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« Will Iceland Erupt? | Main | The BOJ Debacle, better than Shakespeare »

Ms Watanabe Not Easily Deterred

As Bloomberg puts it on their news site sometimes markets roar and sometimes they whisper. In the last couple of weeks they have certainly roared as the crisis in financial markets have haunted the steps of Wall Street bankers and the Fed. At this point in time we are wearily waiting in Europe to see whether (or more precisely when and where) the fangs of the credit crunch will take hold. In the context of whispering markets we got a small but rather significant snippet from Bloomberg last week when we learned that the accumulated value of Japanese household assets fell for the first time since 2002. As an exception I am quoting the entire piece below.

Japanese households' assets fell for the first time in five years as the nation's benchmark stock index fell, eroding consumer wealth and reducing the prospects for their spending to support economic growth. The value of assets held by households as of Dec. 31 slid 0.6 percent from a year earlier to 1,545 trillion yen ($15.5 trillion), the Bank of Japan said today in its quarterly flow of funds report in Tokyo. Japan's Topix index has lost almost a fifth of its value this year, crimping household assets already depleted by higher prices and falling wages. Consumer confidence is at a five-year low, making it unlikely that their spending will support the world's second-largest economy as overseas growth slows. ``The drop in household assets is another reason why consumers don't want to increase spending,'' said Takeshi Minami, chief economist at Norinchukin Research Institute in Tokyo. ``Japan's economy will remain fragile as stocks continue to decline and downside risks from the U.S. economy increase.''

The Topix lost 12 percent of its value last year and has shaved another 18 percent since January. The Nikkei 225 Stock Average has fallen 19 percent this year.

Holdings in shares dropped 16.8 percent in 2007 from a year earlier, according to Masanobu Ishii, director of financial and economic statistics at the Bank of Japan. The value of holdings in government bonds, insurance and pension funds rose to a record, which confirms a trend that households are seeking higher returns than those available from cash deposits, Ishii said. At 0.5 percent, Japan has the lowest benchmark interest rate in the industrialized world.

The point conveyed by this small Bloomberg piece is not at all insignificant even if it is still too early to derive a general trend. We consequently need to think about what potentially drives the dynamics of Japanese savings and subsequent attempt to make all those pennys work to earn yield. As such and keeping the point above in mind the reason why Japanese savers are now sitting on a dwindling asset base is of course partly to be found in the context of Japanese asset markets themselves. With an interest rate of 0.5% and a main stock index stubbornly bend hell on declining Japan does not exactly spell an attractive investment opportunity even if we are still talking about the world's second biggest economy with a corresponding stock market capitalisation to boot. Foreign investors seem to be voting with their feet even if of course the unwinding of carry trade means that the Yen, much to the chagrin of Japanese companies and policy makers, is rising. 

Foreign investors last week sold the most Japanese shares since the Black Monday market crash in October 1987 after the yen rose to a 12-year high, clouding the profit outlook for exporters. Outflows from Japanese stocks by foreign investors were 922.7 billion yen ($9.26 billion) on a net basis in the week ended March 14, according to figures released today by the Tokyo Stock Exchange. That was the most since the period ended on Oct. 23, 1987. Japanese stocks have attracted net buying on a weekly basis by overseas investors once this year.

One week does not of course make a trend but if we step up in the helicopter and look at the big picture I do think that the main tendency supports what was rather dramatically demonstrated last week. As Morgan Stanley's main man on Japan Robert Alan Feldman put it a couple of months back; 'investors just don't find Japan that exciting anymore!' So, what am I really getting at here? Well, in what follows I try to sketch a rudimentary framework for my argument as well as I provide some further recent evidence. Basically (and this is only on the consumer side), we are moving into life cycle theory and how it connects with the well known inclination for investors to invest dis-proportionally (from an optimization point of view) in their home country assets (i.e. the home bias). In terms of life cycle theory I would argue that we are stuck in that damn 'we don't know' situation since we cannot look into the future and currently, with Japan, we are standing on the edge of the demographic frontier in an ageing context. In short, it is very difficult to gauge the future saving and consumption pattern in Japan since, and this is of course merely my personal guess, the life cycle is endogenous to the demographic transition at the same time as institutional and cultura factors exert influence. What  we do know however with a reasonable degree of certainty is that as the ratio of retired to working people increase and as (presumably) the labour market shifts onto lower value added work for the ageing cohorts (i.e. all those part time jobs we are seeing coming online in Japan) we can expect an overall process of dissaving on the aggregate scale. But (and this is a big but), the traditional way to narrate this process is not very satisfactory in the sense that it tends to take place in 2050 or something and the prediction of a great asset price meltdown. Me and my colleagues have always found this venue of debate rather tedious since who the hell knows what happens in 2050 and in any case it is what happens in the meantime which will make all the difference. In this way, I feel that a couple of the traditional dissaving assumptions need to be considerably loosened.

