Syzygeist: Who’s Interest(ed) in Japan?

   On my father’s desk in his office during my entire youth, and included among his memorabilia after he died, was a small, framed sign, which read, “Old Bankers Never Die – They Just Lose Their Interest.” He had joined Chase Bank in New York in the 1920s as a utility analyst and would later end his career in finance as the treasurer for several New England utility companies.
   His little sign occurred to me in Japan last week during a long and increasingly academic debate about the true source of underlying interest. I raised my hand to offer the bit of humor along with a question as to whether it might translate into Japanese. But there was a serious question to be raised as well.
   We were all wearing headpieces for the simultaneous translators, and the Japanese faces looking at me broke into smiles and some outright laughter among dignitaries when I got to the punch line. The panel entitled “What future for economic reforms?” was part of the Future-of-Japan Roundtable Seminar, jointly hosted by CLSA, Nikkocitigroup and Shinsei Bank.
   It had convened an impressive array of public and private officials to discuss the challenges facing Japan, whose population is aging rapidly, shrinking in size, and confronted with the largest fiscal deficits among the developed economies. Moreover, the country has about 1500 Trillion Yen ($15 trillion) in its postal and banking savings system on which depositors are earning less than 1 percent.
This is the reason for the well known but troubling “Yen-carry trade,” in which investors – an increasing number of them Japanese, in addition to foreign hedge funds – borrow Yen at home to invest in higher interest-bearing vehicles abroad. This steady outflow contributes to the somewhat startling fact that the Yen is at the same US dollar exchange rate as it was in 1985 - even though the country has racked up impressive trade surpluses during that period.
   The joke turned out to be a starting point for several other questions, which I posed to the now slightly apprehensive audience. What does it mean, I wondered aloud, that this country pays “no interest?” Has Japan “lost interest” in itself? Is the government not interested in paying interest to its own savers? Surely it should be.
   Could it be that no interest is paid in the economy because the economy itself is not interesting - not attractive enough to warrant an interest payment? Some would argue that Japan, which has the lowest rate of firm-turnover among developed economies – has frozen out the innovative in favor of the habitual. As a local Japanese chief counsel had said to me during the week, it’s not only that in Japan the nail that stands up is hammered flat, it’s also that people don’t pursue their own success as much as they hope for the failure of others.
   In whose interest could this persistent lack of interest (rate) be, I asked? (One might blame the exporters, because the manufacturing base and institutional arrangements within the country are all tilted toward export growth, which the Liberal Democrat Party has served very well. Some argue that the necessary restructuring in the service economy can only come with a stronger Yen, which can only flow from rising interest rates.)
   I could see from the expression on a few faces that my line of questioning was making an impression, even on Hiroko Ohta, Prime Minister Abe’s Minister of State for Economic and Fiscal Policy. She had expressed the commitment of the prime minister – whose approval ratings have recently fallen to new lows, equal to George W. Bush in his country – to an “Open Japan” that intends to become friendlier to foreign and domestic investors through continuous reform. She acknowledged that the declining population demands an increase in labor productivity, as Japan’s is the lowest among the advanced countries and the worst in services, at 70% of the US level. She said the administration was focusing on occupational training in medical care and ICT, and on renewed support for universities. The administration has targeted a productivity growth rate of 2.4 percent within five years and wants to accelerate Foreign Direct Investment and agricultural reform.
   Whether these are the right intentions, clearly enough expressed, seems to be a question. The popularity surveys suggest the voters want something else – including pension reform and more compelling reasons to be optimistic about the future.
   It is worth noting that in China’s economy, the population tends to believe it is better off now than it was five years ago and will be better off still in another five years – this is the heart of animal spirits, which animate an economy. In Japan, however, one is struck by a kind of entrenched malaise, exacerbated by the fact that households earn nearly zero interest on savings, total price-adjusted compensation for workers rose only 2 percent from 1997-2006, pay per worker actually fell in 2006, and almost 25% of all households have no savings, up from 8 percent 10 years ago. Japan’s poverty rate is now the second highest in the developed world, behind only the US.
   Risks remain that Japan, seen to be in a nascent recovery, might not be guaranteed success. Takeshi Niinami, President and CEO of Lawson. Inc, which owns convenience stores in rural areas and small cities, warned the audience this non-Tokyo economy is extremely frail. People have no money, or little inclination to spend it, and the numbers of people in the cities and towns is falling.
   In this context I mentioned that Richard Katz and Peter Ennis in a recent Foreign Affairs article (March/April 2007 “How Able is Abe?”), had warned that failure to take action (on the population/aging challenges) “would not only jeopardize Prime Minister Abe’s longevity but also condemn Japan to lackluster growth, stagnant living standards, and diminishing global influence.”
   So it was my conclusion that among other reforms, the nation needed to increase its interest rate – in the interest of investors, foreign and otherwise, so that they do not borrow low at home to invest high abroad – a sure sign of disinterest that cannot be good for the country in the long run. And as time had now run over for the workshop, the moderator smiled broadly and bowed in my direction, thanked me for my most interesting observation, and the workshop concluded.

