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Vol 2/2, 1 January 2011 www.amphora-alpha.com
IN THIS EDITION
MR MIZUNO RETIRES
I We have read much in the financial press of late regarding Japan’s poor demographics, chronic government budget deficits and declining household savings rate. Several of these analyses conclude that these factors are negative for the yen. True, all is not well in Japan, but it is important to keep things in perspective. What options does Japan have to deal with an ageing population? Actually, they have several, and theirs are somewhat more palatable than those of the US, UK or even the euro-area. Yes, the Japanese may be gradually retiring, but at least they have saved prudently, and this legacy of savings is negative for US assets and positive for the yen.
MR MIZUNO RETIRES Today is Mr Mizuno’ s last day in the office. He has reached the mandatory retirement age of 60 years old. He is still healthy, sharp as a tack, highly productive and he enjoys his work. He would happily keep working for another five years, he thinks. Or perhaps even ten. But company policy is company policy. While clearing out his desk, a number of thoughts are going through his mind. First, he notes that his firm’ s retirement policy is not unusual. Nearly 90% of Japanese firms have mandatory retirement ages of 60 for most employees. Yet the Japanese are amongst the healthiest, longest-lived, economically productive people on earth and could in most cases remain at work through their 60s. Many of his friends are just like him: They would enjoy a few more years at work, if perhaps part-time in some cases, or with slightly more vacation time. He is also aware that the government has been encouraging firms to raise their mandatory retirement ages to 65, given an apparent desire by many older Japanese to continue working for longer. In this context, he finds it odd that 60 remains the standard retirement age in Japan. Second, he thinks about his savings and pension and how these will finance his retirement needs. Like many Japanese workers, Mr Mizuno has worked his entire adult life for a single firm, although that firm has expanded and changed greatly during his time there. He has accumulated a substantial pension, which will provide him a steady if modest retirement income, enough to remain comfortable within his current lifestyle. The mortgage on his home was recently paid off, as he always planned to do prior to retirement. He has also saved some additional funds through the years, most of which has been conservatively invested in bank deposits and savings certificates and, as such, has more or less retained its value to the present day. To be sure, Mr Mizuno (and his wife) are most probably going to run through the bulk of this extra savings over the coming 20
years but, even in the event that they live somewhat longer, the pension will nevertheless cover their basic living costs indefinitely. (Incidentally, Mr Mizuno’s company pension is fully-funded in primarily low-risk investments so there is minimal risk that, for some unforeseen reason, his pension plan might become insolvent or be restructured in some way, reducing his income.) Third, he thinks about his family. He and his wife have two children who are now middle-aged, employed and, with the exception of the 30-year mortgages on their homes, free of debt. They have one child each of their own, both of whom attend their local, traditional public school. Mr Mizuno loves watching his grandchildren growing up and is looking forward to spending more time with them following retirement, one of the positives of leaving work. Reflecting on these things, Mr Mizuno knows he has much for which to be thankful. His parents had a rougher go in life, suffering as they did as young people during the war and aftermath. For years they worked six-day weeks for wages that, at times, barely put enough food on the table. Sure, things began to improve rapidly in the 1960s, when Mr Mizuno was old just enough to understand. They continued to improve through the 1980s and even in the 1990s, the decade in which both of his parents died. But Mr Mizuno was taught by his parents’ experience to be thankful for having missed a few rough decades. As he places his last few belongings into a small box– including a picture of him being congratulated by the company’s former president at a team outing, in which he had scored the highest collective points total in the various competitions–a few concerns do enter his mind. For one, he read last week in the papers that the Finance Minister is pushing for another rise in sales tax to shore up government finances, which have been gradually deteriorating for years. Sure, Mr Mizuno and his fellow Japanese have long been accustomed to reading about government
