ABENOMICS: HAVE THE GOVERNMENT CREATE A MESS AND THEN SPEND MONEY CLEANING IT UP

9/13/13

Japanese Prime Minister Shinzo Abe has apparently decided to go ahead with the first increment in the increase of Japan’s sales tax; consequently, the national sales tax in the Land of the Once, and Maybe Again, Rising Sun will increase from 5% to 8% in April of next year.   If further increments are implemented, the sales tax will rise to 10% in October, 2015.  (See my 6/7/13 post, JAPANESE GROWTH RATES:  THE ONLY PLACE INTHE WORLD NOSTALGIC FOR THE ‘70s for my last ruminations on Abenomics.)

Mr. Abe and his allies, however, fearful that such a tax increase will hurt Japan’s still nascent economic recovery, have proposed a stimulus plan to offset the deadening impact of the sales tax increase.

Hmm…

One not trained in the more advanced theories of economics, or perhaps too lethargic of mind to understand the deeper aspects of that discipline, might ask a perhaps simplistic question, to wit…

Rather than embarking on a stimulus program to dull the desiccatory impact of a yet to be enacted tax, why not dispense with both the tax increase and the stimulus program and call it even?

One can come up with two possible answers to the above question.   First, Mr. Abe and his braintrust buy into the puzzling Keynesian presumption that a dollar miraculously multiplies when it passes through the government’s hands but goes into the economic equivalent of a coma when it stays in private hands.   Therefore, the government’s spending money is ALWAYS more salubrious for the economy than having the people who earned it decide what to do with the fruit of their labors.  Since Mr. Abe is a politician, and those he hires are, at least to a certain extent, in all likelihood political toadies and hangers-on, this is always a possibility.

Second, money that passes through public hands and is spent according to the designs of politicians provides those public servants with not only greater avenues for rewarding campaign contributors but also more control over our lives.  Therefore, there is no debate in the mind of the typical politician; it is ALWAYS better to spend money rather than let said money remain in the hands of the taxpayers.  The job of their economic braintrust is to come up with some theory, no matter how hare-brained, that will justify, or at least rationalize, this political predilection for “stimulus” programs.  This is true, to varying extents, in every nation on the planet.

The second explanation answers our question so effectively that one wonders how one conducts one’s life, or finds the answers to any public policy question, without a seemingly bottomless store of what yours truly calls realism but which others insist on calling cynicism.

JAPANESE GROWTH RATES: THE ONLY PLACE IN THE WORLD NOSTALGIC FOR THE ‘70s

6/17/13

Japanese Prime Minister Shinzo Abe, speaking the other day in defense of his three pronged stimulus plan (See my 6/14/13 post, JAPAN:  THE MARKETS DETECT A PAPERING OVER OPERATION), said

“There is no reason whatsoever why achievable growth in Japan in the 1970s and 1980s isn’t achievable now.”

Hmm…

“…no reason whatsoever” why Japan can’t grow like it did in decades past?  I’ll give you several reasons, to wit,

• Demographics; Japan’s population is now the oldest in the developed, and probably the entire, world
• Japanese wages are far higher than they were in the past; Japan is now a high wage nation by any measure.
• Japan’s former role as preeminent Asian exporter has been assumed by China, and a whole host of other Asian nations have become export powerhouses.
• Japan’s massive debt; its public debt/GDP ratio, at 220%, is the highest in the developed, and probably the entire, world.
• Japan’s savings rate is down to Americanesque levels from the 44% level seen as recently as 1990; consequently, Japan will have to soon import not only raw materials but also capital to finance its brobdingnagian debts.

All the printing and spending of money (two legs of Mr. Abe’s three-legged plan) in the world won’t solve the above problems.

This is not to say that Japan cannot shake off its economic doldrums and resume its proper role as one of the world’s economic great powers if it undergoes the serious fundamental economic restructurings such resurgence would require.   But the growth rates of the ‘70s and ‘80s, when we were forced to read such tomes as Ezra Vogel’s Japan as Number One: Lessons for America in business school are not coming back.

