When it comes to Japan, a country often eluding clear understanding not only in cultural matters, but economically too, we tend to exaggerate where we don’t understand. I still remember how in the 1970s and 1980s, Western industry feared that very soon Japan would eclipse the world in manufacturing prowess and technological advances.
Japanese economic progress at the time was astounding. Enigmatic “samurai” businessmen became the topic of Hollywood movies.
While its awe-inspiring industrial superiority came to a crushing halt in the 1990s, Japan is still an outlier in most respects of economic observation. Its partly extreme data sets are often taken as a cautionary tale about our own future. We warn of “Japanification”. Industrialised nations all suffer from crippling birth rates.
Our populations are shrinking and we loath to counterbalance this threat to prosperity and retirement funding with appropriate immigration. Well, Japan has long outdone us all. Thirty per cent of Japanese are now over the age of 65 and foreign workers are still eyed with suspicion.
Depleted rural villages may bemoan the absence of young people but would never consider taking in new residents. Italy (24 per cent are 65+), or Germany (22 per cent) look like a university campus in comparison. Note: Malta (19 per cent) has avoided this age trap by actively fostering inward migration lately.
As a consequence, economic growth has been modest. Japan grew in the last 40 years 1.74 per cent per annum on average. The stock market, despite its recent spectacular advances, has never reached its high-water mark of January 1990, when the Nikkei index hit 38,170.
Someone believing in the long-term wealth accumulation of stock investing would still be sitting on painful losses 35 years later: the Nikkei was, at the time of writing (July 24), oscillating at 32,715. Most Japanese companies have misleadingly low price/earnings multiples, which should make them attractive to value investors. This is, of course, not only due to economic underperformance, but also to very specific corporate behaviour. In Japan, shareholder interest is usually not much of a concern to Japanese CEOs.
I have persuaded myself a couple of times to tiptoe into Japanese shares; not with much success. When the Fukushima nuclear accident happened, I was sure to buy at a stock market low (9,206). A year later, when I threw in the towel, I was looking at a gain of miserly three per cent (9,458).
There wasn’t even much of a Covid rebound (March 2020: 18,917, June 2022: 21,129). It was therefore with quite some chagrin when I had to take note of Warren Buffett’s sizable investments in Japan’s big trading houses last year. He must have pocketed gains exceeding 50 per cent by now.
Being the world’s third-largest economy, Japan is not per-capita rich. It ranks alongside Italy and Malta (approximately $34,000 of GDP per person). Yet it is a fairly equal society. It ranks no 6 in all-inclusive indices, which take not only income and wealth disparities into account, but also public health and other support factors ‒ close to Northern European countries. Its unemployment rate, which is admittedly difficult to compare country by country, is as low as 2.6 per cent. Labour participation has Japanese characteristics: people work until old age, female participation is low.
To boost growth and to fight engrained disinflation, Japan has experimented for decades with those unorthodox financial tools that we learned about only in the 2010s after the Global Financial Crisis: quantitative easing (QE), positive inflation targeting, negative interest rates, yield curve control, large-scale fiscal stimulus. The Bank of Japan (BOJ) became the biggest buyer of Japanese bonds and stocks, gobbling up not only government bonds, but also shares and stock exchange-traded funds (ETFs).
As a result, the BOJ is the biggest holder of Japanese government bonds (JGBs) and a major stock market investor. It holds 50 per cent of all JGBs, and ‒ to bring down long-term yields ‒ the majority of long-dated bonds.
The Japanese are too polite to rip others off- Andreas Weitzer
Neither growth nor inflation budged. As at 2021, inflation was -0.21%. Then came the supply disruptions after Covid and soaring food and energy prices after Russia’s invasion of Ukraine. For the first time in three decades, and much later than anyone else, Japan is experiencing inflation. It was as painful for consumers and wage earners as we know it over here. Overall inflation as at June 2023 stood at 3.3%, food inflation at 8.4%.
Japan is suddenly not an outlier anymore: It may not have produced inflation, but it has at least imported it. This was helped by a cheapening yen. The value of the US dollar, the currency for most commodities, has risen 44 per cent in the last 10 years. Judging by our own experience, painful inflation may be here to stay in Japan, and for longer than anyone may have imagined.
This puts into question decades of monetary easing. Mission accomplished, interest rates may soon rise again, with implications for all of us.
A foretaste of things to come was a minuscule tweak to yield curve control in December. For years the yield of 10-year JGBs were stuck at around 0.25%, a manufactured result of relentless BOJ purchases. This had the absurd effect of nine-year maturities yielding slightly more. When departing BOJ governor Haruhiko Kuroda declared a new yield corridor around 0.5% to correct these abnormalities, bond prices tumbled and the Yen soared.
Promises to maintain monetary easing by Kuroda’s successor Kazuo Ueda saw the yen tanking again. A dollar now buys 141 yen, a low reminiscent of the 1990s. Few investors, alas, believe that this will be the end of the story. It became therefore increasingly expensive to hedge yen exposure.
This endangers one of the most popular investment strategies for international and domestic investors, to raise debt in yen and to convert it into better yielding investments abroad. As a consequence, Japan is buying less foreign bonds and other investments than it did until recently. Note that Japan is still the largest foreign holder of US debt, owning $US 1.1 trillion, and has invested over three trillion $US in other western bond markets.
A meaningfully strengthened yen would mute imported inflation in an instant, killing hopes for any noteworthy return to inflation, to raising corporate profitability and wage growth. Japanese entrepreneurs have not yet learned the West’s brazen style of profit-margin-boosting in face of inflationary pressures. What we suffer is largely profit inflation, after all. The Japanese are too polite to rip others off. This is perhaps the reason for Ueda insisting that no change of plans is envisaged yet. Easing is to be continued until wage earners and industry becomes greedier. As long as everyone decides to rather suffer higher prices without passing them on, than having to face the embarrassment of upsetting customers, inflation will not gain a societal foothold.
Yet the pain is real. For how long this is politically acceptable I do not know. The French are on the barricades for lesser reasons. Inflation might subside without the BOJ having to change course. It is hard to gauge what will happen when Japan really changes tack, and as a consequence, retreats large scale from foreign bond purchases. It is also hard to tell what will happen with the elephant in the room: Japan is by far the most indebted nation on earth (262%), surpassing Venezuela (242%) and Greece (193%).
If interest rates really go up, as we have seen them rising in Europe and the US, how will the government afford the interest payment burden? How will its banks fare, large holders of JGBs? Who will replace as a buyer the BOJ, wishing to exit QE? My guess is that Ueda is forced to carry on as usual, because any radical change would change our whole financial world with it.