including Japan.4%. at 5. for example. before the US even came into formal existence. doesn’t Japan have a massive government debt? Well yes. Think of Mr Mizuno. their government debt is held almost entirely domestically. Japan was late to the industrial game. he was content to oversee such a fine. who owns this debt? Well guess what. Mr Mizuno has read some articles in the press suggesting that the debt is now too large to ever pay back.6% in 2010. growing rapidly in number.) How rapidly is this debt growing? Well. But there seems a new sense of urgency for some reason. As with essentially all his classmates. although slightly higher than the UK. the Japanese do. But like his fellow middle-class retirees. But the topic of what is happening in Japan. He had a few ideas about things he might change but. If those regions are now going to be growing more slowly in future. In history classes he learned of how the British and other Europeans had established trading routes and colonies all over the world. Ouch! (Net debt/GDP. And in the former case. although this is at a slightly higher rate than in the euro-area. Japan ran a deficit of about 9. The gross government debt/GDP ratio has thus risen relentlessly and is around 200% today. In recent years. This is a potential risk with the US. for the most part. where he had worked for much of his previous 20 years at the company. some might interject.) So while Japan’s public debt situation is serious and growing. even though he has only rarely travelled abroad–including a bargain family vacation to Hawaii and California when the yen/dollar exchange rate was below 90 in 1995–has some concerns about the world at large. which practically ensure an elevated US deficit over the coming year or two. he grew up with tremendous awe of and respect for the United States. Japan is currently running a CAPB of 6. incidentally. is much lower. UK and much of the euro-area economy suffering in the wake of a massive credit crisis. He’s a member of the vast Japanese middleclass. He is retiring and expects a modestly lower income in future as a result. at least he has saved for retirement. perhaps because the government’s total debt burden is now so high.amphora-alpha. which is the deficit adjusted for the business cycle. Yes. Beginning in the early 1990s. Mr Mizuno. which have been chronic amidst efforts to stimulate the economy. Perhaps a better way to think about Japan’ s government deficit and debt servicing costs is to look at what economists and sovereign debt analysts call the cyclicallyadjusted primary balance (CAPB). and what it implies for the rest of the world. which relies on foreigners to finance a substantial portion of its government debt. UK and most of the euro-area. a great deal of new stimulus has just been thrown at the economy in the form of tax cut and unemployment deficit extensions.2% and 11. to stabilise the public debt at the current level? Maybe that ’s it.com deficits. As such it can be thought of as a longer-term “core” measure of the deficit. Regular readers of the Amphora Report will not be surprised by the narrative style employed above. it is at least not growing more rapidly than either the US or UK. then this implies that your debt servicing costs are trending down rather than rising. Now that doesn’t mean that this debt isn’t an issue. slightly lower than that of the US. which pays a low rate of interest. It has remained in deficit ever since. Japan began to run large government deficits. how might this impact the business going forward? The colleagues he is about to leave behind might need to deal with that. surveying the activity below. But now with the US. After all. Wait a minute.2%.THE AMPHORA REPORT Vol 2/2. at 6. who bowed when he saw him and then smiled. 1 January 2011 www. although it had mostly played it rather well. slightly below the 10. That’s right. somewhat more of these exports have started going to China and elsewhere in Asia. As Mr Mizuno was leaving the building for the last time as an employee. according to the IMF. (The euro-area looks somewhat better on this measure. Retiring is only a potential problem if you haven’t saved for it. welloiled machine in action.5%. It was now his turn to have the office with the fine view out over the factory floor. nevertheless deserves some direct analysis. minus interest payments. Also according to the IMF. but many still go to the US and Europe. More on that below. They basically owe their public debt to themselves. his successor walked into his new office and went straight up to the window. Japan in an immensely wealthy country with an equally immense demographic problem. following the collapse of a colossal housing and stock market bubble. it is he and his fellow citizens (and his pension fund) which owns the vast bulk of this debt. who might decide to sell that debt someday to buy some other country’ s debt or to finance domestic investment or consumption. Admittedly he is not in a position to buy up any more of the debt. 02 . given that he is now retiring. If the CAPB is positive. at about 100%. We sometimes find it easier to communicate important ideas in this way as it avoids the need to rely entirely on economic equations and jargon. Finally. But let’s put this in perspective: First of all. as it stands now. prosperous Japan? His lifelong employer produces precision tools largely for export all over the world. So perhaps this is why the government wants to raise sales taxes. how might this affect modern. but it’ s not the same sort of issue as if your government debt is held largely by foreigners. Japan’s government debt/GDP ratio is more than double those of the US. as a matter of fact it does. This thought sort of worries Mr Mizuno but he has difficultly understanding why the debt would ever need to be paid back. After Mr Mizuno finished packing his final box he walked out of his office and down the corridor to that of his successor.1% deficits in the US and UK last year.