JAPAN: THE MARKETS DETECT A PAPERING OVER OPERATION

6/14/13

The Japanese stock market has done a round trip since the Bank of Japan, embarking on its leg of “Abenomics” two months ago, started buying everything in site…bills, bonds, even stocks.   The yen has also done a similar round trip since the monetary leg of Abenomics made its debut in April.   Real measures of the Japanese economy seem to be holding up; first quarter GDP growth was 4.1% and the employment picture is brightening, but the financial markets’ reaction to Mr. Abe’s reflation plans do not bode well.

While we don’t know yet how the embryonic experiment we call Abenomics will turn out, one suspects that Abenomics, which boils down to spending lots of money, watering down the yen, and supposedly embarking on structural change in the Japanese economy,  is doomed to failure because, aside from the obvious shortcomings of the first two measures, it is running smack into Japan’s overwhelming problems of demographics and cultural change, the latter not for the better.

Even before Prime Minister Shinzo Abe announced that he was throwing out the rule book and taking drastic action to turn Japan’s economy around, Japan’s public debt/GDP ratio, at 220%, was the highest in the developed, and probably the entire, world.   The Japanese could get away with such brobdingnagian spending because they also had the highest savings rate in the developed world for much of the post war era; as recently as 1990, the savings rate in Japan was 44%.   (See my 4/9/13 post, THE NOT SO INCREDIBLE SHRINKING YEN, for further discussion on these points.) While the government’s spending huge amounts of money is rarely salubrious for the economy, the negative impact is muted when the government can tap such enormous savings to satisfy its more lascivious impulses.  

But the numbers that supported a big spending government have changed markedly in the last 25 or so years.  With a rapidly aging population and cultural changes (i.e., exposure to the West, and especially America, and our free spending ways), the Japanese savings rate is now down to 2%, which is considered healthy only in America.  At the same time, an aging population demands more government services.   So those who used to lend the government money are now tapping the government’s coffers for income and services, as we all do when we age.  Further, younger Japanese are not emulating their elders’ big saving ways; they are starting to spend like Americans.   Simply put, the Japanese can no longer service a debt load that was predicated on a young and saving population now that it has an old and spending population.   Servicing the normal increase in government spending brought about by demographics would have been tough enough, but spending even more to “stimulate” the economy is simply unsustainable.

Despite these demographic realities, Mr. Abe decided that the Japanese could continue to spend like it was 1985 and essentially create the money to do so.  The latter would have the ancillary benefit of weakening the yen, thus improving the Japanese “terms of trade,” policies that back in the ‘30s were derisively and justifiably called “beggar they neighbor.”  Some could argue that the policy worked; first quarter GDP growth was strong, but that was the FIRST quarter, before Abenomics was implemented.   Things are slowing down and the Japanese stock market, with its inherent foresight, is taking a beating.  Strangely, though, the yen, as I said in the first paragraph, is strengthening and, 94.67 to the dollar, is about where it was at the end of March after trading over 102 to the dollar in May.   This not only run counters to the foreign exchange goals of Abenomics but also seems to defy logic; the yen should not be strengthening when the BOJ is creating so many of them.

Meanwhile, the third leg of the Abenomics stool, economic restructuring, has so far been disappointing.   High hopes for corporate tax reform and modifications of onerous employment rules have been dashed.  

So the Japanese government is spending and printing lots of money.   The real economy appears to be responding, but it’s too early to tell how much of the first quarter’s resurgent growth can be attributed to policies not implemented in the first quarter.   Structural reform has so far been disappointing.   And the proverbial, and trite, 900 pound gorillas, high debt, demographics, and the partially attendant declining savings rate, still loom.

Would it be a surprise if creating lots of yen and spending them didn’t solve the problems of a once great nation?

JAPANESE CAR EXPORTS TO CHINA: VALUE AND QUALITY TRUMP POLITICS

5/24/13

It looks as though Chinese car buyers have gotten over their politics spawned aversion to Japanese cars.  (See my 10/10/12 post in the now defunct Rant Finance entitled WE’VE FOUND THE ULTIMATE VALUE INVESTOR!, reproduced below for your convenience.  And, no, I didn’t buy a bunch of TM, HMC and NSANY stock, which have since surged, after writing that now immortal missive, even after seeing the buying opportunity, which demonstrates one of the reasons I don’t trade nearly as actively as I once did.)   Japan shipped 16,000 vehicles to China in April, 2013, up from 4,417 units in October of last year, the low reached at the height of the tensions surrounding the, depending on whom you are talking to, the Senkaku or Diaoyu Islands in the East China Sea.  Last month’s 16,000 units were still below April, 2012 levels, but the more than three fold increase in shipments from the bottom is a sure sign that things are turning around.

