My tipper on Astarra

Tipping the authorities off about Astarra required – as I said – no special genius on my part.  I was tipped by a blog reader who noticed that the Astarra investment committee claimed Charles Provini as a member whilst Provini was the CEO of Paradigm Asset Management.  I have written extensively on Paradigm Asset Management (see here for a decent summary). 

Anyway my tipper has now revealed himself.  He is Dominic McCormick – the chief investment officer of Select Asset Management.  Dominic insists his team deserves any credit.

Dominic (and presumably his team) had many of the issues with Astarra nailed by the time he tipped me off.  I worked out a few more.   

I reported the story to the Sydney Morning Herald who did not think they had enough evidence to run the story.  [They printed nothing until much later.]

Later I worked a few more things out and using connections ensured that the whole story landed directly on the desk of Tony D’Aloisio (the head of our securities regulator). 

Dominic found about half a dozen red flags with Astarra.  He has since listed them in this article without revealing that he was my original tipper.  Dominic’s article shows clearly that there were plenty of reasons not to invest in Astarra – and these reasons are valid reasons to be wary even if you have no strong basis to allege fraud.

The problems are wider than either Dominic or I anticipated.  For instance we knew nothing of ARP Growth – and that may be the most seriously impaired fund of the lot.  It is also the only fund on which I am willing to determine – absolutely – involved fraud.  (I have two wildly different sets of accounts for ARP Growth - at least one of those accounts must be fraudulent.)

The rest of the issues with Astarra I will leave in the capable hands of our regulator and perhaps the class action lawyers.  I want to get back to making money for our clients.

 

 

John

Barclays: do you employ these psychopaths?

Felix Salmon directs us to a blog post in which former Lehman executives (possibly safely employed by Barclays) talk about the Valukas report. 

http://blogs.reuters.com/felix-salmon/2010/03/17/repo-105-like-whatever/

Felix rightly describes these people as psychopaths. 

I am not going to further roast these executives – I just want to know how much of this culture infected Barclays. 

It remains a source of amazement to me that Barclays came out of the crisis so well.  Sure they got a (real) bargain buying Lehman’s US Broker-Dealer.  But they were hardly Snow White and their leverage levels were way higher than Lehman.  Moreover the crash-or-crash-through attitude of Bob Diamond would not have been out of place at the most aggressive (failed) hedge fund.  [The first post on this blog that got more than 30 readers was on Barclays – and – unlike many of my early posts – it looked very good for a while – but less good in the long run.]

Barclays is here and prospering so my pre-crisis view of the investment banks (that Lehman and Barclays would be the troubled ones) did not turn out precisely right.

 

John

PS.  Sorry for the absence of posts – but I was busy walking from Mallacoota to Wonboyn and there were no people, phones, internet or stock quotes.

A little follow up for people who want to reinterpret what Buffett said… oh – and a stock reason for looking at all of this…

There are a few comments on the blog that annoy me.  One for instance is repeated below:

A review of the transcript will show that Buffett believes that: a) the legislation must focus on cost, in order to achieve the goal of universal coverage. This has nothing to do with socialized medicine; b) he believes a broader political consensus is required. Everyone is entitled to the their opinion, but not to someone else's.

Buffett clearly said he was for universality of health care.  He would – if given no other choice – vote for the current bill.  Universality – unless someone else has worked out how it happens – involves a person who can’t pay (or possibly won’t pay) being covered by other people.  That can happen via the tax system or via some kind of forced levy on other people.  But it necessarily involves the (partial) socialization of medicine.

He implies however – though does not say so directly – that universality (necessarily involving some socialization of costs) – could be a disaster if costs are not controlled.  I will go further and say that it will be a disaster if costs are not controlled.  Australia has spent the last twenty years on measures that control costs (with considerable success).  In the UK – but to a much lesser extent in Australia – those measures include queue rationing of some services.  Queue rationing known here as “hospital waiting lists” was for a long time one of the dominant issues in State politics.  Queues are less of an issue now than (say) ten years ago – but if you run the expression “hospital waiting lists” through Google News you will still find that it is a political issue.  Anyone who tells you that you can have universal coverage without some queue rationing is lying.  A decent part of the system however is working out what procedures must take place quickly and what procedures can safely wait a while.  In Australia some people are in pain whilst on waiting lists. 

Buffett states clearly that controlling costs will not be done with a bill that pleases everybody.  There are $2.3 trillion of costs – and every bit of those costs has a constituency.  He wants a real analysis of medical spending effectiveness.  He wants experts – and he points favorably at Dr Gawande.  Dr Gawande focuses on things that involve medical incomes (including the use of the Doctor’s pen to order tests and specialist treatment). 

