This Japan business is beginning to get a bit tiring. As soon as you think the authorities are getting a grip, they instantly lose it.
I was thrilled when the Japanese electorate took a stand and elected a non-LDP politician as PM last year, ending half a century of very conservative one-party government. But the knives have been out for poor Yukio Hatoyama for months now (no great surprise given that he has been commanding popularity ratings of under 20%) and yesterday he gave in and resigned.
He had, he said, tried to change politics so that the Japanese people would be the driving force behind change. He failed.
His replacement is likely to be Naoto Kan – currently Japan’s finance minister. He’ll be the fifth PM in four years, thanks to a hugely change-resistant political system that gives its PMs very little in the way of real power.
The good news is that Kan is seen as a reasonably good bet, in that he might have a go at dealing with the budget deficit (he is keen on putting up consumption tax). He also appears keen on a weaker yen, something that might stimulate both exports and a hint of much-needed inflation. However, the bad news is that he has a horrible job to do which, given how Japanese politics tends to work, he won’t get long to take a stab at.
The Japanese deficit is now around 10% of GDP with under half of government spending currently covered by tax revenue. Gross debt, as is often reported, is more than 200% of GDP. It’s a number that makes even the UK’s horrible national debt look almost manageable.
However, if Hugh Hendry is right, the current level of debt might be the least of Japan’s problems.
When I interviewed him a few weeks ago he said that he feared for the yen. The general consensus is that the yen is too expensive at the moment and if you look at it on a purchasing power basis, that is certainly the case. But that doesn’t mean it can’t get more expensive.
Imagine, says Hugh, that things really do go horribly wrong in Japan. Take Japanese pension companies. They have yen liabilities, but are often heavily invested abroad. But if the value of their yen assets suddenly falls (as China collapses and exporters drag down the Nikkei for example), they’ll have to repatriate assets to fill the gaps. But in doing so they have to buy yen. That forces up the yen, which hits exporters further, kicking off a vicious circle of collapsing asset prices and a rising yen.
Right now, a US dollar costs you about 90 yen. Hugh reckons we’ll see it costing a mere 50 yen before China’s drama has played itself out. Add that to the fact that the Japanese have had no nominal GDP expansion for 20 years and you would have to be “insane” to invest in Japan.
This is scary stuff and it is absolutely true to say that Japanese industry is heavily leveraged to China. But I’m not quite ready to turn bearish on Japan yet. Our hopes lie not so much in the possibilities inherent in its commercial links with China, but in its cheapness and in the possibility that domestic consumption will soon improve.
The market as a whole is trading on a price-to-book ratio of a mere 1.2 times (although as the cynics always say, stuff is always cheap before it goes bust). That, as our own Simon Caufield notes is half the price of the S&P, and the cheapest it has been during its 20-year bear market.
I still think Japan is worth buying and holding for the long term.