One knew that Chinese consumers would be buying Japanese cars again despite the nationalistic whoop-whoop that dissuaded them from doing so for a time.  First, we had intrepid consumers like Mr. Zhou San, the ultimate value investor, who, quoted in the aforementioned and below reproduced post, said

“I won’t buy a Japanese car unless it is very, very cheap because purchasing a Japanese car is dangerous now.  People would beat not only the Japanese car, but also the car owner, when something goes wrong with Sino-Japan relations again.”

So Mr. Zhou would risk being beaten within an inch of his life if he could get a good enough deal on the car; I must have Chinese cousins, but I digress.

Then we have Mr. Yan Ke, a 33 year old Shanghai information technology project manager (Talk about stereotypes!), who is quoted in the Wall Street Journal as saying, after buying a sharp Nissan Qashqai (pictured…not Mr. Yan’s Qashqai, but a representative Qashqai),

“I wanted to buy this car a year ago.  I’ve been saving money for it.  (Saving money for it!  What a concept!  But I digress.)  I don’t give a damn about the Sino-Japanese tensions.”

Mr. Yan is not at all unique; his habit of actually saving money in order to buy something may seem as foreign to Americans as his name and the brand name of his car, but he is not unique.  He simply, like most people, doesn’t give a damn, as he puts it, about silly squabbling of politicians over islands that may or may not have much value beyond their ability to satisfy jingoistic impulses.  Whether one finds that sentiment admirable or not, it reflects reality; people want to live their lives, make a living, get the most for their buck (or yuan), and take care of their families.  The games politicians play matter little to them; apparently, though, the pols didn’t get the memo, but I digress once again.

And speaking of value, one knew that Chinese consumers would still be willing, indeed in line, to buy Japanese cars.  For all the catching up U.S. “domestic” companies have done, and for all the (largely, but not always) baffling appeal that overpriced European (often, but not exclusively) troubleboxes have for consumers in, among other places, China and the United States, the Japanese still make the best, most reliable, most value laden cars for the broad range of consumers.   And competition from places like Korea (See my already seminal 5/20/13 piece, I TEST DROVE A KIA TODAY…) only make them better…and more desirable.   Consumers like Messrs. Yan and Zhou, and Smith,  Jones, Kowalski, and O’Brien, continually affirm that sentiment…or fact.

PROMISED REPRODUCED POST FROM RANT FINANCE

WE’VE FOUND THE ULTIMATE VALUE INVESTOR!

10/10/12

Value investors, as most readers of Rant Finance know, are people who like to buy stocks, or any investments, that they consider cheap.   Cheapness can be determined in terms of price/earnings (“P/E”) ratio, dividend yield, or other factors.   The overriding point seems to be that, while no investor wants to buy a lousy company, value investors are not necessarily looking for great companies.   They are looking for good, or at least passable, companies that are undervalued by some metric the investor deems important.  This is an old, tried, and largely true approach to investing that appeals to, among others, yours truly, at least to a certain extent.

With that background, consider what is going on with the Japanese auto companies in China.   Since China and Japan, among others, are squabbling over ownership of some islands in the East China Sea (See my 8/23/12 post in Rant Political entitled EXPANSION OF MISSILE DEFENSES IN ASIA…PROTECTING OUR INTERESTS OR PAYING BACK THE “DEFENSE” CONTRACTORS?), and the Chinese and Japanese politicians are, like politicians anywhere, concerned primarily with keeping their jobs, nationalist fervor has been whipped up throughout east Asia, but perhaps especially so in China.  One of the manifestations of this fervor is a near blanket refusal on the part of Chinese consumers to buy Japanese branded cars.   Not only will they not buy Japanese cars, but the irate Chinese have taken to street demonstrations that involve the destruction of Japanese cars and, in some cases, their drivers; last month, a driver of a Japanese car in Xi’an was beaten into partial paralysis by an angry mob.  From the coverage we see of these near riots, one wonders why no one has been killed yet.  

