Japan’s Highly Protected Insurance Industry Has Taxpayers On The Hook

Japan’s Insurance industry isn’t only heavily distorted as a result of protectionism but likewise exposes taxpayers heavily to losses.

That’s according to Economic Policy Journal’s Robert Wenzel.

Mr. Wenzel writes, (bold emphasis mine)

First, the Japanese government protected domestic insurers by limiting foreign insurance companies from providing insurance. Then, the government wrote regulations that limit payouts from earthquake damage.

Because of all this, many in the region, where the earthquake just struck, don't even have earthquake insurance.

There's also a loss-sharing agreement that remains in place and if the damage stretches into the billions (which it will), the Japanese government (read: taxpayer) will be on the hook for much of the bill that rightly should be picked up by the insurance companies involved.

No wonder the subtle cries over a prospective fiscal crisis.

No wonder too why the BoJ was quick to resort to massive inflationism.

Japan’s Earthquake-Tsunami In Pictures

Below is an awesome picture which virtually illustrates of how man is seemingly helpless against wrath of nature. (please spare me the climate change drivel)

It’s just one of the 40 incredible tragic images captured by the Boston’s The Big Picture from yesterday’s 1-2 punch of earthquakes compounded by tsunamis that struck Japan.

See the rest here (ht: Mark Perry)

Integrating Asia: Japan-India Trade Pact

More signs that Asia continues to deepen her trade ties with each other.

This from the Japan Times

Prime Minister Naoto Kan and visiting Indian leader Manmohan Singh officially agreed Monday in Tokyo to activate an economic partnership agreement as soon as possible and to speed up talks on civilian nuclear cooperation.

The deal to strengthen economic ties between Japan and India, a fast-growing democratic nation with a population of 1.2 billion, comes at a time when Asian nations are becoming increasingly concerned about China's activities in the East China and South China seas….

The two countries will continue working-level preparations for signing the EPA. Tokyo aims to sign it around the end of the year so it can be submitted to the Diet early next year for ratification, Japanese officials said.

Under the EPA, the two countries will abolish a wide range of tariffs on products ranging from car components and electronic goods to bonsai plants. Broader than a free-trade agreement, the EPA is a more comprehensive pact on economic and trade cooperation that also includes promoting investments.

"This is a historic achievement that signals the economic alignment of two of the largest economies in Asia," Singh said. "It will open up new business opportunities and lead to a quantum increase in trade and investment flows between our two countries."

Japan and India began discussing the possibility of a civilian nuclear energy deal in June that would allow Tokyo to export its nuclear power technology to New Delhi. But India is not a signatory member of the Nuclear Non-Proliferation Treaty, and it is unclear how soon the two nations can conclude a deal, given the strong antinuclear sentiment here…

The EPA will eliminate tariffs on 94 percent of two-way trade in 10 years after the pact takes effect. The tariffs to be abolished include those on Indian exports of car components, DVD players, video cameras, peaches and strawberries to Japan, while Japan would improve access to most industrial products, as well as durian, curry, tea leaves and shrimp.

If there is anything to be bullish about, it is that the direction of geopolitics seems headed towards embracing broader ‘free’ trade.

Japan’s Lost Decade Wasn’t Due To Deflation But Stagnation From Massive Interventionism

Many of you may be familiar with the idiom to “fit a square peg to a round hole”. This simply means, according the Free dictionary, “trying to combine two things that do not belong or fit together.”

From Oftwominds.com

I think this expediently characterizes mainstream’s misplaced notion about Japan’s long held predicament: deflation.

Because of the mammoth boom-bust cycle seen in Japan's property and stock markets, which led to Japan’s economic “lost decade”, the image of the Great Depression of the 1930s has frequently been conjured or extrapolated as the modern version for it.

Of course, there is a second major reason for this, and it has been ideologically rooted, i.e. the bubble bust has been used as an opportunity to justify the imposition of theoretical fixes by means of more interventionism.

Has a deflationary depression blighted Japan?

If the deflation is measured in what mainstream sees as changes in the price level of the consumer price index, then the answer is apparently a NO.

As you would notice from the graph from moneyandmarkets.com, deflation isn’t only episodic (or not sustained), but likewise Japan’s intermittent economic growth (blue bars) came amidst the backdrop of negative or almost negative CPI (red line)! In other words, economic growth picked up when prices where in deflation--this translates to real growth.

And if measured in terms of changes in monetary aggregates, then obviously given that the changes in Japan's M2 has been steadily positive, as shown by the chart above from Northern Trust, all throughout the lost decade, then we can rule out a "monetary deflation".

Of course, the next easiest thing for the mainstream to do is to pin the blame on credit growth.

chart from McKinsey Quarterly

While there is some grain of truth to this, this view isn’t complete. It doesn’t show whether the lack of credit growth has been mainly from demand or supply based. It doesn't even reveal why this came about.

We can even say that such generalizations signify as fallacy of division. Why? Because the problem with macro analysis is almost always predicated on heuristics-or the oversimplification of variables involved in the analytic process.

Banks have not been the sole source of Japan’s ‘credit’ market. In fact, there are many as shown below.

According to Promise.co.jp (bold emphasis mine)

``Providing credit to consumers is generally referred to as "consumer credit." This can be classified into two types. The first is providing credit to allow consumers to buy specific goods and services, which is called "sales on financing," and the second is providing credit in cash, which is called "consumer finance." There are many types of financial service companies that offer consumer finance, including banks, but compenies which specialize in providing small loans to consumers are referred to as "consumer finance companies."

