Musha Research Commentary

4 January 2024

S\

Strategy Bulletin (No. 347)

2024 Why the U.S. and Japan Will Lead the World Economy?

We wish you a happy new year.
New Year's Day, 2024
Musha Research Co.

The world economy has undergone astonishing changes over the past few years.
However, the basic axis of the global economic situation has been set by 2023, and it isassumed that the year 2024 will be an extension of this axis. From a macroscopic
viewpoint, the global economy will be developed around 1) geopolitics and the U.S.China confrontation and 2) the new industrial revolution. The driving forces of the global
economy will also be simple: the U.S. and Japan. This is because both are thebeneficiaries of 1) and 2).
The reason the U.S.-China confrontation is so important is that the international divisionof labor, which has continued for the past decades, will fundamentally change. The U.S.
and other liberal countries cannot stand to be dependent on China for supply, and they
will make concerted efforts to build a supply system that is free from China. The biggest
beneficiary of this effort will be Japan, which had been sinking due to the U.S.'s efforts toknock Japan out of the market. Japan and the U.S. will promote deep U.S.-Japan
industrial cooperation in areas where the U.S. and Japan used to compete, such as
semiconductors, automobiles, and iron and steel. The super depreciation of the yen is an
essential and powerful means to achieve this. Japan is the only country that can build anindustrial cluster of high-tech manufacturing industries that can replace China.
The largest growth area in the world will not be India, Africa, or the Global South, but the"Seventh Continent," cyberspace without borders. U.S. companies overwhelmingly
dominate this "seventh continent. The "Seventh Continent," which was once thought tohave entered a mature phase with the spread of smartphones, has entered the next stageof growth thanks to breakthrough innovative technologies such as chat GPT. The real
strength of GAFAM+, the dominant player in the "Seventh Continent," is yet to be seen.
The gatekeeper of the "Seventh Continent" is hardware, namely semiconductors andelectronics. It is also an era in which cyber-physical interfaces, Japan's forte, will comeinto play.
The hegemonic currency, the dollar, will be further strengthened by its powerful
technological advantages and corporate earning power. A strong dollar will bring the U.S.
unjustified trade gains and seigniorage (debt that are not returned) by allowing the U.S.
to buy cheaply from abroad and sell at high prices to other countries. Over time, theeconomic advantages of the U.S., multiplied by the strong dollar, are bound to overwhelm
the tyrannies. The tragedy of tyranny is evident in Ukraine, and the world will welcome
the strengthening of US hegemony through a strong dollar. As the largest military,economic, and industrial ally of the U.S., Japan is in a better position than ever before.

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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

Strategy Bulletin vol347

4 January 2024

(1) The Rapidly Purifying Autocracies and Their Economic Decadence
The most important historical factor in the developments in 2022-2023, which have been full of upheavals andsurprises, will be the rapid purification of despotic regimes and the economic decadence of these countries. With
this, the West had a clear opponent to confront, and issues such as the environment, human rights, and inequality
became subordinate factors.

Tyrannical States Strengthening Their Cohesion
In the war in Ukraine, the economy of the aggressor country, Russia, has shown surprising durability, and the war
situation is in Russia's favor. China, which was cautious when the war began two years ago, is now overtly
pursuing a course of Sino-Russian cooperation. Putin also revealed that during the Korean War, "the Soviet
military, which was seen as sitting on the sidelines, had actually sent soldiers in Chinese People's Army uniforms
into the war. The cohesion of the despotic group of states has become clear, as North Korea and Russia havegrown closer through arms transfers and the provision of military technology.In China, Xi Jinping's personal
dictatorship has progressed at an alarming pace. The country is heading toward a dictatorship of fear, with theousting of the Communist Youth League faction at the party congress, the sudden death of former Premier Li
Keqiang, and the successive dismissals and disappearances of Foreign Minister Qin Gang and Defense Minister
Li Shangfu. Putin, who is facing a snap election in April, has also become increasingly dictatorial, including theassassination of the rebel Mikhail Blighozin (WSJ observation), and both China and Russia have become more
like North Korea, which is seen as an abnormal state. The Israel-Hamas war has benefited these rogue states.