He notes that medical employees as a percent of population are low in the US compared to other jurisdictions and yet medical expenditures are high as a proportion of GDP.  Some of this must be expenditure that does not go to medical staff (he points directly at medical kit).  But some of it must be the incomes of the participants are high relative to the rest of the population.  [Simple math here – less employees – more cost – so more cost per employee.  And I know kit is part of that equation… but kit expenditures are simply not large enough to make up the difference.  And most of the rest of the cost of a doctor is the doctor’s income.]

Buffett does not prescribe how you would crush medical costs as he suggests – but he notes that other countries have done it with universal coverage, providing more doctors, more nurses and more consultations.  He thus thinks it is possible (though politically terribly difficult).  He specifically thinks that this cannot be done by consensus (despite the comment repeated above) because a bill that pleases everyone can’t deal with costs.  [I added – though Buffett did not say – that that implies that the bill cannot be bipartisan.  In the current context that means a filibuster process – though Buffett did not say that either.  Still if there is a way for a non-consensus medical bill which provides universal coverage and cuts costs to be bipartisan show me and I will stand corrected.]

I doubt Buffett – as the world’s second richest man – would find queue rationing acceptable for himself – but that discussion never came up.  If you want to accuse him of hypocrisy go ahead.  When my wife damaged her knee in a skiing accident we queue jumped using supplementary private health insurance.   So accuse me of hypocrisy too.

Buffett obviously knows that a system that radically cuts costs but has the government meet some of those costs will necessarily involve rationing.  He is not a fool.  He just never said how the rationing should take place – preferring to leave that discussion to experts.  That way though he could sound reasonable and friendly whilst proposing reforms that will radically reduce some peoples’ incomes and somewhat limit access to medical care.  And that I guess is Warren Buffett to a tee.  He sounds all genial – but underneath is one of the most hard-headed men you will ever come across.

Why I am interested

This is actually a hard headed investment blog.  And Buffett is right.  Medical reform which does not control costs will be a disaster.  He is also right to finger medical kit.  The current bill does not address costs – so it is not the time to think about this – but some medical kit companies trade at nose-bleed valuations because they can sell growing amounts of high tech kit at high margins.  (Intuitive Surgical is a good example.) 

I am an irregular short-seller of stock in even the finest companies.  When America finally gets serious about controlling medical costs some of these stocks will be fantastic shorts – simply because controlling costs means reducing some people’s incomes and some corporate profits.

And – that is enough reason to take the partisan glasses off and look entirely rationally a the problem.  This bill does not give me a good reason to short Intuitive Surgical.  From the perspective of Warren Buffett however that is why it is not a good bill. 

 

John 

 

Follow up: 

Namazu  - the provider of the comment that annoyed me - suggests we might be arguing over the meaning of socialized.

I think that is probably a fair comment... it is not a word Buffett used.

I consider the mixed market system of Australia partially socialized. By far the bulk of medical costs are picked up by government and are shared through the tax system - but it looks quite different to the UK.  [My UK friends also prefer the Australian system…]

Still – a system where by far the bulk of the costs are picked up by government and shared through the tax system meets my definition of socialized.  [Though people who say keep government hands off Medicare might have a different view…]

Still in many categories (for example pharmaceuticals) the Australian government is effectively the monopoly buyer - and it uses that power to reduce costs. That is a KEY part of the story as to how costs are reduced in almost all other countries.

And yes - it does crush incomes of doctors and corporate profits. 

Warren Buffett on Obama’s health reforms

Warren Buffett did one of his regular (extended) interviews with CNBC.  I think he appreciates the charm and attention from Becky Quick – even enough to get up at 5am and go to the steakhouse turned TV studio.  Most of these interviews are Buffett repeating his wholesome (and oft repeated) wisdom.  However he often comes up with a piercing analysis of something topical.  Today it was health care.

We (the US) have a little over 2.5 doctors per thousand.  Much of the world has over 3 doctors per thousand.  We have 11 nurses per thousand – much of the world has more.  We have three beds per thousand – much of the world has 6 or 7 beds per thousand. 

Having said this he points out that costs as a proportion of GDP are considerably higher than the rest of the world.  He then points out some statistics (for example infant mortality) where the US does worse than some other developed countries.  Importantly he points out that these costs are a passed onto other sectors of the economy.  He did not describe them as a “tax” on the rest of the economy – but that is what he meant.

He describes the situation as a “tape-worm” strangling American productivity and he is for health care reform but particularly health care reform that controls costs.  He would – in the absence of other choice – vote for the current bill.  That however is – in his case – very qualified support for the current bill.

The health-care part of the interview is worth watching.

