Published in Japan Forward January 3rd 2024
Enter the Dragon, a symbol of dynamism, wisdom and strength. Let’s hope it lives up to its billing.
In 2023 normality resumed, or so it seemed. People stopped talking about Covid. No prime minister was assassinated. Inflation fell to reasonable levels in many developed countries.
Concerns about a Taiwan emergency faded as Russia’s stalemated invasion of Ukraine demonstrated the risks of military adventurism. Despite concerns about a full-scale war in the Middle East, the oil price fell, and America’s Dow Jones Index hit an all-time high.
In other words, 2023 was, as predicted here, a “Pinker year”, named after the optimistic Harvard University professor Steven Pinker, rather than a “Roubini year”, named after the apocalyptically pessimistic author of “Megathreats”, Nouriel Roubini. Could there be some dragon magic in 2024?
Peter, Paul and Mary: Puff The Magic Dragon
Probably not. The geopolitical and economic fault lines are still there and could generate massive disruption at any time. They are currently held in check because everyone is aware of the dire consequences.
Our other predictions proved to be a mixed bag to say the least. The hope that the Brave Blossoms, Japan’s rugby team, would take a big scalp in the Rugby World Cup, as they had in the previous two competitions, was not realised. This was particularly disappointing as Japanese sportsmen such as Shohei Otani in baseball and Kaoru Mitoma in football (“soccer” to some) have been in sensational form.
It was noticeable that Japan’s rugby team contained quite a few veterans who had lost the speed and energy of previous years. Could it be the case that considerations of seniority are holding back the rugby team, while Otani and other Japanese stars overseas can give free rein to their natural talents?
As forecast, it was a bumpy year for the huge ESG (Ethical, Social, Governance) lobby, which has run into heavy political crossfire in the United States. One of the harshest critics of the concept is Professor Aswath Damodaran of Stern Business School, who recently described it as “born in sanctimony, nurtured with hypocrisy and sold with sophistry.”
His point that an “unconstrained” mandate– one that can invest in all stocks – will eventually deliver better returns than one that excludes supposedly “bad” industries is unanswerable.
Well wide of the mark were our expectations about the currency market and domestic Japanese politics. Rather than rising as anticipated, the yen spent most of the year in the 140 to 150 range, as U.S. interest rates stayed remarkably high for a remarkably long time – leaving many forecasters, ourselves included, feeling blue.
Meade Lux Lewis: Dragon Blues
An early exit for Prime Minister Kishida seemed likely simply because that is historically what tends to happen after a long stay in power by a strong leader like the late Shinzo Abe. Yet Kishida has managed to cling to power despite sagging support ratings and a series of low-grade scandals.
According to investment guru Howard Marks, being too early is the same as being wrong. We were definitely wrong about the yen and domestic politics, but perhaps that was a case of being too early and the failed predictions of 2023 will be bang on the nail in 2024.
After all, the fundamentals are still in place. The Japanese yen is still extraordinarily cheap in purchasing power terms and the U.S., with a presidential election looming, is about to embark on a cycle of interest rate cuts. Likewise, Kishida is suffering the fate of many weak Japanese prime ministers: getting caught between the priorities of the powerful financial bureaucracy and the desires of the public. If he does go, there is a sporting chance that his successor could be Japan’s first female prime minister, as suggested here last year.
The same could be said of our view that China would “pivot” to pragmatism in the Year of the Rat. That turned out to be half-correct, at best. Yes, the Chinese leadership has dialled down the “wolf diplomacy” and sought more stable relations with the United States at a meeting between President Joe Biden and Chairman Xi Jinping.
Yet strong measures to stimulate the domestic economy, which is suffering from the collapse of a gigantic real estate bubble and traumatized consumer confidence, have yet to appear. Surely, they must though, as prolonged youth unemployment and deflation can only erode support for the regime. The barometer will be the Chinese stock market, which has been such a disappointing performer in recent years.