China’s Economic Difficulties, Dilemma of Economic Policies, and Coercive Intervention
However, China's real estate bubble has burst, and trade has declined, consumption has cooled, and deflation
has set in, and the liquidity trap and monetary policy have become ineffective, making it almost clear that thecountry has entered a process of long-term decline. In China, policy dilemmas are occurring frequently. Monetaryeasing is essential to stop the bubble from bursting and to stimulate consumption, but this will lead to an outflow
of funds from China and a plunge in the renminbi. The only way to deal with these dilemmas is to suppress themby force. To do so, economists who insist on economic rationality must be silenced, which has led to the authorities
intervening in economic analysis. The structural problems of a declining population and a rapidly declining
birthrate are also ongoing. There are positive factors such as a surge in investment in semiconductors due topolicy measures, an increase in EV exports due to automobile measures, and an expansion of exports to Russia
and an increase in the ratio of RMB settlements (expanding the RMB economic zone), but none of these factors
will be sustainable.

Reexamination of economic and social mentality required
The world has thus entered an era of extreme danger, an era of aggression and war as it was until the first halfof the 20th century. Japan and the world need to clean up the "taking peace-for granted mentality" that has
persisted for the past 77 years since the end of World War II. A reexamination of this mentality is underway in thedomestic politics and societies of each country as well. The intrinsic needs of the people have become stronger,
and the era has come to a point where tokenism and idealism are seen as hypocrisy. The rightward turn of politics
in each country, the so-called populism, has become a trend. The rhetoric of environmental responsiveness has
also revealed its side effects and undercurrents. The adverse effects of humanitarian immigration have become
extreme, and even in the Netherlands and Sweden, which are leaders on the liberal track, right-wing parties areon the rise. Criticism is growing for excessive protection of human rights, for example, CRT (Critical Race Theory),
which calls for a reckoning with the history of past discriminatory persecution, and for the promotion of LGBT.
While nationalism is returning to the political scene in many countries, there is an underlying desire for the
restructuring of the world order and a new consensus on values. It can be said that this is an era in which theconstruction of a new order requires the strengthening of U.S. hegemony.
It is inevitable that the U.S. will become even more hostile toward China. No matter who becomes president, thetop priority will remain victory in the Cold War against China, and building a supply chain that excludes China willremain the single most critical issue. The "big government" orientation will also remain unchanged. The
development of a domestic industrial base and social insurance spending, as seen in the Corona subsidy, areessential. Although Trump is a Republican, he is not traditionally small government oriented. There is no
significant difference in terms of achieving economic buoyancy through tax cuts and government spending.

Trump's popularity is because people are looking for a redefinition of values.
In 2024, there are two major events: the U.S. presidential election and the Taiwan presidential election, but
regardless of the outcome of the elections, there will not be a broad range of policy choices. The Trump
phenomenon is a sign of the ongoing redefinition of issues in the United States. The fact that support for Trump
has not wavered despite his outspoken denial of the results of the previous presidential election is due to thestrong public sentiment for a new order. If Trump is reelected, he will be expected to "impose 10% tariffs onimports, restrict and ban immigration (from Muslim countries), abolish MFN against China, increase production of

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Strategy Bulletin vol347
4 January 2024
anti-environmental oil and gas, reconsider the shift to EVs, strengthen his power (dictatorship) by intervening in
the personnel system of public officials and making it easier to fire people, restore traditional values, leave NATO,rebuild alliances? There is a strong possibility that the U. S will further eliminate China.
In that case, the Japanese political situation may be such that the wind may blow in favor of Prime Minister
Takaichi's candidacy. The European economy is stuck in a deadlock. Germany, its main ally, is amid a period ofadjustment to its strategy since the Merkel administration of relying heavily on Russia for energy and China for
trade, and it is unlikely to be able to shake off the stagnation it has been experiencing.

