Still lost in translation

This is a piece about Japan by my friend James Alexendroff, an investor and philanthropist who thinks originally about the world.

"I am sitting at a window staring out at the Tokyo skyline thinking back twenty two years to when I was last here on an investment trip. There's no Scarlet at the bar but its fascinating to be back all the same. I'm changing my mind about Japan.

I ran a Japan Fund from Edinburgh from 1988 to 1991. I watched the tail end of the bubble to beat all bubbles through 1988, thinking that I was an investment God as everything I touched turned to gold. Then in early 1989 I attended a presentation at The Caledonian Hotel where the strategist at the local leading broker Nomura declared that inflation wasn't an issue; but he was sweating and I knew he was lying.

Then on 24th Feb 1989 the appropriately named Bank of Japan Governor Mieno moved interest rates up by a bip or two, but it was enough to signal that the party had come to an end. Knowing nothing then about anything, I was running my Japan Fund, a measly USD 8 million, with daily advice from a rotundly friendly broker, a Dairmaid Kelly of Baring Brothers, reputedly one of the highest paid brokers in the City (I think he liked coming to Scotland for the shooting).

He rang me up on the eve of the 24th and said that an important announcement was coming and told me to put on unlimited orders to sell all financial stocks, which he declared would be losers in the coming wipe out, but that I should hold onto my exporters like Sony and Cannon, beneficiaries of the oncoming collapse in the Yen. Selling about one third of a portfolio in one day was not an every day occurrence to say the least but I said Yes because he knew a great deal more than me, albeit with my heart in my throat. The market fell 15% the following day as I lay sleeplessly in bed (plus ca change) but still his trader in Tokyo sold into the carnage. I was horrified by the prices he had got when I made it to my desk at dawn but a few months later the market was down 50% and I looked like a genius. My fund emerged as the top ranked Japan Fund out of about 100 which is what got me a job in Hong Kong two years later. Serendipity and no more. Thank you Dairmaid wherever you are now.

For students of economic history it's worth understanding what had happened. Simply put, paranoid Americans in the mid 1980's, worried about the sun setting in the West and rising in the East, epitomised by Toyota, Sony, Cannons singing corporate songs in the exercise yard at dawn whilst Americans binged on fast food, forced the overly compliant Japanese at what became known as the Plaza Accord of 1985 to let the Yen start to appreciate. Over the ensuing four years the currency went from 250 to 100 to the Dollar. Simultaneously, savvy US and British investment banks invented the Eurobond market which allowed the Japanese to borrow in USDs. So with interest rates then low and repayable in an appreciating Yen the cost of capital turned steeply negative. Trillions and trillions of USD denominated Eurobonds were issued by Japanese banks with the money recycled relentlessly into land and stocks back home which rose and rose justifying further issuance setting off a virtuous cycle of unparalleled proportions. Of course, it was the Japanese banks that held the baby post the "Mieno Shocko" as it came to be known locally. Once values starting to fall collateral vanished, the Yen fell, nobody could repay the bonds and the Emperor was found standing starkers.

By then stocks were trading on 100x earnings and justified by asset values - in truth just stakes in each other (talk about double counting) and in land (that's when the Economist claimed that the value of the Imperial Park in Tokyo was worth more than the whole of California and the land under the embassies of African countries in Tokyo was worth more than their national debts!). So the bust was huge and took a decade to work through as the government bought the debt from the banks at a few cents in the dollar. Meanwhile, I had read a pull-out feature by my University friend Christopher Wood in the Economist published in mid 1990 arguing that the structural problems in Japan were much more severe than just a cyclical bust. This resonated with what I had seen there on my twice yearly visits and so I did a shimmy, moving to Hong Kong to work on what seemed the more exciting markets of South East Asia.

Now, two decades on, the bad debts in Japan have been removed and written off. So why is Japan still stuck in a deflationary trap of low growth and irrelevance? At the peak, Japan accounted for 48% of the world stock markets index. Now it's about 10% and owned only by locals. Foreigners have vanished, bitten too many times by false dawns to care or trust coming back.

Fundamentally, Japan is now as solid as a rock. Banks have recapitalized and with loan to deposit ratios of only 60% are desperate to lend. Individuals are cashed up. Sure the government looks heavily indebted having abolished taxation (71% of listed companies pay no tax!) and paid for the repaving of miles of river beds stretching to oblivion. The infrastructure here is truly awesome from versus what I recall some twenty years ago. The Tokyo under ground map is so riddled by train tracks its a wonder the city doesn't fall into a giant hole.
There's been pump-priming gone mental. But actually, if one counts its stake in the Japanese Postal System, which sit on the huge savings of individuals, the government isn't really indebted and certainly less so than, say, in the UK where Lloyds and RBS are counted in the government's books. And despite closing 52 out of 54 nuclear plants post Tsunami and importing more oil, the country still enjoys a massive current account surplus.

So, John Maynard, why hasn't your fabled solution worked? The reason in my view is obvious: poor Schumpter has been kept in a box. There's been no creative destruction. Corporate Japan has not downsized or restructured. In a week when both UBS and Ford announce plans to close plants and fire an astonishing 10,000 people each, we heard that it costs a Japanese firm USD 120,000 to lay off one worker! We saw the same thing time after time at our various meetings. From Kirin to Asahi to Kao. Great brands, great products, high gross margins but falling to measly net margins. The fundamental problem, put simply, is that companies in Japan employ too many people. Brewer Kirin, half the size of Brazil's Ambev, employs 15 times more people. Fifteen times! One sees this everywhere from the ladies who stand at the bottom of escalators greeting customers in department stores, to men standing at information kiosks in the subway, to the multiple layers of wholesalers that make the market so hard to penetrate for foreign brands.

