Japan's 26-Year Descent

In at least one alternate universe, the U.S. Federal Reserve raised rates last week and your editor arrived on time to board his flight back home to Taipei. In the known universe, however, neither of these things came to pass.

The Fed, for one, is staying put at near free money and leaving intact its $1.75 trillion purchasing plan, including up to $1.45 trillion in the MBS sludge and $300 billion in treasuries (so called, “quantitative easing”). For how long the people who didn’t understand the risk in the first place will be able to manage it, we couldn’t say. We only know that the physical world doesn’t support any ex nihilo activities. In other words, something never comes from nothing; neither in money nor in anything else confined to the laws of nature.

The rules here are incontrovertible, like the rule that you can’t have your cake and eat it too, or catch a plane that has already left. Which brings us to our second “alternate universe” point.

Without the aid of his hyper-organized girlfriend, your editor has the tendency to get “lost” in foreign cities. “Lost” in this context may refers both to geographical position as well as in the time it might take him to get from one point in the city to another, particularly if that second point is a train, plane or bus station. Ergo, our planned two-day skip has turned into a weeklong trip.

We came to Japan last week for a first hand look at what one possible version of America’s future might look like. We wanted to see what a “staying the course” policy of zero interest rates might do to an economy and to the people living, eating and trying to invest in it.

The Land of the Rising Sun began to set, aided in no small part by the implosion of its gargantuan asset bubble, in the early nineties. Over the previous decade, speculators frantically bid up prices, particularly in real estate, to unheard of heights. At the peak of the euphoria, space in Tokyo’s Ginza district had reached the magical “million a meter” apex (about US$95,000 per square foot). The stock market too had run quite the temperature with the benchmark Nikkei 225 peaking at just below 39,000 points in 1989, roughly four times where it sits today.

Then came the crash and the ensuing “lost decades,” referred to in Japan as “ushinawareta jnen” or “the end of the century.” Mired in a deflationary spiral, the Japanese Central Bank cut rates to about where Bernanke has them right now. Similarly, policy wonks stepped in to save collapsing banks and financial institutions whose main specialty, it seemed, was in making loans to as many people who might never pay them back as possible. It all sounds very familiar.

So what about now? What does the place look like today? Has the market picked up? Do the Japanese kids skip to school, knowing they will inherit a better tomorrow?

Anecdotally, things are very quiet on the far-eastern front. Despite consumer prices falling at an astonishing pace (down 1.1% in May, the fastest annualized pace on record), Japanese consumers themselves are still terribly cautious at the counter. The venerable Itawaya and Mitsukoshi department complexes, multistory labyrinths of high end retail space, still draws the crowds…but far fewer customers leave with designer bags than with designer coffees from the courtyard Starbucks. It’s a place to be seen, in other words, not a place one can afford to shop.

As for the chic restaurants along the streets in the fashionable Nakasu area, no reservations need be made. Your editor ducked into a stylish eatery near his temporary residence for lunch today and, to his amusement, had the place all to himself. The bill for a three course lunch in superlative surroundings came to under ¥1,500 (about $15). Two waitresses tended to our every hand gesture (most of which were misinterpreted, we suspect) and even brought us a small ceramic vessel of local sake, gratis, when we tried to leave our conspicuous window seat.

Analysts blame “sluggish” wages as one reason for consumers’ tepidity. Perhaps they might also consider the “bull who cried bottom” syndrome. Japanese investors hoping for a turnaround in their economic fortunes have been told too many times that “this time is different.” As we’ve pointed out in these pages before, the Nikkei 225 actually rallied more than 30% on ten separate occasions during the last two decades, including three rallies of more than 60%.

For frame of reference, it is worth noting that the Japanese stock market did not find its post crash “bottom” until October of last year, when it reached a 26-year low of 6994.90. That’s a long descent…with plenty of time to stockpile a healthy supply of skepticism. Then, in the first quarter of 2009, the enervated economy suffered its worst contraction on record, shrinking at an annualized pace of 14.2% as exports – especially those to the U.S. – fell off a cliff.

So, where to from here?

The Daily Reckoning