How much sense all this makes is a valuable point of digression.   These “Japanese” cars are built in China by Chinese workers using mostly Chinese parts.   Chinese industrial policy dictates that few cars, and mostly only very upper end luxury models, are imported.  So the cars that are being trashed, in some cases, are really Chinese cars; just as the Toyota Camry, for example, is the most American car an American consumer can buy, the “Japanese” cars that are now being used as flaming party favors by rioters on a lark are really Chinese cars.   So who’s hurting whom?  I digress, but I do so valuably.

Into this fray steps Mr. Zhou Shan, a Chinese citizen who works for Baidu, who states

“I won’t buy a Japanese car unless it is very, very cheap because purchasing a Japanese car is dangerous now.  People would beat not only the Japanese car, but also the car owner, when something goes wrong with Sino-Japan relations again.”

So there you have it; Mr. Zhou is aware that it is physically perilous to buy and drive a Japanese car, that doing so might result in his being beaten to within inches of his life, but he would do so if it is “very, very cheap.”  Ladies and gentlemen, we have found the ultimate value investor.

Many of you doubtless started to read this thinking that yours truly, as a guy who has made a dollar or two trading and investing in car stocks at various points in his career, would offer advice on Japanese car stocks at these levels.  All I can say at this stage is that I’m getting interested because it appears that the stocks are starting to reflect overly dire consequences from their Chinese exposure for the likes of Nissan (NSANY), Toyota (TM), and Honda (HMC).   But never (okay, rarely) wanting to try to field a falling knife, or getting between China and Japan when they decide to mix it up (a position nearly as perilous as getting between Jesse Jackson, Sr. and a television camera, but I digress), I think I’ll watch a while before getting interested in these stocks from the long side.

AN AMERICAN MANUFACTURING RENAISSANCE; IT’LL TAKE MORE THAN CHEAP ENERGY

5/15/13

Appaloosa Founder and CEO Dave Tepper was on CNBC yesterday arguing that America’s increasingly abundant supplies of oil and gas could lead to an industrial renaissance.   While it’s usually not advisable to bet against the unbelievably successful and incredibly insightful Mr. Tepper, he might be getting carried away with his enthusiasm in this instance.

Certainly abundant and relatively cheap energy supplies are a huge positive when companies are deciding where to locate.  But if cheap and abundant energy were so decisive in determining a country or a region’s manufacturing base, Saudi Arabia, the United Arab Emirates, and Russia would be manufacturing juggernauts.  

There are many other things that go into the manufacturing soup…a favorably business climate, a skilled and motivated work force and the highly underrated physical proximity to markets are perhaps most salient.

A favorable business climate?  Despite all the very justified complaining some of us do in this country about the government’s hostility to business, the United States, on a relative basis, is a very favorable place to do business from a tax and regulatory standpoint if one looks at the entire picture.   Yes, corporate taxes are high, but no one pays them at the 25% top rate.   And, believe it or not, individual tax rates are low on a relative basis, and how much a company’s employees, and especially its management, who make the location decisions, pay in taxes is a major consideration when deciding where to do business.   American laws allow far more labor flexibility than do those in Europe or Japan.   All in all, this is a good place to do business…on a relative basis.   Of course, the White Sox are a good baseball team relative to the Cubs, and that is not a complete digression.

A skilled and motivated work force?   We may have a problem here.  Given the “everyone must go to college” mentality in this country (See my 5/10/13 post, STUDENT LOAN FORGIVENESS:   THE OBAMA ADMINISTRATION’S (?) ASSAULT ON THE RESPONSIBLE), our near disdain for anything approaching manual labor, and our failure to impart the basic math and reading skills that are necessary for skilled and semi-skilled jobs, we fall behind many countries e.g., Japan, Germany, Korea, and, to a growing extent, China) in worker training.  And motivation?   I invite those who wax enthusiastic about the motivated and eager next generation to spend some time in a college classroom.   While the spread among students is indeed wide and there are a number of very impressive kids among my and my colleagues’ students, observations don’t skew toward the “I’m hungry, eager, and willing to bust my hindquarters to make it big” end of the spectrum.   Let’s leave it at that.

