Letter from Toyko

I was in Tokyo with Richard Woolnough-san last week. We think the perma-bears on the Japanese economy are wrong, and that some of the official economic statistics are masking an underlying recovery. There are some significant structural changes happening in the economy: for example, participation in the labour force by younger women is increasing dramatically, and immigration is increasing (albeit from an extremely low level). Both of these things could mitigate the problems of the ageing population that we are all familar with. The privatisation of the Japanese Post Office last Monday also has big implications – particularly for the Japanese Government Bond (JGB) market. Most Japanese people have savings accounts at the Post Office, paying, on average, a measley 18 bps per year. Japan Post typically invests these deposits in JGBs. But money has started to flow away from postal deposits (towards mutual funds – hoorah!) and this long term bid for JGBs could fade away. This is still very much a domestically owned market.Elsewhere, whilst Japan has slipped back into deflation this year, we see this as a temporary trend. In particular there is a lot of criticism about the statistical methods used by the authorities. The price of housing and rents (a quarter of the CPI) is referenced on increasingly rare wooden homes, rather than the condo blocks where most people live. A regulated rebalancing of mobile phone bills away from handset subsidies towards lower monthly tarrifs will also have a massive deflationary impact in months to come, even though the net cost to consumers is likely to be a wash. And we learnt that the inflation stats haven’t coped well with the grocers reducing portion sizes (e.g. on pot noodle meals) whilst keeping prices unchanged (which should show up as inflation, but doesn’t). Positive inflation should be back in 2008 – another reason to underweight JGBs, although we think the nacent index-linked market looks to have value.

What could derail a Japanese recovery? Well 40% of Japanese GDP by value added is from the auto sector, and another 40% from electronics. Both of these sectors are big exporters, and a recession in the US would likely see Japanese growth slow back to below trend. The other risk is political – the radicals (economically liberal, global facing) appear to have been defeated and there is a risk of a return to “big government” and pork barrel politics (pointless state funded road building projects to appease regional interests). Further rises in the oil price would also be bad news for a nation which doesn’t have any of it – although it is somewhat protected by having 50% of domestic power generated from nuclear.

Finally, no trip to Japan would be complete without a gadget update. The next generation of TV screens are organic, and just 3 millimetres thin (and the picture quality is amazing); electronic purses have taken off dramatically for smaller purchases (Japan Rail runs one of the most popular schemes – you simply touch a pre-loaded card on a scanner to pay – no PINs or signatures); and Sony’s latest, er, thing, is called the Rolly, and it appeared to be a combination of dancing robot, lightshow and stereo speaker. Yours for 40,000 Yen (about £175).