(2) The Secret of the Incredible Strength of the U.S. Economy, the New Industrial
Revolution and MSSE
U.S. potential growth rate is likely to be on the rise
The U.S. economy is doing well and will grow 3% annually in 2023, a 2-percentage point improvement over the
IMF's forecast a year ago and a stunning rejection of the consensus that a rate hike would inevitably lead to a
slowdown. We may be forced to hypothesize that an industrial revolution and structural transformation of the U.S.
economy, driven by the deepening of information technology, are raising the potential growth rate. Threecharacteristics of the current U.S. business climate can be pointed out. First, the virtuous cycle of consumption
and employment is continuing. Consumption is driving the economy, and strong employment is supporting that
consumption. Employment, which is a lagging indicator, is leading the economy. Second, strong employment is
supported by strong value creation in the corporate sector. Even though productivity has increased and absorbed
wage increases, the labor participation rate remains low, ensuring ample cash flow for companies. Third, the shift
to "big government" and government spending is working. In addition to household social benefits under theCorona Disaster, industrial policies such as the CHIPS Act and IRAs have invested fiscal resources to promoteindustry. These three factors are structural factors. We should consider that the impressive performance of the
U.S. economy is due to the higher potential growth rate caused by these structural factors

Figure1: US monthly personal income & outlays

Figure2: US employment by sector(± from 2019 average,US$ bil.）

5000

Consumption

4000
3000

Weages2000
1000

Government Transfer
Unemployment Insurance

0
-1000

Saving

-2000

23/7

23/4

23/1

22/10

22/7

22/4

22/1

21/7

21/10

21/4

21/1

20/7

20/10

20/4

20/1

-3000

190
180
170
160
150
140
130
120
110
100
90
80
70
60

Professional & biz services
Leisure andhospitality

Construction

Financial activities

Trade, transportation&utilities

Information

Manufacturing
Source: US Dept of Commerce, Musha Research

Figure3: Us Labor share

Figure4: US Free cash flow of non-fin companies(US$ bil.
3,000
2,800
2,600
2,400
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
-200
-400
-600
-800
60 65

Recession

65

60

55

50

45
60 65 70 75 80 85 90 95 00 05 10
Sources: U.S. Dept. of Commerce, Musha Research

Nonfarmtotal

95 97 99 01 03 05 07 09 11 13 15 17 19 21 23

Source: Bureaau of Economic Analysis, Musha Research

70 （%）

Education & health services(1995 Q1=100)

15

20

nonfinancial
corporations

Cash flow

Capital investment
Capital surplus

70

75

80

85

90

95

00

05

10

15

20

Note: Capital surplus is defined as cash flow minus capital investment
Source: FRB, Musha Research3 / 12

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4 January 2024

Strategy Bulletin vol347

The New Industrial Revolution in the Cyber WorldHistoric technological revolution is taking place in the cyber world, including the Internet, AI, and robotics. Thiscyber world is a "seventh continent," without borders, a world of wisdom that anyone can instantly enter as a user
or a company. US companies almost dominate the Seventh Continent. The biggest Bright Spot in the world is not
India or the Global South, but the "Seventh Continent," and the U.S. almost single-handedly dominates that BrightSpot, The S&P 500 index is up 23% for the year through December 15, 2023, but the seven U.S. technology
companies, the "Magnificent 7" (Google, Apple, Microsoft, Meta, Amazon, Tesla, and NVIDIA), are the mostdominant with a combined share price up 75%, while the other 493 companies up 12% have a huge disparity.
These stock price trends indicate that there are two economic areas in the United States. One is the cyber-growtheconomic area that is driving the new industrial revolution, and the other is the general economic area that, likethe rest of the world, is hardly growing. Value creation in this "seventh continent" is changing the structure of the
U.S. economy significantly.
Figure5: M7, SP500.SP493 price since Jan2023(WSJ)

Figure6: Mar cap of M7and Majer countries (WSJ)

