The Third Arrow

The Japanese government messed up. Low interest rates and high currency were not a problem. Low interest rates are a consequence of high competition for capital. After all the low-hanging fruit has been picked, what’s left is the opportunities that offer lower rates of return. Low rates are a natural occurrence in a developed market. Even negative rates are not that unusual – the Swiss just issued their first negative-rate government bond. The Euro is so volatile that people are willing to pay the Swiss to keep their money safe. The same status had formerly been accorded to the yen as a reserve currency. Higher inflation rates in Asian economies lead people and governments to be willing to pay in the form of negative interest rates to have their money safe.

Reducing the value of the yen by 50% puts money on the balance sheets of exporters and big companies that already have high overseas sales, but hinders companies from making overseas investments. The economy previously grew through exporting, and the Japanese government is trying to promote growth by promoting exports. This is an inefficient way of promoting export, at that, since all production inputs that must be imported end up costing more. Yet, by simply doing nothing, the high yen would have encouraged foreign investment, as foreign assets looked cheap and banks and companies sought a higher rate of return.

Companies in Japan were dependent on domestic consumption, failed to generate enough demand for products overseas, and failed to invest in production capacity overseas. Companies like HGST, Sony, or Toyota that invested in overseas sales and production capacity continued to do well through the period of high yen and low interest rates. Companies like NTT, dependent on a declining domestic market, have not done well. The effect of inflating the currency has been to benefit those companies who were already doing well, while at the same time to discourage foreign investment by making foreign assets more expensive.

Politically, as China is expanding its soft power with its launch of the Asian Infrastructure Investment Bank, Japan is decreasing its ability to lend or invest abroad by devaluing its currency.

With domestic consumption saturated, no amount of domestic investment will create a larger rate of return. Japan has an excess of capital. It is squandering it by devaluing the currency. Stop. The government should not be concerned with trying to grow the domestic economy, which is already saturated. People already throw away expensive items like large screen TVs in order to make room for new ones. How many more TVs can they use? Instead of playing with numbers and destroying capital with QE, the government should be concerned with enabling the profitable employment of capital.

MNCs get higher return on capital by outsourcing production in developing economies and investing in production capacity there. Think Intel, Apple, Toyota. Allowing the yen to remain high would continue to encourage companies to invest overseas.

Domestically, the government could improve the way capital is employed.

  1. It should be made easier to fire people (companies are ever-hesitant to hire people because it’s hard to get rid of them).
  2. Bankruptcy law should be reformed so that entrepreneurs have true limited-liability. Wide experimentation necessarily leads to a few successes and many failures, as Silicon Valley can attest to.
  3. Retirement age should be raised in order to relieve strain on the pension system. It is currently 60.
  4. Labor practices should be reformed so that it is easier to be a parent, including making it easier to take paternity leave and making it easier for women to rejoin the work-force if they take time off to raise children.
  5. There is a shortage of daycare centers. Access to daycare should be improved by allowing the easier conversion of defunct elementary schools to publicly-subsidized daycare centers.
  6. The cost of raising a child should be reduced by making high-school free. Why spend billions in QE when the same billions can be spent to improve education?

It’s time to learn new tricks. What got Japan here was domestic consumption and domestic investment. Forget about the numbers. What’s important is to keep things interesting for young people. Otherwise, who’s going to have children? I met a college graduate recently who decided to take a job as a hotel concierge. That’s what it’s come to. The system is so locked, there is so little opportunity for experimentation and growth, there are so few positions in society open for people who are coming of age, that college graduates are deciding to take jobs as hotel concierges. The government must make structural reforms to remove obstacles toward the natural redeployment of capital, instead of caffeinating the economy to continue to run in the way of the past.

As for young people with a college education, I would say: leave and get experience elsewhere. A concierge job is fine, if it’s what you want to do, but it was definitely not what the guy I met was hoping for. Why fight in a little world with other college-educated people for a little job that is entirely confined to Shinjuku, doesn’t require a college education, and doesn’t teach you to be anything else? Leave. Is it better to be a concierge in Japan business development manager overseas? You get to choose: comfort or experience? Directly apply to the overseas branch and get some experience at a job that you actually want to do. There are so few people doing this sort of thing that you will actually face no competition.

And after you have gotten foreign language and cultural experience, the long-term demographic trend in Japan will still not have changed. The domestic market will still be shrinking. The excess of Japanese capital will still be looking for higher returns. Companies will be looking for linguistically and culturally competent people to be their face to the outside. You will have new ideas and ways of thinking that you would not have learned if you had stayed behind. It will be hard, but you will have a greater appreciation for what is good and bad about Japan after spending some time on the outside. You will be ready. There will be no competition.

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