Musha Research Commentary

17 January 2024

S\
Strategy
Bulletin (No. 348)

Geopolitics will be the decisive factor of 2024
~Why will the outstanding strength of Japanese equities continue?
･･････Notice of Great East Japan Earthquake recovery Charity Seminor ････････
The 13th Donation Seminor
Date: March 2, 2024 (Sat) 13:40-16:30 (Reception starts at 13:20)
Venue: Nikkei Hall, 3rd floor, Nikkei Building, 1-3-7 Otemachi, Chiyoda-ku, Tokyo
Participant’s donation: 3,000 yen per person,
Program
Key note Speech1 International Community Perspectives
Ichiro Fujisaki Former Japanese Ambassador to the U.S.
TAMF Co-Chair
Key note Speech2 Japan in a period of great revival
Ryoji Musha President of Musha Research
Panel Discussion Investment Environment in 2024, Micro Trends and Sectors to Watch
Chisako Hardy, Mitsunari Akino, Ichiro Takamatsu / MC･･････････････････････････････････････････････････････････････････････(1) Geopolitics will make the difference in stock performance
Outstanding Japan's stock market rally, U.S. firms, China's setback
The year 2024 opened with an outstandingly impressive performance of Japanesestocks. In the first seven business days, the Nikkei 225 rose 8%, or 2,700 yen, andU.S. stocks were also strong, with the NY Dow already reaching an all-time high at
the end of last year and the SP500 rising 14% from November to December last year,
close to its all-time high. However, on the other hand, Chinese stocks have continued
their decline since last year. Comparing the performance of stocks since thebeginning of 2023, the Nikkei 225 +36%, the US SP500 +25%, the German DAX+19%, the UK FT100 +2%, the Chinese Shanghai Composite -7%, the Korean
Composite +13%, and the Taiwan TAIEX +24%, among major country stock markets
Japanese stocks stand out. This performance gap can be explained by geopolitics.
Figure 1: Stock Market Performance by Countries

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Musha Research Co., Ltd.
President
Ryoji Musha
musha@musha.co.jp
http://www.musha.co.jp
Tel ＋81-3- 3740 2143
2-16-7-3912, Konan,
Minato-ku, Tokyo
108-0075,Japan17 January 2024

Strategy Bulletin vol348

U.S. National Interests Supporting Japanese Stocks
The powerful performance of Japanese equities is backed by U.S. support for Japan. As the U.S.-China
confrontation has worsened, the U.S., which once went crazy in its efforts to knock Japan, now needs astrong Japan to decouple from China and is willing to accept a weaker yen to achieve this. The remarkablerise of China plus Asian NIES (South Korea, Taiwan, and Hong Kong) over the past 30 years has been madepossible by Japan's declining competitiveness. This one-victim Japan situation will be reversed. The
establishment of a significantly weaker yen has changed the major framework of the Japanese economy.
The era of deflation caused by the strong yen is over, and the Japanese economy in 2023 was the brightest
volume growth economy year since the collapse of the bubble economy, and this will accelerate in 2024.
Factories, capital, business opportunities, and employment that fled Japan overseas due to the strong yen
are returning to Japan due to the weak yen. Corporate earnings and capital investment are at unprecedented
levels. The U.S.-China conflict has brought the semiconductor investment boom to a climax, and TSMC
Kumamoto has decided on a third phase of expansion.
In addition to unprecedented corporate profits, the yen's depreciation (Japanese salaries are now 40% lower
than the global average) is expected to ensure a 5% wage increase, and the long-awaited end to deflationand 2% inflation are in sight. The weak yen is also increasing inbound tourism, which is stimulating local
domestic demand in all regions of Japan.

5: PPP and Dollar/Yen trend from Punitive to Beneficial
Figure 2:(¥/US$)

360
330

From punitive strong yen to benefiicial weak yen
Punitive strong yen

300

Beneficial weak yen
Spot rate < PPP

270
240
210

180
JPY/USD spot rate
2022/12/31 131.5
2023/11/7 150.0
2024/1/15
145.7

Domestic-foreign
price differentials

150
120
90

PPP
2022 95.2

60

Inversedomesticforeignprice
differentials

70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15 18 21
Source: OECD, Musha Research

China's Outflow of Funds Becoming Severe, Buying Up the Yuan
Meanwhile, China is experiencing serious economic difficulties. In the country, the bursting of the bubble
economy and a drop in consumption have led to ongoing deflation. Until 2022, influential investors in WallStreet ignore the Washington's warnings and piling up investments in China. However, Panda huggers areforced to shift their investment policies against China due to the establishment of China's dictatorship of fear,
the enactment of anti-spying laws, the bursting of China's bubble and economic difficulties. This is the causeof the single largest decline in Chinese equities.

