Monetary & Social Trends in Japan
It has been almost two and a half months since the devastating Tohoku earthquake and tsunami. Now that the focus on Japan has died down somewhat, I thought I’d comment on the monetary and social trends in Japan and consider the implications for the contrarian investor.
Hysteria over Japan – All Eyes Turn East:
When the disastrous events of March 2011 hit Japan, investors became – at once – extremely focused on the news coming out of Japan. This natural spike in interest can been seen in the chart below; it shows an index of the search volumes for the query, ‘Japan’.
With this spike in interest came a heated debate about whether to be long or short the – then collapsing – Nikkei 225 index. Today, the Nikkei trades at around 9600, which is 17% higher than the low of the panic (at around 8200).
The Social Context:
During the late 1980s, Japan was in vogue as the next super-power of the world. From the perspective of newspaper columnists, academics and government officials alike, it was just a question of how far and how fast. To the consensual mind, it was deemed prudent to get to grips with the language and culture to prepare for Japan’s ascent to greatness. Or if that was too much, it was deemed benevolent to adequately prepare the next generation for the Japan-oriented future. Indeed, in the 1991 film ‘Other People’s Money’ – when asked the question “Do the Japanese celebrate Christmas?” – Penelope Ann Miller revealingly replies “No, but they’re buying it”. Likewise, De Vito has only praise for the Japanese at around 1:40 in the following video:
In time, the peculiar nature of markets exposed the misguided prejudices held during the colossal Nikkei bubble. In fact, the Nikkei topped out in 1989 and has remained well below that top ever since (see chart below).
Instead of the ascension to greatness that was widely anticipated, Japan has suffered the deteriorating social mood that comes along with (and spurs) falling asset prices. If your pension halves in value, you don’t feel good, right? Well, as the entrepreneurial spirit waned en masse, this dynamic became self-fulfilling. As a cheeky (but effective) measure of the path of social mood, compare the fashions of the late 1990s with those of today (picture from Elliott Wave International):
Moreover, as Jim Grant said in March of this year, he had to close down his long-only Japanese equity fund for fear that the indifference to money making would persist long beyond his investment time horizon.
The Monetary Backdrop:
As I often reiterate here on greshams-law.com, debt can be regarded as a ‘short on money’. When you sell – say – a stock short, you borrow the stock, sell it for money and later buy back the same stock. If the money price of the stock falls, you can buy it back for less than you paid and hence keep the difference. Otherwise, you have to pay the difference. So, analogously speaking, when you take on a debt, you borrow money, ‘sell it’ for something, and later ‘buy back’ the money. If the thing price of money falls (i.e. the money price of the thing rises), then you can buy it back for less than you ‘paid’ and hence keep the difference. Otherwise you pay the difference.
So, getting on to Japan, we find that an epic and enormous ‘short position’ in the Yen was accumulated by the private sector by 1990 (via the medium of debt). The resultant ‘abundance of money’ manifested itself in the equally epic Nikkei bubble. By the early 1990s, the short Yen (debt) positions taken on by the private sector reached fantastic proportions (see chart below). In fact, those positions were so large that Japan has experienced a mass unwinding of those trades for decades (i.e. a period when people are ‘selling stuff’ to ‘buy money’ ). The result has been a grueling and depressing bear market in Yen-denominated risk assets.
As the Austrian business cycle theory predicts, many entrepreneurial projects had been started that were premised on an imaginary level of real savings. So, as the private-sector reached its peak capacity to be leveraged, those projects were revealed to be illusory and the market trend switched to an ousting of the prevailing politico-entrepreneurial class (that is, the entire entrepreneurial class was faced with mounting monetary losses).
Of course, we know the rest; Japan experienced a ‘lost decade’ and a series of very weak inventory re-stocking cycles. Moreover, they pursued the same reality-denying policies that the west is pursuing today – most notably, quantitative easing.
The Recent Devastation:
So, after decades of sluggish growth, falling house prices, falling pension values, falling equity prices and uninviting business conditions; along comes an unprecedented catastrophe that destroys vast quantities of wealth. When that was exacerbated by the collapses of the TEPCO plants, it shouldn’t be hard to hear the cries of; ‘enough is enough’? Jörg Guido Hülsmann eloquently described the situation that was facing Japan even 8 years ago:
By the late 1980s, … it was politically impossible to allow deflation to cleanse the economy and politics. The Japanese governments of the 1990s sought to “fix” the economic crisis through increasingly heavy doses of inflation. [Note: Hülsmann uses the term 'inflation' to denote increases in the monetary base (M0)] But the only result of this policy was to give a zombie life to the hopelessly bureaucratic and bankrupt conglomerates that control Japanese industry, banking, and politics. After almost fifteen years of mindless inflation, Japan’s economic crisis has turned into a fundamental political crisis that sooner or later will bring the country onto the verge of revolution.
Perhaps the overly indebted government (see chart below) that was already on thin ice is starting to see the metaphorical cracks emerge underfoot. The prospect of a massive ramping-up of government expenditure seems not only likely, but inevitable. What’s more is that this government already has an unsustainable debt load; it seems likely that calls for the printing press will be in full force (even if the institutional conservatism at the BOJ resists for some time).
The Contrarian Strategy:
As a result, here in 2011, we find that the Pension fund industry in Japan is 100% geared towards a future where Japanese stocks do poorly and where JGBs remain elevated (see chart below). Furthermore, consider that we have completed a (working) generational cycle where Japanese equities have been avoided. Japanese investors have accumulated emotional and intellectual prejudices that say ‘I don’t want to own equities’. So, a shift out of JGBs into equities could have immense momentum behind it: each re-allocation from JGBs to equities could tempt more pension fund managers to do the same.
Here, we have an exhausted generational trend and a favorable risk/reward scenario. Should the premises of Japanese investors hold true, then the likely shifts in positioning will be muted. However, if those premises do not hold true, there could be great optionality in being long Japanese Stocks against JGBs. [Whether or not we have to test the March 2009 low at 7000 to get there, I do not know.]
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