Inflation Investment Up 89.5%


Economic trends that create inflation are upon us. The last time this economic phenomenon was bad, I made a fortune because of international investing. I am trying to figure out how to react this time.

In the last inflationary round, protection seemed easier because other major governments were not involved in excessive government spending. I recommended (and invested myself) investing in Australia, Germany, Japan, Switzerland and gold. Sure enough those currencies skyrocketed versus the greenback.

Now after more then a decade of doldrums, I wonder if investing in Japan could come back.

The Japanese Stock Market is certainly hot as a report in the Jul 7 issue of USA Today by John Waggoner entitled “Japanese funds are as hot as wasabi".

See here.

This article points out that while US stocks are slow, Japanese shares are booming right now. The average fund that invests in Japanese stocks is up 12.4% this year versus 3.9% gain for the average stock fund. The best mutual fund in the last year is the fidelity Japan Smaller companies fund up 89.5%. In addition the Matthews Asian Japan Fund is up 75.3% and ProFund Ultra Japan Investment Fund up 63.6%.

These are pretty good numbers when compared to the normal inflation fighter: gold. The average gold oriented fund in 2004 is down -19.5%.

The Japanese fund results are impressive but this does not mean that all fundamentals for Japanese investments are good. For example look at some fundamentals of the yen.

There are positive short-term yen fundamentals as Japan’s enormous trade surplus rises. An April 2004 Economist article, “The unstoppable surging yen” says:

“Japan’s GDP grew at an annualized rate of 6.4% in the final quarter of 2003 and its trade surplus ballooned by more than 50% in February, compared with a year earlier. Manufacturers are brimming with a confidence they have not felt for nearly seven years, according to the quarterly Tankan survey released on Thursday, and some of that optimism is even spreading to the service sector, ending four years of negative thinking. It is easy to conclude, therefore, that Japan’s strengthening economy warrants a stronger yen. But that conclusion would be a little hasty. For Japan, a cheap yen is not just a way to conquer foreign markets; it is also a way to conquer deflation—and with the GDP deflator, a broad measure of the price level, still falling by 4.4%, that battle has yet to be won.”

The entire article is here and points out that the huge trade deficit the US has with Japan could well cause the U.S. dollar to fall.

But longer-term negatives cloud the yen future. The word Yen, literally means "circle" and we have seen a full circle here. Over a decade ago, when the yen was 111 (it is 143 as I write this article), I recall recommending to borrow yen as I believed it was overvalued. The yen then gradually rose all the way to 80 yen per dollar before plummeting down to 143. Now it has come back to the same 110 range and is being pressured upwards.

You can see this clearly in a graph present by Prudential Securities here.

However this recent boom is in part due to massive Japanese government spending and this has created enormous debt. Japan’s budget deficit as a percentage of GDP is a whopping 7.1%. This overwhelms the 4.1% deficit for the U.S. (which is already horrible) and 2.3% deficit for the euro area.

A really excellent analysis of this debt problem is here.

This analysis points out that government borrowing has forced Japanese bond issues to record highs. In spite of the recent efforts to decrease the bond issuance, the bond issuance is still high and ratio of bond dependency hit a record high of 44.6% in the 2004 budget.

The analysis states, “The amount of outstanding bonds has continued to rise at an increasing rate, and it is expected to amount to around 483 trillion yen. The amount that will be equal to approximately 12 years worth of general account tax revenues.

In other words, the amount will be approximately 3.78 million yen per person and 15.12 million yen per family of four members. This will leave a great burden to the current and future generations.”

That works out to about $37,000 of debt per person in Japan! Yet the problem has an even more serious factor as the analysis explains that the successive issuance of the government bonds has pushed the national debt services to approximately 20.5% of general account expenditures in 2004.

This is bad enough but matters are made worse because this high figure is with interest payment that have been maintained at historically low interest rates. If interest rates take a rising trend along with future economic recovery, interest payments will also increase accordingly.

So the Japanese market may be hot. Japan securities may even grow dramatically. After more than a decade of bear markets, why not?

However this is not the rock solid investment of two decades ago. The yen though it has some upward steam now is nearing its historical high point. Japanese debt has soared even past the pathetic U.S. pace.

Plus two decades ago Japan was king. Now its neighbor China is breathing down its neck, competing well.

Like Switzerland (see our Swiss concerns here), the Nippon Islands may not be a long term, fundamentally sound place to invest for protection against inflation.

What do you think? Share with me as I would be interested in your opinions. We’ll keep looking. I know there are good places out there to invest as inflation grows. We just have to keep digging…and we will.

Until next message, good investing.

Gary


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