 

 

In the interview he refers (favorably) to an article in the New Yorker by Atul Gawande which compares medical costs in high cost locations and low cost locations.  Dr Gawande describes health care driven by entrepreneurial doctors in an environment of over servicing.  I think the money quote in Gawande’s article is this:

Most Americans would be delighted to have the quality of care found in places like Rochester, Minnesota, or Seattle, Washington, or Durham, North Carolina—all of which have world-class hospitals and costs that fall below the national average. If we brought the cost curve in the expensive places down to their level, Medicare’s problems (indeed, almost all the federal government’s budget problems for the next fifty years) would be solved. The difficulty is how to go about it.

I have written about health care before (but I think Buffett says many things better).  Though in summary the costs of American health care is higher because:

1. America pays its doctors more than other countries (indeed substantially more than other countries)
   
2. There is less control on pharmaceutical expenditure and other medical kit (and Buffett notes that Americans spend a lot on medical kit), 
   
3. There is more hospital and health care administration – especially insurance operating - expense than other countries (although anyone who follows the bureaucracy of the National Health might think otherwise), and
   
4. There is more litigation and insurance expense than in other countries (though Buffett did not play up this aspect of cost comparisons).

I would love a decent breakdown of those things.  Unless however the costs are addressed health care reform will ultimately be an economic failure. 

And that is roughly how Buffett thinks about the Obama reforms.  The current health care bill provides universality of health care – but does not address the fundamental cost issues. 

That however is very difficult.  As Buffett puts it – the current health care bill is about $2.3 trillion annually.  And every one of those $2.3 trillion has a constituency.  Moreover that constituency is organized and are effective lobbyists.  Buffett thinks that there is simply no way to do an effective cost reduction health care bill by consensus.  That is hard to disagree with. 

As he puts it:

Everyone of those dollars is going to somebody and they are going to yell if that dollar becomes 80c or 90c. 

I thought he was being generous.  If American doctors were paid like Australian doctors my guess is those dollars would not become 85 cents.  More like 60 cents or less.  The squealing here was intense – but even after all that trimming doctors remain pretty well paid.  But you can’t get rich doing general practice and even specialist medicine is a ticket to the upper-middle class not to dynastic wealth. 

What allows Australia to pay so little for doctors is a monopoly buyer (the Government) actively suppressing their income.  It is little surprise that doctors do not in general support that bit of the reform agenda.

What ultimately Buffett was saying was that proper health care reform does not and cannot get broad agreement – and hence must be done with the expenditure of significant political capital.  He never says it – but I think he thinks that this would be a good time for the Democrats to outlast a filibuster.  Triangulating Democrats have their place – but not here.

Buffett thinks that if this is not done medical care will remain a growing parasite (“a tape worm”) for the rest of the American economy.  He supports an aggressive and interventionist solution.

Still – if you follow his numbers he thinks the savings are probably 4% of GDP.  The ambitious number in my original post was somewhat larger.  He is probably right on that too.

 

 

John

 

PS.  One of the more amusing things about this interview is Joe Kernan making an ass of himself.  Buffett is clearly saying that – correctly done – socialized medicine will improve the competitiveness of American industry (though the current bill is not a solution to costs).  This is anathema to Kernan’s oft-stated ideology – and Kernan repeatedly tries to restate Buffett’s position to suit his own ideological view rather than Buffett’s clearly enunciated position.  Becky Quick proves again that she is the heavyweight on that show and I can see why Buffett does appreciate her (intellectual) charms.

In which Paul Krugman proves he is an academic snob who argues from his prejudice rather than the data

Felix Salmon has a lovely post where he picks apart the news values of the Wall Street Journal – including picking apart differences between the front page of the WSJ and the online version. 

From this Paul Krugman argues that the New York Times rather than the Wall Street Journal is likely to wind up as the only national US newspaper (at least if the US does wind up with a single national newspaper). 

Frankly, there was a time when I thought the Journal was better on business/economic news than the Times. But no longer; and it’s not just things like referring to the estate tax as the “death tax” in news stories. Overall, coverage is getting cruder, with more tendency to report opinions as if they were news, and substitute prejudices for real analysis.

And this bad news is good news. There’s a pretty good chance that we will end up with only one great national newspaper. And I know which paper that should be …

Krugman’s prejudice matches mine.  I prefer reading the New York Times. 

But one of the things Paul Krugman does better than most is argue from data or a testable model – but he lapsed badly here.  Below are the top 15 newspapers in the US by circulation now and two years ago.  [The sources are revisions to the relevant Wikipedia page.]

