Wednesday, October 8, 2008

What the Japanese Stock Market Tells Us

Remember the Japanese and their banking problems? Japan is much different from the U.S., but this chart does not bode well for the U.S. stock market. Japan currently has the world's third largest GDP (on a purchasing power parity basis). Check out this article:

The Japanese economy was growing at a headlong rate, and companies were expanding and investing as never before.

The trouble was that much of this investment was being financed by an extraordinary boom in property and share prices. Property and shares were used as security for huge bank loans - and when the property markets and stock markets suddenly crashed at the beginning of the nineties the whole spiral of borrowing, asset price inflation and investment came to a full stop.

And despite many government initiatives to kick start demand, Japan's economy has remained fairly stagnant for the last six years. The stock market has been flat too, making it difficult for make profits.

Sound familiar? Defensive investors know that consumers will always need health care and consumer staples (e.g., Unilever products); however, investors looking for more than a 5 to 7% annual return are evaluating other options. After all, the key to getting high returns is determining the next high growth economic area and/or product.

U.S. companies realized earlier than most Americans that their growth would rely on non-U.S. countries. As a result, most major companies have shifted their emphasis overseas while lobbying for fewer trade restrictions. Now that the American consumer appears to be down and out, the question is whether the world economy can finally gain traction without the U.S. The most obvious way this decoupling will occur is if the American dollar is devalued, creating incentives for other countries to buy American products. If a Chinese yuan buys quite a bit of American goods, the Chinese consumer will feel flush and may start spending more, allowing the world economy to have more than one major source of income. A similar scenario can also play out with the Indian and Brazilian consumers. In fact, non-U.S. citizens must spend more in order to maintain economic stability.

Once you realize how small the American population is--only 5% of the world population--it's fairly easy to see that the most growth will come from abroad. As a result, trade restrictions will harm U.S. companies and their ability to expand and get their products into the hands of other countries' consumers. American companies that fail to achieve high growth rates will lay off workers in order to become more efficient. Thus, improving the job market means helping American companies gain more consumers, which means giving them more access to non-U.S. consumers. To achieve easy access to the international market, we have to negotiate with other countries and have fewer restrictions to encourage a free flow of ideas, money, and traffic. As much as we may hate to admit it, reducing trade restrictions and devaluing the American dollar may actually stabilize the world economy in the long run.

At the end of the day, what choice do we have, really? The American consumer is tapped out. Other countries' consumers must step up to the plate, and we need to encourage them to do so. In an era where the world economy requires more trust between countries, the latest failure of the Doha Development Round is an ominous portent. Thankfully, the failure of governments is not determinative.

The American corporations that succeed will be the ones who understand that the American consumer is but one small slice of a very large worldwide pie. In an era of cynicism, skepticism, and security fears, we must regain our confidence and look to maximize our international footprint through trade and superior products. The "Post-American world" can no longer be an amorphous, distant concept if we are to succeed--Americans must begin to see the world as one large marketplace in which they have the advantage because of their greater access to technology (Google, Yahoo, eBay, Intel, etc. all made in the U.S.A.); the world's common language (English); an above average health care system (better health means more productivity); and entrepreneurship (it can take less than a week to set up a small business in California--for fun, compare that time with India and its small business rules/red tape).

I never thought I would advocate a weaker domestic currency, but sad times create sad consequences. The time has come to work harder and re-gain our stature in the world. When the non-U.S. buyers come, America must welcome them with open arms and the American attitude formerly known as optimistic. America is down, but as long as we have immigrants arriving and hoping for a better future, you cannot count America out. For better or worse, we are still the world's major repository for dreams. That's why I don't see a Japan-style economic morass happening in America--Japan is getting older and has never liked immigration. As long as we stay away from protectionism and encourage responsible immigration, we will do just fine.

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