Weight in MSCIAC
M7
META
TSL
GGL

UK

NVDA
AMZN

CHN

MSFT

F

APL

JPN

SP500

SP493

Where did the high-tech restructuring at the beginning of last year go?
The high-tech revolution, which was thought to have ended with the finish of spreading smartphones in the second
half of 2022, has begun to accelerate again. This restructuring appears to have accelerated the replacement oflabor by innovative technologies in high-tech companies, further raising productivity and boosting corporate profits.
The fact that employment has declined only in the information industry (Chart 2), while employment growth has
continued in all industries, tells us that the business model is evolving in high technology. As shown in Figure 7,
an examination of GAFAM's cash flow since before Corona Pandemic shows that 1) the decline in 2022 wasmerely a reaction to the special demand for the Corona Pandemic demand boosting , 2) the companies used thisrecession as an excuse to implement a major restructuring, 3) at the same time, R&D expenses increased
significantly to reduce surface profit, and 4) the sharp increase in sales and profit from 4Q2022 onward.
Magnificent 7's robust stock price is made by the rebound from a sharp decline (almost 30%) in 2022, and by thestrong profit recovery.

Double Benefit of Cost Reductions and Higher Sales Prices
High-tech companies are also using their monopoly positions to drive up selling prices: NVIDIA, which has amonopoly on GPUs, which are essential for generating AI, has overtaken TSMC and Intel to become the industry
leader in semiconductor sales thanks to its high selling prices. Intellectual property rights create price dominanceand value is determined by them. On the other hand, technological improvements increase productivity andreduce costs. The synergy of price dominance and cost reductions supports the unabated profit growth of Internet
platformers and other high-tech companies, which are expected to generate $400 billion in after-tax profits by
2024, equivalent to the profits of all Japanese corporations. The M7's share of the MSCIAC Index, a global stock
price index, is 17%, higher than the combined 15% of Japan, France, China, and the U.K. (WSJ 12.18.23),
indicating the size of the M7's market capitalization. The fact that such a huge "seventh continent" is still growing
exponentially should be taken more seriously.

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Strategy Bulletin vol347

Figure7: GAFAM Net income, R&D, Operating CF(2019.4Q=100)

200
180

Net Income

160
140

R&D Expence
Operating CF

120
100
80
60

Figure 8: GAFAM Cach flow trend(Musha Research)
400000mil dollar
300000Net Income

200000100000R&DExpence
Dip

0
capex

-100000-200000

Share buyback-300000
2009201020112012201320142015201620172018201920202021直近

Higher for longer, No major correction in the U.S. economy, no major interest rate cuts
A serious slowdown in the U.S. economy and a sharp drop in stock prices are unlikely in this situation. Sinceinterest rates will start to fall from the current U.S. policy rate of 5.25-5.50%, a rate cut of as much as 2-3% ispossible, which would inspire animal spirits and boost stock prices significantly. However, if there is no danger ofa recession, there is no need to force a rate cut and push up stock prices excessively. In the past, rapid rate hikes
have been followed by rapid rate cuts, and the market is rushing to discount rate cuts, assuming past will be
repeated. However, the Fed has repeatedly stated that it is "Higher for Longer" to check the market's growing
expectations for a rate cut.
Inflation, which was the impetus for the rate hike in the first place, has been quelled. It is now clear that the inflationthat began in late 2021 was transitory, as Musha Research claims. Energy prices, supply chain disruptions, andfood prices have completely subsided. Service prices and rents are still rising, but average hourly Earnings, thedeterminant of service prices, have fallen from a peak increase of 7% y/y to 2-3% y/y. In addition, imputed rents
are a lagging calculation based on housing prices, and we see them coming down.

Inflation transitory that is falling sharply
Why does the Fed maintain a Higher for Longer stance? One can only assume that it is because the level of theso-called neutral interest rate, which is suitable for maintaining sustainable economic growth, has risen. However,since no one knows the correct level of the neutral interest rate, the Fed has been raising interest rates with
gradual and cautious stance. Fed Chair Jerome Powell's famous remark at the Jackson Hole meeting last summer,"We are navigating by the stars under a cloudy sky," illustrates this.

