Demographics and Japan

The original Star Trek television series only ran for 33 months, from September 1966 through June 1969. It’s ironic that the short-lived series was canceled a month before man walked on the moon and yet I’d bet that more people can identify Captain Kirk over Neil Armstrong.

Star Trek has lived on through reruns, spin-offs, remakes and movies. Still, there’s one small piece of the original series in particular that sticks with me — the opening sequence. I can hear the music in my head, along with William Shatner starting his lines with: “Space… the final frontier…” and ending with: “… To boldly go where no man has gone before!”

Welcome to the Starship Japan, a country that, economically speaking, is bent on going where no country has gone before!

While Japanese Prime Minister Shinzo Abe doesn’t look a lot like William Shatner or Patrick Stewart, he’s definitely the captain of a ship that’s hurtling toward the unknown…

In 2012, Abe was elected Prime Minister on a platform of economic reform. His plan for bringing the country out of a deflationary funk (called Abenomics) was based on three areas of attack — printing more yen, reforming business and eventually raising taxes.

The hope was to foster inflation by devaluing the currency, which should lead to more consumer and business spending. Increased spending combined with looser regulations about hiring, firing and other structural hurdles should lead to business development and higher wages in growth industries.

With greater spending, economic growth, and rising wages, the country would be in a position to raise taxes so that it could issue less debt.

In terms of success, Abe’s been able to print a lot more yen, creating a just a smidge of inflation… but that’s it. Business reform has been painfully slow in some areas but simply non-existent in most. The governrnment increased the sales tax from 5% to 8% in April and planned to raise it to 10% in October 2015.

Businesses and consumers shifted their spending ahead of the tax increase and have since pulled back, which caused the Japanese economy to fall back into recession, the fourth one since 2008. Based on this recent trend, Abe has decided to push out the next tax increase by at least 18 months.

Since printing yen was the only thing to yield a positive short-term result, Abe and the Bank of Japan (BoJ) have decided to do more of it. In late October, the BoJ announced its plan to print even more yen, bringing its monthly total of bond buying equal to the amount of debt issued by the governrnment.

So the central bank is printing money at the same rate the governrnment is borrowing, the currency is falling, yet inflation is non-existent and bond yields are at historic lows.

This is truly where no economy has gone before.

Typically, printing this much money would devalue a currency so quickly as to cause strong and then hyperinflation. There would be a run on the currency as foreign trading partners did everything they could to liquidate their currency holdings and even domestic businesses would seek to denominate transactions in other currencies, much like what occurred in Argentina.

But this also involves rapidly rising interest rates, shortages of goods and other dislocations in the home market.

Japan has none of that. Instead, the country is exceptionally stable. It’s the third largest economy in the world and enjoys a robust import/export market.

The eventual fate of the Japanese economy is anyone’s guess. Do internrnational markets get spooked by all the printing at some point and leave the yen in one mass exodus? Does the governrnment move to raise taxes to lower its annual deficit and then begin working on its debt?

Or does Japan eventually restructure its debt in a one-time, massive dislocation of the financial markets and then open its doors the next day and conduct business as usual?

My best guess is an eventual restructuring of debt. The BoJ owns more than 20% of all Japanese governrnment debt, while insurers own just under 20%, banks and other financial institutions own almost 30%. Overseas investors own about 8%, while households have about 2%. The rest is held by branches of governrnment and others.

With ownership of Japanese governrnment bonds so concentrated in just a few domestic entities, the fallout from restructuring would be dealt with mostly internrnally and fall mainly on large institutions. This is probably preferred to other approaches, such as increasing tax rates.

Higher taxes work to bring down deficits and debt in theory but in reality they slow consumption and motivate entities to shelter income. It’s hard to escape a restructuring.

The big question is timing. When would a restructuring, catastrophic loss of confidence or some other event occur? Who knows? The pieces are in place today. The governrnment is issuing debt that the central bank is buying. The governrnment deficit is a whopping 7.6% of GDP and it’s spending 18% of its budget on interest.

But the country keeps marching on.

It’s true the yen has fallen dramatically but that hasn’t slowed trade. The world keeps buying Japanese products… even when the Japanese can’t afford to buy as much from the world. It’s amazing that the Japanese Starship has been able to stay aloft this long.

Even if the timing and structure of the watershed event are hard to guess, the group that will be hurt the most is easy to identify — older Japanese citizens. Those relying on their savings, which will be devalued and their pensions, which will be cut, will experience a dramatic drop in their standard of living.

The shake-up should make life a little cheaper for those earnrning wages by forcing down the price of assets and could force the business restructuring that for the moment seems stuck in limbo. Both of these things would benefit younger Japanese citizens.

No matter how this unfolds, owners of Japanese property, both real and intangible, will suffer losses. The best way to play in this market is to short the yen, which we’ve done in our Boom & Bust portfolio since the summer of 2012.

No matter where the Starship Japan ends up crashing, this play should work out well for investors.







 Ahead of the Curve with Ben Benoy

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