3 July 1999 - The Pitiful, Helpless Giant

TOKYO — What a paradox—Japan, the world’s richest country, in desperate trouble—brought on by itself.

Japan’s first great trouble is its severe demographic problem. Its population is the second or third oldest in the world, and to judge by its low birthrate, in a hundred years its 125-million people will be reduced by half.

Europe, which has a similar problem, at least allows immigration, which Japan doesn’t. Even if a Korean is born here, even if that Korean’s family has been here for decades, generations, he cannot become a Japanese citizen. Before World War II Koreans, who were then a Japanese colony, were allowed to become citizens, but after the War in a fit of nationalism the Japanese stripped away their citizenship. Thus, foreigners, even fellow Asians, have little incentive to move to Japan and settle. Even though Japan has this serious problem, it’s doing nothing to improve the situation. With fewer youth, who will care for its aging population? How will the dwindling Japanese population pay the giant debts that its government is now creating?

And indeed the central government is heavily indebted. This giant debt is Japan’s second big problem and another paradox. As a result of decades of successful exporting, Japan has more foreign-currency reserves than any other country, and yet in a vain attempt to stimulate its economy and appease the voters, Japanese politicians have built hundreds of “bridges to nowhere,” public-works projects that serve no useful economic purpose, much like our porkbarrel projects. Their only real purpose is to keep the Liberal Democratic Party in power by currying favor with local voters and ward politicians.

Despite Japan’s overseas reputation as an efficient entrepreneurial superpower, its economy is heavily regulated. These inflexible regulations are the third great millstone around Japan’s neck. Think of the inflexibility of our public utilities, our public schools, and our post office, and that’s Japan. Rules, regulations, and “can’t do.” When I was in China nine years ago, the one word I heard the most was “maio,” which basically meant “No” in Chinese, used whenever I asked for something. What I heard the most back then in Japan was “hai,” which meant “Yes” or “I’ll try” or “Let me see what I can do.”

Today that’s reversed. To every request it’s the Chinese who say they’ll try and the Japanese who say no.

As an example, I tried to open a brokerage account here so I could buy Japanese stocks. However, so many brokerages told me I couldn’t do it that I finally called the stock exchange itself, which informed me it was perfectly legal for a foreigner to open an account and buy and sell stocks. However, only one, Toyo Securities, said okay, but my account officer there didn’t know how to convert dollars to yen and wasn’t willing to figure out how to. I assume this was his way of also saying no.

Everywhere in Japan today there is little or no flexibility. Paige and I have run into rigidity everywhere, and it’s a huge contrast to how helpful everybody was as recently as nine years ago.

How did all this happen? Government-industry cooperation, a strong work ethic, a mastery of high technology, a high savings/investment rate, and a comparatively small defense allocation–roughly 1% of GDP–helped Japan advance after World War II with extraordinary rapidity to its rank as the second most powerful economy in the world.

A second basic feature has been the guarantee of lifetime employment for most of its urban labor force, a guarantee that’s now eroding. Of course, being a small island makes Japan dependent on imported raw materials and fuels.

For three decades overall real economic growth has been spectacular: a 10% average in the 1960s, a 5% average in the 1970s, and a 4% average in the 1980s. However, growth slowed markedly in 1992-95 largely because of the after-effects of over-investment during the late 1980s and contractionary domestic policies intended to wring speculative excesses out of its stock and real-estate markets.

Growth picked up in 1996, largely a reflection of stimulative fiscal and monetary policies as well as low rates of inflation, but fell back to 1% in 1997. Today, as a result of its expansionary fiscal policies and its declining tax revenues due to the recession, Japan has one of the largest budget deficits as a percent of GDP among the industrialized countries.

Over and over Paige and I have encountered Japan’s peculiar fearfulness, as if the whole country has lost its nerve. For instance, at the Shibuya Medical Association we obtained inoculations. While the clerks charged us $45 for a stamp on their standard form, the same clerks refused to stamp our WHO International Vaccination cards. I still can’t understand it, figuring it to be bureaucratic terror of the unknown.

In all of Japan only one health club would allow us to pay to use its gym for a day. Virtually no health club in Japan will allow a visitor to buy a day pass, nor can they explain why beyond, “We don’t do it,” even when you point out that it’s extra gravy for them. A few gyms would allow a day pass if we would first take a 90-minute course in how to use the gym. Needless to say, we’ve used gyms all over the world for years and weren’t about to spend 90 extra minutes for a one-day pass because “It’s our rule.”

All I can figure is that Japanese business has been so protected and insular for so long that it’s lost all flexibility and competitiveness. The entire service industry here is hopeless and would be decimated if the country ever opened up to foreign competition. In yet another small example of excessive protective rules and procedures, most gas stations here will not take credit cards on foreign banks—Visa, MasterCard, Diners Club, and American Express. Still another: At a sushi restaurant we were told we couldn’t be served a simple bowl of rice. We were forced to order six sushi pieces and a bowl and to remove the fish from the rice in order to fashion our own bowl of rice.