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Time to change our view of interest rates over the past 50 years
This perspective leads us to the conclusion that current lifted level of interest rate is a good thing. Looking backat interest rate trends over the past 50 years, it appears that the sense that rising interest rates are bad and fallinginterest rates are good has persisted: the interest rate hikes of the 1970s were bad, with inflation, declining
government confidence, and dollar instability causing risk premiums to rise, interest rates to rise, and stock prices
to remain depressed. Figure 11 shows the real NY Dow index deflated by the rate of price increases, whichpeaked in 1966, when interest rates began to rise, and fell 75% over a 17-year period to bottom in 1982, a decline
comparable to the Great Depression. This was truly a bad interest rate rise.

Figure9: US Long& Short-term interest rates and rate differential
20

15

10
10YTN(A)5

FFrate(B)0Differinceial(A-B)-571 72 74 75 77 78 80 82 83 85 86 88 90 91 93 94 96 97 99 01 02 04 05 07 09 10 12 13 15 16 18 20 21 23
Source:Bloomberg,Musha Research

Figure10: Relation between Interest rates and Economy ,Stock prices

Good

Interest RiseInterest Down

Business cycle UP

Saving Increase

Potential Growth Rate Up

Fiscal Confidence Up(Stock Price Up)

Inflation down
➡NOW?

➡1980～2020

Bad

Saving Down

Business Cycle Down

(Stock price Down)

Inflation UP

Potential Growth Rate Down

Fiscal Confidence Down
➡1970's➡Period of Recession '90,'01,'08,'20

Source: Musha Research

In contrast, the 40-year long-term decline in interest rates after 1981 was a good decline in interest rates due tolower inflation, a growing savings surplus, and the resulting lower risk premium. Real stock prices increased 32fold (9.1% per annum) over the 40-year period from 1982 to 2022. However, one cannot simply assume that risinginterest rates are bad and falling interest rates are good. As shown in Chart 10, if the current rise in interest rates
is due to higher potential growth, it is a good interest rate increase. If the Fed continues to keep policy rates at
low levels under rising growth potential and rising neutral interest rates, inflation and asset bubbles will increase
eventually. Therefor the Fed will have to keep rates high even if inflation fears disappear for the time being. If thisis the true meaning of the Fed's Higher for Longer, then the current high interest rates are a factor for higher stock
prices.

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Figure11: Real NY DOW index and Economic regime in the U.S.
(Log. scale)

10,000Great
depression/World
War II(regectionofclassical
liberalism)

Prosperity
underclassical
freemarketeconomyKeynesianeconomy(managedcurrency system+ fiscal policy)

Prosperity
under neoliberalism

Trilemma(rejection ofKeynesianeconomy)New
Keynesian ?
Failure of (QE+MMT)
neoliberalism

?

1,000

2020

2015

2010

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

1955

1950

1945

1940

1935

1930

1925

1920

1915

1910

100
* Real stock price＝DJIA/US CPI. (CPI ; Oct 1982 = 1) Source: Bureaau of Economic Analysis, Musha Research

Convergence of Diverging Profit rates and Interest Rates
More fundamentally, it is important to note that the "convergence of profit rats and interest rates, which have been
diverging," is now rapidly progressing. Musha Research has been pointing out the anomaly of the continuous
divergence between the profit rate and the interest rate for more than a decade. In both Japan and the U.S.,
interest rates have been falling since around 2000, while the profit rate has been rising, as if a crocodile had
opened its mouth, and I pointed out this strange phenomenon in "The New Imperialism" (Toyo Keizai) publishedin 2007 (p. 108), but I did not understand the reason at that time. Shortly thereafter, the GFC caused the profit
rate to decline, and the crocodile's mouth closed for a time, but since then the gap between the two subsequently
widened even more significantly. The profit rate is measured by return on total capital, return on equity (ROE),
and earnings yield (profit/share price), but the expansion of the crocodile's mouth is evident in all profit marginindices.
Figure12: Earnings yield, 10YTN and Fair value of S&P500 based on Fed Model

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Strategy Bulletin vol347
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Figure 12 shows the trends of earnings yield and 10-year Treasure yields, which were linked until around 2000
but have diverged significantly since then. The Fed once proposed the model of "expected earnings per share /10-year JGB yield" as a fair value of stock prices. The model states that the appropriate stock price is the level atwhich the expected earnings yield (expected earnings per share/stock price) equals the yield on the 10-year
Treasury note. Based on this model the stock price have been undervalued significantly, since the yield on equity
have not declined over the past 20 years as interest rates foll This undervaluation of stock prices, have comemuch closer to fair value as interest rates have risen.