there is general agreement that the large and growing global imbalances in the 1920s contributed to the severity of the Great Depression that began during the global financial crisis of 1929-33. to those of the West. the bulk of which are held in the form of US Treasury securities. (The US and UK have essentially no foreign exchange reserves. gradually selling off its large accumulated holdings of foreign assets to service its domestic debts. and China. Treasuries and exchanging the proceeds for yen cash to service Japanese government debt then. 1 January 2011 www. the current set of global imbalances is eerily reminiscent of the 1920s. The US has been borrowing money from abroad for a generation But wait. This is one reason why many observers have been concerned in recent years with the growth of global imbalances. is called a current-account surplus. US Treasury yields are going to rise and the dollar fall versus the yen. Viewed in this way. other factors equal. if Japan is indeed dissaving. especially to the US. But then. you run a trade surplus which. The euroarea has some $200bn. if Japan is winding down its holdings of US 1 It is an economic identity that. a legacy of massive WWI spending and economic upheaval. which in any case is declining in importance for Japan as its Asian neighbours are growing much faster. which has been running large deficits. could in fact be yen positive. Japan’s demographic issues. whereas the US and UK have net foreign debt positions of around 19% and 22%. in particular that of the US. stocks and bonds. the value of those assets will come under 03 . And as they wind down their holdings of foreign assets. when the US was running large surpluses and the UK large deficits. why are these figures so important? Think about it: If you are approaching retirement. as you export more than you import. but at least they have a huge stock of private savings. This is reflected in part in Japan’s large official foreign exchange reserves of just over $1tn. it will be less reliant on exports. or do you want them to owe you? Japan may be an ageing society but it is an ageing society with a private sector that has saved prudently for retirement! Japan may have a huge government debt but it can service that debt for an extended period by gradually winding down its massive net foreign credit position. such that demand for Japanese exports will likely decline. far from being automatically yen negative. what does this imply? If Japan is now beginning to gradually “dis-save” in this manner.) Now. at least for a period of some time.THE AMPHORA REPORT Vol 2/2. this brings us to the most important point of all. have occasionally been associated with major international financial crises. including interest payments for example. Yes. and exchange the proceeds for yen. with the euro-area 1 roughly in balance . public and private. which has been running large surpluses. or deficits.com Having discussed government finances. As a legacy of decades of large trade and current-account surpluses with the rest of the world. Rising yields will crimp US growth and a weaker dollar will reduce US purchasing power.amphora-alpha. in the past. While economic historians disagree on the specifics. cumulative current-account surpluses. Japan has a cumulative net foreign credit position of some 57% of GDP. respectively. In key respects. Japan’ s potential growth rate may be in gradual decline for demographic reasons. which is to compare the entire Japanese economy. when broadened to include all crossborder transactions. what is going to happen to interest rates and currencies? Well. Over long periods of time. do you want to owe other people money. can become large and.
which given the huge numbers of “bridges to nowhere”.) The US. even state capitol buildings have been sold (and leased back) to raise revenue for cash-strapped governments! Japan has not even begun to go down this road. UK or European corporations and public sector entities. They devalue their currencies. as mentioned in our narrative above. in fact we would agree that it hasn’t. have reason to be outright terrified. might the political temptation to devalue unfunded liabilities away be much greater in the US than in Japan? We believe so. Perhaps someday there is going to be some sort of restructuring of Japanese government debt. but as they owe it primarily to themselves and are only now just beginning the long process of dis-saving. for example. Now we are no fans of misguided Keynesian stimulus. this has been going on in western economies for years. could actually be quite complex. Can’ t do it? Well that’s because there isn’ t one! (There are some smaller ones. Certain western countries have large and growing health issues which suggest that. restructuring pension liabilities. with estimated future public liabilities of some five times GDP may be the most egregious example of massive. We all know what happens to countries that have borrowed too much and can’t pay it back. It is not just the economics of foreign asset sales that favour the yen over the dollar but. but if we had to. But consider: Rather than transfer cash to households to spend on food. The West. we don’t see nearly as much potential risk of a pro-active devaluation of the yen as we do for. Moreover. which implies less reliance on exports. say. which at the extreme is as counterproductive as paying people to dig holes and then fill them up again. has mostly reached the end. isn’t it politically somewhat more expedient to devalue. If Japan does get into budget difficulties down the road that cannot be fully addressed by increasing the retirement age. much ridicule has been directed at Japan’s relentless and ultimately futile attempts at fiscal stimulus over the past two decades. need to rise dramatically to rebalance those economies. default on their obligations. a bridge is going to depreciate without maintenance. Fair enough. etc. as with all capital assets. however. social security. than to default? As a result. drawing down net foreign savings. many of which are already facing pension funding problems. 