 

No paper has – in this data – maintained circulation.  For most papers the fall has been catastrophic.  (The effects of falling circulation on pulp pricing is background to my next post…)

Nonetheless, it is pretty hard to see disaster or even the “great recession” in the Wall Street Journal numbers.  I gather of late that the fully paid circulation of the Wall Street Journal is rising again – albeit slowly.  None of this says that Rupert did or did not overpay for Dow Jones but Paul Krugman’s argument from prejudice rather than data about the New York Times possibly becoming the nations largest newspaper because of editorializing is – well – hogwash.

What sells the news?

Paul Krugman gives his view of what sells the news.  It is a view that fits the vision of the Gray Lady quite well: a clear distinction between news pages and editorial pages, facts supported by data etc.  That is also how I want my news presented.  However the evidence that that sells the news is quite thin.  Whatever Rupert did to the WSJ Journal (that which Felix Salmon and Brad Delong rail against) appears to be working. 

More generally opinion dressed up as news, especially when it panders to the prejudice of your readers or viewers works seems to sell really well.  A while back I gave a quarterly series of operating profits (in millions) for Fox Cable Networks – a business dominated by Fox News.  Here they are again: 197, 262, 211,194, 249, 275, 282, 284, 289, 337, 330, 313, 379, 428, 429, 434, 495.

There are few businesses with growth in operating profits without substantial capital expenditure that look anything like that.  Well Fox News gets even better (at least from the perspective of a News Corp shareholder).  The latest number is was $604 million operating profit for the quarter ended 30 December 2009. 

I am not a newspaper guy – but I have watched for long enough to form a supported opinion – which is that opinion and prejudice sell media – especially when they back the readers’ opinion and prejudice.*  It is respectable to present an alternative viewpoint – but only if it is a caricature – something weakly presented to rile the audience – but only till they pick it apart and make themselves feel smug.  The lightweight Alan Colmes – the token Fox News Liberal – and the equally lightweight Miranda Devine – the conservative for the Sydney Morning Herald fit this bill. 

Rupert knows this – and his news outlets all blur opinion and fact.  If his audience is left-leaning he will blur from that side (he once owned the Village Voice) and he knew enough to leave its politics alone.  He is (obviously enough) more comfortable with right-wing media markets (with a special love for “working class tories”) – but again – it might just be that is where the big markets are… 

Krugman however insists on wonkish articles arguing closely from data.  Those articles are like eating spinach.  Reading them is good for you but you would rather have ice cream.  But sometimes – as he did this time – he lets his prejudice out and argues like the Liberal equivalent of Fox News.  His prejudice matches mine – and I love him for it.  I suspect it also increases his value as an author.  Advice to Paul: get it wrong more often and ask for a pay rise.

 

 

 

John

*Local newspaper guys – who know far more about this than I ever will – say that what sells newspapers is local relevance.  All politics is local (but the internet is global).  Readers like to see pictures of themselves and their schools and teachers and articles about their roads and public transport. 

Submission to the Cooper Review of Superannuation

I have written a submission to the Cooper Review of Superannuation (that is privatized social security) in Australia. 

You can find it here. 

The submission is entirely about asset security issues – that is can you be assured that the assets are really there?  This is (obviously) of concern to people charged with looking after the (entire) retirement savings of tens of thousands of Australians.  However I have also found it is a very useful conversation to have with anyone recently finding themselves in possession or care of many millions in financial assets.  [If you run a small family office managing financial assets after you have (for instance) sold the family business then you should probably read it.]

The issues covered are broker and custodian failure (think Lehman failing and not returning assets to the clients) and also simple theft or misplacing of assets. 

Under normal circumstances this would normally be (very) dry reading.  However the events of the last two years have driven home the relevance. 

Weekend edition: an old Astarra marketing leaflet – and some comment on Astarra’s very peculiar asset base

The Astarra funds were amongst the top performing sold retail in Australia. 

According to the advert below it is because of market timing.  Shawn Richard knew when to go to cash. 

This suggests that his asset base was highly flexible – able to be converted into large licks of cash on market turns.

He says (in the picture) and I quote:

People ask me all the time how we do it.

To me it’s simple…  why be fully invested in a deteriorating asset class?  Investors don’t pay me to invest in cash, they pay me to get out of assets at the right time.

I believe that every asset class should be treated from an absolute return philosophy.  If that means higher cash weighting for a short time then so be it. 

Shawn Richard, Chief Investment Officer

Now if it was easy to shift Astarra funds to cash then it should be easy now.  Alas Peter Johnston in an article in Investor Daily suggests otherwise:

AIOFP chief executive Peter Johnston said he disagreed with [the administrator’s plan of liquidating the funds] and that the AIOFP intended to voice its opinion on the matter.