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Strategy Bulletin vol348

Figure3: China’s Balance of Payments Indicators
2,500

mil $(quarterly)

2,000

Current accountbalance

1,500
1,000
500

Trade balance(goods)0Service balance-500-1,000Primary income balance-1,500Foreign currency reserve change-2,000Capital flow

1998Q1
1998Q4
1999Q3
2000Q2
2001Q1
2001Q4
2002Q3
2003Q2
2004Q1
2004Q4
2005Q3
2006Q2
2007Q1
2007Q4
2008Q3
2009Q2
2010Q1
2010Q4
2011Q3
2012Q2
2013Q1
2013Q4
2014Q3
2015Q2
2016Q1
2016Q4
2017Q3
2018Q2
2019Q1
2019Q4
2020Q32021Q22022Q12022Q42023Q3-2,500Source:China SAFE,Musha Research

As shown in Chart 3, in addition to large deficits in the balance of services and primary income balance,
China has experienced significant capital outflows despite capital controls.
The foreign currency situation is in a lull, with foreign exchange reserves building up in 3Q2023. However,China's wages are the highest among emerging Asian economies, and U.S. import restrictions on China willcause its trade surplus to decline significantly. Despite the superficial stability, China's holdings of U.S.
government bonds have declined sharply, suggesting that support for yuan purchases is underway. The
foreign currency situation will worsen and pressure for yuan depreciation will continue to mount as China
reschedules and revalues its massive loans to emerging economies and further withdraws the foreign capitalon which it has been relying.
Figure 4: Real Effective Exchange Rates ofMajor Currencies
180(Jan. 1995=100)

Figure5: Treasury Holdings of Major Countries
1400 (bil $)Chinese
Yuan

JPN

160

1200

140

1000

CHN

US$
120

800

100

GBP

80

60

Euro

600

UK

400

200

Korean Won

BLGM

JPY

40
94 96 98 00 02 04 06 08 10 12 14 16 18 20 22
Source: BIS, Musha Research

005 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24、Source:USDoT Musha Reearch

The ongoing trend toward yuan settlement and de-dollarization with Russia is a desperate measure by thetwo countries excluded from the dollar international settlement system, and it does not mean that confidence
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Strategy Bulletin vol348

in the yuan is growing stronger. As shown in Chart 4, the real effective exchange rate of the Chinese yuan
is at a historically elevated level. For China, which has reached the highest wage level in Asia, the current
yuan exchange rate is extremely unfavorable, but it must be maintained at this unfavorable rate to cope withthe uncertainty over foreign currencies.

High-Pressure Economic Environment in the U.S. under the U.S.-China Conflict
The soft landing of the U.S. economy is almost certain, and corporate earnings have begun to recover after
bottoming out in 2Q2023. Behind this is the functioning of high-pressure economic policies in the U.S. tomaintain high demand and avoid a Great Depression-type situation of excess supply and insufficient demand.
In addition to the aggressive fiscal policy shown in Figure 6, the new industrial revolution, innovation using
AI and robots, and the resulting increase in corporate productivity and high profits played significant role.
Profits are returned to society through dividends and share buybacks, and new demand and job creation
are being promoted through households’ asset income. Consequently, the potential growth rate is rising,and the natural rate of interest is increasing. They indicate that the economy is becoming more selfsustaining and that there is a growing fear that the low interest rates of the past will lead to inflation, bubbles,
and other overheating. Stock prices, which have been undervalued for a long time according to the FED
model presented in our previous report, are now at appropriate levels when viewed at current interest ratelevels, and the risk of bubbles is increasing.
The Fed will be wary of an excessive rise in stock prices. This outstanding economic strength of the U.S.
and high interest rates will cause the dollar to appreciate. The hegemonic currency, the dollar, will be further
strengthened by its powerful technological advantages and corporate earning power. A strong dollar willbring the U.S. unjustified trade gains and seigniorage (debt that cannot be repaid) by allowing the U.S. tobuy cheaply from abroad and sell at higher prices abroad. The economic advantages of the US, multipliedby the strong dollar, will over time overwhelm the tyrannical powers. Looking at the contrast with China's
currency woes as it stakes against the U.S. the economic consequences of the struggle for supremacy arealmost obvious.
Figure 6: U.S. Fiscal Balance and Fed’s
Treasury holding / GDP

Figure7: Fiscal Balance / GDP of Majer
Countries(％ of GDP)25

2 (% of GDP)

20
15Euro area

0

Treasury securities held by
FRB / GDP

-2

10

-4

5
-6
0
-8
-5
-10

-10

Japan

Fiscal deficit / GDP
-15

-12

-20

-14

-25
04

06

08

10

12

14

16

18

20

22

OECD
total
US

-16
93 95 97 99 01 03 05 07 09 11 13 15 17 19 21 23→
Source: OECD, Musha Research
E

