Japan Inc. Hesitates to Invest as Yen Spurs Nikkei RallyJason Clenfield
The last time Masao Namiki bought machinery for his company, Emperor Hirohito had just died, Japanese investors took the Rockefeller Center as a trophy, and a new central bank chief was about to prick the bubble economy. It was 1989.
The $1 million Namiki borrowed to outfit his workshop with computerized lathes and drills almost bankrupted him as orders from clients Canon Inc., Panasonic Corp. and NEC Corp. evaporated. As interest rates cranked up to 6 percent, crashing stock and land prices wiped out $15 trillion in wealth and triggered an economic malaise that still drags on.
The bubble, and the five recessions since, help explain why business owners like Namiki aren’t buying into investor euphoria over new Prime Minister Shinzo Abe’s campaign to end deflation. Even after the steepest five-month slide in the yen for 18 years made global companies like Toyota Motor Corp. more competitive and Japan the world’s best-performing major stock market, Namiki said he’s still not ready to invest.
“If we had the orders I’d think about adding equipment, but right now the work’s just not there,” the 72-year-old said at his small factory in Tokyo’s Ota district, where he and a handful of employees have made thousands of steel molds for phones, stereos, and keyboards. “The manufacturers are still in wait-and-see mode.”
The reluctance to borrow and spend of companies like Namiki’s that don’t operate abroad and make up the bulk of Japan’s economy is the biggest threat to Abe’s plans, said Nomura Research Institute Chief Economist Richard Koo.
“The greatest bottleneck in the private-sector economy today is the lack of private-sector borrowers,” said Koo. “That comes from the fact that they went through this balance-sheet correction for the last 20 years. Americans went through the same thing in the 1930s, and many who lived through the Great Depression never borrowed again.”
Japan’s trauma was greater still, Koo said. The wealth lost was three times gross domestic product. The U.S. crash cost a year of 1929 GDP. And just when Japan was showing signs of recovery, the 2009 global financial crisis hit. Then came the 2011 tsunami. After all that, the Nikkei 225 Stock Average is two-thirds off its 1989 peak. Land is cheaper than in 1981.
To jump start investment, Abe and his handpicked Bank of Japan governor, Haruhiko Kuroda, said they will double the money circulating in the economy to drive inflation to 2 percent within two years, remove structural barriers to growth and add fiscal stimulus with tax cuts and other incentives.
Since mid-November, when it became clear Abe would win power, the yen has weakened about 20 percent, the steepest five-month decline since 1995. The currency had been trading close to a post World War II high, so the slide has been a relief for companies like Toyota that get most of their revenue in other currencies.
Shares of Toyota have surged 81 percent. Mazda Motor Corp., which makes 77 percent of its sales internationally, has tripled. Sony Corp. will probably snap four years of losses partly thanks to the yen; its shares have jumped 88 percent.
Foreign investors who account for about 70 percent of the volume on Tokyo’s stock exchange haven’t just driven up exporters. The biggest gains so far have been in brokerages and real estate companies, which stand to benefit from higher asset prices. The Topix gauge of securities firms is up 172 percent, with largest member Nomura Holdings Inc. more than doubling. The index tracking real estate firms has also more than doubled.
The advance has added almost $800 billion to Japanese stocks -- or about half the value of France’s market. The Topix Index, Japan’s broadest gauge, has jumped 56 percent since Nov. 15, the top performer among the world’s 10 biggest markets. All 33 industry groups have gained.
“The currency has done a lot to improve that sentiment,” said Kathy Matsui, chief Japan equity strategist at Goldman Sachs Group Inc. “But it’s not just that. It’s ‘we finally got a government that’s pro-growth.’”
Decades of disappointing returns is part of the reason the Topix is off to its best start since 1987, she said. The 1,698-member index was valued at 0.9 book value before the rally. That means shares could be bought for less than the cost of their assets. Even in the weeks after the collapse of Lehman Brothers Holdings Inc., when the U.S. financial system was on the brink of meltdown, the Standard & Poor’s 500 Index was never valued at less than 1.4 times book value. The U.S. benchmark is now at 2.3 times; the Topix at 1.3.
“We had an anti-bubble in Japan that was waiting for some kind of catalyst to set it off,” said Nicholas Smith, Tokyo-based strategist at CLSA Asia-Pacific Markets.
Abenomics, as the prime minister’s anti-deflation policy is dubbed, was the trigger.