FIVE AND A HALF SCINTILATING SCENARIOS
Increasingly Cosmopolitan Japan
Towards the end of 2024, Taiwan Semiconductor (TSMC), the world’s largest manufacturer of highly advanced semiconductors, will open a plant in Kyushu, Japan’s “silicon island”. It has already started work on a second plant, and there is talk of a third. Taiwanese engineers have been transferred to Japan, and Japanese recruits – whose pay is well above the local norm – are being sent to Taiwan for training.
This move is driven by geopolitics, specifically the risk of China making a move on Taiwan, but in a wider sense the same dynamic is requiring Japan to be more open, more Asian and more influential. Shrinking, or being perceived to be shrinking, is a dangerous path to tread. It was the strategic far-sightedness of the late prime minister Shinzo Abe that led him to open up the labour market to foreign nationals.
Interestingly, it will soon be possible for foreigners to take the Japanese exams for taxi and bus driving, which are under the authority of the Police Agency, in any one of twenty foreign languages.
Japan is facing a structural shortage of labour, and the transportation and delivery businesses are amongst the worst affected. Importing labour is the obvious solution. Opinion surveys by Pew Research and NHK, the national broadcaster, show that the Japanese public is more appreciative of foreign workers than most European countries and sees their contribution as a net positive.
The number of foreigners in the workforce has doubled over the last decade, thanks to Abe’s reforms, but the overall scale is still small at 1.8%, with the Vietnamese taking over from the Chinese as the largest ethnicity. From here, the increase could be quite rapid, given the encouraging attitude of the Japanese authorities and the tendency of immigrant communities to grow fast once critical mass is reached.
Like it or not, Japan is now a more strategically important player than ever before in the post-war era, and stands as an antithesis, though not necessarily an enemy, of Xi Jinping’s China.
It has fulfilled that role before. In the early twentieth century, Chinese dissidents and intellectuals – including Chiang Kai-shek and Sun Yat-sen – based themselves in Japan for long spells. Something similar could happen again, this time including Chinese tech billionaires and wealthy Hong Kongers as well as writers, journalists and artists.
Apple Swoops
Japan’s stock market culture has undergone significant change over the last two decades, with new proposals, reforms and codes coming thick and fast recently. The result has been to transform the relationship between companies and investors.
One noteworthy example is the new protocol for takeovers, set out by METI, the Ministry of Economy, Trade and Industry. Taboo for a long time in Japan, hostile takeovers should now get the green light if sufficient value is created for the shareholders of the target company – meaning that the price is high enough.
And in fact that is what happened in August 2023 when electric machinery company Nidec launched an out-of-the-blue bid for Takisawa, a smaller company that produces machine tools. Takisawa’s initial response was to reject it, but Nidec, citing the METI document, won the argument.
How can companies protect themselves from being taken over? Easily – by removing themselves from the stock market and going private. In fact, several well-known companies did exactly that in late 2023, taking the MBO (Management Buy Out) route to a takeover-free existence. Others may follow, deciding that the increasing hassle and risk of being listed is no longer worth it.
What about a large-scale international takeover using the METI playbook? It seems that top staff of Microsoft discussed buying Nintendo before deciding on Activision Blizzard. Given the huge scale of the market capitalization of the “Magnificent Seven” (Apple, Tesla, Nvidia, Microsoft, Alphabet, Amazon, Meta) not even the most iconic Japanese companies could be safe from their clutches. Any one of them could attack like a dragon.
Queen: Dragon Attack
Back to Deflation
Japan’s Producer Price Index soared to +10% in December 2022, the highest level since 1980. One year on, it has collapsed to +0.3% – and further declines are certain, given the falling oil price and stronger yen.
Producer prices, the costs that companies incur when they buy their inputs, are more volatile and quicker to respond than consumer prices, but they do signpost the direction of travel. If they sink into negative territory and stay there – as is likely – it will probably mean that inflation is past its peak for consumers too.
