Turning Japanese

That the whole of the West ends up looking like Japan is the shadow of the Grim Reaper that hangs over us. Is it, however, such a bad thing? Whisper it quietly, but good things are happening in Japan. The shadow of Japanification, which looks like the Grim Reaper’s scythe, might turn out to be the waving arm of a benediction. Japan appears to be coming out the other side of its long torpor. What looked terminal might be temporary. We, in the West, may not notice but Japan is enjoying nigh on its longest economic expansion since World War II. A 23 year old Japanese has a good chance of earning more than their parents. Abenomics has worked: there is growth and inflation in Japan. Not, of course, that this is unalloyed. Japanese indebtedness is truly heroic. Overall, however, Japan is a bastion of stability. Its world did not end. Who’d’ve thought?

What does Japanification mean? It does not mean no growth. Anyone who has visited Japan during the dead years since 1990 has seen growth. Japan in 1990 was not as rich, as sophisticated, as Japan in 2019. Over the almost 30 year, generational, era since 1990, there has been growth in real per capita income in Japan. But the journey has not felt like that (especially for investors, who saw the Topix peak at 2884 in late December 1989. Since then the Topix has failed to breach 1870 – the ‘iron coffin’).

What Japanification means is low growth, not no growth. It reminds us of Thomas Piketty’s economic finding (the bit before he dived into policy proposals) that per capita productivity growth at the technological frontier is hard yards and has historically been at or around 1% per annum. Add to that, low to no population growth and this sort of growth is growth you see over a generation. It is not growth you see over a Western five-year electoral cycle. It is nineteenth century growth not post World War II growth. Or, rather, it is Japanification growth.

Of course, low growth is not uniformly experienced. The Japanese journey has felt arduous because there were relative losers. Living off your savings in a quasi-perpetual zero interest rate environment is hard going. You can euthanise a rentier quickly with inflation but, it turns out, you euthanise slowly with low interest rates. Inflation is like withdrawing oxygen or water; it is a quick death. Disinflation is like withdrawing food: it takes a long old time to go. What’s more, middle management in Japan has endured tough times. Years of no wage growth, which, in the short term in a low inflation economy, you might not notice, become, in the long run, visible. But the work has been done. The social contract with the salaryman has been rewritten.

Would we, in the West, be able to cope? There is some Japan exceptionalism. Do Western countries, Europe and the Anglo Saxons, have the sense of country, people and shared destiny to allow a whole generation to reset its expectations? Or will they succumb to populist quick fix solutions that lay the blame with dodgy foreigners. In addition, whilst we call Australia the lucky country, Japan too deserves that epithet. How handy, during the years of hardship, to have been located next door to China’s extraordinary catch-up growth!

So, what lessons are there for us from Japan? A couple of thoughts. It clearly requires strong social cohesion. I do wonder whether you can have social cohesion at a supra-national level. Let’s look again at populism. Is, in fact, the desire to be more British, more French, more American, the necessary precursor to a wrenching change in expectations? Do we need to rediscover a shared national identity in order to live with the 1% growth that is available at the technological frontier? Is populism the organic auto-immune response to the unwinding underway. Are we, without knowing it, preparing ourselves for the fact that although living standards will not, year-by-year, seem to be improving, it is ok because the next generation will be noticeably richer? I am not sure I totally believe this, but I do wonder.

Another lesson is that fiat money is fiat money. We may, of course, be living the calm before the storm but, up to now, negative interest rates, mass indebtedness, the monetisation of fiscal deficits, the central bank purchase of risk assets, have happened without the world ending. An important part of the financial system is maturity transformation – providing long-term capital from short-term borrowings. But the state through the central bank can borrow long and lend long. There have, over the centuries, been various models of financial intermediation, of funding economic activity. They used to give a pivotal role to the state, then they didn’t, maybe they are once more. Again, I am not sure I totally believe this but I do wonder.

So, if Japan was first, who will be second? Everyone’s prime candidate is the Eurozone. The message of Japan is that, if you can get through the chemo, there is remission and new life after: a different life but nevertheless life. Japanification, whilst not being something to welcome, appears not, in the long run, to be as bad as we think. In this case, Japan has gone first. Perhaps countries that follow will be able to get to the end more quickly having seen what worked and what did not work there.

How should one engage investors in real estate opportunities at a time when macro conditions look less than propitious? With valuations at cyclical peaks, recession risk increasing and the shadow of greater regulation and new tax burdens looming, standard real estate is a tough sell. A sales event about real estate, which concluded that now was not the time to invest in real estate would be a bit of a damp squib and would be unlikely to attract any sponsors. We attended a real estate conference recently which was faced with the challenge of squaring that circle and did so by looking for a new angle on the subject. The approach it hit upon was tech and the changes to how we use real estate that will be wrought by tech.

And there was indeed excitement in the room at the vision of the future that was conjured up. As with the internet of things, investors are now being tempted by an internet of bricks in which commercial real estate morphs from being physical space to house office workers or retail customers to a dematerialised set of services, powered by tech, which just happens to be housed in a building. Facial recognition and movement sensor technology will enable personalised heating and lighting conditions to follow the individual as they move around, with services from security to communications taken online for the optimal consumer experience.

Individually in thrall to the tech in our pockets, we are already primed to value tech highly and consequently the idea of tech-enabled real estate has great appeal. However, a cautionary tale emerged at the conference about a new risk to businesses that tech-enabled real estate could open up. In a break out session on cyber security (under-attended in our view), we learned that a major US corporation suffered a dramatic theft of customer information at the hands of a sophisticated hacker gang. Rather than using the more well-known attack techniques, the criminals had hacked into one of the company’s property management systems (specifically a wireless air conditioning control network), which, it turns out, had minimal defences. Over several weeks, the hackers used this stepping stone to work their way up into the firm’s main network, accounting software and eventually into their customer records.

With increasing outsourcing, we view this as a real risk. Air conditioning companies are unlikely to have the same security needs as the businesses they cool. Why would they? They are in air cooling. Their customers are in fast fashion, financial services or food production. As we outsource and tech-enable our outsourced providers, we open up a major security risk – the vector here was air conditioning but it could be catering, telephone services or utility providers. This vision of an internet of bricks will require supply chains to be managed much more closely if we are to tackle these vulnerabilities.

This applies even outside of the tech-enabled space. The search goes on for a single culprit to blame for the terrible fire at Grenfell Tower that killed 72 people in 2017. It appears, though, that a complex network of outsourcing to contractors and subcontractors, each navigating a different set of regulations for the products and services they supplied, will make it difficult to identify a single point of failure. The longer and more complex supply chains become, the more points of vulnerability there are. Adding outsourced tech into the system adds another point of vulnerability. The solution – as ever – is better and stronger management of the building as a whole and the supply chains that serve it.

Capital Generation Partners LLP is authorised and regulated by the Financial Conduct Authority and registered as an Investment Adviser with the SEC. This publication does not constitute investment advice and does not constitute an offer to sell or a solicitation of an offer to purchase any security or any other investment or product. The document is not intended to be a financial promotion and is intended for professional clients only. This publication has been provided to you solely for your information and may not be copied, reproduced, further distributed to any other person or published, in whole or in part for any purpose. Any other person receiving this document should not rely upon its content. Opinions expressed in this publication, whether in general or specific, represent only the views of the authors at the time of preparation.