Archive for the Category Japan

 
 

Japan is in the details

Those who have already been here will want to skip over this post for something more informative—for example Noah Smith.  But I thought I’d make a few comments about my first trip to Japan, which is 60% over.  Consider these to be non-authoritative impressions.

1.  Just say Noh:  After arriving at 4am very jet-lagged, I stayed up all day and attended a performance of Noh theatre at the Yasukuni Shrine.  (Yes, that Yasukuni Shrine.)  Despite the jet lag and the tiny uncomfortable chairs, I sort of enjoyed the event.  Perhaps it helped that I had previously read William Vollmann’s Kissing the Mask, although it had been awhile and I still didn’t really understand what I was watching. In any case, I recommend a performance of Noh, at least for those with patience. (I’d like to thank my friend and his wife for bringing me to this show, and helping my wife and I adjust to Japan.)

2.  The “wouldn’t it be neat if” country: Japan seems like a land of contrasts (how’s that for a cliche!)  From the understated subtlety of Noh we transitioned to the sensory bombardment of Robot Restaurant, which makes Las Vegas seem refined and tasteful by comparison.  If you like young Japanese ladies in skimpy comic book outfits using whips to mercilessly attack men dressed up as awful monsters, all to the sound of deafening rock music (and who doesn’t?) then be sure not to miss this show.  I saw roughly zero Japanese there, which must mean something.  Later that day we saw a group of western tourists driving go-carts through Shibuya, all dressed up in bizarre costumes.  I like the fact that the Japanese seem rather uninhibited in terms of coming up with offbeat ways of having fun.  In many cases, it’s just a matter of tweaking some familiar product to make it more convenient.  Which brings me to my next observation:

3.  Japan is in the details:

One of the pleasures of traveling in Japan is that you notice all sorts of interesting little details.  The Japanese are good at perfecting products or processes that are widely used elsewhere.  In the basement of a Tokyo department store I saw the most astounding collection of baked goods that I’ve ever come across.  This place is paradise for people with a sweet tooth. There are lots of innovations in travel, such as taxi doors that open automatically, and a train system that runs with such perfect precision that you’ll almost burst out laughing.  When I watched thousands of commuters pour through a Tokyo train station in the morning their movements were so precise and efficient and synchronized that it almost seemed staged, like as scene in a Hollywood film.  I dared not cross this river of people, fearing it would throw the clockwork precision out of whack.

Detail of a door in Nara:

Screen Shot 2018-04-12 at 10.31.53 PM

4.  Libertarian Japan:

I read that the drinking and smoking age in Japan is 20, but the age limits are not enforced.  There are lots of vending machines selling cigarettes, and I’m told there are also a few machines selling alcohol.  In an Osaka restaurant I saw an ash tray with a couple cigarette butts.  What a thrill that was!  To paraphrase Colonel Kilgore, cigarette smoke smells like . . . freedom.  Japan still has phone booths, so you can get by without a cell phone.  (My model 6s iPhone broke on the first day of my trip; I borrowed my wife’s for the Nara picture.)  Most businesses I’ve frequented don’t take credit cards—another big plus in my view.

5.  Visual Japan

I’m a very visually oriented person, so it’s visual images, not food, that motivates me to travel.  Japan has the sort of visual aesthetic that I like best, especially in art, film, architecture and design.  And yet much (perhaps most) of the architecture is pretty bland, even ugly–especially buildings from 20 to 60 years old.  Lots of mediocre stuff was thrown up during the post-war boom.  I’m interested in the very old and very new stuff.  Newer Japanese houses are often very attractive, as are some of the modernist commercial buildings or museums.

The older temples and gardens in places like Kyoto are even better than I imagined.  If you are in one of the better Kyoto gardens on a nice spring day, you’d see some of the most astoundingly beautiful scenery that you’ll ever experience.  At a smaller scale, they are very good at things like pottery design, and also the presentation of food items, in stores or restaurants.  BTW, I’m not a foodie, but the food here seems excellent, and relatively inexpensive.  I recall one lunch in Tokyo that was 700 yen (includes tax and there is no tipping), which is $6.50.  The meal would have easily been over $10 in the US, especially including tax and tip.

Japanese cities often look better at night, with parts of Osaka looking like Times Square.