The crisis of capitalism was averted, with the contribution of MSSE
Now, this divergence between the profit rate and the interest rate is a dangerous precursor to catastrophe. In
capitalism, there is a struggle for funds because there are lucrative business opportunities and jobs, and interest
rates rise as money is put to effective use. However, if companies make money but the money is idle and unused,
the resulting interest rates fall means that capitalism is not functioning. I have argued that if the profits ofcorporations are not returned to the recirculation process of the economy, we are in trouble, and this is adangerous signal that could lead to a Great Depression. A concept of this is shown in Figure 13.
Figure13: The basic contradiction of modern capitalism,
the divergence between the rate of profit and the rate of interest
Basic contradictions of the current US (developed countries)
Divergence between the profit rate and the interest rate

Profit raterowth rate

Excess corporate profits

Interest rate
Capital hoarding

Wideninginequality
argued by Thomas Piketty

Conundrum
called by Alan

reenspan

Scenario turning divergence to converge
iscal policy

Convert surplus capital into effective demand

Monetary policy

ormerly demand creation by bank credit
Now demand creation by rising asset prices (asset effect)(Share buybacks are the most efficientroute)

Wage hike policy

Efficientmarket, High-pressure economic policy

Two patterns of demand creation
TyrannyWar, invasion,colonies,huge structures(pyramids,

Democracy
62

Improvement of standard of living for all

reat Wall, royal palaces)

Marx could not foresee

Source: Musha Research

There are several ways to return capital to the economic cycle. In the U.S. today, interest rates have risen becauseof the successful functioning of these methods, and idle funds have begun to be put to effective use. So, how did
the idle funds start to move? One of them is fiscal policy. The government has begun to put the money it has beenplaying with to effective use. High-pressure economic policy (MSSE), led by Treasury Secretary Yellen, seems tohave contributed admirably.

Monetary easing and rising asset prices have led to demand creation = job creation
The other is monetary policy. Monetary easing has started to put money to effective use. However, the process
of monetary easing is different from the past. With conventional monetary easing, interest rates fell, bank lending
increased, and idle money was returned to economic activity, but now there are no borrowers even if banks try to
lend.

Figure 14: U.S. Corporate Sector (Nonfinancial) Flow of Funds ($ billion)

Source: FRB Musha research

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The way in which the money made by corporations during monetary easing was used this time around wasthrough share buybacks and dividends. By returning the entire profits to shareholders, companies increased theirstock prices, resulting in a virtuous economic cycle. Since more than half of U.S. household savings, including
pensions, are effectively in stocks, higher stock prices increase savings, and the wealth effect boosts the economy.
Almost 80% to 100% the free cash flow of the U.S. corporate sector has been returned to shareholders in theform of dividends and share buybacks, especially since the GFC. Even if households' wages have not increased
much, the rise in the financial assets’ prices they own and increased dividends has provided energy for
consumption. It can be said that the virtuous cycle of the U.S. economy has been supported by an unconventional
mechanism. As a result, the divergence between the profit rate and the interest rate has entered a process of
convergence, which has manifested itself in the form of the current rise in interest rates. Although the increase in
the policy rate due to inflation was one of the triggers, there were underlying process such as shareholder returnof corporations that caused interest rates to rise. Therefore, the Fed is not likely to cut interest rates easily even
if inflation subsides.

Figure15: Accumulated Investment by U.S. Equity
EntityFigure16: U.S. Household Assets, Debt, and Net Worth

5,000

180 (USD Tril.)

