Blain’s Morning Porridge, Sept 3, 2020: Lessons from Japan

Blain’s Morning Porridge, Sept 3, 2020: Lessons from Japan

“The Frog in the well knows not the great sea.”

Tesla’s taken a bit of spanking this week in 10% volatile up/down market. Maybe it was the $5 bln cheeky stock sale, or long-term holder Baillie Gifford taking profits? Does that mean it’s now a “buy”? If you think so – shouldn’t you have gone back to school this week? Its a bubble stock and at some point (I suspect sooner than later): the lower Tesla goes, the lower Tesla will go… 

Meanwhile… back in the real world…

Let me start by saying I’m not a Japan expert – just an observer. As Prime Minister Shinzo Abe fades into retirement, I wonder if the Japanese economy might provide some insights into what’s in store for Europe and the US?

Recently, a number of analysts have described Japan as a warning from history. Its an interesting perspective – but I suspect a somewhat flawed one. Japan has problems – Europe’s are likely to prove much worse.

The perception is Japan’s decades of lost growth since 1991 – despite negative real interest rates and the longest sustained period of monetary experimentation in the form of QE -highlights that artificially low rates and too much debt will repress economic growth.

It’s a fair observation – but needs refinement. Like any nation, Japan has unique problems include its ageing demographics, but also rigid social structures including s fixation on above-the-surface consensus, and social barriers like discouraging women in the workforce. Its’ arcane political system – described as flawed democracy and a one-party state (despite a brief period where the opposition got in)- does not encourage dramatic policy responses. It’s also deeply suspicious of the outside – the recent problems of Carlos Ghosn show Japan is not a place for foreign devils to succeed in business.

On the other hand, Japan is not some decaying backwater. In many way’s its culture, social cohesion and economic stability remain the envy of other nations. I’m wondering if the Japanese may even have stumbled on the secrets of a long-term comfortable slow-economy – but that’s a discussion for another day.

In the 1980s, aided by dollar appreciation, the Japanese economy completed its evolution from a low-cost manufacturer into a leading global economy on the back of cheap and readily available credit. Bubbles erupted as the stock market rose to record levels. The land the Imperial Palace was built on in Tokyo was said to be worth more than the whole of California. Japanese companies were top global brands leading by design; Toyotas were hip, and everyone wanted a Sony Walkman. There was easy money to be made in Japanese equity warrants and a stock market that was only going higher.

But sure enough, in the early 90’s the stock bubble popped. It left Japan’s Zombie debt-addled companies struggling on aimlessly as economic growth stuttered despite the central bank slashing interest rates. Its industrial design lead was overtaken, while productivity crashed and household industrial names became largely irrelevant in the global markets. “Japanification” became a bedtime story to scare the kids.

30 years later Japan does not look like an economy in deep trouble. There is low unemployment, but the economy isn’t close to full capacity. The stock market has gone up and down, while the once vibrant JGB government bond market is largely held by the Bank of Japan (50%), which has also been buying EFTs to try and boost the deflating economy.

Effectively Japan’s economy stalled in 1990, and has never truly recovered the pace of the 1980s. There were moments when growth took hold and the markets showed promise, but each recovery quickly faded.

Along comes Shinzo Abe – an able and capable politician promising economic renewal. His “three arrows”: liquidity creation via essentially unlimited monetary policy, fiscal stimulus to rebuild infrastructure and prestige projects, and a dash for growth sounded like genuine policy. But that’s all they ever were – policies that failed to address the rigidities at the heart of Japan.

To be fair.. it didn’t help that natural disasters and an associated nuclear accident compromised growth, and now the pandemic has stifled what little growth shoots were visible. The reality is that Abenomics promised much but achieved little.  It certainly didn’t help that Abe made the mistake of allowing bureaucrats to impose consumption taxes on the economy to pay for his monetary creation and fiscal handouts. Taxing consumption in an economy notorious for thrift and saving was right up there with European Austerity as a really stupid economic mistake.

The failure to ratify TPP – the trade agreement with the US – and with Europe, has pushed Japan outside the Western hegemony and closer to China. Not a problem for Japan – it wants to do deals. But, there are serious doubts on how whomever succeeds Abe can continue to drive the economy. Political leadership seems in short supply – the political system is raddled by factions within the ruling LDP based on patronage rather than talent. Bureaucrats were constrained under Abe, but will likely resume their “overly comfortable” command and control of the economy now he’s gone.

Does that gallop through the treacle that is Japan’s complex political economy trigger any alarm bells? Zombie debt ridden companies? Negative Real Interest Rates? A lack of leadership?