6.  The barbarians are coming

When you see a mix of foreign tourists and locals in a place like Tokyo, the locals look better.  The tourists (mostly Westerners and East/Southeast Asians) seem louder, less well-mannered, less attractively dressed, fatter, etc.  In affluent parts of Tokyo the men wear suits and the women dress more elegantly than in the West.  The younger women often look very  . . .  demure, if that’s the right word.  Unless they look totally crazy.  Whatever the look, there are no halfway measures in Japan.

Locals in Kyoto are a bit dismayed by the sudden influx of tourists.  I read that tourism in Japan has soared from 5 million in 2005 to 24 million in 2016, and is expected to soon reach 40 million.  Tourists don’t know all the complicated rules that make Japanese society work well despite the high population density.  (The alt-right would have a much stronger argument against immigration in Japan than in the (mongrel) US.)  I feel oversized and clumsy here, always bumping my head on something, or my knees against a table.

Before the trip I read The Three Body Problem trilogy.  In the future, the people were more attractive, softer, less rugged.  The cities were full of video screens.  Tokyo sort of reminds me of that imagined future society.

BTW, it’s hard to tell Chinese and Japanese apart at the individual level (until they speak), but easy at the group level.  Sort of like Germans and Italians.  That reminds me of the “race is a social construct . . . no it’s not” debate. To my eye, the Japanese look slightly more Western.

7.  Surprises

I recall reading about an island off the north coast of Australia where the natives have no concept of left and right.  Everything is described in terms of compass directions, such as north or east.  They’d say “John was sitting to the west of Max.”  Tokyo seems the opposite.  When I spoke of a neighborhood lying to the north of where we were staying, my host said that almost nobody in Tokyo thinks in terms of compass directions.  The numerous maps on the street confused me at first, as they are often upside down, with south pointing up.

There is often surprisingly light traffic in Tokyo–it’s not hard to get around.  I’m told that’s because there are few places to park, so people take public transport.

Subway cars are sometimes “women only”, I believe to prevent groping.  So the “Me too” movement is also making some progress in Japan.

Why are the Japanese so slim and healthy?  The secret seems to be a diet rich in sugar, carbs and fat, and light on fruits and vegetables.  Oh, and lots of smoking.  Try finding a Diet Coke, or sugar-free sweetener for your coffee.

When I watched animated films by Miyazaki I used to think the trees were drawn in a very interesting way.  Now I know why.  Many Japanese trees actually do look like large green cumulus clouds of foliage.

At dinner last night, in a traditional Japanese onsen near Mt. Fuji (recommended), the clams served were still moving around quite vigorously, right at our table. Memories of Oldboy. Many Americans would be disturbed by this sight.

Many of the waitresses speak with a soft child-like voice.  (Maybe they are children, I’m not good at judging ages.)

Mt. Fuji is more impressive than I imagined.

8. The economy:

It’s really hard to compare Japan to the US, because the countries are so different.  I visited the home of a professional couple in Kyoto, and the living standards seemed closer to what you’s see in a lower middle class house in America.  I suspect that Japanese consumption is more equal than in the US, and that the upper 50% of Americans consume at far higher levels than in Japan, while the bottom 50% are closer to Japanese levels.  Japan does have some advantages, like excellent services and low crime rates. The high level of service is labor intensive, and may reduce measured labor productivity.  Productivity is probably hurt someone what by the high population density (it’s hard to find room to build Walmarts) as well as burdensome regulations, which partly reflect a culture with strict rules.  But this is just guesswork on my part.  There seems to be a tight labor market, with many foreigners brought in to do routine work.

9. Random impressions:

I recall Donald Richie saying that Japan was a great place to live, as long as you were not Japanese.  A Westerner visiting Japan benefits from all the attractive aspects of Japanese society, without being expected to adhere to all the rules, which can seem stultifying to an outsider.  I very much enjoy being here as an outsider, and wish I could live a year in Kyoto, as Pico Iyer did.

When I lived in London back in 1986, I wanted to blot out all of modern London, and imagine I was in the city described by Stevenson and Chesterton.  That’s less true of Tokyo, for which futurism is part of the appeal.  Even so, the Japan described in earlier accounts has some appealing features that have been lost.  On the plus side, Japan seems less influenced by the world’s major religions (Christianity, Islam, Hinduism, etc.) than most other places.