Source: US Dept. of Treasury,FRB,
Bloomberg, Musha Research(2) No worries about the geopolitical developments and Trump's reelection
Although the economy and the financial markets are looking at 2024 as a bright year, people's sentiments
are gloomy. The postwar international order based on democracy and international law has been shaken by
the U.S.-China confrontation and the growing possibility of a Chinese invasion of Taiwan, the Russian
invasion of Ukraine in which Russia has the upper hand, the Israeli attack by Hamas and Israel's
counterattack, and the conflicts in the Middle East. The decline of the U.S. presence is significant. The
Obama administration said that the U.S. could not stand to be the world's policeman, and the Trumpadministration has increased its disregard for alliances by advocating MAGA. As China continues its military

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buildup at an exceptionally rapid pace, the U.S. defense budget has fallen from 7.7% of GDP in the Reagan
era at the end of the Cold War between the U.S. and the Soviet Union to 3.7% of GDP in 2022.The root
cause of the geopolitical turmoil is the weakening of U.S. hegemony, as if Pandora's box had been opened.
The tragedy of the tyranny of a despotic state is evident in Ukraine, and the world is demanding thestrengthening of U.S. hegemony as the world's policeman, but this is not happening. The victory of the DPP
candidate in Taiwan's presidential election is a good sign, and the fact that the Taiwanese people rejected
the idea of Taiwan becoming Hong Kong is extremely significant.
The root of the pessimism that persists, however, lies in whether the U.S. has the will to maintain its global
hegemony. There is a whiff of isolationism in Mr. Trump, whose approval rating is rising and who isconsidered the most likely to become the next president of the United States. The political will of the U.S.
will not be confirmed until the end of 2024, and uncertainty persists. Indeed, Trump's reported election
agenda includes "10% import tariffs, immigration restrictions & bans (from Muslim countries), elimination of
MFN against China, increased anti-environmental oil and gas production, rethinking the shift to EVs,
strengthening his power (dictatorial color) by intervening in the civil service personnel system and making iteasier to fire people, restoring traditional values, withdrawal from NATO, alliance relations Restructuring?
The report also states that "the United States will rebuild a more radical international order based on thenational interests of the United States, including the acceptance of nuclear proliferation. The trend towardisolationism is undeniable.
Figure8: Current Account Balance of Major
Countries / Global GDP

Figure9: Accumulated Current Account from1980-2022 of Majer Countries

2.25(bil $）
5000
4000
3000
China
Japan OPEC
2000
Germany
1000
0
-1000
-2000
-3000
-4000
-5000
-6000
-7000
-8000
-9000
-10000-11000-12000US-13000-14000-1500080 83 86 89 92 95 98 01 04 07 10 13 16 19 22

2.00

(%)

1.75

OPEC

1.50
1.25
1.00

China

0.75
0.50
0.25

Germany

Japan

0.00
-0.25

US

-0.50
-0.75
-1.00
-1.25
-1.50
-1.75
80 83 86 89 92 95 98 01 04 07 10 13 16 19 22 25 28
Source：IMF、Musha Research⇒E

Source：IMF、Musha Research

U.S. Abandonment of Taiwan is Unlikely
Trump insists on withdrawing from Ukraine. If that is the case, how far will he go in committing to the defenseof Taiwan, where greater sacrifices are expected?
Musha Research would like to emphasize that the next U.S. president, whoever he or she may be, does
not have the option of abandoning Taiwan. If China's annexation of Taiwan succeeds and China controls thesea lanes of Japan and South Korea, Japan and South Korea will inevitably become under China's military
influence. This would mean the U.S. withdrawal from Asia, the world's growth center, and the end of U.S.
hegemony. Dollar hegemony will be severely damaged, and the yuan economic zone will prevail.
This will cause the U.S., the world's largest debtor nation, to face serious debt withdrawal from other nations,leading to a major plunge in the dollar. Intense import inflation will occur in the U.S., and the U.S. economy's

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presence in the world will shrink sharply. A sharp deterioration in the living standards of the American people
is inevitable.

MAGA's number one priority is to maintain dollar hegemony
As shown in Charts 8 and 9, the U.S. has accumulated a huge amount of foreign debt, but its creditors are
not worried at all about its ability to meet its obligations because it is the reserve currency. However, oncethe dollar's hegemony ends, the amount of debt repayment will be enormous. The inability of the U.S. torelinquish the privilege of this massive debt, which it has no obligation to repay, is forcing the U.S. to commit
to Taiwan at any cost. We would like to emphasize that maintaining dollar hegemony is a lifeline for Trump's
MAGA (Make America Great Again).

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