Contemplating the Global Economy by the Uji River

After the Nikkei stock average fell below 7,000 and the yen rose to 90 against the dollar, the stock market began functioning this week as if it had come to its senses.

While looking a little unsteady, much like a patient right after leaving the hospital, the stock market has been recovering compared to when it was rushed to hospital with a sudden illness.

It seems that the second stage of the sub-prime bubble collapse may have come to a close. The first stage started with bankruptcies and mergers of investment banks and other banking institutions caused by the default of sub-prime loans and ended when governments around the world injected public funds to bail out some of these institutions.

The second stage opened with upheaval in the stock market. This was a period in which a financial meltdown hit countries such as Iceland, Ukraine, Pakistan, and Hungary. At the same time, stock prices and exchange rates fluctuated wildly.

The main players in the first stage were the governments of various countries as represented by US Treasury Secretary Henry Paulson as well as investment banks and other banking institutions. The image of the bald, sturdily built Treasury secretary who repeatedly appeared on the business pages of newspapers is no doubt still fresh in everyone’s minds. Meanwhile, the main players in the second stage were the IMF (International Monetary Fund), stock markets, and the yen. Finance Minister Nakagawa began appearing more frequently on the covers of foreign magazines just as a spotlight was being cast on the IMF managing director’s sex scandal.

From reading the Financial Times and other publications, various aspects of the world situation could be seen. For example, the richest man in Russia is now at the brink of financial disaster. He had invested in companies, and when share prices rose, he used the stock as collateral for even more investments. Just as during Japan’s bubble era, when share prices began to fall, the collateral value of the stock collapsed, and the Russian businessman must now offer additional collateral or repay his debts earlier.

With this as an example, individuals, companies, and countries around the world who had believed the economy would continue to grow are about to be tripped up.

Examples can be found outside Russia as well, such as excessive investment in Dubai, the collapse of the real estate bubble in China, declining stock prices in India and Brazil, and decreasing profits and assets in Middle Eastern countries due to falling oil prices. Cash that had flowed into newly developing countries is starting to return to the originating countries as if seeking equilibrium. In addition, the yen strengthened against the dollar, and finally, the second stage came to a close with the yen emerging as the only rising currency.

Now we are entering the third stage of the sub-prime bubble collapse. The main players here will be consumers and companies. As consumers tighten their belts and become more selective about which commodities they buy, it is easy to imagine many companies around the world going bankrupt.

The first test will be the Big Three American auto makers. It is extremely difficult for companies to survive when sales drop by 20–30%. With consumers spending less, the first companies to go under will be those with no appealing products and who have invested too much based on the expectation of future growth. A similar situation occurred when the bubble burst in Japan. This time, however, bankruptcies and mergers will occur across the world. Losers will dissolve and be consolidated into winners.

Under these circumstances, I believe Japanese companies are in a relatively good position. GLOBIS maintains relationships with many companies through corporate training. Partly because many of these businesses have invested aggressively in human resource development, they have ample organizational power and high adaptability to change. Their portfolios are sound as a result of carefully selecting their core business. In addition, productivity and profitability have improved as a result of eliminating inefficiencies. Finally, short-term liquidity accumulated since the burst of the Japanese bubble economy is high. Given these considerations, I think the day will ultimately come when Japanese companies gain the upper hand around the world.

The Japanese stock market, however, has shown the biggest drop among developed countries. I simply don’t understand this at all. One economist explained the negative influence of the decline in overseas demand and a strong yen on Japanese companies by pointing out the heavy dependence of Japanese companies on overseas demand. But if that were true, those most strongly impacted would surely be overseas companies serving markets in Europe and America, the areas most likely to be affected. I didn’t think dependency on overseas demand could explain the plunging Japanese stock market.

I figured out the reason for this plunge during a business trip to the United States. As mentioned in my previous column, a bursting economic bubble is, in the end, a path Japan has already gone down once, and now Europe and the US are on it for the first time. Everyone in Japan, including investors and consumers, knows what comes next: a serious depression. On the other hand, since this is a new experience for investors overseas, they don’t quite see how things will turn out in the future in a real sense, although they may know in theory.

In short, my hypothesis is that while Japan and Asian countries are over-reacting from the fear of previous experiences, the West has not reacted strongly due to a lack of experience. (However, since my hypotheses often prove wrong, don’t feel too anxious over my thoughts. After all, I also predicted Hillary Clinton would defeat Barack Obama.)

I believe psychological factors can significantly influence the market. If my hypothesis is correct, I think only markets in Europe and North America (especially the US market) rather than those in Japan and Asia will start to slow considerably at some point.