Japan gives me a powerful sense of nostalgia, for reasons that are not entirely clear.  I don’t believe in reincarnation, but even the red and white electrical pylons and the trains running on elevated tracks seem oddly familiar.  Perhaps the sense of deja-vu comes from seeing so many Japanese films, and having the images burrow deeply into my subconscious.  (BTW, when you come here it’s immediately clear that Ozu and Naruse are more “Japanese” directors than Kurosawa.)  Or maybe it has to do with spending so many hours looking at woodblock prints, and then finally seeing the actual places they depicted.  Or maybe my personality is more Japanese than American.  I like polite people. (Don’t judge me by my nasty internet persona.)

When you are young you should visit China and SE Asia, and then late in life come to Japan, to rediscover your (imagined) past.

PS.  Because of my injured foot, and because I’ve had a bad cold for the past 11 days, and because I’m twice as old as when I lived in London, I saw much less than I hoped to (and much less than my (younger) wife saw.)  The fact that I’m nonetheless enjoying the trip speaks volumes about Japan.  My only recommendation for Kyoto is to see the popular places in the early morning or near closing time, and the quieter places at midday.  If you go to Arashiyama, don’t miss this house:

Screen Shot 2018-04-17 at 10.52.47 PMPPS.  I positively HATE the way email and Facetime are destroying the romance of travel.

Japan bleg

I will be visiting Japan next month (Tokyo/Kyoto and some rural areas) and would appreciate any suggestions (more along the lines of things to see, rather than places to eat.)  I was told the Bank of Japan has an excellent museum of woodblock prints, but was not able to find any information online.

When I was young, Britain was my favorite country.  Now it’s Japan, mostly due to Japanese art.  This will be my first trip to Japan.

Also, any suggestions for dealing with a foot problem (plantar fasciitis?) would be welcome.  I always do a lot of walking when I travel, and my left foot has been killing me for the past month.

Looking forward to my first “real” vacation in many years.

 

Applying Occam’s Razor to the forward value of the yen

After my previous post, Brian McCarthy left the following remarks:

I believe there is a fair bit of empirical evidence that current spot rates are a better predictor of future spot rates than are current forward rates. So a naive “long carry” strategy does generate positive returns over time. The reason this “free money” isn’t arbitraged away, I would imagine, is that the strategy doesn’t have a good sharpe ratio. ie low returns relative to the volatility. In market slang it’s “picking up pennies in front of the steam roller,” involving a significant risk of ruin if done “in size.”

So the market really does “expect” the yen to be at 106 in 30 years, which is where it is today.

This is a good argument, but in the end I favor the alternative view.

Over the past 40 years, the US price level has risen from 1 to 3.975, while the Japanese price level has risen from 1 to 1.556. That means the US price level has risen by 2.555 relative to the Japanese price level.  Over the same period, the yen has appreciated from 241.37 to 106 to the dollar, a ratio of 2.227.  So the appreciation of the yen in the very long run is pretty close to the change predicted by PPP (although over shorter periods there are quite wide discrepancies.)

So here’s how I look at things.  The simplest explanation for the forward yen trading at 50 is that the public expects Japan to continuing having lower inflation than the US, just as has been the case for the past 40 years.  They expect the yen to continue appreciating, just as it has over the past 40 years.

The alternative explanation is possible, but involves more “epicycles”:

1.  Yes, the Japanese yen has been appreciating in the very long run.

2.  Yes, the Japanese inflation rate is consistently lower than in the US.

3.  Yes, the 30-year forward yen is trading at a strong premium, just as you’d expect if these trends were going to continue.

4.  But these facts are actually unrelated.  Starting right now, the Japanese inflation will suddenly rise to US levels, even though the markets don’t seem to expect that.  And starting right now the yen will stop appreciating.  And instead some other “real factor” explains why the forward yen is trading at a strong premium, some real factor that would cause 30-year Japanese real interest rates to be hundreds of basis points lower than American real interest rates.

That’s all theoretically possible, but isn’t the simplest explanation that the forward yen is at a strong premium because investors expect the spot yen to appreciate, and they expect the spot yen to appreciate for the same reason that it’s strongly appreciated over the past 40 years?