Further promise.co.jp describes the function of consumer finance companies as providing credit

``including loans but, unlike banks, do not take deposits are referred to as "non-banks." Leasing companies, installment sales finance enterprises, credit card companies, and consumer finance enterprises belong to the non-bank category.”

So how has Japan’s alternative financing companies performed during the lost decade?

Promise provides as an especially noteworthy chart. It shows of the following:

1) During the lost decade or from 1989-2007, the share of consumer financing companies (yellow-orange bar) has exploded from 15.6% to 41.9%!

2) Other forms of credit (apple green bar) also jumped from 13.4% to 30.1% during the same period.

3) The bubble bust has patently shriveled the share of 'traditional bank' based lending or the share of lending from commercial financial institutions collapsed from 48% to 12.4%.

4) The sales financing companies likewise lost some ground from 22.4% to today’s 15.6%.

All these reveals that while it is true that nominal or gross lending has declined, there has been a structural shift in the concentration of lending activities mainly from the banking to consumer financing companies and "other" sources.

And importantly, it disproves the idea that Japanese consumers have “dropped dead” or that the decline in lending has been from the demand side.

Obviously banks were hampered by the losses stemming from the bubble bust. But this wasn’t all, government meddling in terms of bailouts were partly responsible, as we wrote in 2008 Short Lessons from the Fall of Japan

``One, affected companies or industries which seek shelter from the government are likely to underperform simply because like in the Japan experience, productive capital won’t be allowed to flow where it is needed.

``Thus, the unproductive use of capital in shoring up those affected by today's crisis will likely reduce any industry or company’s capacity to hurdle its cost of capital.

``Two, since capital always looks for net positive returns then obviously capital flows are likely to go into sectors that aren't hampered by cost of capital issues from government intervention.

``This probably means a NEW market leadership (sectoral) and or money flows OUTSIDE the US or from markets/economies heavily impacted by the crisis.”

Apparently, our observation was correct, the new leadership had shifted to the financing companies.

But there is more.

Because the banking system had been immobilized, which conspicuously tightened credit access, the explosive growth of the financing companies emerged as result of demand looking for alternative sources of supply.

In addition, financing companies, who saw these opportunities circumvented tight regulations or resorted to regulatory arbitrage, in order to fulfill this role.

According to the Federal Bank of San Franscisco, (bold emphasis mine)

``Prior to the passage of the new legislation, Japan had two laws restricting consumer loan interest rates. The Interest Rate Restriction Law of 1954 set lending rates based on the size of the loan, with a maximum rate of 20 percent. The Investment Deposit Interest Rate Law, last amended in 2000, capped interest rates on consumer loans at 29.2 percent on the condition that any rate exceeding 20 percent requires the written consent of the borrower. Most Japanese CFCs have been operating in this “gray zone” of interest rates, charging rates between 20 and 29.2 percent.

``Non-bank consumer finance companies in Japan comprise a ¥20 trillion industry, averaging 4 percent annual loan growth over the past decade while bank loan growth was negative. Most of the approximately 14,000 registered lenders are small, with the largest seven operators-which include the consumer finance arms of GE Capital and Citigroup- having a 70 percent market share. The significant growth in this industry can be traced directly to the collapse of the asset bubble in the early 1990s when consumers whose collateral had dwindled in value turned to CFCs offering uncollateralized loans. Adding to the success of the industry was the fact that CFCs were more service-oriented than the retail operations of Japanese banks, offering a wider network of loan offices, 24-hour loan ATMs, and faster credit approval.”

In short, banking regulations and policies proved to be an important obstacle to credit access.

Yet, the Japanese government worked to rehabilitate on these legal loop holes. This led to further restrictions to credit access.

According to Yuki Allyson Honjo, Senior Vice President, Fox-Pitt Kelton (Asia), [bold emphasis mine]

``The Supreme Court made a ruling in 2006 to make it easier for individuals to collect repayment of interest in excess of that allowed under the Interest Rate Restriction Law (grey zone interest). The court ruling called into question the legality of the grey zone. This prompted revisiting of the rules governing money lending and forced companies to create grey zone reserves. People were entitled to claim the "extra" interest they paid from their lenders.

``Revisions to the money lending laws were passed, and by June 2010, the maximum lending rate will be unified to rates specified under the Interest Rate Restriction Law, thereby eliminating the grey zone. Loans will be limited to a third of borrowers' annual income. For loans exceeding 1 million yen, moneylenders would be obligated to inquire about the applicant's annual income. Implementation is still ambiguous. Regulators are to have more power, such as the ability to issue business improvement orders.

``The rate decline held various consequences for the industry. Margins were lowered as lenders were forced to lower their lending rates. There was a reduction in volume, with loans to current borrowers no longer being profitable, some customers were deemed too high-risk to borrow at the lower rates. Customers could borrow less due to new legislation restricting total loans as a percentage of income. Also, there has been a rise in write-offs.

``The result of all of this is that the number of registered money lenders has dropped precipitously since regulation began in 1984. The loan market is an oligopoly with 60% of the total loan balance with the Big Four, and 90% percent with the top 25 firms. This oligopoly was created in reaction to regulation.