Restaurants have empty tables, yet turn away customers because they don’t have enough staff. Despite long waiting lines we have watched tables sit empty for 20 to 40 minutes. That the service sector is hopeless may be a sign that no one notices or believes what I see as the coming recovery—that is, nervous restaurant managers won’t hire the staff to meet the demand that’s in their faces.

Japan’s absurd protectionism will continue to destroy the country’s economic position just as the UK’s politicians destroyed the UK’s: In order to keep open two coal mines the government recently forced Japanese power companies to buy domestic coal at three times the world price and pass the cost on to consumers. Thus, 125-million people and an entire economy will have higher electric costs to protect a very few workers.

The Japanese political system today is supported by the inefficient, moribund sectors of the economy—those in agriculture, construction, distribution, glass, paper, etc—a major reason why the country’s economic problems never get addressed. Today Japan spends 20% of its income on food versus the 10% the U. S. spends. Imagine if the Japanese opened up their agriculture sector to the world market and spent only 15%, on food, how much extra spending money would fall into their citizens’ hands. With rice imported and the all-important Japanese farmers not protected, land prices would plummet, making housing cheaper—and putting yet more money in the pockets of the ordinary citizen. Food processing here is so protected that it is only a third as efficient as food processing in the US—in fact, more people work in food processing here than in autos and steel combined.

There are two key macro-sectors in Japan, the extremely efficient exporters who were forced to learn to compete in foreign markets, and the terribly inefficient and weak domestic sector. Many of these efficient exporters have moved their manufacturing units overseas because domestic costs are so high. Today more cars and electronics are produced outside Japan than in it. These super-efficient export companies keep building up cash—all those immense international reserves—because it’s financially stupid to invest in such an inefficient economy.

And yet despite the domestic inefficiencies I still expect a temporary upward surge in the stock market. After all, there is an election next year, which will insure that the economy is pumped up.

Thus, after a decade of stagnation, Japan’s entire system is becoming more and more rotten, and eventually it will collapse under the weight of its bloat and corruption. In the 1998 elections for the Upper House of the Diet the urban voters—who mainly do not benefit from the corroded system—sent the politicians a message. Soon the old political guard will self-destruct because they are being supported by only the least efficient parts of society, which by definition are moribund and declining. In time this old guard will be swept away, but it will leave a terrible legacy, a gigantic mortgage, for future governments and generations to face—just as happened in the UK and is happening now in the U.S.

Don’t get me wrong: Japan is still the richest country in the world. It’s not about to go bankrupt or drop off the face of the earth any more than the UK did after 1920 when its fate was sealed and yet it was still the richest country in the world. However, the wind is no longer at Japan’s back—indeed, quite the opposite. The political system here will also change as much as the UK’s did after 1920 as it becomes evident that Japan has passed its peak. None of this means an investor should avoid Japan—after all, even after four generations of decline in the UK a lot of people are still having fun and making money. However, it’s important to remember that the British are now about the 25th richest country in the world instead of at the top.

Indeed the wealth of the Japanese infrastructure today is remarkable: The highways have electronic signs which display the expected time it will take to drive to the various cities down the road. Computers figure this out based on weather, accidents, and the current speed limit. Other electronic signs give the current speed limit based on weather, time of day or night, etc. The software seems to assume everyone will drive a certain percentage over the speed limit, as many do—including us—and amazingly these estimates come out right.

If the economy’s in such a hide-bound rut, why am I interested in buying stocks at all? Because the economy is showing all the classic signs of bottoming out—at least for the short haul, the one measured in years, not decades. As an example, last year the suicide rate here was the highest ever, and the birthrate the lowest ever, signs of extreme pessimism. Polls of Japanese students say the career most preferred by youth is to work for the government. All this says to me that there’s little confidence left in the Japanese populace, and thus the bottom of the current economic mess must be near at hand.

Oddly enough, in this time of dire economic troubles, it’s hard to get a hotel room, and its restaurants and sights are packed. There’s lots of spending, and the country looks prosperous enough to be in a recovery. The local press continues to bray about how bad things are, but you simply can’t see it. It reminds me of how Bush lost the 1992 election—the U.S. economy had in fact turned for the better, but the press convinced Americans otherwise.

So, I’m convinced that the Japanese economy has hit a temporary bottom, and that a prosperous time is coming—call it a rebound. Thus, I’m looking for stocks to buy for the medium term.

What might I buy? To my surprise, no Japanese stock-market analyst follows its movie industry. To understand my surprise, you have to understand the role Tokyo plays in the imagination of Asian youth. It’s New York, Miami, and Buenos Aires all rolled into one, the Asian continent’s great hot city. In the outer burbs of Asia the youth buy Japanese books, mangas, records, films, tapes, and CDs. In China it’s not English that’s the most popular foreign language, it’s Japanese. The hottest movie in Hong Kong last month was a Japanese film. The politicians might not, but the people in the streets of Asia simply love Japan and all things Japanese.