PS.  After I wrote this post (a few days ago), I discovered a similar post written earlier by Julius Probst, who has a very nice monetary economics blog.  He anticipates my basic point.  But read his post anyway, as it ends with some interesting remarks on Japanese monetary policy.

 

Money is fundamental, interest rates are secondary

Let’s try one more time, with the dollar/yen forward exchange rate.  I’d like to make the following assumptions.  It doesn’t matter whether you think these assumptions describe the real world; I’d simply like you to consider them as a hypothetical.  When we’re all done, we’ll think about what it means.

1.  Let’s assume the BOJ is determined to adopt a very tight money policy, over the next 30 years.  This policy will be so tight that the yen will end up valued at 50 to the dollar, more than double its current value.

2.  This very tight money policy causes very low inflation and very low NGDP growth in Japan.

So far interest rates don’t enter the picture, indeed interest rates need not even exist—imagine a world with no debt. I’m trying to make the appreciation of the yen into the fundamental shock, from which everything else flows.

3.  Now let’s add interest rates.  Because of the ultra-low expected inflation, and the ultra-low expected NGDP growth, nominal interest rates in Japan are more than 200 basis points below nominal interest rates in the US.  These low rates are caused by a tight money policy that leads to yen appreciation.

I’m still assuming the tight yen policy that leads to yen appreciation is fundamental, and everything else is an effect of that policy.

4.  Now let’s assume that the US and Japanese debt markets are very deep and liquid, and the 30-year forward yen contract is very lightly traded and not very liquid at all.  Let’s also assume that the forward premium on the yen is linked to the interest rate differential according to the covered interest parity theorem, although the theorem doesn’t work perfectly due to various market imperfections caused by regulations.  It’s roughly true.

I’m still assuming the tight yen policy that leads to yen appreciation is fundamental, and everything else is an effect of that policy.

Now let’s take stock of where were are.  Thus far, I have NOT claimed to describe the real world.  I’ve described a scenario where, by assumption, the huge forward premium on the yen drives the interest rate differential.  Quite possibly, this imaginary scenario has nothing to do with the real world.

But here’s the problem.  Not one commenter has given me a single fact that would lead me to conclude that this imaginary scenario does not in fact describe the real world.  Note, for instance, that I assumed that the two bond markets are highly liquid and traders focus on the interest rate spread.  I assumed the forward yen is lightly traded, and hence considered peripheral in the world of finance.  But I’ve also constructed an example where, by assumption, that difference in liquidity between the two markets has no bearing on causality.

So what would count as evidence against my imaginary scenario?  Perhaps you could convince me that while the 30-year forward yen is 50, traders actually expect the yen to be trading at 105 in the year 2048.  And investors continue to buy low yield JGBs in any case, because of market segmentation, or some other reason.  So the differences in interest rates are unrelated to differences in inflation, etc. If you offered that sort of explanation, and backed it up with evidence, I would be persuaded.  But I’m not seeing people do that.  Until then, I’m going to assume the causality goes from an appreciating yen to a situation where Japanese interest rates are lower than American interest rates.

PS.  The “carry trade” may partly explain why people disagree with me, but carry trades suffer from the “peso problem”, so I’m not convinced the carry trade will “work” going forward.  If Japanese inflation stays well below US inflation (as I expect), then the carry trade will break down at some point.

PPS.  Financial variables may or may not be linked to macro events.  The 1929 stock market crash seems to have been linked to fears of depression, while the 1987 stock market crash seems to have been sort of random.  You can view my claim here as being that the 1929 case is more typical.  Asset prices move based on shifting expectations regarding economic fundamentals.  Even if a forward exchange rate market did not exist, I’d claim that expectations of the future spot rate drive the interest rate differential.

Why is the 30-year forward yen at about 50 to the dollar?

Nick Rowe likes to teach PPP with a thought experiment, asking students to imagine how they might guess an exchange rate between the dollar and a foreign currency.  Thus if you went to Japan and noticed that most prices seem to be about 100 times higher than in the US, you might guess that 100 yen equals one dollar.  Of course PPP often does not hold true, but it’s still probably the best first guess for the exchange rate, if you had absolutely nothing else to go on.