Even if we have a skilled and motivated work force, ours is by no means a cheap work force.  Yes, it’s cheaper to hire a worker here than it is in Europe, Japan, or Canada, at least at first glance.   When one factors in health care costs, though, the comparison gets tighter.   Further, while labor is quite rapidly getting more expensive in China, Chinese workers are still far cheaper than American workers.   And there is all of south Asia and sub-Saharan Africa waiting in the wings.   Before you guffaw at the productivity gap or the capability of such workers, remember when it was said that Chinese workers could never compete with American workers?   And yours truly is old enough to remember when the expression “Japanese piece of junk” was more than an ironically humorous tag line.

Proximity to markets?   Some of the world’s fastest growing markets lie to our south, but the distance between the United States and, say, Brazil, is not as small as one might think.   Certainly, Brazil is closer to Brazil than we are.  More important, the fastest growing markets are in Asia and we are long way from Asia.   Shipping costs are high and will likely get higher, making proximity to those markets imperative, especially for heavy manufacturers.

Cheap energy is a big plus and will certainly be a positive for American manufacturing.  But there is plenty more in the mix that makes manufacturing here attractive.  And our country is, well, mixed in our relative attractiveness in those categories.  

ASIA HAS A CHOICE: GERMAN RESPONSBILITY OR AMERICAN SILLINESS?

4/22/13

This morning’s (i.e., Monday, 4/22/13’s, page C1) Wall Street Journal reports that consumer debt is exploding in Asia, primarily in China, Indonesia, and Malaysia.  Nonmortgage consumer debt in Asia outside Japan has risen 67% to $1.66 trillion in the last five years.  In Indonesia alone, such credit has tripled.   Consumers are lining up to pay interest rates ranging from 15% on secured car loans to 40% on unsecured loans.  No wonder lenders are rushing to Asia.

Why are the newly prosperous Asians borrowing so much?   Such expansion is typical, we are assured, at this stage in their economic development as people start to make decent livings and yearn to buy the things they manufacture for others.   And it is certainly understandable that, after years of having very little, and being inundated with media images of the prosperity of Japan, Europe, and the United States, Asians outside Japan would want to acquire lots of the same junk with which we are curiously so fascinated.   But when one listens to the explanation of one Wiwik Sugiarti, who lives in Indonesia, of why he borrows to buy such things as televisions and DVD players…

“I can buy two or three things at the same time and not have to worry about how to pay for it now,”

one who has seen such misunderstanding and misuse of credit and its consequences gets the urge to utter something like “Uh-oh.”

Again, one can understand Asia’s desire to buy stuff.   But it seems to yours truly that the people in that part of the world can make a choice regarding the development path they would like to follow and the attitude toward money and credit they would like to emulate.  They can be like we Americans, who, through some misplaced sense of entitlement, have decided we deserve everything we want regardless of our ability to pay for our heart’s desires.  Alternatively, they can be like the Germans, who only consider buying things they don’t absolutely need when they have the money to pay for those things and even then agonize over parting with their hard earned euros.   There are, of course, exceptions to these generalizations; I am sure there are some spendthrift Germans out there and there are plenty of Americans (Yours truly comes immediately to mind.) who are much more German in their spending and saving habits.  But there is little doubt that the overall American approach is quite different from the overall German approach.

So which will it be, Asian friends and brothers?   Spend like drunken sailors, eat through the seed corn, and expect, or hope, others will continue to lend you money…or act like mature adults in financial matters?   The choice is, presumably, yours.  

We in America had better hope the non-Japanese (The Japanese are apparently already lost, by the way; see, inter alia, my 4/9/13 post  THE NOT SO INCREDIBLE SHRINKING YEN.) in Asia pick the latter.   If they spend like us, who will pick up the tab for our childish spending?

THE NOT SO INCREDIBLE SHRINKING YEN

4/9/13

When we last visited the issue of Japan’s attempts to reflate its economy at the behest of Prime Minister Shinzo Abe (See two posts from the now defunct Rant Finance written early this year and late last year that are reproduced at the end of this screed.), yours truly expressed great concern about this seemingly necessary but inherently dangerous policy.   Now that new Bank of Japan (“BOJ”) Governor, and Abe henchman, Haruhiko Kuroda, has fitted the printing presses at the BOJ with turbochargers that would make native son Speed Racer envious, the obvious results are coming to fruition; the yen hit a four year low against the dollar yesterday.

