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#43 S2N: The Land of the Rising Sun

#43 S2N: The Land of the Rising Sun

Michael Berman, Ph.D.
April 17, 2024

I am late today—better late than never.

Today’s Spotlight

In the early 1990s, Japan was at the peak of its bubble mania. The 3.4 square kilometres occupied by the Imperial Palace was worth more than the entire real estate value of California. The Nikkei was at an all-time high. Japan had the second-largest economy in the world. I recall all the business management textbooks at university focusing on Japanese case studies of success. Then the bubble burst.

It wasn’t just the real estate market; it was the stock market as well.

Japan, as a country, was determined to avoid taking its bitter medicine by declaring many companies and individuals bankrupt. Instead, it embarked on the world’s most aggressive fiscal and monetary stimulus. It was in late 1990 that I got my first exposure to the term “zombie” company. A “zombie company” refers to a firm that is economically unviable in the long term yet continues to operate due to the support it receives through external financial assistance, often from banks or the government. These companies earn just enough revenue to continue operating and service debt, but they are unable to pay down the principal on their debts or fund new projects. It was for this reason that economist Richard Koo called the era a balance sheet recession. It didn’t matter how low interest rates dropped; people and companies didn’t want to borrow because they had more than enough debt.

Yes, even zero and negative interest rates struggled to get the average Japanese consumer to spend and borrow money. If business and the public are not borrowing then who is?

You can see in the table below, Japan has the highest percentage of government debt to GDP in the world, reaching 264% (currently 205%).

In 2012, Shinzo Abe implemented his economic policies (“Abenomics”) by printing huge amounts of money along with yield curve control. You can see how this was achieved by increasing the Bank of Japan’s balance sheet; see the blue line. However, this intervention has come at a cost. Since 2012, the yen has lost 50% of its value.

However, Japan and the rest of the world’s central bankers felt they had rediscovered the “printing press” and all its wonders. With all the liquidity pumped into the system, asset values started rising. You can see that a month ago, the Nikkei made new all-time highs, ending a 33-year drawdown.

Over the last 18 months, the world and Japan in particular, have been reacquainted with an old foe, inflation. In December 2022, the BOJ shocked markets by raising the ceiling of the Japanese 10-year bond to 0.5%, and then a few months later they lifted the ceiling to 1%. In October 2023, they dumped the ceiling. In March last month, they scrapped negative interest rates of -0.1%, raising them aggressively to 0%. They also claimed they would continue their QE of around $40 billion a month.

The BOJ is trying to do its best to talk anyone out of speculating against the yen. They have managed to somehow keep a lid on this QE pot for decades. They have kicked the can further down the road than most. You can see the yield curve is presenting a pretty steep slope. It will become increasingly difficult for Japan’s government to fund its debt.

If this reminds you of the US, its unsustainable budget deficits, and mountain of federal debt, then you should be taking note. The yen is the weak link in the Japan story. Dollar strength has been the surprise factor, but it turns out that it has been more of a relative factor. The dollar being the least bad of the currencies. What gold making new all-time highs has shown us that even the dollar has been losing purchasing value. We are living through epic times, this is a big story.

S2N Observations

I discussed how cocoa prices were taking off around the time of Easter and that I was going short. The market is currently trading a little higher than the 10,000 where I said I would short it. I am lowering my stop loss to the high. I think there is more weakness ahead.