As mentioned above, markets can be affected by psychological factors. This is how bubble economies happen. And I believe newly emerging economies such as the BRIC countries will be the most severely hit by the burst of this sub-prime bubble. The reasons are simple. When buzz words such as “BRICs” are coined and become popularized by the media, attention focuses on these countries and money begins flowing in without sufficient grounds. For a while, the agendas of international conferences were dominated by issues related to China and India. With all the attention, money pours in, and this is how bubbles occur; but such bubbles can easily collapse when triggered by some incident. The money flow then reverses. This can be seen in the fact that the Shanghai Stock Market showed the most dramatic decline (more than 70%).

On the other hand, Japan, America, and Europe were the focal point of the media with regard to the global economy after the sub-prime meltdown. I have seen very few articles on China and India in the newspapers recently. In short, the BRICs bubble was clearly created by a media that regarded it as larger than it really was. In times of emergency, the main players continue to be Japan, the United States, and the EU countries.

Within this group, the euro has substantially dropped while the dollar has weakened against the yen, which has become the dominant player. However, the global media has not shown any interest in reflecting on this situation, much less ceasing their Japan bashing or “Japan passing” (completely overlooking or snubbing), although it can sense the strengthening presence of Japan as the yen assumes a stronger role in the global economy. (The media will soon focus on what is good about Japanese companies and their strong fundamentals, as if they have known all along.)

Many Japanese experts have lamented Japan’s declining presence, and I was once a part of this crowd. But my attitude changed some time ago.

I have started declaring openly, “Go ahead, ignore Japan as much as you want. If you don’t want to get involved in Japan, don’t.”

Japanese can’t compete at the same level of English communication with native speakers like the Americans and the British. The Japanese really cannot be expected to exhibit the same audaciousness as the Chinese and Indians in their persistence and aggressive participation in discussions. In politics, the Japanese will not be able to flaunt their strength and presence by voicing their opposition for opposition’s sake or through political grandstanding, like the Russians and the French. In international conferences, Japan has no choice but to be modest.

I began to believe Japan might do best to stay out of the limelight. If the world only consisted of countries that strongly expressed their opinions, such as America, Russia, China, India and France, there would never be any agreement at all. In fact, at recent international conferences the intransigence of these countries has made it increasingly difficult to reach agreement on such issues as WTO negotiations and global warming.

Japan would be better off if it were to remain humble and quiet, as it tends to be, and gain some respect as a good global citizen that does what needs to be done without fail.

Still, I think it’s okay for anyone who still ignores and underestimates Japan to keep doing so. Japan will continue to be a major player in this third stage despite these attitudes.

However, even though Japan has become a major player, I think it’s best to remain quiet. Expectations that are too high are difficult to meet. Some might want to say, “After all that Japan bashing and ‘Japan passing’, what do you expect from us now?” But we should hold back. I think it’s best to be modest and keep a low profile, saying, “We’re not that great, so don’t expect too much from us.”

The G-20 will be held in Washington, D.C., and I hope the Japanese delegation will downplay Japan’s presence with the attitude of “Go ahead, don’t expect much from us.” The reason is that Japan may not be able to turn the current financial crisis into opportunity as a result of overly high expectations and responsibilities.

I think Japan should maintain its current presence of quiet leadership. The country can earn respect as a quiet leader by judicially surviving the sub-prime meltdown as a calm and upstanding global citizen.

I am now in Kyoto for the GLOBIS president’s office retreat (an overnight management seminar).

I can see the Uji River flowing before me as I write this column. I can also see the colors of autumn appearing on the yellow-green leaves at the foot the mountain. The red bridge over the river and the white spray splashing against the pier create a splendid contrast. The blue sky, white clouds, and green mountains reflect beautifully in the sunshine. Autumn in Kyoto is just around the corner.

Looking back in history, more than 1,200 years have passed since the capital was established in Kyoto. Even before then, the river flowed quietly without interruption, and continues to do so to this day.

No matter what happens in the world, despite the movements of markets or the relative strength or weakness of Japan’s presence in the world, I would like Japanese companies to move forward without losing the essential goodness of Japan.

“The flow of a running river is ceaseless, yet the water is never the same. The foam on a pool also vanishes and then reforms, the same foam never lingering.” Hojoki

There is no place related to Hojoki near here, but I have heard there is a scene from The Tale of Genji in this neighborhood. I think I’ll take a leisurely stroll tomorrow.

Yoshito Hori
October 29, 2008
By the Uji River, Kyoto