracks. Japan must either raise taxes (cutting off nascent growth), raise the retirement age (a political non-starter), bring in immigrants for labor or monetize the debt (an effective tax on lenders and the middle class). These are simple arithmetic realities of a country with a very low birth rate, a very high life expectancy, mandatory retirement ages, low economic growth, low investment returns and somewhat generous national pensions.
On current savings. As for a strengthening yen's effect on an export-driven economy, it's definitely had a negative effect on a person's human capital, that is, the value of their expected earnings over time. Bonuses have gone from being 20%-ish of salary to being non-existent at several companies. On a purchasing power basis, Japanese most definitely perceive themselves as being worse off.
Just a plain ole coon here, no financial or societal guru. Seems to me that it is overly ambitious to pronounce a country/currency/society/economy dead until it actually falls over and starts stinking. There are some great arguments above about how resilient and cohesive the Japanese are. Same could be said for other areas of the world as well. Gauging a country solely by its "GDP" and such clap-trap is misleading. Are they healthy? Are they content? Are they focused? Are they secure? Maybe a "GDA" is needed: Gross Domestic Attitude.
During the dark days of the inflationary 1970's predicting the imminent demise of the US was also a popular pastime for pundits.
If I had 100 JPY for every article I've read about Japan, like the one by V.K., over the last two decades, then I would be easily retired by now.
Japan certainly has it's problems and challenges.
Spending money to maintain the oversized construction industry by building roads and bridges to nowhere being one such problem.
However, unlike the US,
Japan owes it's debt to itself;
is the second largest lender to the US and thus underwriter of the US lifestyle;
has not de-industrialized it's advanced economy through FIRE (Finance, Insurance, and Real Estate);
finance still operates for the benefit of industry (rather than the tail wagging the dog) with financial speculators held in lower regard that pimps and chinpira;
has invested very heavily in automation to increase efficiency and productivity;
is a net exporter with a positive balance of payments; and
is socially cohesive and does not have the no-holds-barred cultural and political left-right polarization.
As always, time will tell.
If I owe money to myself, what harm have I done?
Isn't that what Japan has done? Isn't most of their debt owed to themselves?
Yea, I was sitting in a bar on Shawmut Ave, Boston's South End one night in the late 90s listening to 2 German industrial designers and a conversation ensued; one, who was on his way back to Berlin after having lived in SF, Detriot and Boston answered my question by saying, "There are no redevelopment opportunities like this (South End) left in Europe. Most people who come to America think America is represented by New York, SF and Boston. If you really want to see what America ia all about then visit Detroit".
That was then.
Not sure if Pitz lives in Japan, but as someone who travelled there extensively and ran operations for a Japanese company here in India till a few months ago, I have to agree with the premise of the paper and disagree with Pitz.
Japan is a cartoon country. They live cartoon lives. Societal pressures are high. High to bursting. The social fabric is straining.
Even if one was to believe the false illusion of it's fiscal health and housewife investors, no point having a functioning money system without a functioning society, eh?
ORI
http://aadivaahan.wordpress.com
They can live those 'cartoon' lives precisely because the economy is so prosperous.
The housewife investors are evidence of this. In Japan, housewives can stay at home, because the nation is so prosperous. In America, since things are organized so innefficiently, housewives are forced to work.
"Social fabric is straining" sounds more like the United States, where, unbelievably, people are still keeping it together, but barely.
http://mpettis.com/2010/07/do-sovereign-debt-ratios-matter/
Mike Pettis just posted this piece which I believe is on point.
His primary argument is that the quantity of debt is less critical than how it is structured, most particularly whether there is a material likelihood of a sustained mismatch between earnings and debt service.
He argues that manipulating interest rates as low as does the Japanese (and the Chinese) government implies a de facto "debt forgiveness" on savers.
And that a sovereign with long term fixed rate debt denominated in local currency can safely run much higher ratios of debt than can another with short term debt or debt denominated in a foreign currency.
Until the domestic debt holders need the money for retirement, at which point the Ponzi starts unwinding.
If there's no inflation, or actually deflation (as is the case in Japan), why do savers need to be paid an interest rate greater than 0%?
Doesn't sound like the savers are suffering from such "debt forgiveness".
"In some countries, most notably Japan and China, interest rates are set artificially low – much lower than they would be by the market. Local central banks can do this because the financial systems in these countries are heavily banked (i.e. most savings and financing occur through the banking system), there are few investment alternatives, and the financial authorities determine deposit and lending rates."
