Musha Research Commentary

23 June 2024

S\
Strategy
Bulletin (No. 356)

An Analysis of the Inevitability of the “Japan Decline with
China Rise to Japan Rise with China Decline” (1)～The Japanese Revival from the Collapse of the Bubble Economy and Lessons for China
The Japanese economy is once again on a long-term recovery path after a period of rapid
postwar growth, the bursting of the bubble economy, and prolonged economic stagnation.
On May 25, 2024, at the annual academic conference of the Center for Industrial
development and Environmental Governance (CIDEG) at Tsinghua University, wedelivered a keynote report on "Japan's Economic Revival and Lessons for China" under
the theme of "A comparative Study of Chinese and Japanese Economic Policies. "The following is a detailed explanation based on the report. The first is that Japan's
economy is now on a long-term recovery path and that two factors have contributed tothe prolonged stagnation. The prolonged economic stagnation was caused by externalpressure (pressure from the U.S. and the strong yen) and policy errors. Second, there
are three similarities between Japan's past and China's present. Third, there are four
differences between Japan and China. A comparative analysis of Japan and China
reveals that there are common circumstances behind the post-World War II development
and setbacks in both countries. Such an understanding is essential when considering
policy choices and prospects for Japan and China.
(1) Japan's Entry into the Era of Great Growth (this issue)(2) Three Similarities between Japan and China that relates US Debt (next issue)(3) Four differences between Japan and China: (next issue)(4) Conclusion (next issue)

Figure 1: Vigorous Recovery of Japan with 5 Indices (1984=100)500
450

Personal Financial Asset
2023.3Q441.6

400
350

300

EmployeeComp.
2023.Q4
187.7

250
200

Nikkei Av.
2024.Q1
369.4

150
100
50

Corporate Taxable
IncomeFY2023 (e)265

Land Price Idx.
(6majer cities)
2023.73.5

080 81 83 84 86 87 89 90 92 93 95 96 98 99 01 02 04 05 07 08 10 11 13 14 16 17 19 20 22 23
Source:MoF,DoL,BoJ,Japan Reaestate Institute, Bloomberg,Musha Research

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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 vol356

23June 2024

(1) Japan's entry into the Great Growth Era is almost certain
It is almost clear that Japan has emerged from its prolonged economic stagnation and is entering an era ofgreat recovery. This is confirmed by the strong rise in stock prices, the earliest leading indicator of economic
trends in the capitalist economy.

Japanese companies' great revival of earning power
Leading this recovery is corporate earnings. True corporate earnings, after deducting extraordinary losses
such as write-offs of nonperforming loans, can be measured by tax-reported income by companies.
Corporate earnings peaked at 43 trillion yen in FY1990 and declined sharply to 2 trillion yen in FY 2000,
one-twentieth of the peak, but are expected to grow rapidly to 50 trillion yen in FY2022 and 57.5 trillion yen
in FY2023 (estimates by Musha Research). Value creation in the corporate sector is the engine that drives
the economy forward, and the robustness of this engine brightens the outlook for the Japanese economy.
Figure 1 provides an overview of the five indicators, showing that corporate profits are recovering andexpanding strongly and quickly, along with stock prices, while labor wages (=employment income) and land
prices are recovering more slowly. The trickle-down effect of strong corporate profits is likely to cause an
expansion of wages, consumption, and capital investment.

Initiative corporate efforts, a major shift in business models and improved corporate
governance
The revival of Japanese corporate profits has been supported by two factors: (1) the efforts of Japanesecompanies and proactive conditions such as the government's reform policies, and (2) improvements in theexternal environment, including a very weak yen and a semiconductor boom brought about by the US desire
to strengthen its supply capacity in Japan as a result of the US-China conflict. Japanese corporate profits
were plunged to5% from previous peak by the U.S.'s aggressive attack on Japan, the super-strong yen, andthe profligate management of Japanese companies that sat on their bubbles, but they have made aremarkable comeback. In response to the strong yen, they shifted their factories overseas. It also took
advantage of the strong yen to acquire overseas companies and transformed itself into a global player.
Furthermore, the company cut costs in Japan through restructuring, mechanization, and labor cost
reductions. In addition, the company thoroughly revised and restructured its business model, including
concentration and selection.
Furthermore, corporate governance reforms as part of Abenomics have progressed since around 2015, andthe pursuit of return on capital over cost of capital, a capitalist merkmal as a compass for corporate
management, has taken root and financial efficiency has improved significant