4,500
4,000

（$ bil.）Non-financial
corporations

160

3,500

140

3,000
2,500

120

2,000

DurablesHouseholds

1,500

100

Net worth

1,000
80

500

Total asset

Foreign sector

0

60

-500

Financial asset-1,00040-1,500-2,000-2,500US Pension funds and otherinstitutions

20
Real estate0-3,000Liabilities-3,50009 10 11 12 13 14 15 16 17 18 19 20 21 22 23-20
95 97 99 01 03 05 07 09 11 13 15 17 19 21 23
Source: FRB, Musha Research

Source: FRB, Musha Research
Researchstrong dollar accompanied by high U.S. interest rates as the future trend
If the growth rate of the U.S. economy is higher than that of other countries due to the industrial revolution andtechnological innovation, the result will be high interest rates, and the dollar will appreciate. If the strength of U.S.
innovation continues, the dollar will remain strong for some time.
In addition, there is another factor supporting the dollar's strength. After the Nixon Shock of 1971, the U.S. wasable to issue bills without backing them with gold, and it printed more bills to buy goods from overseas. Japan
was the first to benefit from this, followed by South Korea, Taiwan, and China. China became so strong because
the U.S. bought more goods. It is important to note, however, that the U.S. has had enough, and there is no room
left to increase imports any further. Until the Nixon Shock of 1971, the U.S. import dependence rate (how muchof the goods that Americans need is imported) was around 10%, and at that time the U.S. made all its TV sets
and clothes domestically. Now, however, the U.S. relies on imports for about 90% of its goods. Since there is noroom for further increase in U.S. imports of goods, the trade deficit is likely to peaking. On the other hand, theU.S. invisible income from foreign trade will increase significantly in the future. These are services, intellectual
property rights, and asset income. These are easy to understand if we think of them as income from the cyberworld. Since the cyber world is the sole domain of U.S. companies, we are entering an era of ever-increasing
income from it (see Strategy Bulletin No. 345, 11/24/2023).

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(3) Japan's time has comeA rare situation has arisen: the greater the seeds of global unrest, the more Japan's brightness emerges. For the
past 30 years, Japan has been the world's underdog. It was the only country in the world to suffer from long-term
deflation, and its nominal GDP remained flat at just over 500 trillion yen for 30 long years. It was the only country
in the world where wage growth stopped for 30 years and was overtaken by South Korea.
Japan's share of the MSCIAC Index, a basket of global equities, fell from over 40% to 5%, almost one-tenth.
During this period, global investors continued to sell Japanese stocks, and by reducing the ratio of Japanesestocks, they were able to win the investment competition. Not only the Japanese, but also investors around theworld have developed an attitude of disregard for Japan. Japan is suddenly becoming the world's brightest spot,with the Nikkei Stock Average rising +28% in 2023, the US SP500 +24%, Germany's DAX +19%, the UK FT100+4%, China's Shanghai Composite -4%, and South Korea's Composite +19%, all of which stand out among majorcountries' stock markets.
Figure 17: Stock price indices of major countries (since the beginning of 2023 and since 3.9.2009)

Two actors Behind Japan's Brightness, A. Subjective Change
What has happened to Japan? Two major changes should be noted. The first is a fundamental change: Japanesecompanies and the economy have improved during the Abenomics era since 2013. Through reforms and thecreation of new business models, companies have doubled their profit margins and continue to post record profits.
Public pension fund GPIF's investment income has quadrupled to 108 trillion yen. Tax revenues have increased
70% over the past 10 years. Wage growth, which had been lagging, has begun, and 2% inflation is on the horizon.
Many Japanese companies have developed creative business models that are not copycats, have made great
strides in corporate governance reform, and are now profitable enough to meet the demands of their shareholders.
The value created by these companies is currently being stored in the form of ample retained earnings. In orderto promote the return of this retained corporate income, the Kishida administration is implementing a new capitalist
policy that will trigger a virtuous cycle from savings to investment by: 1) promoting wage hikes; 2) requiring
companies with P/B ratios below 1x to take corrective measures and induce profit returns through share buybacks
and dividend increases; and 3) promoting investment through NISA reform and other measures. The supplydemand balance for Japanese equities is expected to improve significantly.