``Stock prices for money lending companies began to drop steadily in 2006, predating the current economic crisis. The necessity for grey zone reserves has caused problems in money lenders' balance sheets. In March 2007, there are many large negative numbers visible in the balance sheets of Aiful, Takefuji, Acom and Promise. Loans approval rates crashed around 2006, with Aiful only accepting 7% of loans recently, down from over 50% before the 2006 Supreme Court rulings. Every month, 25-30 billion yen is paid out by money lenders to customers in grey zone claims, increasing steadily since 2006. Grey zone refunds have begun to pick up recently as a result of the recent economic crisis.

``The consequences of the court ruling and the re-regulation are that the Big Four companies found direct funding difficult. Credit default swaps have increased dramatically for Takefuji and Aiful, who are now essentially priced to fail. Bond yields also increased and going to market is difficult for these companies.

``From the regulator's perspective, re-regulation has been largely a success, given their aims. The size of the industry and the number of players have been reduced. The government has greater control on the industry and over-borrowing has been reduced. In regard to this last goal, its success is unclear as black market statistics are not reliable. In fact, anecdotes suggest that black market lending demand has increased.”

So aside the aftermath bubble bust, the bailouts of zombie institutions and taxes we discovered that government diktat have been the instrumental cause of supply-side impairments in Japan's credit industry.

Moreover, the other consequences has been to restrain competition by limiting the number of firms which led to the persistence of high unemployment rates, and fostered too-big-to-fail "oligopolies" institutions.

So we can conclude two things:

1. Japan’s economic malaise hasn’t been about deflation but about stagnation from wrong policies.

2. The weakness in Japan’s credit growth essentially has also not been about liquidity preference and the attendant liquidity trap, or the contest between capital and labor, or about subdued aggregate demand, but these has been mostly about the manifestations of the unintended consequences of the Japanese government's excessive interventionism.

As Ludwig von Mises wrote,

``The various measures, by which interventionism tries to direct business, cannot achieve the aims its honest advocates are seeking by their application. Interventionist measures lead to conditions which, from the standpoint of those who recommend them, are actually less desirable than those they are designed to alleviate. They create unemployment, depression, monopoly, distress. They may make a few people richer, but they make all others poorer and less satisfied.”

And it is here that we see how the mainstream can't seem to fit the square peg (deflation) to the round hole (stagnation).

Marc Faber: China Next Shoe To Drop, Bullish Japan, Possible War Ahead

Here is an audio of Dr. Marc Faber's latest interview (source Marc Faber)

some excerpts...

China’s Imminent Implosion

My guess is that the economy despite all the stimulus is growing at between 0% to 3 ½%...

Bank lending went mostly into further misallocation of resource, it created another bubble in the share market and probably led to over construction in properties around major cities...

When will the Chinese economy also implode? And I think that is still a shoe to drop on the global economy. Maybe it is going to happen in 2010 and maybe they can postpone it for another year or 2 and so forth…

We have a credit bubble in the US, in China we have an investment bubble with overcapacity arising in the export industries..in the property market. When you try to kindda of support these bubbles markets with intervention through fiscal and monetary measures, you don’t solve the problem but you postpone it...

My view is that the economy globally will remain weak, maybe we have a period of recovery that last 6-9 months, because of all the stimulus packages, and then the economies weaken again, but that asset markets in some cases despite the weak economy will go up for the simple reason central banks will keep on printing money...

Bullish on Japan

In the case of Japan I would add that when the market bottomed out in March 2009, we were at the 30 year low basis, we were at the same level then we were in 1981, so if you took the S&P down to that level we would be at 120...

So we have in Japan a secular bear market, in other words we peak out in 1989 and from 89 we went down and we had several rallies of over 40% and finally bottomed out in 2009 and in my view this is a major secular low, the way we had a secular lows in the US in the 1940s in real terms and in 1982, we were we had significant increases in share prices. So on any setback, I would consider increasing my position in Japan...

Possible War Ahead

Nothing at all has been solved or improved..

Policymakers took decisions that will actually make the system less transparent and more vulnerable than before..

What kind of policy that try to create prosperity out of bubbles?...that’s the mentality of the Federal Reserve..

The entire capitalist system will totally collapse…I don’t whether it will collapse in one year’s time or in 5 years time or 10 years time…

Total collapse is ahead of us…

Before everything collapse what governments usually do is to go to war so they can distract attention for awhile, and stay in power, and then eventually everything goes sour….

Buy gold but keep it out of the US

Emerging Labor Protectionism In Japan

In 1850 Frederic Bastiat wrote in his prologue the magnificent must read essay, That Which is Seen, and That Which is Not Seen

``In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause - it is seen. The others unfold in succession - they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference - the one takes account of the visible effect; the other takes account both of the effects which are seen, and also of those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, - at the risk of a small present evil."

In other words, laws always constitute an economic trade off between the present and the future. Policymakers are usually predisposed to respond to short term visible effects arising from crops of present concerns but ignoring the larger costs from unforeseen consequences.

We have a very good example of this phenomenon unfolding in today's crisis laden environment.

In Japan, the current deep recession has compelled policymakers to repatriate its migrant workers as reaction to widening unemployment.

According to the New York Times, ``But the nation’s manufacturing sector has slumped as demand for Japanese goods evaporates worldwide, prompting job cuts and pushing the jobless rate to a three-year high of 4.4 percent. Japan’s exports plunged 46 percent in March from a year earlier, and industrial production is at its lowest level in 25 years.