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No interest, no return – will Japan return? Will there be interest?

To make Japan a "gateway" to Asia, another idea being prominently featured in the future of Japan dialogue, where will the interest come from? Will it be a gateway for the Western world to gain access through Japan to China? To Russia? To India? From Asia to the West? Are these plausible scenarios? Is there interest?

Other ideas include more transparency in financial markets, and allowing filing of IPO documents on the TSE in English. If the market becomes more transparent, will more foreign firms again choose to list in Japan? In 1991, there were 127 foreign firms listed on the TSE, today only 24 foreign stocks are traded on the TSE. Will they return?

A striking assessment of the current situation in Japan was offered at an opening panel discussion. The panelist offered that Japan missed so many opportunities in the last 15 years and that the focus now has shifted to "survival" instead of competing to win. What happened to all the chances – liberalization of markets, currency policies, needed legal system reforms, service sector reforms? Why is change still described as post-war? How many missed boats? Which war? This unfortunately describes what people are thinking about – the catch up and it "can't be helped" victim mindset instead of a winning orientation. In can be helped – but only if there is interest. There could be returns, but only first if there is interest.

Without interest, huge amounts will languish in inefficient savings accounts and there will be very scant returns to support an increasing number of retirees at a time of decreasing tax revenue. Big problem. There must be interest in this debate or there will be no return for Japan. The problems of kakusa will intensify and generations of wealth and savings will vanish. The very quality of life, safety, and security will change at a time when regional powers will have increasing participation in the new Asian miracle.

How will Japan participate in this new miracle? Must the country also age and lose its economic vitality? Can Japan return to the world stage as a leader in environmental and geriatric sciences? Can Japan once again display adaptive resilience in the face of overwhelming adversity?

More questions than answers. Part of the change problem in Japan is that the past 15 years of stagnation and missed boats has not produced the types of problems in daily life that many would associate with prolonged economic slump. Look at the skyline of Tokyo today and you will see a vastly transformed city from just 10 years ago. Walk down the street and you will still see luxury brand shops packed with young shoppers. Visit high-end restaurants on any night in Tokyo and you will be hard pressed to get a seat without a reservation. There may be new poverty in Japan but it is still relative and very hard to see.

With interest, Japanese investors might return. With interest, more foreign investment would find its way to Japan. With interest, the yen could find its own level and the massive currency interventions supporting a weak yen and export-led recoveries could stop. With interest, that money could find a better home, in Japan, and spur a recovery with wide participation and renewed foreign interest. With interest, Japan could finally focus on improving productivity in the service sector.

With interest and returns, the current situation can and must reverse. There is no alternative. As lifetime employment and seniority based pay systems are becoming things of the past, the very social contract offered by employers has changed. Just as 401(K) in the US shifted risk from companies to individuals for retirement planning, defined benefit programs in Japan are following a similar path. Underfunded pensions in Japan of the 21st Century loom large without interest and returns.

A correction would be painful. As the carry trade unwinds and exports become less competitive at a time that quality standards for Asian substitutes are improving, the old thinking of post-war catch-up Japan decision makers would kick in. We could be right back to the can't be helped scenario. Game over.

This can be helped. With interest.

Posted by: Tom Pedersen | June 20, 2007 at 07:13 PM