Exchange rates are one of the reasons Toyota President Akio Toyoda said in January he’s “beginning to see the light.” Only 15 months earlier, he warned that Japanese carmakers could collapse under the weight of a currency at a postwar high of 75.35 against the dollar.
Toyota is one of a handful of companies that have raised wages. Japan’s biggest manufacturer makes an extra 35 billion yen in operating profit for every 1 yen the currency falls against the dollar and will probably report its highest net income in five years next month.
Japan’s largest companies start releasing earnings and forecasts today, with Canon and Fast Retailing Co. due later this week.
Meanwhile the yen is making the books look better at companies from Nippon Yusen K.K. and Uniqlo operator Fast Retailing. Shipping lines, such as Nippon Yusen, stand to gain because their contracts are priced in dollars. Fast Retailing, which opened 10 stores in China and Taiwan last year, raised its profit forecast after overseas operating income jumped 40 percent on the weaker yen. The stock has doubled since November.
Airlines, energy and commodities companies have been among the worst-performing groups as the weaker yen increases the cost for importing oil, metals and food. Japan Airlines Co. has gained 14 percent. In dollar terms, it’s down. Tokyo Electric Power Co., the country’s biggest utility, raised rates for businesses by about 15 percent last year and others will follow. Japan now imports more than it exports, and this month posted its longest run of trade deficits in three decades.
In Ota, home to the biggest concentration of suppliers for Japan’s auto and technology manufacturers, the brouhaha from the financial markets has yet to filter through.
Namiki’s workshop is typical of the thousands of small engineering firms clustered in the district. At the height of the 1980s boom, people used to say, you could fold a blueprint into a paper plane and throw it from any rooftop in Ota and expect a finished product back in three days. Maybe not today.
Seated at a table in his office above the workshop floor, Namiki pointed to an old members’ list from a neighborhood trade association. Most of the names were scratched through, a reminder that half of Ota’s factories have closed since 1989 as the big companies they served moved overseas or shut.
Since Lehman’s collapse, 1.2 million factory jobs have gone, government data show. Faced with a shrinking population and excess capacity, Japan’s largest firms say they plan to cut investment this year, a BOJ survey showed this month. Average wages in Japan are about 9 percent lower than in 1997, even after adjusting for falling prices.
“I used to walk around and see products made with my molds everywhere,” said Namiki. “I made tons of molds for cell phones over the years. Last year, zero. The work isn’t done in Japan anymore.”
Abe has plans to change that, by cutting corporate taxes, making it easier to fire full-time workers and other pro-business measures. First his Liberal Democratic Party must win back control of the upper house in July elections, repeating their December victory in polls for the lower house.
The prime minister has already committed to free-trade talks that may pit him against the powerful farming lobby. He’s also outlined plans to cut electricity prices by allowing competition between power companies. Both will take time.
It’s in monetary policy, though, where Abe has made the biggest break from the past. Before Kuroda promised to do “whatever it takes” to end deflation, successive central bank chiefs had stuck to the task of snuffing out bubbles rather than fostering growth, heirs of a tradition begun by Yasushi Mieno, BOJ governor in December 1989.
In his first policy decision, Kuroda this month embarked on what billionaire investor George Soros called a “risky experiment,” doubling monthly purchases of government bonds to to about 70 percent of the government’s planned sales. Hedge fund manager Kyle Bass, founder of Hayman Advisors LP, said that relative to the size of the economy the intervention is twice as big as the Federal Reserve’s quantitative easing.
Kuroda’s move sparked the yen’s biggest three-day slide since January 1988. The currency reached 99.95 on April 11, its weakest against the dollar since 2008, and was recently at 99.76.
South Korean Finance Minister Hyun Oh Seok said the exchange rate was hurting his country’s economy more than North Korea’s threats of destruction. However, finance ministers and central bankers at the Group of 20 meeting in Washington last week were more focused on the threat of slowing global growth, accepting Japan’s explanation that the yen’s move is a “byproduct” of policies aimed at stimulating domestic demand, Finance Minister Taro Aso said.
‘Sense of Confidence’
“Having spent about four days there just a week and a half ago, I do feel there is a greater sense of confidence” in Japan, U.S. Undersecretary of State Robert Hormats said in an interview last week on Bloomberg Radio’s “Surveillance” with Tom Keene. Abe’s “leadership and his sense of purpose about addressing these economic issues has given people a more positive feeling about the future.
‘‘A lot of structural things have to be done to free up opportunities in the Japanese economy and reduce regulations and make it a more competitive economy,’’ said Hormats, the former vice chairman of Goldman Sachs International. ‘‘Not just competitive because the currency goes down.’’