The obvious response would be something like “Well, what did Messrs. Abe and Kuroda think would happen if they publicly stated that their aim was to print yen with reckless, carefree abandon in an attempt to infuse the Japanese economy with what they consider a salubrious bout of inflation?   Did they think a policy designed to weaken the yen domestically would not have repercussions in the foreign exchange (“FX”) markets?”   But such a question would be naïve.  Both Messrs. Abe and Kuroda knew that the yen would weaken; that was, while not the primary object of their loose money policy, certainly a secondary object.  A weak yen would not only make Japanese industry “more competitive,” according to the textbooks, but also would help domestic prices to rise.

Such a policy is always dangerous, largely because it is hard to put the inflation genie back in the bottle and attempts to make one’s self “more competitive” by weakening one’s currency are doomed in anything but the short run.   (If a weak currency made a country more competitive, Zimbabwe would be the world’s economic juggernaut, but that is grist for another mill.)  But such a policy is, ironically, especially dangerous for Japan, whose primary economic problem for the last twenty or so years has been deflation. 

Japan has the highest debt/GDP ratio in the developed world at 220%.   Yet it still has the lowest government bond rates in the developed world; as I write this, the Japanese 10 year yields 0.53%, less than 1/3 the rate on the U.S. 10 year and less than ½ the rate on the German 10 year.  Part of this is due to Japan’s experiencing deflation rather than inflation and thus having real rates closer to being in line with those of its developed world counterparts than are its nominal rates.   But even on a real basis, Japanese rates are far lower than U.S. and German rates.   Why?   Because Japan’s gargantuan public debt is largely financed domestically due to the formerly enormous Japanese savings rate.   But, as I pointed out in my 12/19/12 post,  SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!, the days of the 44% savings rate (That was in 1990, not in Cro-Magnon times.) are long gone; Japan’s savings rate is now around 2%, or the rate at which Americans declare that we have “deleveraged”…and then go back to our usual custom of excreting away money even faster than we earn it.   But I digress.  This decline in the Japanese savings rate is due largely to demographics; the Japanese population is getting older, and retired people tend to dis-save rather than save.   But it is also partially due to the infection of the Japanese psyche with the type of financial irresponsibility that is endemic to modern America.   Yet another case of our exporting our worst traits, but, again, I digress.

As yen are created by Mr. Kuroda and his subservient, to Mr. Abe, colleagues at the BOJ, Japanese investors pull their money out of yen denominated assets in order to protect themselves against the inevitable deterioration in the yen’s value both domestically and internationally.   This leads to further yen devaluation and starts a vicious downward spiral, further lessening the incentive not only for foreign investors to put money in Japan but, more importantly, for Japanese investors to keep their money at home.   This would be bad enough under any circumstance, but, in Japan, with its 220% public debt/GDP ratio, and which thus needs all the investment, both domestic and foreign, it can get, such a policy could be financial suicide.

The Japanese are very smart people, and one suspects, but can’t be sure, that  Mr. Kuroda nor Mr. Abe are not glaring exceptions to this rule.   However, one wonders how much Messrs. Kuroda and Abe have thought through this loose money, reflationary policy.   Sure, one must break the deflationary cycle and mindset in Japan.  But given the vulnerability wrought by the Japanese government’s inability to put its financial house in order, does the BOJ really have the latitude to so discourage people from financing the government’s debt?  Clearly, yours truly’s use of terms like “financial suicide” does not indicate that I would answer that question in the affirmative.

PROMISED REPRODUCED POSTS:

“I’M TURNING (AMERICAN) NOW!”

1/8/13

It seems that the same Japanese businessmen who were clamoring for a weaker yen now are concerned that new Prime Minister Shinzo Abe’s enthusiastic accession to their desires may be going too far.   The major fear of these captains of Japanese industry is the impact a too weak yen might have on imported energy prices, especially in the wake of Japan’s at least temporary denuclearization.