"Because these assets of hedge funds are off-market assets ... if there's a fire sale, in other words if the administrator wants to get in there and just wants to wind it up in a bloody-minded sense, you're going to find they run the risk of devaluing the assets," Johnston said.

"We just disagree with their strategy. So we intend on voicing our opinions on this because they don't have any experience in dealing with hedge funds at all.

These are very peculiar assets.  They can be liquidated in response to a market turn – but they can’t safely be liquidated in response to a court order.

Enough said.

Surprise: Peter Johnston still has not taken my bet…

Nobody has taken my bet.

But another fund manager across town is offering a derivative bet (in smaller denomination) that nobody will.  And nobody has taken that either. 

My proposed bet with Peter Johnston from the Association of Independently Owned Financial Planners: an Astarra follow up

The Association of Independently Owned Financial Planners is a rival to Financial Planning Australia as an umbrella group for financial planners in Australia.  Financial planning in Australia is a big business because Australia – unlike America – has a privatized social security system called “superannuation” and financial planners are the front-end for the sale of many superannuation products.

The industry has had its share of scandals (see Storm Financial and Westpoint) but there are many fine operators in the industry and I am unashamedly admit that some of my best friends are financial planners.

That said – the AIOFP was closely associated with Astarra – a fund of funds and distributor of funds which was closed recently by the Australian securities regulator after a whistle-blowing letter from your blogger.  [I wrote about Astarra and my role in precipitating the investigation here though I can’t claim too much credit – a reader of my blog suggested that I look at it.]

Anyway – back to the AIOFP.  According to this article four financial planning groups – all members of the AIOFP – represent about 90 percent of the funds in the “Astarra Strategic Fund” (now known just as the ASF).  The strategic fund is the main black hole in Astarra – and the administrator has said that they cannot prove the existence or value of the foreign assets of the ASF.  They said this possibly to quiet media claims by the AIOFP that the assets have been found.  The AIOFP just wants the strategic fund taken out of liquidation – and presumably valued on the the basis of assets that they claim they can find. 

Now my guess is the administrator – who intends to liquidate the ASF – is accurate.  The assets of the ASF are pieces of paper which state that there are assets there but real proof of the existence of the assets cannot be found and liquidation is the only way to determine what is recoverable.  But as said – the AIOFP has a different opinion and wants to sack the administrator.

Peter Johnston of the AIOFP suggested that I wrote my letter to regulators motivated by “professional jealousy”. 

This is of course defamatory. 

I am a hedge fund manager: I am motivated by money. 

Professional jealousy is a counter-productive (and defamatory) motive because – frankly – it just stands in the way of what I should be doing.

And so – being motivated by money - when Peter Johnston offered me a bet on whether the money would turn up I leapt on the chance.  I offered $100 thousand to be escrowed either by Morningstar or the Sydney Morning Herald.  [I have since offered Peter three for two odds.]  And he backed out.  (The Sydney Morning Herald CBD gossip column reported the story this morning.)

Peter is of course a coward – he backed out of the bet – but that has not stopped him from boasting to the press about how his organization has found the ASF money and that all is well.  Worse – his members have been telling their clients that their money will turn up and their superannuation (meaning their entire retirement savings) will be unimpaired. 

Now this article names the financial planning companies that have – as Peter Johnston notes – about ninety percent of the claims against the ASF.  I know many victims do not know they are victims because their financial planners say that they are going to be alright.  And maybe they will.  Maybe the money will turn up as Peter Johnston says it will.

But Peter Johnston is a coward and will not carry through with his bet.  That however does not stop at least one financial planning group (or at least some financial planners) telling their clients that their money is safe.  If they believe that maybe they could take the bet Peter Johnston backed out of.  If they are certain enough to tell their clients that their money is safe then they should be certain enough to take that bet.

The Sydney Morning Herald has said they are willing to be the escrow service. 

And I look forward to spending the winnings.

The final failure of the Meiji right-wing ideology … Japan fades into the future with a walking stick…

This blog does not usually play war with other bloggers – but something in Ampontan’s criticism of me has got my goat.  So if you do not want to indulge me a little flame-throwing just skip this post. 

Ampontan (AKA Bill Sakovich) writes a wryly amusing but deeply nationalistic Japanese blog.  He is – as far as I know – the only English language exponent of the virulent Japanese nationalism that initially gained power with the Meiji Restoration, waged and lost the second world war and – unlike the German equivalent – respectably survives to this day.  My favorite comment on his blog – and one I do not think he resiles from is that he has “Hirohito’s nutsack lodged so far down his throat its amazing he hasn’t asphyxiated himself long since.”