In any case, a focus on the yen may be misplaced, says Martin Schulz, an economist at Fujitsu Research Institute in Tokyo. Exports only account for about 15 percent of the economy, and Topix companies on average rely on Japan for more than 80 percent of sales, data compiled by Bloomberg show.
‘‘There aren’t enough people involved in exports to make the yen a centerpiece of a growth policy,’’ said Schulz. ‘‘What you need as a base is stable domestic growth that runs on consumption and domestic investment -- and that’s low because you have the Toyotas investing outside.’’
Toyota builds most cars overseas. The company wants to focus on ‘‘production and business that’s free of currency risks,’’ Toyoda said April 10. A week later he was in New York to announce plans to build Lexus sedans in Kentucky, the first time the luxury marque will be produced outside Japan.
Mazda, whose dependence on domestic production is one of the reasons it lost money four years running, is opening a factory in Mexico next year. Honda has built most of its vehicles overseas since 1998. It’s the top stock on the Nikkei 225 since the bubble burst, with a fourfold return.
The weaker yen is probably not enough to change the fortunes of companies like Sony Corp. and Panasonic, which have been slow to expand into emerging markets and have fallen behind on investment, according to Fujitsu’s Schulz. South Korea’s Samsung Electronics Co.’s $20 billion in capital expenditure last year was almost double that spent by the two Japanese companies.
‘Investing Like Hell’
‘‘Competitors like Samsung were investing like hell, while Japanese companies were focusing on reconstructing,” said Schulz. “Japan’s management for 20 years has done nothing but restructuring.”
For all of the hand-wringing about Japan’s 20-year slump, some companies never faltered. In a 2011 book titled “No-Excuses Management,” Chihiro Kanagawa describes how he built Shin-Etsu Chemical Co. into a 2.7 trillion yen juggernaut that hasn’t lost money since he took the helm in 1990.
A focus on two unglamorous businesses where Shin-Etsu holds the world’s top market share -- plastics used in pipes and silicon wafers for chips -- helped Kanagawa avoid bubble-era excesses like the one that saw Mitsubishi Estate Co. sink $1.4 billion into New York’s Rockefeller Center, only to sell it at a loss six years later. When presented with a plan to build a hotel during the last throes of the boom, Kanagawa rejected it outright, saying “what do we know about hotels?”
A network of factories in the U.S. and Asia help insulate Shin-Etsu from currency swings and keep it close to overseas customers, who make up two-thirds of sales, Kanagawa said. The stock has returned 292 percent since the end of 1989, the second-best return on the Nikkei 225.
In an interview at Shin-Etsu’s Tokyo headquarters, the 87-year-old chairman, dressed in a pinstriped black suit, white shirt and burgundy tie, waved away questions about Abenomics.
“I couldn’t care less,” he said. “I don’t depend on the government, anywhere.”
Flanked by an aide punching numbers into a calculator, Kanagawa reeled off the math that shows why his next factories probably won’t be built in Japan. Bottom line: electricity costs are double those in the U.S. Shin-Etsu opened a plant in China last month and will complete one in the U.S. next year.
“If you invest enough money and buy the best machinery, anybody can make good products,” Kanagawa said. “But if you can’t sell at the right price you’re going to lose money.”
You’d never know Namiki’s drab, two-story building is a factory from walking by it. Hidden away between houses on a narrow street, only the sound of grinding metal gives it away.
Inside, men in rough clothes mill around a room carpeted with metal shavings. Desktop PCs are loaded with more recent design software that Namiki said helps make up for the age of his 1980s-era machines. One worker sits by a kerosene heater with a kettle on top. Others smoke.
Up a steep staircase above the workshop floor, Namiki’s office tells a history of Japan’s consumer electronics industry.
From a jumbled pile of gadgets, he pulls out a futuristic green plastic wheel for a prototype electric scooter for Bridgestone Corp. Next comes a Denon compact-disc player. Then a Panasonic handset so old the paint is flaking off. Each of the phone’s 24 plastic parts required its own steel mold -- they weighed eight tons in all. “Now with all the smartphones, there aren’t any buttons,” he said. “No buttons means one less source of work for us.”
Namiki says he’s not ready to admit defeat yet: some clients have started talking of bringing work back to Japan if the yen stays around 100 because of the quality.
“They’re thinking of doing it ‘Made in Japan,’” he said. “It’s a good sign. But until they bring production back to Japan, we won’t get the work.”