Investing Through Japan’s Next Big Inflection Point

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GEOPOLITICS

by Jacob Shapiro

Why People Get Japan Wrong

Japan is a unicorn, and there are no general frameworks for understanding it that can be outsourced from other countries or regions around the world.

A better approach is, instead, to understand Japan’s unique characteristics before making any assessment of the country’s future potential – something slightly more challenging for those with a Western bias. Roger will delve more into the macro situation but, in the meanwhile, consider this:

• Investors wearing Western-tinted glasses look at Japan and see an oddity – a country with debt to GDP exceeding 260 percent engaged in yield curve control (which continues to force the government to issue more debt) to keep interest rates low in the hopes of stimulating the Japanese economy.
• Stimulating that economy is easier said than done. Japan has been mired in lost decades of anemic growth since the 1990s – equities have been virtually flat over that time and a decade of so-called “Abenomics” did not achieve a goal of maintaining 2+ percent inflation and more importantly stimulating growth and innovation.
• Questions around the sustainability of this approach have continued to mount as the Federal Reserve, and consequently most central banks of developed nations, started raising rates last year. Inflation hitting a 41-year high of 4.2 percent in January is also driving this line of analysis.
• With that, so have speculative bets that the Bank of Japan will be forced to abandon its easy monetary stance (which mostly come as a consequence of ideological Western narratives that call out the Bank of Japan to find “the courage to change course”), independently of how economically painful that might be.
• This is why the upcoming change of the Bank of Japan’s governor has grabbed so much attention – it has been interpreted as the long-awaited potential catalyst for the BoJ to finally find said courage, abandon easy monetary policy, and start raising interest rates. There’s only one problem with that line of thought – it isn’t the catalyst everyone expects it to be.

Foreign observers don’t understand that from the Bank of Japan’s perspective, a 41-year high in inflation is a good thing rather than a threat to be quashed. The Japanese government wants more – more wage growth, more capital expenditure, more investment in research and development, more public-private partnership in critical areas like semiconductor and aerospace and defense. Inflation is the lesser of all evils.

The Financial Times published a long article on Japan on November 3^rd titled, “How long can Japan’s central bank defy global market forces?” The answer is “As long as it needs to.”

Fixating on Japan’s unorthodox monetary police misses the bigger story happening with Japan: namely, that its aging demographics, its dependence on imports, and the rise of a more aggressive China pose the most significant geopolitical challenges the country has faced in three-quarters of a century. The last two times Japan faced a similar range of threats, the Japanese economy roared to life and Japan reshaped the world. Japan faces ample constraints, but the history of Japan over the last 155 years has been that of a country that has overcome its constraints when its back is against the wall – can it repeat the feat today?