MW-77 -- Blowing Bubbles

J@pan Inc Magazine Presents:
Weekly Financial Commentary from Tokyo

Issue No. 77
Tuesday, May 25, 2004

@@ VIEWPOINT: Blowing Bubbles

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@@ VIEWPOINT: Blowing Bubbles

One of the more interesting aspects of an economy that allocates
capital poorly is the tendency for such economies to be able to
inflate isolated investment bubbles within the economy. The US had
the tech bubble of the late 90《 and early 00《, and a particularly
acute housing bubble in California and New York today. Australia
appears to be having a property bubble, China appears to be creating
bubbles in Shanghai real estate and stock market valuations in

If the US, the leader in free market economics, can inflate bubbles,
shouldn't Japan be able to?

The interesting thing about bubbles is you are never sure about
them until they deflate, or at least I am never sure about them until
they deflate. But there are some telltale signs that give a reasonable
degree of confidence. The banks in Japan have historically been the
worst at allocating capital efficiently, and in that respect little
appears to have changed in the last ten years. These institutions have
allocated capital at the behest of their political masters and ensured
vested interests received subsidized loans. Then, of course, when it
all went horribly wrong, the poor taxpayer had to foot the bill.

Now all the banks are awash with cash and have very little capital to
support such large amounts of cash, so they invest in the "safest" asset
they can find: Japanese Government Bonds (JGBs). Cash is collected at
0 percent and deposited into 10-year bonds with a 1.5 percent yield.

Sounds good -- but the assumption is that the bonds are safe.

These bonds are backed by the Japanese taxpayer who, at the moment,
cannot sustain the healthcare, pension and education systems without
massive borrowing. The tax base is eroding quickly.

How can we be bullish on equities if we are so bearish on the bond market?

The key question is: How will Japan extract itself from this problem?

My best guess is via inflation -- and lots of it. Bubbles can deflate
to the normal size (think of the dotcom bubble in the US, or the Japan
bubble); alternatively and metaphorically speaking, the inflated bubbles
can revert to the mean by all other bubbles or, "the rest of the economy"
growing to the same size through inflation (think of the inflation in
the US between 1946 and 1950 that reduced the real value of the war debt).

Both strategies are risky from a macro perspective, but the second is
better for equities in general, especially as inflation would,
in the normal course of events, cause the yen to devalue and increase
export earnings that Japan already relies on so heavily.

This is only what we think is the most likely course at this point. Time
will be our judge, and as we get new information we may change our
minds. But as we are so bullish on Japanese equities, we felt obliged
to go on the record for interest rates too, and the bottom line is we
believe the biggest wealth destroyer is coming to Japan: Inflation.

While on the subject of maintaining wealth, the biggest destroyer of
wealth I have found personally are those "Tax Equalization Calculations"
that I am sure many of you struggle with. On numerous occasions I
have tried to understand mine only to end in failure, but then I
found a gentleman who understands it! The best bit is he will
provide a full audit of your tax affairs and equalization calculations
for a nominal fee. He will take up any errors with the
accountant who prepared the reports on a contingency basis, and then
suggest ways to save money going forward!

He saved me many thousands of dollars and is currently working with a
few of my friends. If you want an introduction just send me
an e-mail at:

-- John Charles-Decourcy

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Written by John Charles-Decourcy (

Edited by J@pan Inc staff (


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