Strategies: Japan Starts to Recharge After Two Lost Economic Decades

Envious foreigners called its export-driven economy a “miracle.” Its real estate and stock markets seemed to defy gravity, and its financiers were so flush with cash that they bought skyscrapers, golf courses and corporate empires far from Japan’s shores.

Then the bubble burst. In 1990, Japan began more than 20 years of stagnation and deflation. Invest in Japan? For most foreigners, it was wiser to avoid it. At the end of 1989, the Topix, a k a the Tokyo Stock Price index, reached 2,881. Now it’s less than half that.

It’s possible, at least, that those lost decades are finally over. Japanese markets have become turbocharged again, and are beginning to move markets worldwide. This year alone, the Topix has risen more than 22 percent in dollar terms, far exceeding the gain of the Dow Jones industrial average and nearly every other major stock market. The yen has weakened sharply, trading at more than 100 to the dollar for the first time in four years. That exchange rate should make many Japanese companies more profitable and more competitive. It may also inject inflation into the Japanese economy, encouraging consumers to spend and companies to invest.

“What is happening in Japan is revolutionary,” said Mohamed El-Erian, the chief executive of Pimco, one of the world’s largest bond managers. “Nothing they’ve done since the Second World War comes close in terms of economic experimentation,” he said.

It’s far too soon to judge whether “Abenomics” — the new policies of Prime Minister Shinzo Abe and Haruhiko Kuroda, the Bank of Japan governor — will be successful. But they have already begun to change expectations within Japan and around the world.

Most crucially, there are signs that the policies may be breaking Japan’s debilitating spiral of deflation. In April, Mr. Kuroda declared that Japan would achieve an inflation target of 2 percent within two years — an ambitious goal that he said he would achieve by doubling the country’s monetary base.

The central bank, which has already been holding short-term interest rates near zero, is making direct purchases of long-term bonds and other securities. That program of quantitative easing is enormous, Mr. El-Erian said: “It is much bigger than the Federal Reserve’s in the United States, when you consider the size of the two economies.”

Is the new monetary policy working? It hasn’t been in place long, and no up-to-date inflation data is yet in hand. The latest government figures show that in March, Japan’s consumer price index fell 0.5 percent, annualized, a deflationary reading. But Japan’s bond prices imply that expectations for inflation two years from now have already jumped to well above 1.6 percent.

“It’s not quantifiable yet, but the psyche of the Japanese consumer may actually be changing,” said Taizo Ishida, lead manager of the Matthews Japan fund, a stock mutual fund for American investors. “Anecdotally, you can feel it,” he said. “People are beginning to put money into equity mutual funds in Japan, and consumers are buying luxury goods. But we’ll have to see where this ends up.”

MR. ABE, who faces elections in July in the upper house of the Diet, Japan’s parliament, has not unveiled all the details of his policy, which comprises “three arrows”: monetary easing, fiscal policy and structural reform. Monetary easing is the only one of the three that is substantially under way. It appears to be largely responsible for the yen’s weakening and could have a sharp impact.

Forced for many years to adjust to competitive pressures from overseas, Japanese companies said in a government survey last year that they were profitable at an exchange rate of 84 yen to the dollar, a big change from 1986, when they said they needed a rate of 175 yen to the dollar.

The current rate of more than 100 yen to the dollar will make many export-oriented companies much more profitable, said Eileen Dibb, a portfolio manager and Japan specialist at Pyramis Global Advisors, the institutional arm of Fidelity Investments. Her portfolios include Toyota and Fuji Heavy Industries, and both should benefit from the yen depreciation, she said. While the cheaper yen could heighten trade frictions, Mr. Abe says he would like Japan to join the negotiations for the Trans-Pacific Partnership, an Asia-Pacific free trade pact supported by the Obama administration.

Ms. Dibb is bullish on the Japanese stock market, saying it is still quite reasonably priced even after its recent run. In 1988, for example, the Topix traded at a price-to-book ratio of 6.5, compared with only 1.4 today, yet current earnings are attractive and strengthening. For the first time in years, she says, the outlook is extremely positive. “It’s as though Japan has turned the lights back on,” she said.

Mr. Abe has adopted a stimulative fiscal policy. It may give the economy a short-term boost, but in a speech in April, Christine Lagarde, managing director of the International Monetary Fund, warned that Japan’s fiscal policy “looks increasingly unsustainable,” saying its debt-to-G.D.P. ratio is now nearing an extraordinarily high 245 percent.

Japan has some factors in its favor, however, making it quite different from debt-burdened countries like Greece, said M. Campbell Gunn, portfolio manager of the T. Rowe Price Japan fund. Japan’s debt is overwhelmingly financed by its own citizens, he noted; it is denominated in its own currency, and Japan runs a steady current-account surplus, all of which insulate it from bond market pressure.

Furthermore, he said, Japan can reduce debt by privatizing or more efficiently operating billions of dollars worth of state-owned assets, like the nation’s ports and its postal system, which doubles as a gigantic savings bank. “Japan now is in some ways like the U.K. before Margaret Thatcher,” he said. “There is much that could be done if the government wanted to do it.”

Structural problems, however, are major impediments to economic growth. Japan’s population has been aging and declining in size, said Roger Aliaga-Díaz, a senior economist at Vanguard. Unless Japan permits enough immigration to offset this, he said, demographic constraints are likely to trim gross domestic product by 1.3 percentage points a year. “That’s a big hurdle for Japan,” he said.

Shifts like raising the retirement age and removing impediments to work force participation by women could improve matters, but improvements are likely to be slow in coming, he said.

Still, Japan’s markets have awakened, its economy may be reviving, and the flood of yen is certainly flowing into other markets around the world, Mr. El-Erian said. “This is an ambitious effort,” he said. But, he added, “Japan’s mounting debt load and difficult structural problems make this program a very high-risk and high-reward one.”

Article source: http://www.nytimes.com/2013/05/19/your-money/japan-starts-to-recharge-after-two-lost-economic-decades.html?partner=rss&emc=rss