Ampontan is surely the only native English speaker who simply denies the Japanese (war crime) of mass forced prostitution as “comfort women” happened (more precisely he endorses deniers).  He regularly defends the Yakasuni Shrine (and by extension the visits to the shrine by any serving Japanese Prime Minister). 

Not that I can complain about that.  The Shrine was on my must-visit places list when I went to Japan.  It is a dull Shinto shrine with a bizarre attached museum which with thoroughly revisionist history absolves Japan from all and Nazi Germany from much responsibility for any atrocities committed in the Second World War.  I paid my admission fee – and by extension I supported that nonsense.  The Shrine also memorializes war dead including those who died at the gallows after being convicted of war crimes. 

It is not that Meiji era Japanese nationalism has nothing to recommend it.  That view of Japan, how it should be administered and Japan’s place in Asia and the world is one of the most successful industrial-development ideologies ever invented.  Not only did Japan grow into an industrial superpower twice (once before and once after the war) but the system was copied by Korea and it worked there too.   Nazism too was a successful economic system in that it allowed Germany to build an industrial base large enough to wage total war from a relatively small country.  Germany and Japan (and Italy) took on the UK (then the largest empire the world had ever seen), the US, Russia and China, and a host of other countries and had a military-industrial establishment that made more than a show of it.  These ideologies worked at producing industrial goods (and a military-industrial complex). 

They were also of course deeply nationalistic and racist ideologies.  Colonialism always had an undertone of racism (as any modern reader of Rudyard Kipling should not fail to notice) but these ideologies were far more murderous than anything imposed by the Brits or French (even though the Brits occasionally and the French more often were murderous).  The scale of the atrocities committed by the Japanese in China were only exceeded by Hitler at his worst (though they have also been exceeded by some murderous Post War regimes).

I said I find Sakovich’s blog wryly amusing.  I would not find a German equivalent amusing but that was because I was raised to vicariously remember the holocaust.  My grandmother ran a safe house in Warsaw and a man who was by repute her husband and my grandfather was murdered at Auschwitz.  I was not raised to remember Japanese slave drivers on the Burma Railway, comfort women or Nanking – and so an unapologetic Japanese blog is amusing whereas an unapologetic Nazi one would be offensive.  Propaganda about Asian co-prosperity zones was pure propaganda.  The truth was that much of occupied Asia was a Japanese rape-and-plunder zone.   

I can’t envisage a German leader visiting a memorial to Nazis hung after Nuremburg whereas Japanese Prime Ministers make a show of going to Yakasuni.  But then that particularly rabid Japanese nationalism survives whereas the German equivalent is dead.  Denazification is a word that appears in many modern history books (see for example Tony Judt’s excellent history of Post War Europe).  I do not know the equivalent Japanese word…

That said – this is an economic/finance blog and not one to inclined to debate with a heartless denier of Japan’s less-than-glorious Imperial history.  And I should outline the good-bit of the Meiji industrial system.  I have done it before in a stylistic history of industrial Japan (one that a few Japanese economic professors endorsed as simplistic but essentially accurate).  I will just repeat the key bits modified to fit the narrative (but you can find the original here):

First however I need a stylised history of Japan starting with the arrival of Commodore Perry’s black ships in 1853.

Before Perry Japan was almost autarkic. There was a relatively weak central government and about 300 “han” – being relatively strong feudally controlled districts. The Emperor did not effectively speak for Japan when Perry came in, guns blazing.

The Meiji Restoration changed this. Japan was reformed as a centrally controlled empire – with a ruling oligarchy ruling through the Emperor who claimed dominion over all of Japan. The “han” were combined to form (75?) prefectures with a governor appointed centrally.

The view of the new oligarchs was that Japan would get rich through (a) industrialization and (b) unequal trade treaties to match the unequal treaties imposed on Japan by Perry et al. To this end they invaded Korea and started the military industrialization that ended eventually with World War 2. There were major wars in Korea and against an expansionist Tsarist Russia (especially 1904-1905).

Ok – that is your 143 word history of Japan from Perry to World War 2. Like any 143 word history it will leave out important stuff. I just want to focus on how this foreign policy adventurism was financed.

Financing Japanese expansionism - and that financial system until today

Firstly it is simply not possible to expand heavy industrialization of the type required by an early 20^th Century military-industrial state without massive internal savings. Those steel mills had to be funded. And so they set up the infrastructure to do it.

Central to this was a pattern of “educating” (the cynical might say brainwashing) young girls into believing that their life would be happy if they had considerable savings in the form of cash balances at the bank (or post office) or life insurance. Japanese wives often save very hard – and are often insistent on it. The people I know who have married Japanese women confirm this expectation survives to this day.