  • People do not dissave to 0 since by very nature of the human life cycle they don't know when they pass away. Add to this that there might be some altruism and bequest involved. Also, remember that people in the dissaving part of their life cycle do not take on debt which is a very important point to take aboard when we talk about a country's 'capacity' to 'sustain' a housing boom etc. Obviously, this does not negate the dissaving hypothesis but it does tend to differentiate it not least because evidence suggests that people do not dissave with pace that theory predicts
  • Rising life expectancy across the board will induce people to save longer and/or dissave more slowly as well as we can perhaps expect people to try to live off of their assets (i.e. dividend income, interest etc) in stead of spending them.
  • Forced savings(?) Perhaps this is where people tend to get lost since if you don't think about the inter generational and thus 'sustainability' perspective from society's point of view you don't get it. As such, we need to think about the fact that ageing costs and if you are a young worker coming out of a Japanese university you will, quite literally, need to start saving from day one. I mean, the public pay-as-you system simply won't be able to cover it and to the extent that policy makers try to keep it alive they will levy taxes on the population in order to pay for it. This would be the 'forced' savings part. In short; the working cohorts are fewer in number, face a less dynamic economy, and need to support an ever growing burden. This means quite naturally that they will have less money over their life cycle to pump up consumption than if the population pyramid had been more stable. This hypothesis would one of the main arguments for why ageing economies will tend to exhibit congenially weak domestic demand.

Now, I don't know whether this is an adequate explanation of the process. Empirical testing and a sound strategy of scientific falsification will see us through this one. But when I look at the evidence I feel somewhat vindicated. One key part of the picture here is consequently the decline in home bias amongst Japanese investors which cuts a straight line from those savvy carry trading housewives to buyers of Samurai bonds both on which I have reported several times. Recently, we got further indication that this is a process set to linger.

Japanese retail investors are still showing an appetite for overseas assets despite the dollar's tumble to near 13-year lows -- more weary of low returns at home than frightened of foreign exchange risk. Driven away by razor-thin yields on domestic bank deposits, Japanese retail money has piled into overseas investment in recent years, such as foreign bonds, mutual funds that invest abroad and leveraged currency trading. Japanese brokerages said that while there had been some withdrawals in investment trusts targeting Japanese equities, overseas securities, especially non-U.S. dollar securities, were faring well. "Japanese retail investors are keen on investment trusts targeting foreign bonds as they believe that the dollar is near a bottom against the yen," said Koichi Kitamura, general manager of Daiwa Securities' investment trust department. "Although they are somewhat reluctant to spend now, we expect to see an increased inflow of retail money to investment funds focusing on high-yielding foreign bonds," he added.

"There has been no panic. Investors are still calmly allocating toward foreign bond funds and newly issued foreign bonds," said a spokesman for Nomura Securities, who declined to be identified. Earlier this month, Nomura Securities sold A$590 million in Australian dollar-denominated "uridashi" bonds issued by Toyota Motor Credit Corp, a unit of Japan's Toyota Motor Corp. The two-year bonds came with a coupon rate of 6.82 percent. Nomura also sold A$650 million in two-year Australian dollar-denominated uridashis issued by International Finance Corp [IFC.UL], the private-sector lending arm of the World Bank, with a coupon rate of 6.71 percent.

The general point about how Japanese retail investors living in a low yield environment will attempt to ship their money abroad in order to earn income is important to take aboard. In this context it is crucial that we are able to distinguish between the microeconomic and macroeconomic perspective. We consequently need to think about the fact that while saving in a microeconomic sense is governed by the strict rules of life cycle theory it is completely different on a macroeconomic scale. A society cannot dissave or at least it will fight long and hard to avoid this since this would ultimately erode its level of existence. This could be why ageing economies will try to live off of their exports of goods and capital in order to survive; remember that an external surplus is a proxy for savings and in this present context not only the trade balance but also the income balance is worth watching. Of course, dissaving will happen but paradoxically and even if household saving rates will be declining we could see a process by which the capital surplus is kept high. As an important aside here note the concept I often refer to as 'capacity.' Basically, I start out differently than most growth theorists by noting that the ultimate measure of capacity is 'human capital' both qualitatively (i.e. education, productivity etc) and quantitatively (ratio of old people to young (working) people). The amount of physcial capital you can absorb (i.e. growth) depends on your human capital and if there is a mismatch we run into trouble. Currently I would say that this is materialising itself on two fronts.

1) The old and ageing industrialised economies of which many are now steadily becoming dependent on exports in order maintain a respectable and much needed growth rate if they are to pay for their welfare systems. They simply have too much capital (physical and non-physical) for their domestic economies to absorb.

2) Emerging economies who have moved through the demographic transition way too fast relative to the growth expectations levied upon them. Eastern Europe/Russia and perhaps now China would be examples here.

On both 1 and 2 the global economy is faced with notable challenges. In terms of number 1) we need to remember that Japan and Germany won't be the only ageing economies to come on stream. In fact, if Edward and I are right the whole global economic system is in for a significant stress test since the principles on which the current system works cannot be sustained in the long run. This would then be where number 2 comes in. We need those importers but we also want to make sure that we don't burn them off like fire crackers over the course of a decade as well as we could say that we need to avoid those US style bubble bursting recessions even if this has nothing to do with demographics it a direct sense. Especially, China has now become a pressing issue at this point.

And why all this fuss then? Well, I think that we have mounting evidence for the 'demography matters' thesis yet no one in the high circles has come close to addressing it yet. Quite simply, the demographic transition is not this automated process with a fixed beginning and an end and it is not one which exhibits the same features across countries. I mean, this is where it all shores up. How can we e.g. expect China to simply become the new 'US' given the underlying toll of the one-child policy? Ironically (or tragically?) the turning point by which China is forced into this new role may come now at the precise point in time where the effects of its demographic profile are materialising.

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