It has been said that there are four kinds of countries in the world: developed countries, developing countries, Argentina, and Japan.
Argentina just defaulted on its sovereign debt (again). This was such a dramatic event, so systemically destructive, that global markets did ... nothing. If Argentina were a dude, he'd have a rap sheet a mile long and sport an oft-broken nose and a questionable essay tattoo rife with misspellings, like "Tragdey."
Japan, on the other hand, is the good son. He pays his debts, he always shows up to work on time, he has a bizarre fascination with cartoon cats. He enjoyed an astronomical rise in his early career but has since been skipped over for promotions. A lot.
One of the current government initiatives is to make Japan a "normal" country. This might take some doing.
Japan is a land of cat cafes (each table gets its own cat), owl cafes (each table gets its own owl), maid cafes (you get the idea), cuddle cafes (which are exactly as they sound, except weirder), capsule hotels, prison hospital-themed restaurants, and no apparent dichotomy between masculinity and cuteness. It is the land of Hello Kitty and unironic wearers of work uniforms.
The toilet in our Tokyo apartment has a sink built into the top, so that you can rinse your hands with water that then flows into the toilet bowl. I've thought about this 20 different ways, and it totally checks out.
It's a country where problems are repressed rather than discussed, a land where people have mastered the art of deliberately misunderstanding one another for the sake of mutual comfort. Japan is always apologizing.
But there's something about Japan that has always puzzled me. Something, if that were even possible, is even more remarkable than toilet-sinks. Following Japan's massive financial collapse in the 1990s, the country retained a low-single-digit unemployment rate, a level most countries would envy. There are no obvious signs of decay following the financial collapse. The Japanese public transportation system has to be experienced to be believed. Japan's cities are among the cleanest and safest cities on earth, its consumer culture very much intact. Japan's consumers are world-class. It's a huge market for many of the world's most prestigious brands. Tokyo alone has more Michelin-starred restaurants than the entire United States. This country is a wonder. I view Japan with genuine awe and admiration.
I came to Japan to attempt to square this circle. How did a financial collapse not lead to societal decay? How can a country facing two demographic time bombs (a declining and rapidly aging population) and a corporate sector that doesn't earn much of a return on capital maintain its standard of living? And most importantly, I wanted to see if the rumblings of financial reform -- of the turning of a corner in Japan -- were real, and if companies in the almost-forgotten Japanese market were worthy of consideration for investment.
Every country can have a bad quarter-century.
One of the defining economic events of the latter half of the last century was Japan's economic awakening, culminating with a massive bubble that popped, finally, in 1991. So big was the asset bubble that the Nikkei 225, Japan's main stock market index, still trades about 60% below peak valuations. If those peak valuations had any credibility, then value destruction in Japan rises to the trillions of dollars (or, if that number doesn't seem big enough, hundreds of trillions of yen).
One response has been revulsion toward risk. A huge amount of Japanese liquid assets are invested -- and I use the term loosely -- in the equivalent of passbook accounts maintained by the post office.
You hear "financial collapse" and "20 years of recession" and you, like me, probably think Detroit. Tokyo, on the other hand, has an entire neighborhood dedicated to selling comic books, character figurines, and the like. On its face, it doesn't make sense. And the more you think about it, the less sense it makes. Don't they know they're not rich?
This is not to say the financial malaise has been cost-free. Far from it -- there is an entire generation in Japan that employers have essentially skipped. When they graduated in the economic ice ages of 1996-2004, few firms were hiring, and now they're being simply passed over for newer graduates. They're stuck, unemployed or deeply underemployed.
Social psychologists believe that the tendency for young (to now not-so-young) Japanese men to become hikikomori -- essentially, becoming recluses and completely withdrawing from society -- has among its causes the fear of bringing shame upon their families. Perhaps in sympathy, older Japanese have refused to leave the workforce; the average age of a farmer in Japan is an astounding 70.
All of these facts simply fail to square until you consider the enormous role the government plays in the Japanese economy. Over the last 20 years it has pushed its balance sheet to the breaking point trying to reignite growth, though nothing to date has worked.
But now you have done it.
