A Tale of Two GDP’s

October 11, 2005

Dear Investor:

Japan and Germany have followed the same bizarre trajectory over the past seventy years: fascism, then dynamism, then brooding malaise.

Both countries have been mired in state-directed sclerosis for the past decade, unable or unwilling to set their economies free. The caretaker economies of the post-war years served their respective nations well, creating infrastructure and export machines. Unfortunately, none of this did much to create a flexible economy, one that could stoke growth in the wake of financial crises, such as Germany’s lengthy integration or Japan’s stock market collapse.

In the past year, their paths have finally diverged. Germany has crawled into the economic equivalent of the fetal position, first splitting on the crucial vote of Chancellor while unemployment blows past 11.4%, then arriving at a bland coalition which puts Angela Merkel in figurative charge without any mandate for change. Japan, on the other hand, has decisively cast its lot with Prime Minister Junichiro Koizumi, one of the most impressive and truly “radical” world leaders to take the stage in some time. Koizumi has pressured Japan to deal with its bad loan problems, forcing banks to write down and restructure defaulted debt. Until recently, a defaulting borrower would only be shoveled more money by most Japanese banks, just to forestall the inevitable classification of “default.” Whether this was fueled by misplaced cultural pride or lack of Ben Franklin as a founder is unclear. That it turned the allocation of scarce economic resources into a burlesque is beyond dispute.

Japan had so many problems in the nineties that it became a mirror image of the United States: secular bear markets vs. bull markets; stigmatizing deflation vs. moderate inflation; stunted capital markets vs. the most dynamic the world had ever seen. But Japan never let go of its most prime assets: superior infrastructure and technology. Now that the banking system is well on its way to real solvency, this should allow it to jump quickly into economic pole position. Domestic consumer demand will always be a problem for Japan, with its aging, slow-growing population. China, however, could be its savior, as that nation’s success creates vast opportunities for Japan’s value-added businesses. The efficiency of Japanese manufacturers is legendary. After many years of decay, the manufacturing base is gaining steam. Just today, the Wall Street Journal says that the “economy of Central Japan’s industrial heartland is booming.”

The Japanese stock market has begun to price in this recovery, with the Nikkei trading above 13,000 for the first time in four years. Japanese stocks are benefiting now, but all multinationals will profit if Japan truly becomes a growth engine. If the Nikkei does march upwards, it will have a long way to go to reclaim its peak. The high on that market was 38,915, back on December 29, 1989.