While the fears of these hard to please business titans regarding energy prices are justified, the larger fear ought to be the impact of a weak yen on the price and availability of imported capital.   As I explained in my 12/19/12 post, SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!, and in earlier posts to which it refers, Japan has the largest government debt to GDP ratio in the developed world… 220%.   Until recently, this wasn’t much of a problem because, with the prodigious savings rate of the Japanese people, this debt could easily be financed internally.   But with demographics, and, to a lesser extent, attitudes resulting in a more Americanesque savings rate of about 2%, Japan increasingly has to import capital to finance, among other things, its government’s budget deficits.   A weakening currency, and a decided and declared government policy to further weaken a currency, does not get international lenders excited about committing capital to a country.  Thus, unless Japan’s political and business leaders put away the Econ 101 textbooks with all their drivel about “terms of trade” and abandon that great nation’s newfound weak yen policy, Japan could face severe financial problems in the very near future.

Yes, a nation finds itself in a precarious position when it must import much of the energy it consumes.   But if you think importing most of a country’s energy leads to problems, consider the more debilitating impact of importing most of a country’s capital.   And Japan will soon be in a position of importing both energy and capital in brogdingnagian quantities. 

Yikes!

SHINZO ABE TO THE BANK OF JAPAN:  BE MORE AMERICAN!

12/19/12

The effective election of third generation Japanese pol Shinzo Abe as Prime Minister last weekend spells trouble for the Japanese central bank.  

To the extent people over here have followed the Japanese election, they have focused on Mr. Abe’s nationalistic foreign policy views.  His most immediate, and at least for now, largest impact, should be on the Bank of Japan (“BOJ”).  Mr. Abe is pushing for abandoning the JGB’s current 1% inflation “goal” in favor of a firm 2% inflation “target.”   He also wants the BOJ to go into the business of creating money to finance government spending.   Perhaps most important, he wants to legislatively chip away at the Bank’s independence so that a even a more reasonable future prime minister will feel less compunction about using the BOJ as an arm of the government.

Having the BOJ join its brethren central banks in the developed world in emasculating its currency would be especially dangerous for Japan.  Japanese government debt stands at 220% of GDP, the highest in the developed world, even if we look the other way and expand the definition of “developed” to include Greece.   As I explained in my 9/21/12 post, JGBs AND THE JAPANESE SAVINGS RATE, this condition has prevailed for years but has not been a problem due to Japan’s historical gargantuan savings rate…as high as 44% as recently as 1990.  With people saving at these prodigious rates, even Japan’s brobdingnagian deficits could be financed domestically.  But now, due to demographics and the importation of more American attitudes toward saving and postponement of gratification, the Japanese savings rate has fallen to levels with which Americans are familiar…around 2%.  Thus, Japan’s customary huge deficits must increasingly be financed overseas; indeed, foreigners now hold about 9% of Japanese government debt, a record.

With Japan having to sell a rapidly growing share of its debt overseas, it is imperative that the yen remain strong.  But with Mr. Abe’s pressuring BOJ President Masaaki Shirakawa to pursue a 2% inflation rate and print money so Mr. Abe can spend more and threatening the central bank’s independence, we are beginning to see a very non-Japanese posture toward the value of the yen.   This should have a decidedly negative impact on the ardor of foreign investors for holding Japanese government bonds (“JGB”s).   Predictably, JGBs have taken a beating in the few weeks since it has become apparent that Mr. Abe’s Liberal Democratic Party (“LDP”) would win the election and are now trading at an eight month high yield of 1.74% on the twenty year.

One could argue that the Fed’s pursuing an expansionary monetary policy very similar to the policy proposed by Mr. Abe has done nothing to hurt foreigners’ enthusiasm for treasuries, and we have to finance a much larger share of our government debt overseas.  But one would be wrong.    More than ¾ of Treasury issuance is now being purchased by the Fed; no one, Chinese, Japanese, or American,  is lining up to buy U.S. treasuries at the prevailing 1.79% yield on the ten year, especially when the reason that paltry yield prevails is the Fed’s creating money to finance the government’s spending.  We will be in for a rude awakening when (if?) the Fed decides to throttle back and we expect our Chinese and Japanese friends to pick up the slack.  If the Japanese adopt American attitudes toward central banking, as they have toward saving, they will face the same problem, but with twice as much government debt, relative to GDP, as we have.