1 January 2011 www. at the margin. but it is nevertheless in good company with the UK and several euro-area countries. if you owe the debt largely to foreign. public and private. the dollar or sterling. yet the Japanese are generally much healthier and longer-lived than their western counterparts.THE AMPHORA REPORT Vol 2/2. But it is the now-retiring baby boomers of the West who. However. also the politics. in our minds. After all. notwithstanding a large net foreign credit position. the normal Japanese retirement age is only 60. even if retirement ages are extended somewhat. including Norway for example.amphora-alpha. requiring additional debt issuance just to make interest payments! Now how on earth is that new debt going to be serviced? We’d much rather be in line to receive a fully-funded Japanese pension–despite the demographics–than a ponzistyle pay-as-you-go and hope-the-stock-marketalways-rises westernstyle one! Another point that is worth mentioning here is that. stimulus in Japan has generally taken the form of investment in infrastructure. or vacations. they may not be able to reap the same degree of productivity benefits as Japan. He is perfectly justified in having some serious concerns about the future of his country. implying that it could be quite possible to extend the retirement age substantially. 04 . such as “bridges to nowhere”. Japan’s private sector has nevertheless not saved enough to fully fund its demographic-driven future liabilities. rather than domestic investors. thereby generating additional income and holding down retirement costs.com downward pressure. as will their currencies of issue versus the yen. might be long indeed. if less than what a profit-seeking corporation would 2 have built with the capital instead . So much public infrastructure has already been sold off in some places that there is not much left. In the US. then Japan has much public infrastructure which could be privatised to raise funds. a bridge to nowhere or a hole in the ground. The former might at least be of some value. largely unreported off-balance sheet obligations such as medicare. where savings rates and exports. If toll revenue is not sufficient to provide for proper maintenance. One objection that might be raised at this point is that perhaps. We do sympathise with the Mr Mizuno of our narrative above. or whatever. etc. raising taxes. That could have a huge impact on their ability to deal with their demographic problem. in fact. we would probably choose to own a bridge to nowhere or other such infrastructure rather than an empty hole in the ground. But please answer this: Who has? Please name one large developed country that has fully-funded future liabilities. Finally. For example. or both. leaving it with fewer options. whereas Japanese corporations and also the public sector tend to have essentially fullyfunded pension plans–the primary explanation for why Japan’s net public debt is so much lower than gross public debt–the same cannot be said for most US. 2 The calculation of which is better value. at least for a number of years. and also tend to have a stronger work ethic. then this could imply a negative asset value.
firstname.lastname@example.org John Butler has 18 years’ experience in the global financial industry. © Amphora Capital LLP. New York and Germany. Prior to joining DB in 2007. These terms are governed by the laws of England and W ales and you agree that the English courts shall have exclusive jurisdiction in any dispute.com AMPHORA: A lateral-handled. He is a regular contributor to various financial publications and websites and also an occasional speaker at major investment conferences. ceramic vase used for the storage and intermodal transport of various liquid and dry commodities in the ancient Mediterranean. investment products or other financial instruments. JOHN BUTLER john. Amphora Capital is registered in England and Wales under the number OC345497. Nothing in this report shall be deemed to constitute financial or other professional advice in any way. tools and material presented herein are provided for informational purposes only and are not to be used or considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for securities. John was Managing Director and Head of Interest Rate Strategy at Lehman Brothers in London. All express or implied warranties or representations are excluded to the fullest extent permissible by law. DISCLAIMER: The information. 1 January 2011 www. costs or expenses nor for any loss of profit that results from the content of this report or any material in it or website links or references embedded within it. where he was responsible for the development and marketing of proprietary. having worked for European and US investment banks in London. quantitative strategies.THE AMPHORA REPORT Vol 2/2. where he and his team were voted #1 in the Institutional Investor research survey. 05 . All rights reserved. This report is produced by us in the United Kingdom and we make no representation that any material contained in this report is appropriate for any other jurisdiction. and under no circumstances shall we be liable for any direct or indirect losses. Prior to founding Amphora Capital he was Managing Director and Head of the Index Strategies Group at Deutsche Bank in London.