Having saved at a bank (and for that matter also purchased life insurance from an insurance company loosely associated with the bank) the financial institutions had plenty of lendable funds. 

The financial institutions by-and-large did not lend these funds to the household sector. Indeed lending to the household sector was mostly discouraged and was the business of very seedy loan sharks. To this day Japan has a relatively undeveloped credit card infrastructure with very high fees. These high fees are a throwback to the unwillingness of the institutions to lend to households. [The Japanese establishment are willingly forcing these consumer lenders to bankruptcy as any Takefuji shareholder will tell you…]

Japanese banks instead lent to tied industry – particularly heavy industry. It was steel mills, the companies that built power plants, the big machine tool makers. Many of the companies exist today and include Fuji Heavy Industries, Kawasaki Heavy Industries and other giants such as Toshiba. Most of these super-heavy industrials were tied to the banks (and vertically integrated) called Zaibatsu.

Now steel is a commodity which has wild swings in its price. Maybe not as ordinarily wild as the last five years – but still very large swings. And these steel mills were highly indebted to their tied banks. Which meant that they could go bust.

And as expected the Japanese authorities had a solution – which is they deliberately cartelized the steel industry and used the cartel (and import restrictions) to raise prices to a level sufficient to ensure the heavy industry in question could service its debt.

The formula was thus (a) encourage huge levels of saving hence (b) allow for large debt funded heavy industrial growth. To ensure it works financially (c) allow enough government intervention to ensure everyone’s solvency.

When the Americans occupied Japan their first agenda was to dismantle the Zaibatsu. They were (in the words of Douglas McArthur) “the moneybags of militarism”.

Like many post WW2 agendas that agenda was dumped in the Cold War. The owners of the Zaibatsu were separated from their assets and some cross shareholdings were unwound – but the institution survived – and the Zaibatsu (now renamed Keiretsu) remained the central organizing structure of Japan. Dismantling Japan’s industrial structure did not make sense in the face of the Korean War.  The pre-war Zaibatsu had more concentrated ownership than post-war Keiretsu. 

Unlike in Germany there was no real attempt to dismantle the establishment ideology.  Douglas McArthur may have appeared to tower over the Emperor in the famous photo – but Hirohito was not tried as a war criminal – even though he would certainly have been hung if put to a fair trial. 

The point is that it was the similar structure before and after the war – and it allowed massive industrialization twice – admittedly the second time for peaceful purposes.

Now the system began to break down. Firstly by 1985 steel was not the important industry that it had been in 1950 or 1920. Indeed almost everywhere you looked heavy industry became less important relative to other industrialization. By the 1980s pretty well everywhere in the world tended to look on such heavy industries as “dinosaurs”. This was a problem for Japanese banks because they had lent huge sums to these industries guaranteed by the willingness of the State to allow cartelization. You can’t successfully cartelize a collapsed industry.

Still the state was resourceful. Originally (believe it or not) they opposed the formation of Sony – because they did not know how to cartelize a transistor industry. Fifteen years later the French Prime President would refer to his Japanese counterpart as “that transistor salesman” and he was not using hyperbole. Still the companies coming out of new Japan – technology driven mostly – did not require the capital that Japan had in plentiful supply. If you look at the companies coming out of Kyoto (Japan’s Silicon Valley) they include such wonders as Nintendo – companies which supply huge deposits to banks – not demand huge funds from them. [Incidentally in typical Japanese fashion the biggest shareholder in Nintendo is Bank of Kyoto. Old habits re-cross shareholdings die hard.]

The banks however still had plenty of Yen, and they lent it where they were next most willing – to landholders. The lending was legion and legendary – with golf clubs being the most famous example of excess. [At one stage the listed exchange for golf club memberships had twice the market capitalization of the entire Australian stock exchange.]

Another place of excessive lending was to people consolidating (or leveraging up) the property portfolios of department stores. Think what Bill Ackman plans to do to Target being done to the entire country – and at very high starting valuations.

Meanwhile the industrial companies became zombies. I have attached 20 year balance sheets for a few of them here and here. These companies had huge debts backed by dinosaur industry structures. They looked like they would never repay their debts – but because they were so intertwined with the banks the banks never shut them down. As long as interest rates stayed near zero the banks did not need to collect their money back from them. As long as they made token payments they could be deemed to be current. There was not even a cash drain at the banks at low rates. The rapid improvement in the zombie-industrial balance sheets in the past five years was the massive boom in heavy industrial commodities (eg steel, parts for power stations etc). Even the zombies could come alive again…  only to return to living dead status again quite rapidly with this recession.

Anyway – an aside here. Real Japan watchers don’t refer to the banks as zombies. They refer to the industrial companies as zombies.  (Although most of the Western blogosphere does.) 

