Chinese real estate

The New York Times writes about Chinese State-Owned Enterprises (SOE's) growing investments in real estate and how this adds to bubble symptoms in the real estate market. The article also states that the Chinese central government is trying to ebb the flow of capital into real estate, but that it has so far not been successful. This is not news; since the beginning of the year the central government has indeed signified that non-real estate-focused SOE's will need to exit real estate businesses (but not within the near future). However, the New York Times does point out that SOE's are using sophisticated legal structures to fund real estate developments and that their cleverness allows them to continue real estate ventures.

We will see what instrument(s) the government uses next to block SOE involvement in real estate, in order to cool down a hot and heated market.

Ambassador Niwa

Japan's Ambassador to China, Uichiro Niwa, continues to take an aggressive stance vis-a-vis the bureaucratic mentality of Japan's Foreign Ministry. For Japanese businesses and other groups frustrated by a lack of pro-active support from their government, Niwa-san is a breath of fresh air.

Mizuho fundraising

Mizuho is pricing new equity shares at JPY 130/share in order to raise approximately US$8.5 billion in fresh capital, as reported by Dow Jones. This follows other Japanese financial institutions in an effort to shore up capital ratios. There is much talk in financial circles of implementation (finally!) of Basel II requirements in 2011 and sales of non-performing loans. Equity raising is an essential prerequisite to Japan taking this step.

Looking at the results of last weekend's Upper House election and the DPJ's failure to maintain control of both Houses, pundits are claiming fiscal austerity and controlling national debt are again on the backburners. Certainly, Prime Minister Kan's lack of eloquence in framing discussion around a doubling of the consumption tax has been a stumble. On the other hand, the public face of the DPJ's budget-cutting team, Renho, was the top vote-getter nationwide, and more impressively, in the highly competitive Tokyo district, claiming over 1.7 million votes. The second-largest vote-getter nationwide was at the 1 million vote range. This is a show of strong public support for cutting the public budget.

There are other signs that public debt will be tackled; a number of pro-business anti-public debt representatives, such as Kenji Nakanishi, have been voted in. Nakanishi is a former JP Morgan banker and part of the Your Party, was elected on a platform of continuing with Japan Post's privatization and against using Japan Post deposits as a piggy bank for government works. Another data point is a release showing Japan's national pension fund was a net seller of Japanese Government Bonds last year - if the public pension's money cannot be guaranteed to support government spending, perhaps Japan has a chance to rein in national debt.

Suburban Tokyo housing

A continuing trend in Japanese real estate follows the demographic movement of mass migration to several hub cities, led by the nation's capital, Tokyo. In addition, the recent economic boom led to a rush of residential tower developments in central Tokyo. Individual ward offices competed for larger residential populations, and thus greater political power, by approving floor-area-ratio bonuses and allowing for higher developments, which in effect led to more residential area coming onto the market. Notwithstanding the economic bust of the past 2 years, these developments have largely been successful, and have led to greater density in central Tokyo. Salarymen are happy to have shorter commutes; empty-nesters can enjoy the conveniences of downtown Tokyo, students and young employees can stay out later at night enjoying abundant social life (or working...).

However, this trend is not without its losers. The Nikkei reported last week on stress in residential properties in suburban Tokyo. Suburban Tokyo is defined as being 40 or more kilometers from the Tokyo city center, encompassing parts of Saitama, Kanagawa, Chiba and Ibaraki prefectures. Accordingly, the Nikkei reported that 49% of vacant suburban residential properties have been vacant for over one year. The top reason for vacancy, capturing 57% of responses, was due to previous tenant's vacancy. Demand seems to be dwindling quickly for suburban residences. The article also notes a similar trend in the Osaka metropolitan area.

What does this mean for suburban communities and services such as shopping centers, restaurants, and even post offices? Will there be a further separation between winners and losers of suburban train operators (who operate a multitude of ancillary services in their various geographies, including buses, grocery stores, and property management), such as Tokyu, Odakyu, Seibu, Keikyu, Tobu and Kintetsu?

Futenma

Okinawa's prominence at the front of Japanese newspapers has declined with former Prime Minister Hatoyama's resignation and new Prime Minister Kan's proposal to restart consumption tax increase debate (and lowering of corporate taxes). To some extent, the "Okinawa issue" of how to deal with U.S. troops in the prefecture will remain in the background, directly affecting only 1% of the Japanese population. Perhaps this is a good time to stand back and reflect.

Over the previous six months, opponents of the U.S. bases in Okinawa have received ample airtime to vent, thanks greatly to Social Democratic Party leader Mizuho Fukushima. It appeared that the whole prefecture was up in arms about the U.S. military's presence; several protest rallies claimed to tally up to 100,000 demonstrators. However, as many Japanese tabloids recounted, these figures were often rounded several times up. In fact, ultimately it was a minority, not a majority, that was against the U.S. military's presence.

This makes sense; Okinawa boasts three main industries - tourism, public works (subsidized by national government) and support of the U.S. military operations, as shown by the Bank of Japan. Agriculture and fisheries is a distant fourth. Removing any of the three economic pillars would be a disaster for the Okinawa people's livelihood, and this is greatly understood by the local population, regardless of any negative personal feelings to military presence, generally, and the U.S. military's presence, specifically. On a political level, local players understand Okinawa's geopolitical location in the Pacific and value as a naval base and military outpost, regardless of the operator's nationality. These local players spend their efforts on profiteering from this reality, not by fighting it. Over the decades, they have also become adept at linking support of the U.S. bases to public works subsidies, continuously winning national public funds as an economic remedy to the emotional burden of housing the U.S. military. Indeed, removal of the U.S. bases might also cause a reduction in national subsidies, in one blow felling two of the three economic pillars! The connection between military support and national subsidies was recently addressed by the Japan Times.