Prime Minister Shinzo Abe came to office in 2012 as a frank nationalist. His strategy rests upon either attempting to reinvigorate citizens' pride in their country (if you're being charitable) or trying to reestablish Japan's might (if you aren't). Abenomics policy is alternatively a supremely dangerous game or the country's last hope to restart its economy, depending on whom you ask. Truth is, it's probably a little bit of both.
The Japanese market is the world's second-largest, yet it plays quite a small role on the global scene: Japan has no real listing standards for companies and no requirements for outside directorships, and many companies -- even quite large ones -- report only in Japanese. It is as if Japanese managers are terrified of aggressive foreign investors who will come in and get extremely active about pesky issues like profits and costs of capital and disposal of non-performing assets. Japanese labor unions are extremely politically powerful, as are its trade unions. They more or less like things just the way they are.
A quarter-century of economic malaise tends to focus the mind, and many now view this as Japan's last best shot to turn things around. I'm not sure I agree, but Japan's upcoming demographic time bomb will certainly be difficult to manage without a revitalized economy.
The essence of Abenomics is its "Three Arrow" strategy. The first was monetary, with the country undertaking a massive fiscal stimulus strategy, pushing down the value of the yen. The second arrow is fiscal, with the government opening up the floodgates on spending (bridging the budget gap with a national sales tax).
The third arrow is to reinvigorate the corporate sector. This is the most difficult of the three, as it is, in effect, a confidence game. Japan's leaders have to convince enough economic participants (companies, consumers, farmers, and, importantly, the bureaucrats) that the old way of doing things is over. One of the most interesting conversations I had in Japan was with Bloomberg View columnist William Pesek, who told me that even if Abe's nationalist tendencies are unnerving, these same instincts give him credibility with several constituencies that would probably be more resistant to the same message coming from a more liberal source. "I'm your guy," he says, "and I'm telling you how it has to be." Politics, like economics, is path-dependent.
Everything seems to be on the table for the third arrow. Japan's corporate tax rate, currently the second-highest among developed countries (after the U.S.), is in process of being overhauled, but other reforms may be more meaningful. After all, the biggest problem for Japan's corporate sector isn't the taxation of profits; it's the lack of profits. Immigration reform will help Japan reverse its population decline, and labor reform should spur the increased participation of women in the workforce (currently 35% of employed Japanese have unstable employment situations, but the overwhelming majority of working women do), but neither of these is a quick fix.
The quickest way to create inflation in the country is through the expansion of capital. But without rational expectations for adequate returns, foreign direct investment has been, and is likely to remain, low. But Japan already has access to trillions in capital sitting in zero-gain assets in pension funds and government savings schemes. The government is preparing to begin investing some of that capital in Japanese stocks and debt, and it will demand a return. In short, Japan's capital at all levels must become more efficient, because that is the easiest, most logical way to grow the economy. In the words of one of the leading asset managers in Japan: "We have 127 million people who are determined to either get to 2% inflation or die trying."
In the end, the way to invest in Japan is somewhat different from investing in many other countries. Statistical value investments are generally associated with companies that have deeply entrenched, profit-agnostic managers. Most of them aren't going away, but they're a long, long way from the kind of corporate culture that values shareholder return.
Japan also has some extremely dynamic companies -- it is the machine maker for the growth engine in China, and its companies are among the best brand-builders not just in Asia, but in the world. If you don't believe me, ask young women about Uniqlo, the brand launched by Japanese company Fast Retailing. Ask cyclists about Shimano. You, of course, know Sony, and Toyota, and perhaps even Nissin Foods. But I've also come across some names that could be among the next generation of great brands. The only retail experience with which I'd compare the Harajuku branch of Japanese kitchen appliance company Asoko is Apple. On iPad release day. In 2011.
Japan's government has undertaken a go-for-broke strategy, because at this point in its history, it has to. But I expect Japan's dynamic brands, along with its image as a trusted maker of goods with exacting standards, to pay off. Yes, it's a weird country -- Japan has two museums dedicated to instant ramen, and they tend to be crowded. But it is also deeply lovable, a place where passion for perfection can make things like preparing gelatin desserts ascend to high art.
I believe that the changes being applied now in Japan have an excellent chance of revitalizing its economy, but I also believe that investing in Japan is, for the time being, best restrained to the most dynamic companies in the market.
But be alert.
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Bill Mann has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Motley Fool Asset Management manages a portfolio that owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.