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June 25, 2007

Fear of the Future, 18 Years On
by Adrian Ash

"...If depression is short-hand for fear of the future, then here's a glimpse of what lies beyond today's bubble in credit, debt and financial confidence..."

YOU COULD KNOW less than even the British government about trading gold and foreign currencies for profit, but you'd still have to reckon the money of this mystery country a "buy":

• Its jobless rate just hit a 9-year low of 3.8%, and there's plenty more growth to come. The ratio of jobs to jobseekers rose yet again last month.
• It has one of the best-educated populations outside Singapore. Indeed, the Economist magazine calls it "the world's most innovative nation"; per head of population, it holds more patents than anywhere else.
• After a decade of recession, our mystery country has now enjoyed five years of unbroken growth - the longest economic expansion since WWII. It also stands as the world's biggest creditor country, the exact opposite of America's empire of debt. Its exports to Europe alone rose by nearly 18% in May from a year earlier.
• In the financial markets, its yield curve now points sharply higher, shouting to anyone who'll listen that interest rates are set to rise. Two-year bonds are already paying more yield today than they have in a decade.

What's not to want?

But the trouble remains that this country is called Japan - and shaking off its post-bubble depression is proving harder than anyone could ever have guessed. After the almighty credit-fuelled top in Tokyo stocks and Japanese real estate of 1989, the world's second-largest economy remains a basket case.

Far from enjoying huge capital inflows, as Bloomberg reports, "the Japanese Yen is down 6.6% versus the US Dollar and more than 12% versus the Euro in the last 12 months." It's flirting with a two-decade low against Sterling. Measured against gold, the Yen hasn't bought so little since April 1985. It's dropped by more than one-half in the last two years alone.

Yet despite the Yen's incredible vanishing trick on the foreign exchange market, its purchasing power at home continues to rise. Such a phenomenom may seem weird, even alien, to anyone living and investing outside Japan. It up-ends the natural law that makes prices go up, little by little, with each day that passes. Here in West London, for instance, the staff of BullionVault now find a shop selling chocolate bars for less than 45 pence (90¢), no matter how small - not even a Kit-Kat! London's train stations, meantime, no longer sell any kind of liquid to thirsty commuters, not even a bottle of water, for less than £1.19 ($2.38).

But in Japan prices keep falling instead of rising, and this aberration has been in effect for more than 12 years. In spite of losing nearly a fifth of its Dollar value since the start of 2005, the Yen now buys more - not less - than it used to.

Yes, prices had a long way to fall thanks to the Japan's bubble in credit of the late '80s - and Japan is still home to two of the world's ten most expensive cities (Tokyo at No.4 and Osaka at No.8). But Japanese consumer prices including energy costs are falling at an annual rate of 0.2%. And for the poor Japanese schleps trying to make a living, this "deflation" in the cost of living still brings no blessings. Because wages are falling faster than prices.

Household disposable income in Japan dropped 0.4% in the year to April - even though the economy expanded by 2% annually. In fact, hourly wage-rates are now amongst the lowest in the developed world according to Tsuyoshi Takagi, president of Japan's biggest trade union, Rengo.

The reason? Post-bubble it's simple enough; more than four million full-time jobs were lost during the previous government's tenure alone. More than 400,000 women joined the workforce last year, but many went part-time only. Now Rengo is demanding a ¥50 increase in the minimum wage, taking it up to ¥650 per hour...less than $5.25 per hour. And this in a country where you can pay $10 for a coffee - and a weak, tasteless coffee at that.

How to stimulate incomes and spending 18 years after the bubble went bang? The Bank of Japan has already done all it can to stimulate debt. It slashed the cost of credit all the way down to zero at the start of this decade, after the Tokyo government finally gave up pouring concrete in the biggest "public works" program in history. Japan built bridges to nowhere, freeways between small villages, and concreted river beds to make the water run better. More than half the entire coastline was covered with concrete in the mid-90s; in 1996, Japan spent 30% more on government-funded infrastructure than the US, Canada, Germany, France, Italy and the United Kingdom put together.

But "depression" is just short-hand for "no faith in the future" - and no matter how much Tokyo spends - and even with short-term lending rates below 0.5% for the last ten years and more - Japan still refuses to borrow for fear of what might happen next.

Cognitive therapy says that "life is terrible and death is worse" is the internal mantra of the truly depressed. "Only bad things happened to me in the past and only bad things will happen to me in the future. I must never forgive anyone, least of all myself." In Japan this guilt-trip obliges stony-faced executives and politicians to take their own lives rather than embarrass Japan any longer. The entire economy, in short, remains horribly scared of the future.

Could raising the cost of credit help raise a smile? "There [is] the hypothesis that an increase in deposit rates, due to an interest rate hike, will stimulate spending," notes Takehiro Sato for Morgan Stanley. Starting from the current 0.2% paid on cash savings, you might want to agree. By raising rates, or so runs the theory, the Bank of Japan would help boost household earnings - adding 0.3% to disposable income with a mere 0.5% hike - and help consumers to start consuming again.

But Sato points out that rate-hikes would need to continue - year after year - to keep adding cash to Japan's disposable income. And at the corporate level, meantime, Japan Inc. won't borrow at even 0.5% interest rates.

"Asset price deflation has largely run its course," Sato goes on - as though one of his balls is crystal - "[but] when companies ought to be turning from reducing their debt ratios to increasing leverage - in turn raising return-on-equity and market cap - in fact they are reluctant to take on new borrowing."

Raising rates after 12 years of deflation might imply a new confidence in what lies ahead - or so goes the theory. But fear of the future is all that Japan seems to know. Modern psycho-therapy would in fact account the whole nation depressed, even though - on a technical basis - Japan has now climbed out of depression.

Welcome to a post-bubble wasteland left over after risking too much - and losing it all. Tokyo's credit-fuelled mania found its top nearly two decades ago. If you're expecting today's Anglo-Saxon bubble in debt to end quickly and pain-free, just take a look at Japan.

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

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