The U.S.-China conflict and the great turn toward a weaker yen
The most important change in external conditions was the sharp turn in the U.S. attitude toward Japan.
Since mid-1980’just before the end of the Cold War, the U.S. has begun to attack Japan, which is considereda threat to The U.S. because of significant strengthened industrial competitiveness and outpacing U.S. firms
in key industries such as semiconductors, electronics, and automobiles. Trade friction and the super-strong
yen became the means to this end. For example, in the Japan-U.S. semiconductor agreement, the U.S.
demanded that Japanese companies deviate from trade rules by allocating 20% of all semiconductor
purchases to U.S. products, and Japan had no choice but to comply. The Japanese yen was permanently
raised above purchasing power parity, the currency's real strength, by more than 30% between 1900 and2010, and by twice as much at its peak in 1995, severely undermining the cost competitiveness of Japanesefirms. Industrial clusters of high-tech manufacturing industries that had been concentrated in Japan shifted
to South Korea, Taiwan, Hong Kong, and China. Observing Japan's industrial competitiveness in terms ofglobal semiconductor production share shows that Japan, which accounted for 50% of the global
semiconductor market in 1990, has declined to less than 10% since 2013. The strong yen had made theJapanese companies’ cost the most expensive in the world. Factories, jobs, and capital have been moving
out of Japan due to higher costs, which hollowed out the Japanese economy. Also, they have been holding
down wages, making Japan the only country in the world where real wages have remained flat for 30 years,
and deflation has taken hold.

A weak yen combination with strong profits and labor shortages leads to sustained
wage growth
However, the U.S.-China confrontation became decisive in 2018, and the U.S. desire to restructure its supply
chain, which is concentrated in China, has steered the country toward acceptance of significant yen
depreciation. The dollar-yen rate remained between 100 and 110 yen per dollar until early 2022 but has

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Strategy Bulletin vol356

23June 2024

since fallen all the way to the 150-yen level. That is nearly 40% below purchasing power parity, which hassignificantly strengthened the price competitiveness of Japanese companies. Demand has begun toconcentrate toward Japan, which has become a remarkably low-cost country in the world. A virtuous cycle
began to emerge, with factories returning to Japan, exports increasing, and overseas tourists increasing(Figure 2). Furthermore, wages in Japan have fallen to levels not seen in developed countries, which has
increased the pressure to raise wages. The conditions for wage increases are now in place: theunemployment rate is at full employment at 2.6%, corporate profits are unprecedented, and Japanesecompanies must stop the departure of their best personnel. The 2024 wage hike rate is 5.08%, the highest
level in 33 years. In March, the BOJ lifted all of its negative interest rates, yield curve control (YCC), andother forms of monetary easing. It is clear from the above that Japan's economy is almost out of deflationand prolonged stagnation.
Figure 2:

From punitive strong yen to beneficial weak yen

360

Spot Rate
310

Beneficial weak yen
Spot rate < PPP

260

210

PPP(Perchsing Power Parity)

160
Domestic-foreign
price differentials

110

Inverted
Domestic-foreign
price differentials

60

66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11 14 17 20 23 26 29 32

Source: OECD, Musha Research

Going forward, the Japanese economy is expected to enter a period of higher potential growth, which is rareamong advanced economies, because of the synergistic effects of the initiative-taking conditions andfavorable external environment.

Abnormally undervalued Japanese stocks = Negative bubble still intact
Japanese stock prices are severely undervalued and are likely to rise further in the future. The purest andmost accurate measure of stock prices is the comparison with the yield on government bonds, and Japaneseequities are currently offering significantly higher returns than government bonds, yielding 6% on equities
and 1% on government bonds. While they are currently significantly undervalued, in 1990 stock prices weresignificantly overvalued with less than 2% of earnings yield and 8% government bond yield.

Irrational investment attitudes are changing now
However, the asset allocation of Japanese households is irrational. A comparison of the allocation ofhousehold financial assets between Japan and the U.S. reveals Japan's marked dependence on deposits.
In Japan, 73% of financial assets, excluding pension insurance, are in bank deposit with almost zero interest.
On the other hand, stocks, and investment trusts, which return 2% from dividends alone and 6% if retained
earnings are included, account for only 20% of total financial assets. In the U.S., stocks and investment
trusts account for 72%, while cash and deposits account for 18%, exactly the opposite composition,
indicating that U.S. households have continued to build large assets thanks to the stock market appreciation.
The net worth of U.S. households has grown from $59 trillion in 2009, immediately after the GFC, to $156
trillion by the end of 2023, a massive $97 trillion (3.5 times GDP) in 14 years, which has led to robust

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Strategy Bulletin vol356

consumption. In Japan, the Kishida administration's expansion of tax breaks for individual stock investment(NISA reform) will trigger a major shift of funds from cash and deposits to stock and investment trusts, which
accelerates the stock market rally.