The shocking truth is Europe may actually be in much worse shape than Japan ever was.

First: Europe faces an employment crisis for young people that Japan did not. 10% Youth Employment seems to have become an acceptable number for Brussels – that’s a social time bomb in cities with large unhappy and disenfranchised emigrant populations, and in decaying rural backwaters – witness the Gillet Jaune in France, the rise of the right and unrest elsewhere.

Second: Japan had the advantage of its own currency and control of its bond market. It matters less that Japan’s debt stands at 240% of GDP and its spending $2 trillion on stimulus measures. This morning France announced a barely there €100 bln economic relaunch. Italy’s stands at 159% – but it’s borrowing in a currency it can’t control and doesn’t own the printing presses. Japan could notionally write off the 50% of JGBs owned by the Bank of Japan while borrowing as much as it requires by pressing the print go-button. If necessary Japan could even target helicopter money to drive domestic consumption. Italy has to go cap-in-hand begging more from Brussels as its economy collapses after the pandemic zero-tourist season.

Third: Japan had Abenomics. It might not have worked, but it was a clearly stated policy. What have we got from Europe’s Eurocracy? Vague promises to spend Euro 750 bln of other countries money on the poorer parts? Agreement on Brussels’ Eurocracy controlling disbursements? The difference is Japan had unified national government. Europe functions on compromise between Brussels and domestic capitals – democratic oversight isn’t clear or transparent.

Fourth: Japan’s industry might have lost ground over the last 30 years, but its still a dominant force in area such as nuclear power and autos. It has policy and an education system capable of producing the skilled workers that will be required for a new tech 4th industrial revolution in terms of robotics, 3-D, and logistics. It already has effective health care and direction. Some Northern European nations get the importance of industrial planning and resource – but the struggling south never adapted or reformed their economies prior to the Euro, and are now paying future taxes away today to keep their heads above water.

Then there is the debt crisis.

Japan’s 1980’s financial asset bubble created a Zombie economy requiring massive banking bailouts. That was possible for Japan – but it’s proving insurmountably difficult for Europe to agree a common bank resolution format, except for the “do-what-ever-it-takes” mantra. The Americans (and to a lesser extent the Brits) quickly realised banks were the issue and resolved them. The European’s have failed to take difficult decisions.

Meanwhile, despite resolving the banks, its taken 30-years for Japan’s corporates to wean themselves off debt and start to try to re-establish themselves as global lean and mean leaders.

What does the Japanese corporate experience mean for the rest of the West?

US and European firms are still at the start of the Zombie debt crisis – although you could argue it started 10-years ago with ZIPR and QE. It’s going to take years for effects of corporate indebtedness to cycle through the economy in terms of investment and growth opportunities missed.

I would even go as far as to suggest the corporate structure in the West today explains much of the market’s froth. Some of the key factors to consider are about hopes that Western Corporate exceptionalism and Tech Company innovation is going to create a new golden age.

The reality is very different:

· Heavily indebted firms are not delivery quality of life, productivity or product satisfaction.

· There is a widening disconnect between falling living standards and the financial rape of the middle classes versus growing wealth inequality as the owner and manager classes continue to get richer.

· There is still a belief that capitalism works, is inventive and can make everyone better off.

The result is dissatisfied workers (including the middle classes, which itself includes many investment managers) look for magic. They invest their hopes and dreams of wealth in likely sounding projects. They congratulate themselves for their wisdom if these play out positively, and scream at rigged markets when they don’t.

The result is that good ideas – like EVs, video-conferencing, promising pharmaceuticals, and even WeWork, get hyped beyond all common sense. America looks on flamboyant entreprenuers like they were rock-stats, and ascribe all kinds of god-like wisdom and financial acumen upon them.

They invest their hopes and dreams in flawed characters because they don’t want to believe the American corporate sector has become flabby, it’s arteries clogged with debt, and is little more than a personal piggy-bank for the management. They want to believe entreprenuers are great visionaries who have the brains and energy to restore American corporate greatness..

Some people are going to be profoundly disappointed.  The peculiar delusional madness of crowds is something some “entrepreneurs” know how to milk very effectively. Do not buy tickets to Mars – it will disapoint.

Five Things Too Read This Morning

WSJ – As World Turns Inward, Shinzo Abe’s Japan Has Turned Outward

ZH – An Epic Battle Is Raging Beneath The Market Surface

FT – Six Abenomics lessons or a world struggling with “Japanification”

Torygraph – Fear of virus is holding back economy, Andrew Bailey warns

Bloomberg – A Currency War is the Last Thing the World Needs

Out of time and back to the day job…

Bill Blain

Shard Capital