In that case, it is more useful to think of the exchange rate being caused by the Japanese price level being 100 times higher than in the US?  Or should we think about the price level difference being caused by the exchange rate?  Is this even a meaningful question?

I like to think about the two price levels as being in some sense more fundamental, as I could imagine a case with no contract between the two countries.  Then once contact is made by Commodore Perry, the exchange rate conforms to the pre-existing price levels.  But you can also imagine a new country being settled by England, and choosing to use the dollar rather than the pound.  In that case the two price levels would be determined by the choice of the exchange rate.  The adoption of the euro is an obvious recent example, which caused Italian prices to plummet dramatically.

In a recent comment section I’ve discussed the fact that the 30-year forward dollar trades at roughly 50 yen (actually 49.332).  Is that exchange rate caused by the interest rate differential, or is the interest rate differential caused by the forward exchange rate?  People in the financial markets may focus on interest rate differentials as the primary factor, as the 30-year forward exchange rate is not very liquid and seems to be roughly 50Y/$ merely to prevent easy arbitrage opportunities, given the interest rate differential.

[I tried to see if interest parity held, but I don’t know the interest rate on 30-year zero coupon bonds.  So I took the yields on actual 30-year bonds as a proxy.  The US 30-year bond yields 3.17% and the Japanese bond yields 0.747%.  The differential is 2.423%.  Then I took 1.02423, and raised it to the 30th power, which equals 2.0508.  Then I took the actual exchange rate of 106.17, and divided by 2.0508, and got 51.77 as the implied 30-year forward yen. Is that right?]

In my view, it makes more sense to think of the expected 30-year forward exchange rate of 50 as the fundamental factor, and the interest rate differential as contingent on that expected future exchange rate.  Conversely, consider what would happen if we were to start with the interest rate differential as fundamental.  Then thinking in terms of interest rates, what would the BOJ have to do to prevent the yen from getting so strong in 30 years?  Obviously they need to make monetary policy more expansionary.  That’s how you weaken a currency.  But how do you do that in terms of the interest rate differential?  Obviously you need to get rid of the interest rate differential if you want the yen to be worth roughly 106 out in the year 2048.  But how do you get rid of the interest rate differential, while making monetary policy much more expansionary?

Let’s assume the BOJ cannot do anything about the level of interest rates in the US.  If they want the yen to be worth 106Y/$ in the year 2048, they need to get Japanese interest rates up to 3.17% on 30-year Japanese government bonds.  Even more daunting, they must do so with a highly expansionary monetary policy.  (Cochrane and Williamson are smiling at this point.)

So how do you do that?  Normally, a decision to raise interest rates is treated by the financial markets as a tight money policy, which causes the currency to appreciate.  So the BOJ needs to get interest rates up to 3.17% on 30-year bonds, and keep the exchange rate close to 106Y/$.  So how do they do that?  The simplest solution is to go back to Bretton Woods, and peg the yen to the dollar at 106.  If credible, that will cause Japanese 30-year bond yields to rise to 3.17%, and after 30 years the exchange rate will still be 106.  Because of PPP, Japan’s inflation rate over the next 30 years probably won’t be much different from the US inflation rate.  More importantly, the current expected inflation rate will rise to roughly 2%, just as in the US.

The fact that investors now expect the yen to be trading at about 50Y/$ in 2048 tells you just how far away from success the BOJ remains.  This is why I say that any talk of exiting from monetary stimulus is crazy.  Monetary policy in Japan remains extremely tight, expected to produce very low inflation over the next 30 years.  They need more than tinkering; they need a dramatic regime change.  I don’t advocate a fixed exchange rate system, but that’s one example of a radical regime change that would “work”.  A better option might be level targeting, combined with a “do whatever it takes” approach to monetary policy implementation.  I.e. buy as many assets as needed to get prices or NGDP rising along the desired level targeting path.

We don’t have that regime today, which makes the 30-year forward yen a useful proxy for policy credibility.  Only when the 30-year forward yen rises far above the current level of 50 can the BOJ start relaxing.  The BOJ has had some success in boosting prices and NGDP, but very little success in convincing the markets that this policy will continue in the very long run.  It seems like markets believe that once Abe is gone the BOJ will revert to its old habits.

PS.  If the regime change is credible they won’t have to buy very many assets.