``So Japan has been keen to help foreign workers go home, thus easing pressure on domestic labor markets and getting thousands off unemployment rolls.

“Japan’s economy has hit a rainstorm. There won’t be good employment opportunities for a while, so that’s why we’re suggesting that the Nikkei Brazilians go home,” said Jiro Kawasaki, a former health minister and senior lawmaker of the ruling Liberal Democratic Party.

``“Naturally, we don’t want those same people back in Japan after a couple of months,” Mr. Kawasaki said, who led the ruling party task force that devised the repatriation plan, part of a wider emergency strategy to combat rising unemployment in Japan. “Then Japanese taxpayers would ask, ‘What kind of ridiculous policy is this?’ ”

``Under the emergency program, introduced this month, the country’s Brazilian and other Latin American guest workers are offered $3,000 toward air fare, plus $2,000 for each dependent — attractive lump sums for many immigrants here. Workers who leave have been told they can pocket any change.

The idea is, in order to ease statistical unemployment, Japan's policymakers simply decided to send the laborers away! Reduced workers equals low unemployment rates-what genius!

Next, such reactionary program possibly unmasks of Japan policymakers' narrowmindedness and antagonism to global cultural integration.

More from the New York Times, ``But Mr. Kawasaki, the former health minister, said the economic slump was a good opportunity to overhaul Japan’s immigration policy as a whole.

``“We should stop letting unskilled laborers into Japan. We should make sure that even the three-K jobs are paid well, and that they are filled by Japanese,” he said.

``“I do not think that Japan should ever become a multi-ethnic society” like the United States, which “has been a failure on the immigration front,” Mr. Kawasaki added. That failure, he said, was demonstrated by extreme income inequalities between rich Americans and poor immigrants.

Another, Japan's recent actions reflects discrimination and protectionism...

Again from the New York Times, ``Japan’s repatriation offer is limited to the country’s Latin American guest workers, whose Japanese parents and grandparents emigrated to Brazil and neighboring countries a century ago to work on coffee plantations...

``The plan to fly immigrants out of Japan has come as a shock to many here, especially after the Japanese government introduced a number of measures in recent months to help jobless foreigners, including free Japanese-language courses, vocational training and job counseling. Guest workers are eligible for limited cash unemployment benefits, provided they have paid monthly premiums.

``“It’s baffling,” said Angelo Ishi, an associate professor in sociology at Musashi University in Tokyo. “The Japanese government has previously made it clear that they welcome Japanese-Brazilians, but this is an insult to the community.”

Lastly the article showcases Japan's structural long term problems...

``The program comes despite warnings that the aging country needs all the foreign workers it can attract to stave off a impending labor shortage.

``Japan’s population has been falling since 2005, and its working-age population could fall by a third by 2050. Though manufacturers have been laying off workers, sectors like farming and elderly care still face shortages...

``Critics denounce the program as short-sighted and inhumane, and a threat to what little progress Japan has made in opening its economy to foreign workers.

``“It’s a disgrace. It’s cold-hearted,” said Hidenori Sakanaka, director of the Japan Immigration Policy Institute. “And Japan is kicking itself in the foot... we might be in a recession now, but it’s clear it doesn’t have a future without workers from overseas.”

The present recession will not last forever. And as its economy recovers, Japan's dwindling population (see the above chart from japanfocus.org) will endure strains from labor shortages.

While Japan can easily absorb more foreign workers when it is deemed as politically convenient, it would bear additional costs from the "learning curve" to integrate foreign workers to its society.

Moreover, Japan's selective application of repatriation policy will likely incur a political backlash with affected Latin American countries which may lead to policy retaliation and even more protectionism.

Finally, Mr. Kawasaki's bigoted anti "multi-ethnic" society remarks will be faced with harsh reality. The persistence of a dwinding population will lead to societal extinction and economic regression.

Hence without raising its fertility rate, in order for Japan to maintain its status quo "society" means to adopt a culture of multi-ethnicity. (Unless cloning or other artificial scientific means of adding people comes into the script)

This noteworthy remark from Kyohei Morita chief economist at Barclays Capital in an interview with Finance Asia,

``But in Japan, the opposite is happening. Japan’s population has been shrinking since 2006, which will continue to put downward pressure on GDP. In 300 years, at the current rate of decrease, Japan’s population will be extinct." (emphasis mine)

After over a hundred years, Bastiat's message is more than relevant as it is universal.

The Prospective Farming Boom: The Japan Experience

Legendary investor Jim Rogers has repeatedly predicted that participants of the next global sunshine industry would be driving Lamborghinis and Maseratis will be mostly farmers.

In Japan, farming appears to be on a verge to a boom but NOT because of demand-supply disparities as seen through rising commodity prices YET. But because farming seems to be a dying industry (again validating the view that the age long neglect of the industry has been contributing to global supply pressures) and presently benefiting from the recessionary pressures in their economy- farming is one of the industries that has the capability to absorb displaced and idled workers from the recent crisis.

All pictures from Wall Street Journal, slide show here

This from the Wall Street Journal, (all bold highlights mine)…

``As the global financial crisis sinks Japan into its worst recession since World War II and hundreds of thousands of jobs are slashed in factories and offices, farming has emerged as a promising new career track. "Agriculture Will Save Japan," blared a headline for a business weekly magazine. Farmer's Kitchen, a popular new Tokyo restaurant, plasters its walls with posters of hunky farmers who supply the eatery with organic vegetables.