That is not necessarily a bad thing. Indeed, it could set off a mini boom as prices flatten out while wages continue their steady rise and Japan’s terms of trade improve. On the other hand, it could give the Bank of Japan a headache as its inflation target of 2% on a sustainable basis will not have been realised.
Nicer and NISA
The world’s first properly organized futures market opened in 1710 – in Osaka, Japan. Two centuries on, Japan’s defeat of Imperial Russia in 1905 could not have happened without the bonds it floated in the U.S. and Britain to finance warships and weapons. Which is to say that Japan has been financially sophisticated for a very long time.
So there is no reason why the new NISA (Nippon Individual Saving Account) should not, over time, be as big a success as its model, the UK’s ISA. Certainly, the government has set a super-bullish target, expecting the total amount of these tax-free accounts to reach 34 million in five years with assets doubling to 56 trillion yen.
Most people will invest via funds, and there appears to be a strong attraction towards the best performers of recent years, US and Indian equities. Yet, if financial weekly Veritas is to be believed, there is significant interest in Japanese small and medium stocks too.
Japan’s once thriving equity culture took a heavy hit from the collapse of the 1980s bubble economy and the consequent long years of stagnation. That is ancient history now, and the NISA scheme, due to start in in early 2024, should mark the start of a new phase of Japan-style shareholder capitalism.
Green Resistance
As governments across the developed world prepare their citizens for the coming of “net zero”, with all the changes in lifestyle it implies, resistance is starting to mount. Already populist parties in many European countries are using the issue to gather support. The stock prices of many illustrious auto companies are telling a disturbing story – they have no future in this brave new world. Meanwhile, China – by far the largest exporter of electric vehicles – has an energy mix that is 80% fossil fuel, mostly coal.
Most governments have signed up to bans of various kinds on conventional ICE cars, but as the deadlines get closer, many will be tempted to push them out further, as the UK has just done. The most important actor is the United States, and what happens there will be significantly impacted by the upcoming elections. Despite the tremendous success of Tesla, only 8% of U.S. auto sales are EVs. The other 92% are not.
Globally, the production of gasoline is at an all time high. So much for the “Just Stop Oil” campaign.
The energy transition is undoubtably underway, but governments have sought to compress the necessary timeframe by using a panoply of carrots and sticks and now risk facing a backlash. Japan has been far from blameless. In 2020, the government went along with the Europeans in pledging deep cuts in emissions, which would take them down to 46% of 2015 levels by 2030.
That was totally unrealistic, given Japan’s topography. Even now, Japan’s energy mix is 84% fossil fuel, nearly all of which is imported, and EVs have a tiny share of the auto market. If the growing “green resistance” overseas does lead to a more realistic approach to the energy transition, that can only be a benefit to Japan and its industries.
Daniel Yergin, the experts’ expert on energy politics, put it like this in his book The New Map: “Oil will maintain its pre-eminent position as a global commodity, still the primary fuel that makes the world go round…” And quoting David Swensen, legendary head of the Yale Endowment, “if we stopped producing fossil fuels today, we would all die. We wouldn’t have food. We wouldn’t have transportation… We wouldn’t have clothes…”
Let’s hope that prospect remains in the realm of science fiction.
John McLaughlin: Don’t Let The Dragon Eat Your Mother
Bonus Scenario: Medals Galore for Japan at the Paris Olympics
Japan triumphed in the last Olympics simply by holding them in the teeth of the Covid-19 hysteria and a bizarrely negative press campaign. The closing ceremony was unforgettable, with its drone display of the earth in orbit
Undeterred by the outcome of the Rugby World Cup, we expect Japan to do well at the 2024 Paris Olympiad. There are two reasons for optimism. First, Japanese athletes have been performing strongly in a wide variety of sports, from basketball to skateboarding. Second, Olympic host countries usually ramp up their sports budget in the years leading up to the event, and the statistics show that the effect of better training and equipment etc. lasts at least another four years.
Result: Japan’s medal haul should put it within the top four most successful national teams.