Although economic and interest rate forecasting is a complex affair even in the good times, when asked about Japan many fund managers, both bond and equity, shiver visibly. For global investors, investing in Japan has long been accompanied by a fair element of fear. It was back in 1990 that the Nikkei 225 peaked at 38,957. Eleven years on, and that index has just dipped below the 12,000 mark. Sounds like a good environment for bonds, then. Yes and no: Yes because inflation has been falling for over a decade, but with long term interest rates touching 1% and short term ones at virtually zero, there’s not much to go for. And there’s the currency question.
Recent news coming from Japan has caused the markets to reach a new level of pessimism. Prime Minister Mori, who has been voted by the Japanese people as the least popular leader ever, is on the point of resigning. The Central Bank may well have to back-track on a recent policy decision and possibly re-embrace the ZIRP (zero-interest-rate-policy) mistakenly abandoned last August. And now the economy appears to have taken a particularly sharp lurch downwards. The latest composite leading indicator data suggests that the current downturn is intensifying.
“This Prime Minister has to go,” says one categorical Japanese citizen. Yuichi Kohashi, managing director of Daiwa SB Investments, says that PM Mori has been a most unsuitable incumbent and that the final trigger for his departure was his decision to carry on playing golf after hearing the news that a trawler had been sunk with the loss of a number of Japanese lives. Kohashi is not optimistic that the new leader, yet to be named, will be able to carry through the long term strategic changes that are required and that Japan’s problems are not going away yet.
Peter Geike-Cobb of Merrill Lynch Investment Management agrees that Japanese politics must shoulder a lot of the blame for the country’s economic hardships, arguing, “Politics is still a major problem and we do not believe that the departure of the current PM will mean major policy change. They need some major policy shifts, and the longer they carry on with their current attempts the bigger the bang will be when it pops.”
Graham Turner, of GFC Economics, thinks that that ‘pop’ may be happening soon. He is one of that rare breed to have been quite good at forecasting the yen over the years. “I have a strong suspicion that Japan is close to a real financial crisis and that it will happen this year. I think the authorities have still not grasped the basic dynamcis of a debt trap, and are running out of time.”
Turner goes on to suggest that recent moves to restructure, in order to bring about the desperately needed reforms, will prove to be counter-productive. “Mr Yanagisawa, the Financial Services Minister is perceived as being quite radical and positively reform-minded. However even he is failing to understand the key to the problems. He wants the banks to write off their non-performing loans more quickly – I think this is plainly mis-guided and will simply drive Japan deeper into deflation.”
Turner argues that, because virtually all the non-performing loans (to be written off) are backed by property, the resulting selling pressure on land prices would intensify and turn more existing loans into bad loans. “No matter how hard banks try to resolve the issue of bad debts,” he sighs, “the problem will keep getting worse.”
Turner has a radical suggestion for the Japanese authorities: he believes that nationalising the banks is about the only option left to them. He goes on, “Public anger towards the banks could be harnessed to forge a consensus policy that would ultimately succeed. The public would probably accept a pre-emptive nationalisation of the banking system that led to some sort of interest rate moratorium for all companies in trouble. This would provide the quickest route to alleviating the downward pressure on land prices and provide some hope of reflating the economy.”
Dramatic indeed, but where does that leave the nervous investors? Turner believes that the stock market has further to fall, and that 10-year JGB yields may drop below 1%. He says he is ambivalent on the Japanese yen.
The managers at Merrill Lynch, on the other hand, think that JGB’s may enjoy a short rally but that the outlook is negative. Geike-Cobb raises the possibility that we are witnessing a ‘bubble’ in JGB’s, given that the authorities have been the major buyers for some time. They have stronger views on the Yen and think that it will take the strain in Japan’s latest bout of troubles, and have positioned their portfolios accordingly. Whatever the outcome, 2001 may well be another year of stomach-turning shocks for Japanese consumers, corporates and investors everywhere.

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