Two factors behind Japan's brightness, B. Major changes in the geopolitical environment
The second factor is the external environment. The U.S.-China confrontation has worsened, and the U.S., which
once went crazy in its efforts to knock Japan, now needs a strong Japan to decouple from China and has cometo accept a weaker yen to achieve this. The rise of China plus Asian NIES (South Korea, Taiwan, and Hong Kong)
over the past 30 years has been remarkable, but it has been made possible by Japan's declining competitiveness.
This one-victim Japan situation will be reversed. The significant depreciation of the yen has changed the major
framework of the Japanese economy. The deflationary period caused by the strong yen is over, and 2023 was
the brightest volume boom year for the Japanese economy since the burst of the bubble economy, and 2024 will
see an acceleration of this trend. Factories, capital, business opportunities, and employment that fled Japanoverseas due to the strong yen are returning to Japan due to the weak yen. Corporate earnings and capital

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investment are skyrocketing. The semiconductor boom is progressing further, and TSMC Kumamoto has decided
on a third phase of expansion. The weak yen has also increased inbound tourism, and foreign tourists arestimulating local domestic demand in every corner of Japan.

Figure18: PPP and dollar yen rate trend(¥/US$)

360
330

From punitive strong yen to benefiicial weak yen

Punitive strong yen
Spot rate > PPP

300

Beneficial weak yen
Spot rate < PPP

270
240
210
180
Domestic-foreign
price differentials

150

JPY/USD spot rate
2023/12/30 141.0

120
90

PPP
2022 95.2

Inversedomesticforeignprice
differentials

60
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22
Source: OECD, Musha Research

Just before the completion of the 2% inflation target, the BOJ has a good chance to win
Former BOJ Governor Kuroda laid the groundwork for the end of deflation by withstanding criticism from many
quarters. In December 2022, just before stepping down, Kuroda announced an adjustment to the YCC (shifting
the long-term interest rate ceiling from 0.25% to 0.5%), clearly taking a step toward exit. New BOJ Governor Ueda
further adjusted the YCC and allowed long-term interest rates to exceed 1% to a certain degree, leaving longterm interest rates largely to the market. QE (= balance sheet expansion) has also reached its peak at 750 trillion
yen over the past few years. The outlook for achieving the 2% inflation target has also improved, when foreign
hedge funds speculated on selling JGBs and dollars during the YCC correction in December 2022, these
speculations did not last, and the market did not budge at all (Figure 19). The opponents of reflation policies, who
assumed that the exit from monetary easing would be chaotic because the extreme monetary easing was
forbidden measure, were completely off base.
As Japan's economic growth potential increases and 2% inflation comes into view, the BOJ, like the Fed, will
modify its ultra-easy monetary policy and long-term interest rates will rise. However, as in the U.S., the rise ininterest rates that is occurring in Japan is also a good interest rate hike and a factor for stock market rally. In fact,
the divergence between the profit rate and the interest rate is much larger in Japan than in the US. As shown in
Figure 20, In the U.S., the gap between the two shrank sharply in 2023 as interest rates rose, and Japan is
expected to follow suit. The expected rise in interest rates in Japan, as we have seen in the U.S., can be seen asa sign that capitalism is back in action and will be understood as a factor for higher stock prices. There is no need
to be skeptical about the BOJ's policy changes. The BOJ will continue to exit in an orderly fashion without
problems, and the stock market will appreciate it.

Opponents of Abenomics have disappeared
Opposition to Abenomics has disappeared from the scholarly media discourse. There is no longer any objection
to the argument that we should be patient and aim to achieve the end of deflation, which is just around the corner.
The anti-Abenomics camp's unreflective change of stance is not graceful, but it is good news for the market, andwe can expect an all-participant stock market rally in 2024.

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4 January 2024

Figure19: 10YJGB yield and Policy rate /YCC Adjustment

Figure 20: Japan US ROE, Earnings Yield 10yGovernment Bond Yield

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