The "new capitalism" will make U.S.-style equity capitalism take root in Japan as well
The anticipated rise in Japanese stocks suggests that Japan is heading toward an era of U.S.-style stock
market capitalism. In the U.S., we are entering an era of equity capitalism in which rising stock prices are
the primary driver of economic expansion. Figure 3 shows the trends of the three major drivers of the U.S.
economy: private credit, public credit, and equity credit (= market capitalization). In other words, there wasno new credit creation in the banking sector. This was complemented by a remarkable rise in stock prices
and the ratio of stock prices to GDP. The stock/GDP ratio (the so-called Buffett index) rose from 69% in 2009
to 205% by the end of 2023. In other words, the means of credit = demand creation has shifted to stocks.
On the other hand, U.S. companies are now returning almost 80% of their earnings to shareholders throughdividends and share buybacks, and a new money flow has taken root. This is a complete change from thepattern of the past, when households' savings surpluses were absorbed by banks deposits, which in turnbecame bank loans, thereby circulating money. The corporate return to shareholders raises stock prices andincrease households' asset income (price gains + dividend income) Which support household consumption.
This has currently emerged new system as US equity capitalism.
In Japan, corporate governance reforms and demands by the government and the TSE for correction ofcompanies with low capital efficiency are driving share buybacks and dividend increases. Japan's
shareholders return ratio, which is now only 40%, will probably increase to 50-60%. In this way, Japan may
enter the era of equity capitalism, in which rising stock prices will support the economy.
Figure 3: U.S. Private Debt, Government Debt, and Market Value of Stocks (% of GDP)
350

300

250

Eqity Market Cap/GDP
Government Debt / GDP

200

150

100

50

Peivate Debt / GDP
1955Q1
1956Q4
1958Q3
1960Q2
1962Q1
1963Q4
1965Q3
1967Q2
1969Q1
1970Q4
1972Q3
1974Q2
1976Q1
1977Q4
1979Q3
1981Q2
1983Q1
1984Q4
1986Q3
1988Q2
1990Q1
1991Q4
1993Q3
1995Q2
1997Q1
1998Q4
2000Q3
2002Q2
2004Q1
2005Q4
2007Q3
2009Q2
2011Q1
2012Q4
2014Q3
2016Q2
2018Q1
2019Q42021Q32023Q20

Source: FRB, Musha Research

Policy mistakes that prolonged deflation and stagnation
It is necessary here to mention one more reason for Japan's prolonged stagnation: policy errors. The first ofthese is the postponement of problem-solving. From 1990, when the bubble economy burst, until 1997, thegovernment, corporations, and financial institutions covered up the problems, shifted the blame, and took
fiscal levers to cover the problems, instead of taking painful and essential measures to solve them.
In 1997, the crisis of financial institution failures finally triggered painful financial structural reforms, andpublic capital was injected into the banks as compensation for the reforms, and the government and the
Bank of Japan took over the bad loans. The public funds injected into the banks were fully repaid now except
for SBI Shinsei Bank and two regional banks.

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Strategy Bulletin vol356

The Japanese economy began to recover after 2003, but this is where the second mistake occurred. This
was a premature shift to monetary and fiscal tightening. Unfortunately, the GFC coincided with this, and theJapanese economy hit a "W" bottom. The GFC was a financial crisis in the U.S. and other countries. However,Japan, which was the furthest away from the epicenter of the crisis, suffered the greatest economic impact,
and its stock prices slumped the longest. Premature policy tightening pushed stock and real estate prices
down beyond their intrinsic values, imposing additional costs on companies and plunging Japan's recovering
economy and stock prices to a "W" bottom. The total market value of Japan's national wealth, including landand stocks, peaked at 3,142 trillion yen at the end of 1989 and bottomed out at 1,723 trillion yen at the endof 2002, but fell further after the GFC to 1,512 trillion yen at the end of 2011 (and has recovered remarkably
to 2,410 trillion yen at the end of 2023). This double-dip recession could have been avoided if the rightpolicies had been taken. It is likely to be a lesson for China.

Figure 4: Japan's Land + Stocks Market Value
Trends3500

Figure 5: House Price of Majer Countries
450
400

3000
Period of Policy Mistake

350

2500

300
2000
250
1500

1000

EQUITY

LAND

Australia
FranceGermany
Ireland
Italy
Japan
Korea
Spain
SwedenSwitzerland
United Kingdom
United States

200
150

100

500

50

0
80 83 86 89 92 95 98 01 04 07 10 13 16 19 22

0
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