So I’ve bought shares in Japan’s largest movie company, which is loaded with hidden assets, both real estate and old movies. The same is true for Japanese TV companies—no analyst follows them and they’re going to sell their wares all over Asia. In these and other ways I’m buying shares to play the Asian boom in Japanese entertainment and music.

Youth here is stirring under the old guard’s stifling yoke, and in the streets Paige and I saw examples of the youth revolution. At this point there aren’t a lot of rebels, but more will come, unable to stand the stultifying ways of their aging parents and grandparents. Their key word is “maibum,” Japanese for “doing your own thing, and doing it your way.” Young women now marry later, have children later, and are a large part of the high divorce rate. This youth revolution will be fed by the birth-control pill, just arriving in Japan. It’s interesting to note that Viagra (for men) took only six months to be approved in Japan, while birth-control pills (for women) took 20 years—and of course those women who use them must visit a doctor every month for a new prescription. But in time this restriction will be eased.

Other examples of youthful rebellion: Here schoolgirls wear uniforms, but as their socks and shoes are not regulated by the schools their creativity is seen in the different ways they choose and color their footwear. The youth that have left school dye their hair and wear startling makeup. In Hiroshima we saw young men with huge pompadours dressed in a style that crossed a Hell’s Angel with a Ninja warrior. While I’m far enough away from youth as to be the last person to be an expert, these youth oddly enough looked as if they were conforming—to each other. Still, I don’t think they’re going to become “salarymen,” the workaday middle-manager types of Japanese society.

Some positive stock-market signs: Next year there will be private pension plans, the equivalent of our 401(k) plans. Throughout history such plans have always caused bull markets. Also a new law, revising much of the financial system, will allow stock transfers and stock swaps, etc., which will allow a lot more financial flexibility. Mercedes sales here are up 40% year to date—hardly a negative indicator.

In addition, I believe retail oil companies are a good buy here now. There are too many gas stations and the government is giving incentives to reduce their number. Once there’s not so much competition, those left will be profitable.

I am also investing in Japanese commodity brokerages, which are selling at cheap prices. This is a great way to invest in the coming commodities boom without having to deal with margin calls and the roll-over of futures contracts.

There is also a push on to retrain all the people who have been laid off in the past few years, so I am buying companies which train people in new skills.

Of course the press here harps about the Japanese banks, which all the world now know have gigantic loans that are never going to be paid off, loans on the order of a trillion dollars, about twice the size of our former S&L mess. I believe this problem is being addressed. If it weren’t, you wouldn’t hear much in the press about it. The popular press everywhere rarely gets anything right—they’re usually way behind the real (but still invisible) world.

As a people, the Japanese save and invest, just the sort of cautious economic activity which you’d expect a prudent, aging population to engage in. In the U.S. we save almost nothing and borrow from overseas to finance our spending. The Japanese export their production, while we import ours. They save and ship, we spend and import.

I believe over the short term the yen will rise against the dollar so that not only will certain stocks do well, but the currency will advance along with the stocks, giving my purchases a double whammy.

As befits the world’s richest country, this is an expensive place to live. A round trip to the Hiroshima airport, no more than 30 miles, runs $200, compared to a similar trip from New York City to Newark Airport, which runs about $90. In Japan there are lots and lots of taxis, yet another industry protected by the government, all expensive and empty because the fares are so high. In fact, the government recently raised fares because the industry was suffering so much. To me it’s madness. Why not deregulate, let the prices fall, and fill up the taxis with people who need transportation? Yes, the current policy encourages people to use public transportation, but what a peculiar way of allocating resources!

What the Japanese have obtained with their excessive public-works spending is a fabulous infrastructure. For the first time in 20 countries we had no trouble with our e-mail. The roads are wonderful. Many sidewalks are covered so that pedestrians don’t get wet in the rain. Buried in all the major roads are lights that enable drivers to see curves coming up. Down the center of sidewalks are five grooves that allow blind pedestrians to feel their way with their canes, and as they come to the corner the grooves change shape to give them a warning, Braille guidance set in concrete.

So here is a country slightly smaller than California, with 125-million people who may decline in numbers to 60- to 70-million over the next century. They need to deregulate their society at dozens of levels, and they need to rein in their public spending. Normally, you find industrial parks around airports, and for good reason, but here you find rice paddies, the result of rice-farmer protection policies. God knows what the Japanese can do about their low birth rate, but the remedy other countries apply—encouraging immigration—comes hard to such a hugely rich and isolated country. After all, the British, another rich island, felt the same way until they’d lost their empire.

How will all this resolve itself? I have no idea. I only know there will be good investment opportunities here. I believe the best of these will be over the next few years, not over the coming decades. What will the youth do? I don’t know that either. I do know a change of government is desperately needed—you can’t build “bridges to nowhere” forever—and the change will come soon.