``Seeing agriculture as one of the few industries that could generate jobs right now, the government has earmarked $10 million to send 900 people to job-training programs in farming, forestry and fishing. Japan's unemployment rate was 4.4% in February, up from 3.9% a year earlier, but still lower than the U.S. or Europe. Some economists expect the figure to rise to a record 8% or so within the next couple of years.

``Policy makers are hoping newly unemployed young people will help revive Japan's dwindling farming population, where two in three full-time farmers are 65 or older. Of Japan's total population, 6% work in agriculture, most doing so only part time, down from about 20% three decades ago.

``"If they can't find young workers over the next several years, Japan's agriculture will disappear," said Kazumasa Iwata, a government economist and former deputy governor of the Bank of Japan.

Of course a radical shift in the economy export driven environment has brought about a resistance to change in terms of work attitude.

Again from the same WSJ article,

``Despite the popularity of the training programs and of the government's longer, one-year farm internships, many young people end up returning to cities, unable to adjust to life in the countryside. Last year, Fukiko Oshiro, a farmer in western Okayama prefecture, hired five workers from cities like Osaka, including a couple of former salesmen, to work at her nursery and fruit farm. She said she has already lost three of them.

``"These young people think it's their right to come and impose on us," said Ms. Oshiro as she surveyed her busy farm stand recently. "They have no idea how much work we put in to teach them."

``Since the beginning of the year, said Ms. Oshiro, her farm has received a flood of résumés from people affected by the recession, including some let go from a nearby assembly plant of Mitsubishi Motors Corp. While Ms. Oshiro needs more workers for her expanding farm, she doesn't have high expectations for these applicants.

``"At least people who came before were interested in agriculture," the 49-year-old said. "These new applicants are coming because they have no other choice."

All these simply show how resources misused in the previous unsustainable policy induced booms which are released from the present contracting activities and are being transferred into previously underinvested but are today's expanding industries.

Finally as to bust turning into a boom relative to labor, here is a description from John Cochran and Noah Yetter in Capital in Disequilibrium: An Austrian Approach to Recession and Recovery (bold emphasis mine)

``The reallocation of labor develops in much the same fashion as the reallocation of capital. Firms realize they have employed labor in a pattern inconsistent with consumer preferences, and this labor is then liquidated (i.e.: workers are laid off). It must be remembered that labor has specificity just like capital does, and it likely will not do to offer workers pay cuts when the type of labor services those workers provide is realized to be wholly inappropriate (viz. consumer preferences)….Unfortunately for workers, it is difficult for the economy to reallocate labor until it has already reallocated capital. That is, though firms are realizing their errors and adjusting production plans to once again coincide with consumer preferences, labor employment in sectors towards which activity is being directed is not likely to be strong until the necessary capital is in place to complement it.”

Until more capital is promptly reallocated towards farming where the benefits will be strongly felt, the present recovery will likely be muted.

Nonetheless, the torrent of global government spending ensures that this phenomenon will likely accelerate.

Has The Deleveraging Process Culminated? Where’s The Next Bubble?

``Many shall be restored that now are fallen and many shall fall that now are in honor.”- Horace, leading Roman lyric poet in Ars Poetica

Global markets rallied furiously over the week, setting stage for what perma bears call as the sucker’s rally. For all we know, they could be right. But I wouldn’t bet on them. Not especially when central banks start to use the first of its available nuclear option of monetizing government debt. Not when government central banks start running the printing presses 24/7 and begin a Zimbabwe type of operation.

We also don’t know to what extent of the forcible liquidations of the deleveraging process is into, what we do know is that governments are today starting to unveil their long kept ‘secret’ final endgame weapons. We appear to be at the all important crossroads. Will it be a deflationary depression outcome? Will it be a recovery? Or will hyperinflation emerge?

What we also know is that forcible liquidations from the ongoing debt deflation process have been responsible for the “recoupling” saga we are seeing today.

Figure 4 stockcharts.com: Gold leads Rally

In figure 4, compared to the previous failed rallies (2 blue vertical lines), gold, oil and commodities haven’t joined the bullish rebellion in global equities as shown by the US S & P 500 (spx), Dow Jones World (djw), and Emerging Market Index (EEM).

This time we see gold leading a broad market rally. The Philippine Phisix too has obliterated its 10.73% one week loss by surging 11.65% this week. And even our Peso has joined the uprising by breaking down the psychological 49 barrier.

In short, this week’s rally does look like a broad market rally. And broad market rallies usually have sustaining power.

The Philippine Stock Exchange’s market internal tells us that even during the other week’s meltdown, the scale of foreign selling appears to have diminished. It had been the local retail investor jumping ship. This week’s rally came with even less foreign selling even if we omit the special block sales of Philex Mining last Friday.

My ‘fallacy of composition’ analysis makes me suspect that perhaps the issue of deleveraging has ebbed, simply because as the US markets cratered to form a NEW low, just about a week ago, key Asian stocks as the Nikkei 225 ($nikk), Shanghai composite ($ssec) and our Phisix have held ground see figure 5.

Figure 5: Stockcharts.com: Asian stocks Show Signs of Resilience

To consider, even as streams of bad economic news keeps pouring in, as Japan has reportedly entered an official ‘technical’ recession or two successive quarters of negative growth, its main benchmark the Nikkei appear to be holding ground.