Most of the banks had plenty of lendable funds and a willingness to lend them. They did not have the customers – and the biggest, oldest and most venerable of Japanese companies were zombies. So were the golf courses, department stores and other levered land holders. I get really rather annoyed when people talk of zombie banks in Japan – it shows a lack of basic background in Japan.

Note how this crisis ended.

1). The bank made lots of bad loans – firstly to heavy industrial companies and secondly to real estate related companies (golf courses, department stores etc).

2). The loans could not be repaid.

3). The system was never short of funding because the Japanese housewives (the legendary Mrs Watanabe) saved and saved and saved – and the banks were thus awash with deposit funding.

4). The savings of Mrs Watanabe went on – indeed continued to grow – with zero rates.

5). Zero rates and vast excess funding at the banks made it unnecessary for the banks to call the property holders and (especially) the industrial giants to account for their borrowings. Everything was just rolled.

6). Employment in the industrial giants of Japan thus never shrank (Toshiba alone employs a quarter of a million people). The economy continued to sink its productive labour force into dinosaur industries and dinosaur department store chains.

7). The economy stagnated – but without collapse of any of the major banks and without huge subsidies to the banking system. [The number of banks – mostly regional banks – that failed during the crisis was not large given the depth of the crisis.]

They system is very good at funding heavy industry – but it is less entrepreneurial than you would want in a modern economy.  The best Japanese tech companies tend to come from Kyoto (which is outside the Tokyo establishment).  Toyota – what I think is Japan’s finest company – is in Aichi prefecture – well away from Tokyo.

Anyway – this industrialization structure worked brilliantly and the Koreans copied it (with radically different banking outcomes).  It however is less good at low-capital but high-innovation industries.  The tech-boom was an American phenomenon – encouraged and nurtured (for better and for worse) by the American system.  It was not nurtured by the Japanese establishment though Sony and Toyota most certainly are by now…  Many of the most innovative Japanese companies started away from the bosom of the establishment – though the establishment later embraced them.

The Japanese industrial structure and the ideology that drove it produced industrial goods really well – and innovation based goods less well.  But – the system works. 

Economic stagnation is not the greatest of Japan’s problems.  Many a UK visitor has gone to Japan and observed that if that level of economic activity (and living standards) represents stagnation they they wanted some of it. 

The real threat to Japan is demographics.  Mrs Watanabe saved and saved and had fewer than two children.  (Children are expensive – especially housing them in a place with land values where they were in the 70-90s).  So an aging population became a dramatically aging population.  Here is a projection of the median age of population in three OECD countries.  Australia is an aging population offset by immigration, Italy an aging population exacerbated by emigration and Japan is a result of Japan’s military industrial policy and the booms and busts it has caused.  The chart is from the Australian Treasury intergenerational report – but the numbers are broadly accepted:

 

Japan will have a median age of about 55.  This means that the vast bulk of the Japanese population (or more precisely Japanese women) will be well beyond child-bearing age and given low fertility rates anyway (below 2.0 per woman) the population will crash.  That is more-or-less baked in.  Simple equation – most the women past child-bearing age and very low fertility amongst those who bear children anyway.

There is a solution – immigration.  There are an endless supply of well educated and skilled young people (mostly) from the subcontinent who would happily move to a developed country.  There are more than a few from China too.  Australia will import them.  Ampontan rhetorically asked where I expected them all to fit into Japan?  Well that is easy – with a demographic like that I expect them to fit into the slots left by the dying warriors of Japanese industrialization.

If Japan does not do it then aging and death is inevitable.  The working population will be stuck looking after and funding the huge numbers of retired.  Japan’s industrial growth – now anemic – will collapse entirely with its population.  The great Japanese industrialization experiment will walk slowly into the setting sun aided by a walking stick.

There is of course an alternative which is modest levels of immigration.  New immigrants will – like it or not – be Asian – mostly from the subcontinent.  Over time they will also include many Muslims.  The Japanese will have to accept – as Australians have accepted – that their children will breed with these people.  As a white Australian I have fully accepted that it is likely as not that my grandchildren will arrive as little brown babies.  I do not have a problem with that. 

But Japan is a country where they won’t let their hookers sleep with foreigners because – well they are foreigners.  (It was that story in this post that got Ampontan all upset with me.)  But it does not have to be that way.  There can eventually be an Asian co-prosperity zone in Japan – it will be with Japanese children and other Asian children and eventually their joint grandchildren.  The Meiji racist ideology does not have to end with a walking stick – it can end in a truly multicultural society that will lead Japan onto greater things than the original modern revolutionaries of the Meiji era could ever have imagined.

 

 

 

John