Sure, part of the problem is economic: with interest rates at zero and no tax to pay, companies just have to cover their variable cash costs to survive. So their is no reason to take a knife to themselves. And with trade and hidden barriers so high, there are no foreign companies here to eat their over-cooked lunch. So they stay alive by cutting prices in an ever ending spiral to the bottom. Hence the enormous number of walking zombies that populate the corporate landscape. Companies like Sharp, Sanyo, Panasonic that should long since have been allowed to go bust. Even the venerable Sony hasn't reported a profit for four years. And the bottom is a long way down. Hence the deflation can go on for a lot longer allowing for more and more bond vigilantes get carted out.

For sure this is part of the problem? As is the corporate structure, the vast groups, Mitsui, Sumitomo, Mitsubishi, etc., all with a trading company at their core and with a multitude of subsidiaries across all sectors (but not banks as this is not allowed) known as Zaibatsu. One profitable business on one side subsidises a loss making one elsewhere in the group.

But for me these are just symptoms. The root of the problem lies in the culture. The Japanese are too polite to each other to cause pain. Of course the irony is that a culture which drives "salary men" to die from " overwork", shuffling pointless pieces of paper from one side of the desk to the other, diminishing his sense of self in the process, is arguably just unkind in another way.

Productivity growth is the holly grail. Rising output per capita is what dives rising living standards, pure and simple. Nothing else matters. Its not about deflation. Victorian England enjoyed a monumental boom despite prices falling by half a percent every year for a century. Its was the productivity growth riven in the canals and railway lines that allowed people and stuff to move more freely and individuals and capital to become more productive. I read with a smile a piece by the local CLSA strategist who argues that Japan restructuring is taking place naturally as a result of a declining birth rate. Really? How long is that going to take? But he may yet be right as Japan won't turn without structural reform and on the face of it there doesn't seem to be a mandate for structural reform.

And this leads me to Europe. All the noise about austerity is misplaced in my view. It's not about forcing the Greeks to pay more tax or accept lower pensions. It's about forcing the Greeks to deregulate their labour market and remove restrictions getting in the way of the free allocation of capital. It's about abolishing the right of a Corfu taxi driver to pass his licence to his son. But people at the wheel are the winners from restrictive practices and so it's always the last cookie to crumble. Structural change is only possible to force through in a crisis. It took the Jim Calleghan / Denis Healy brush with the IMF in the early 1970's for the UK to usher in the Thatcher revolution. And it took her staring down the restrictive practices of Scargill and his merry men in the mines to break the cycle of restrictive practices which set the UK free. How I miss her.

Thats why I remain so bullish on the USA where productivity growth has been consistently strong. Sadly not so in the UK over recent years where over dependence on financial services and a bloated government stifles invention and risk taking. That and a right wing leadership that for the most part gets the plot but has to pander to a socialist leaning coalition partner.

And that's also why I am also so bullish on Europe. Thanks to the intransigence of Frau Merkel I don't think the Greeks and their Southern European brethren will be let off the hook. That's why the Euro is a good thing. They thought they were buying a free lunch but actually what they were really buying was a not-so-free dose of shock therapy - and the possibility of a desirable future for their grandchildren. I just hope she keeps her foot on their throats until they capitulate, privatise and deregulate. I think she will in which case I see us at the start of a multi decade bull market based on productivity growth led by deregulation and another spurt in technology advances. Our children are indeed blessed and I think they know it deep down.

But I ramble. Why do I say that I am changing my mind about Japan (for those of you to have got this far!). Well because as I wandered the streets I observed the way they are, their manners, their kindness, their decency. There is no sign of misery here. No beggars visible. People behave well. Maybe they have found something in their "hermitry" that the rest of us have missed. Pretty, white-thighed, cloth-capped girls shuffling and giggling and dinky featured boys, grungy and shy-looking with trouser crutch around knees. Bemused expressions but nothing cowed about them. Somehow playing at life. I went down to Akihabra and saw the manga comics and films, the animation centre of the world, teeming with people, impenetrable to me but clearly not to them. But what struck me most was the indescribable politeness of the people, always bowing and smiling. They come running to you when its their turn to engage. Always smiling. Impossibly polite girls giving me roadside directions. Their bicycles parked at tube stations unlocked just sitting on stands, free to be stolen but clearly they never are. How amazingly trusting. Information desks in every tube station (thankfully) with nodding men in uniform. And even a direct line from ATMs to a help desk call centre - just as well as its impossible to get cash out. Perhaps in their decline they have found a secret to life. They know they are too rich to worry. But not so rich that they don't care for each other. So maybe that strategist is right. They can afford to wait.

Meanwhile, of course, the Japanese get systematically shafted by foreigners every time they venture overseas. It's no surprise that its the Japanese girls that get robbed on the London underground. How could Kirin have been stupid enough to buy the number three player in Brazil, so far from home and battling the mighty Ambev? And paid so much for the privilege. And what could Asahi ever hope to get strategically from a 20 % stake in Tsing Tao.

Of course I may be wrong. Corporate Japan may restructure voluntarily. But we saw little evidence of this from our meetings. With CEO salary men of life time service earning what a junior fund manager earns in London, why should they bother to face the vitriol and opprobrium arising from firing the fellow salaryman? And likewise, there doesn't seem to be a case for squabbling politicians to seek such a mandate. This isn't to say that there aren't some great companies. For example machine tool companies like Fanuc and Amata and Keyence are still word beaters. Ditto, the three convenience store operators 7 Eleven, Family Mart and Lawsons. It was wonderful to finally meet Family Mart which was my first buy shortly after it listed in 1987 (I don't think I even knew what a convenience store was).

I was older then, I'm younger than that now."

No comments

Post a Comment

Blogger Template Created by pipdig