It’s been said that once a bear market has stopped being weighed by more streams of bad news or despite this they even begin to rise; this mean that markets may have digested all negative info and may have signaled that a bottom has finally been established. As we quoted Jim Rogers on a video interview, ``When people say it is over and when we you see more bad news and stocks stop going down. But when they go up on bad news, that’s when we are gonna hit bottom. We are not gonna scream I don't know."

Although it could be too premature to decipher recent events as a bottom, we’d like to see more improvement in the technical picture and even more participation from major benchmarks of the region (djp2) aside from sustained rise from the market leader-gold.

Furthermore, if indeed the deleveraging process is beginning to fade, then the next phase should be markets factoring in the repercussions from the recent credit crunch to the real economy. But considering the steep fall during the October-November carnage, it is our impression that most of these had already been factored in.

Moreover, the downturn in the real economy should reflect divergences because not all of the Asian region’s economy will experience recessions see figure 6.

Figure 6 IMF: Emerging Asia Quarterly Growth Forecast

As you can see from the IMF’s regional outlook, except for Industrial Asia (Japan, Australia and New Zealand) which is the only class expected to flirt with an economic recession 2009, the rest of Asia’s economic growth engine is expected to only moderate with the Newly Industrialized Economies (Hong Kong Korea Singapore Taiwan) experiencing the most volatility (steep fall but equally sharp recovery). Most of the Asia is expected to strongly recover during the second half of 2009.

Now if the IMF projection is accurate and if stock markets are truly discounting economic growth to the streams of future cash flows of companies, then we should begin to see today’s rally as sustainable, reflective of these projections and at the bottom phase of the market cycle.

This also means sans further deleveraging prompted liquidations, we could expect some stark divergences in market performances. Unless, of course the headwinds from the collective efforts to inflate impacts every asset class simultaneously, which we think is quite unlikely. But as we earlier said, the bubble structure in the US isn’t going to revive and that any new bubble will come from elsewhere, for example the US dot.com boom bust cycle shifted to the housing industry in 2003 as an offshoot to the inflationary policies applied against a deflating tech industry led market and economic bust.

Boom-bust market cycles always involve a change of leadership. And considering that gold has been the frontrunner during the recent bounce, we suspect that precious metals, energy, commodities, emerging markets and Asia as the next bubbles to blow.

Free Lunch Isn’t For Everyone, Ask Japan

Pundits have long debated about why and how Japan’s policies (e.g. ZIRP, Quantitative Easing, Infrastructure spending, etc…) have failed to “reinflate” its economy following the bubble bust in 1990s, which eventually led to “the lost decade”.

Naturally there won’t be one single or simplified answer to a complex problem, although it is just our thought that this article just may have provided one important clue.

This excerpt from Washington Post’s article entitled “Free Money? In Japan, Most Say They Will Pass”.

All highlight mine.

Japan is having trouble giving away a free lunch.

To perk up the fast-shrinking economy, Prime Minister Taro Aso announced late last month that his government would give everybody money. A family of four would get $600.

Then the trouble -- and the confusion -- started.

Should rich people get it? How rich is rich? Who decides who is rich, and how long will it take to decide?

Aso, who came to power in September and within a year must call a national election that polls show he may well lose, declared initially that everyone, rich and poor, would get the money.

Then Kaoru Yosano, the minister for economic and fiscal policy, said that perhaps the rich should not get any money. He noted that such a giveaway could be viewed as an unseemly attempt by the prime minister and his ruling Liberal Democratic Party to curry favor with voters.

Aso found that to be a reasonable argument and said an income cap would probably be a good idea.

Then his finance minister, Shoichi Nakagawa, said that figuring out who is too rich for a handout would create an excessive workload for local governments. He also said it would delay the distribution of money, which Aso wants to get into people's pockets by March.

Aso found this, too, to be a reasonable argument and said on Monday, "No income cap will be implemented."

Now it turns out that voters do not want the money.

Sixty-three percent said they think that a handout is unnecessary, according to a poll published Wednesday in the Asahi, a national daily. Every age group opposes it, as does a majority in Aso's ruling party, the poll found.

One answer is C-U-L-T-U-R-E.

The Japanese are such fanatical savers that they are the reigning titlist as the world’s biggest savers, which according to aol.com, ``boast nearly $15 trillion in domestic household financial assets, about half of which sit in bank deposit accounts.”

So with so much money stashed in the banks, obviously there isn’t any urgency for most of the Japanese for free lunches in the same way most of the world drools over such opportunity.

The other dilemma clearly emphasized by the article is how noble intentions dreamt or conjured up by regulators and egalitarians get cluttered with the argument over classifications, conflict of interest and the unintended consequence of bureaucratic nightmare.

The morals of the story:

Since everyone would have different set of values, you simply can’t please everybody.

There is no single "regulatory" solution to the problems of mankind.

Short Lessons from the Fall of Japan

Interesting article from Fool.com’s Bill Mann on “Falling Like Japan”, here is an excerpt (all highlights mine),

``In the aftermath of the bubble, Japan's government rushed in to prop up its banking system, which was teetering under the weight of non-performing loans. Rather than letting businesses fail, this has had the effect of propping them up to continue operating. To this day the scope of the problem is still not known.

