I see Japan as a self-volunteering economic litmus test – everything they did and got punished for during the last 20 years the rest of the world is copying. Japan would maybe argue that they were not such a thing, and the West would claim not to be copying anyway, but I find the symmetry quite amusing.
In an essay from 29.01.2005 I suggested we would get either a major and immediate financial collapse or a Japan-like decline over a longer period. Although I was a bit early on the first one it appears a major part of the global economy may be getting both options in sequence. However it’s rather decent for Japan to join us in our economic travels, don’t you think? For there is no question that the last 20 years of near zero growth, massive and persistent fiscal deficits, a significant decline in savings and worsening demographics make Japan as vulnerable as any of the other developed nations to a further tour of the track.
I often think about just what it was that made Japan so economically significant, because they had few advantages in resources at all. The major thing they had was a hard-working loyal workforce who was looked after by their employers for life. Work was more family-like that generally it is in the West. They were very innovative in their own developments, and great improvers of others. They’d also had their country destroyed as a result of WWII and had little option but to work very hard to recover. However looking at their stock market my own observations suggest it was partly their loyalty and exaggerated self-belief that destroyed their financial model – let me explain.
I was working in the markets during and after the 1987 crash, and watched with disbelief as the Japanese gathered themselves together and set about restoring the upwards march of their stock-market. Throughout the stunning move up to 39,000 it was obvious from the market action each day that the market leaders were being ‘pumped up’ each night before the close. If a market is being driven up towards the close, particularly Fridays, traders get wary to be caught short late in the day, so the market gets easier and easier to move. This was happening most days, and it kept on happening too. I’ve seen it many times in many markets; it’s done all the time, but this was truly relentless – more impressive even than the Dow these days!
The end result is that many companies became very over-priced and very inter-twined with each other, and when all of a sudden the market didn’t want to go up anymore it sprung back like a bungee attached to the ground. Major shareholdings that honourable and loyal cohorts had in one another (and partly because of that loyalty) effectively couldn’t be sold. Anyway there was no buyer, so they went down the tubes together, and the country has never recovered from it.
Now I know what it feels like to be caught in a major holding that is far too big for a market, but generally only for a few days at a time; it’s terrible, it really is. But I’m not talking about the tortuous times you can’t make up your mind to take a rational action – just can’t pull the trigger – I’m talking about the situation where you know you’re going to get killed and literally can’t do anything about it! I watched and watched over a period of months and years to see when Japan would finally bite the bullet and start unwinding their cross-shareholdings, but they really never did. And in the early days of that collapse the Japanese valuations were so high when compared to the hammered Western markets there was no-one internationally big enough or strong enough to make a difference anyway.
(Strangely, even within the broker offices I’ve been in, no-one ever wants to discuss the reasons and psychology behind these massive Bear moves – they don’t want to be contaminated by the thoughts somehow. But I’ve always found it just as interesting to play Bear markets as I have Bull markets. To me it makes no difference – the worst market for a trader is a market that refuses to go anywhere – they’re boring and chew your trading capital up week by week without ever giving you a chance to make a bit back. In fact when the opportunities do come finally as often as not you’re so ‘gun-shy’ you miss them anyway. So you won’t see me showing the attributes of a ‘perma-bull’ because I’m not one – from a trading perspective I don’t care which way they move as long as they move.
My experience is that markets invariably move about 20% too far in both directions; only the middle 60% of any move is real, and justified by valuations; the ends are generally more about emotion and either fear or excitement depending on which way they are heading. I can’t understand why you’d not want to trade these rapid reversal markets regardless of which way they look like moving. Being religiously committed to one side of the market and never venturing onto the other seems just foolish to me, and anyway is very likely to wed you to a view that is one day going to prove disastrously wrong, and you’ll be too blind to see it coming.)
Although it’s outside my remit, the same massive over-valuation occurred in Japanese Real Estate – it’s probably true that this was a far greater ‘bubble’ scenario and I never quite understood what happened in the process of unwinding this. However some time back I read a very authoritative article on this, and kept a copy. I read it again the other day and for those who are interested in more detail of what happened and how it happened then look up the following story “The Japan Baloney” by Nathan Lewis. It really does destroy a few commonly held myths.
Anyway back to big-picture Japan – they’ve had a very tough 20 years and there’s no reason while they won’t get some more of the same. They are looking at four really big problems all coming together at the same time, with two of them impossible to change quickly. Demographically they are looking at a continuing falling population which has been falling for a long time already; their Public Debt is already greater than 200% of GDP, and heading sharply higher. Those two are very tough to change quickly, maybe impossible. It’s a significantly non-cosmopolitan country, with hardly any outsiders represented when compared to the West; so they could bring in younger outsiders to alter the demographics, but would they?
Public Debt is near impossible to correct quickly – it can be changed to a lower trajectory over a period, but a reversal in trend is unlikely. Populations get addicted to fiscal deficits even when they are bigger that the country can maintain. Further I suspect the debt has a larger negative potential than generally thought, as much of the borrowing has been at low interest rates and a global stretching in interest rates as a consequence of Sovereign demand is close to being a given for 2010. This may be a bigger factor for Japan than many imagine – I’ll certainly be watching this one.
The last 20 year’s slippage also includes the savings from the ageing population – they’re now pretty much broke, and of course no longer vigourous enough to help any recovery of the situation, and to improve their savings level and that of the country. To the contrary, because they live so long they will be a long term drag on the economy. Part of the Japanese miracle was funded on the savings of exactly this group of aging citizens – their savings funded the economic growth as they saved for retirement, providing funds to Japanese companies, and the production was gladly purchased by the West. It was the virtuous circle that we’ve seen repeated with the Chinese and the West since the decline of Japan.
The 4th big one is the very industrial production that created the miracle – the concentration on big-item capital goods, (which the buyer can easily cancel, as has proved). This was a brilliant strategy and a brilliant story while the West so gleefully purchased the production and made Japan the exporting powerhouse of most of the second half of the 20th century. But most people in the West have discovered suddenly they have everything they want and anyway have been able to feed their desires far cheaper from China. The vulnerability here was illustrated most graphically by the 44% year-on-year collapse in exports to January 2009, when exporting effectively ceased for a period. Things have recovered somewhat since then, but are unlikely ever to return to the days of old. (The ‘jobs-for-life’ culture will make this quite a difficult transition too, making many of the largest Japanese companies ‘too big to fail’ but maybe ‘too big to save’ at the same time.)
While I have little doubt that Japan will nevertheless one day find its way out of this combination of troubles, I really don’t think I want to be the Japanese Minister of Finance – no, I think I’ll just flag that one thanks!
p.s. A few minutes after I finished this piece I received a 2010 predictive essay written by Ambrose Evans-Pritchard of the London Telegraph who is of the view, among other things, that Japan will be the catalyst for a significant mid-2010 correction as markets focus on excessive sovereign debt exposure amid rising interest rates. He predicts a flip from deflation towards hyper-inflation in Japan as a result.