It's not really a matter of what people "need" to be paid, his point is that a free market would set higher interest rates (if nothing else to price in default risk.)
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One might deduce that a falling birth rate is resultant of a stagnant economy, resulting from faulty central banking policy (surprise, why would they do anything to undermine their own station in life), thereby destroying the population growth their model depends on. We need clownfish, not tape worms in government. :o)
One might deduce that a falling birth rate is resultant of a stagnant economy, resulting from faulty central banking policy (surprise, why would they do anything to undermine their own station in life), thereby destroying the population growth their model depends on. We need clownfish, not tape worms in government. :o)
One might deduce that a falling birth rate is resultant of a stagnant economy, resulting from faulty central banking policy (surprise, why would they do anything to undermine their own station in life), thereby destroying the population growth their model depends on. We need clownfish, not tape worms in government. :o)
The falling birthrate is an artifact of the vibrant and prosperous economy. African economies that aren't prosperous, have high birthrates. Since Japan is one of the world's most prosperous economies, it has the lowest birthrates.
And Japan's economy has been anything but stagnant in the past 20-30 years. Be careful when reading articles that are written by finance-centrists. Once you strip out the unsustainable and rather wasteful "financial" growth in the USA from 1980-present, I think you will find that growth rates in Japan over the same interval, excluding the financial system, have been much higher than the USA.
BTW, Japan is a very prosperous nation with the highest standard of living of an industrialized country nearly anywhere in the world. So this disproves your thesis of Japan not 'borrowing their way to prosperity'. I would submit that it has worked out exceptionally well for Japan. Although, I guess, if you're a financial con-man (or Goldman Sachs....same diff), then it would not have been a favourable environment over the past few decades because excess returns were not made available to the financial industry. The Japanese simply were too proud to implement policy that would, like the case in America, destroy industry and create such an enormous wealth gap.
How anyone can call a 20 year recession "prosperity" escapes me. In any event, Japan is well into a demographic collapse that will destroy their nation by the end of the century.
A 20 year recession? Don't see any signs of that in the data. Unemployment is extremely low. Per capita purchasing power continues to grow. These are the signs of growth, not recession.
I'd suggest that those who are 'poo-poo'-ing Japan are those who are in finance, and are upset, or deliberately ignorant that Japan has created an economy where bankers aren't able to sit around, do nothing, and reap an excess return on their doing nothing.
All fueled by debt. 200% of GDP. Horrible demographics. Will lose half of their population by the end of the century. Japan has never been a fan of immigration. Unsustainable model.
All fueled by debt. 200% of GDP. Horrible demographics. Will lose half of their population by the end of the century. Japan has never been a fan of immigration. Unsustainable model.
Thanks for those words, pitz. People are misunderstanding the Japanese situation entirely and the coming decades are going to be much more like you desribed rather than the apocolyptic rampage of debt in the article.
Get ready for the Japanese yen to weaken considerably over the coming decade as the engine of Japanese spirit is rekindled and the country has an upsurge in exports and innovation never before seen in the history of man. It seems not many people can remember that there was a period in the eighties when we Americans were terrified of those guys.
Was it Mr. Miyagi who said, "Never underestimate your opponent"?
:D
Yup, every time I hear, "America will be like Japan, a lost 2 or 3 decades", I smile, because that's a best-case scenario, and certainly something to aspire to, not something to fear.
Japan has nearly full employment. Japan has industry. Japan has a Japanese-worker-first immigration policy. Japan has made huge strides towards energy security. Japan has some of the smartest people in the world. The only thing wrong with Japan is that the world is awash in cheap high-value engineered goods, the production of which makes up a disproportionate amount of Japan's economy.
Accelerating economic growth in Japan, the result of the unwinding of a long-term trend in a reduction in the cost of highly engineered goods, could also lead to a sell-off of US treasury debt as savers re-enter the domestic Japanese stock market in search of better returns.
Japanese savers/investors may very well become extremely wealthy, along with those of other net exporting nations such as Canada.
From my vantage point, Japan's economy is amongst the most sustainable and solid in the world, amongst the industrialized nations.
They'll be much better off in the long run, without debt, just like the rest of the world will be.
I can imagine several societal upheaval possibilities that imbed a massive debt repudiation. Never say never!
Japan? A country with a trade surplus, paying their way. Importers of oil paid for in US$. Zombie banks for nearly 2 decades, bailed out by the BOJ. Who wins? Geopol?