``Without this information, investors both in Japan and outside have made a logical conclusion -- to take their investment dollars elsewhere. Japan's industrial sector has failed to meet its cost of capital over the last 20 years, in large measure because the government has allowed capital-destroying companies to continue to operate. Had these companies been allowed to fail, Japan long ago could have flushed out its system and gotten back on the road to economic health. In the name of protecting jobs, Japan's economy has continued to sputter, punctuated by spectacular bankruptcies in cases where the facade could not hold up. The cost of propping them up has been much, much more economic pain. Japanese call the long economic downturn ushinawareta jūnen, the lost decade.”

My humble two cents:

One, affected companies or industries which seek shelter from the government are likely to underperform simply because like in the Japan experience, productive capital won’t be allowed to flow where it is needed.

Thus, the unproductive use of capital in shoring up those affected by today's crisis will likely reduce any industry or company’s capacity to hurdle its cost of capital.

Two, since capital always looks for net positive returns then obviously capital flows are likely to go into sectors that aren't hampered by cost of capital issues from government intervention.

This probably means a NEW market leadership (sectoral) and or money flows OUTSIDE the US or from markets/economies heavily impacted by the crisis.

OFW Domestic Helpers Beware: The Home Robots Are Coming

If Filipinos worried about a slowdown of remittances from a potential worldwide economic recession seems valid enough, household chores based OFWs should worry about this.

Toyota has developed home robots that can do household work, and is about to hit the market in seven years time.

courtesy of Japan Times

This from the Japanese Times,

``Toyota Motor Corp. and a research body of the University of Tokyo have jointly developed a prototype for what many busy career people have been dreaming of for a long time: A hardworking robot that handles household chores.

``In a demonstration for reporters last week, the robot cleaned up rooms, smoothly put away dishes from a dining table and picked up shirts and put them in a washing machine.

``The 155-cm, 130-kg humanoid robot excels in the capacity to distinguish and perceive objects such as furniture and cleaning equipment, its developers said.

``The robot also analyzes past failures and corrects its behavior patterns, they said.

``Toyota and Tokyo University's Information and Robot Technology Research Initiative said the robot has been designed to help cope with the predicted labor shortage stemming from Japan's aging society and low birthrate.

``The developers said they will keep improving the robot and hope to start marketing it in around seven years.

``The robot is equipped with two arms, five recognition cameras and laser sensors. It gets around on wheels."

Some observations:

One, the present technology of robots are limited yet. They can’t drop or fetch school children, nor can they clothe, bath or apply first aid to them. Nor can they cook for the family or do marketing chores. But constant innovation will probably add more of these features in the future.

Two, if the cost of buying and maintaining a robot would prove to be more affordable or beneficial than one dispensed by the present household maids then our OFWs are likely in jeopardy of losing work. Yes, seven years is still seven years but preparation should prepare us from any shocks.

Three, Japan still has an inherently closed culture such that it would prefer to invent robots to do household work than to allow other nationalities to assume such a role.

With a rapidly declining population its a curiosity that they're afraid or averse to "intermarriages" or opening their society to other nationalities.

Japan’s Nikkei As Indicator

Japan is on the verge of breaking down from its major support levels. The Nikkei closed at 7,649 last Friday, compared to its previous low at 7,607 in April 2003.

Northern Trust: Nikkei 225 Long term chart

Here are some of our observations.

One, in the last major attempt to move forward during the late 1998-99, the Nikkei lost about 61%. Today the Nikkei is down about 58%. From the summit, the Nikkei has lost about 80% since 1989. Thus the tag of the “lost decade”.

Two, a Nikkei breakdown could mean a bottom phase yet to be ascertained since 1989 which also means structural bear markets could last for years.

Three, a breakdown of the Nikkei could signify as a leading indicator to the fate of the US markets over the interim.

Lastly this is not to suggest that the US markets will do a Nikkei’s “lost decade”. While there have been some significant parallels, conditions are greatly different. As an example the lost decade of Japan was “insulated” compared to the more global dependent US whose recent bubble bust has triggered a worldwide contagion. Thus, any comparison of the Nikkei’s travails to the US is an apple to orange comparison.

The point is that a breakdown of the Japan’s Nikkei could likely mean more downside actions for world markets.

Fiscal Bailout, US Monetary Policies To Ensure Inflation Transmission To Global Economies

``It seems clear that much of the current crisis has been exacerbated by mark-to-market accounting, which has created massive, and unnecessary, losses for financial firms. These losses, caused because the current price of many illiquid securities are well below the true hold-to-maturity value, could have been avoided. The current crisis is actually smaller than the 1980s and 1990s bank and savings and loan crisis, but is being made dramatically worse by the current accounting rules." Brian Wesbury, FT Advisors, Mark-to-Market Mayhem

As we have repeatedly been saying, the US Federal Reserve hopes to inflate the world through its currency pegs or dollar links in the hope that the monetary stimulus applied will revive global growth to support its export sector as the local economy is being battered by the deflating debt storm.

Chairman Ben Bernanke understands that without exports the US economy would even be more vulnerable. Thus, the United States’ over reliance on foreign trade underscores the need for such stimulus transmission. It had been an unintended consequence before it looks like an unstated policy goal today.

Of course, another reason for passing the inflation buck is that EM countries have been more than willing to take on the real currency and interest rate risk-which means EM economies can afford to suffer from real value losses (via inflation) of their US portfolio holdings.

Since the Bretton Woods II framework has been driven by political objectives-for EM countries keeping currency undervalued for mercantilist goals- than by economic ones, as EM economies continue to support the US economy by buying into US treasuries despite the extremely low yields or expensive bonds, the risk is that perhaps the changing political objectives might lead to a shift in the global currency framework and consequently a US dollar crisis.

In the same plane, the fundamental reason why the US financial markets are being rescued is probably because Chairman Ben Bernanke understands that the current account deficit has been continuously plugged by foreign financing via the acquisition of paper claims on US assets. First it was Fannie and Freddie. Next it was AIG.

Now signs of growing political heft by foreigners into shaping domestic US policies, from an article in the New York Times,

``Foreign banks, which were initially excluded from the plan, lobbied successfully over the weekend to be able to sell the toxic American mortgage debt owned by their American units to the Treasury, getting the same treatment as United States banks.”

Another reason why? Because Chairman Bernanke understands that the US needs to get its feet back on the ground by having foreigners to provide the much required recapitalization of its severely impaired banking system aside from its present actions to cobble enough resources for a system wide bailout long enough to buy time for the world to recover.

From Kenichi Amaki of Matthews Asia, ``This week, two Japanese financial institutions stepped out of the shadows of the past to pick up stakes in some of their more recognized competitors. Japan's largest securities firm and investment bank announced the acquisition of Lehman Brothers' Asia Pacific, European and Middle Eastern businesses, including Lehman’s 5,500 employees in those regions, for an undisclosed amount. At the same time, Japan’s largest bank, announced that it had agreed to take an equity stake of up to 20% in Morgan Stanley for roughly $8.5 billion. These deals are expected to significantly boost both firms’ investment banking capabilities in geographic regions traditionally weak for them.”

Think of it this way, if the overall outstanding mortgage debt on non farm homes is $11.2 trillion where Fannie and Freddie holds $5.4 trillion, a 10% loss is easily equivalent to $1.12 trillion. This does not include the $2.4 trillion of “other mortgage debt” (corporate farms et. al.) and the $2.5 trillion outstanding consumer credit, which could likewise be impacted by a slowing economy and the ongoing credit crunch (hat tip: Brad Setser). So the proposed $700 billion package for the bailout will probably be insufficient.

Figure 4: The Economist: Cost of Previous Bailouts

Anyway, there had been greater amounts of bailouts as measured by the fiscal cost in % the GDP. According to the Economist,

``CONGRESS is under pressure to approve the Treasury's proposed $700 billion rescue package. Lawmakers, however, are conscious of the cost to the taxpayer: together with loans to AIG and Bear Stearns, public backing so far approaches 6% of GDP. This is well above the 3.7% of GDP of the savings-and-loan bail-out in the late 1980s and early 1990s. But some 6% of GDP is still much less than the average cost of resolving banking crises around the world in the past three decades, which a study by Luc Laeven and Fabian Valencia, of the IMF, puts at 16%.”

In nominal terms the present bailout would be gargantuan but the justifications using historical average cost of 16% could mean there might be more in store in the future as the weakness in US economy spreads.

Thus, my view is slanted towards the idea that any possible rescue package will tacitly be directed to stimulate global economies to enable them to fund the US current account deficit by buying into US financial claims on a guarantee aside from attracting potential financing flows from overseas state and private institutions to recapitalize the floundering US banking system.

There has been a barrage of thoughtful solutions on how to go about the bailout scheme some of which had been suggested by noteworthy figures as Raghuram Rajan suspend dividends and rights offering on solvent banks, Nouriel Roubini New HOLC, Luigi Zingales Debt for equity swap and debt forgiveness, Charles Calomiris Preferred stock assistance, Steve Waldman nationalization, Brian Wesbury temporary suspension of FAS 157 mark-to-market rules and Bill King create a new system parallel with the existing dysfunctional system and decentralization of liquidity (hat tip: Barry Ritholz) among the others.

It’s a wild guess on how the US Congress will go about configuring this package.

Nonetheless, it does seem that most of the world markets have been anxiously awaiting for the details of the US Congress led fiscal bailout of the US banking system.

This poignant New York Times quote from an anonymous Wall Street broker seems to have captured the essence of the markets abroad (highlight mine), ``People have definitely been saying that this is no longer an investor’s market, nor even really a trader’s market — it’s all entirely speculation on what the government is going to be doing next…Anyone who thinks they have a handle on where things are going is deluding themselves.” Indeed, since the credit crisis surfaced last year, the market has been living off from the onslaught of speculations to what government actions would be to done to stave off to magically vanquish the crisis.

Unfortunately, after over a year and upon waves after waves of government actions through assorted means of bridge financing and rescue takeovers this hasn’t prevented its financial markets or of most of the world markets from falling.

However, I think that as the contagion selling should eventually wear off despite the continued pressures in the US markets, aside from the indirect policy stimulus applied to foreign economies, which might give rise to a recovery of ex-US markets first in 2009.

Besides, the streak of selling has been ferocious enough to bring valuations to extremely oversold levels, see our last chart figure 5 from Daily Wealth,

Figure 5: Daily Wealth: Markdown on Emerging Market Valuations In Overshoot Mode!

From Chris Mayer ``The selloff is making things striking on the valuation front... which makes me bullish here. As you can see from the chart below, emerging markets haven't looked this cheap on a forward earnings basis in 20 years...”