Of course, to remain in power, local politicians need to maintain a populist image, thus Okinawa Governor Imanime's public about-face on "nobody in Okinawa wants (a) large-scale reversion" of U.S. bases prior to publicly refuting this stance.

HMV Shibuya and Tsutaya

Following the disappearance of Tower Records, Virgin Records and other titans of the music industry around the globe, it was inevitable for a similar act to happen in Japan. That Japanese music retailers could last so long is a testament to the propensity of the local population to continue buying music and not download illegally, and to a lesser degree, to the lack of music discounting by retailers (by law). Even Japanese dinosaurs cannot survive beyond their age, and HMV announced the closing of its flagship Shibuya store and several others. The Shibuya store was HMV's first of 66 to be opened in Japan (HMV's Japan website).

(It is appropriate to note that Tower Records Japan continues to fight the good fight, following an MBO of the Japanese unit in 2002 which sidestepped the bankruptcy and liquidation of Tower Records in the U.S. Tower Records Japan did have the foresight to understand CD's do not sell themselves in the internet age and lead marketing campaigns in collaboration with producers. Tower's successful "No Music No Life" ad campaign launched the firm's brand recognition similarly to MTV in the U.S.)

The fall of music in Japan is a topic for another column; there are several factors that play a role, and I will only point them out quickly - antiquated legal code prohibiting the discount of new music albums, written novels and other consumable media, lack of innovation and production of saleable music, and changing demographics.

I would rather take this opportunity to highlight what comes next - from the ashes of HMV Japan rises Tsutaya, the brand driven by the awkwardly-named Culture Convenience Club Co., Ltd. ("CCC"). Its main platform, Tsutaya, grew to market dominancy originally through video rentals (a Japanese version of Blockbuster in the U.S.) and then music CD rentals (which helped the quick drop in CD sales) before further expanding to rent comic books in addition to retail sales of the same consumables.

What is CCC's growth strategy going forward?

Sankei Biz (in Japanese) writes that CCC is currently in negotiations to buy HMV Japan's business from current owner Daiwa SMBC Principal Investments. Allegedly, this will include the absorption of HMV's stores, although it is unknown whether the HMV brand will be kept or jettisoned in favor of Tsutaya. This also neglects the fact that many of HMV's locations in prime retails areas are within close proximity to Tsutaya's own; HMV Shibuya lies within 50 meters of Tsutaya at Q-Front Shibuya.

CCC also looks to expand its retail operations in new directions, including online video rentals a la Netflix (Tsutaya Discas) and an online travel agent (T-Travel). More interesting is an adult-geared entertainment complex with retail, restaurants and parking in fashionable Daikanyama adjacent to Hillside Terrace (CCC's press release), which follows a strategy initiated by Tsutaya in Roppongi Hills and Tokyo Midtown.

->This strategy has also been recognized and favored by other retailers in this age of austerity. While the young are more prone to downloading music and movies and shopping for second-hand items, and the older remain a generation of savers (opening their wallets for vacations rather than CDs), the key spending demographic is the 30-49 year-old slice. This has been widely acknowledged over the past couple years, and the Japanese advertising community continues to zero in. One current example is the successful TV drama Dousoukai by TV Asahi, which tells the stories of families breaking under pressure, love affairs and difficulties in parenting that arise during the 30th year reunion of junior high school friends. As a further press for viewers, the drama resurrects teen idols of the 80's and early 90's for the main character roles. <-

One potential future engine of growth is Tsutaya's Point Card System. CCC's 2009 Q2 investor report shows the rapid increase not only in T-Point members and accepting retails partners, but also in number of transactions. What CCC does not break out is revenue attributable to the T-Point system, both in retail partner fees and in credit card issuance.

Of course, as CCC's approx. 6% interest (indirectly held by Tsutaya Co., Ltd.) in second-hand retailer Book-Off suggests mass retailing of affordable goods, both sales and rentals of new and used items, will continue to be the core business strategy. I imagine that CCC will negotiate down rents for its retail sites to take advantage of falling real estate rents and counter-act revenue decreases, which will hopefully boost operating profits.

JAL Hotels

Although no official announcement has been made by either company, the Japanese continues to widely report that Okura Hotels has agreed to take over JAL Hotels. Okura Hotels even explicitly notes there is no existing agreement to purchase JAL Hotels on its website (Japanese only). The decision for Japan Airlines to sell its hotel operations, branded under Nikko Hotels and Hotel JAL City, has long been expected by the investment community. That this decision took half a year FOLLOWING bankruptcy to be made highlights the political opposition within JAL and the government. Nonetheless, as a business decision this is a no-brainer.

Through the two brands, JAL Hotels currently operates 58 hotels, 41 domestic and 17 overseas. Its 2009 financials show JPY 13.8 billion in sales and JPY 0.2 billion in operating profit (Mainichi Shimbum in Japanese only). For any business manager, this is an unexceptable profit margin and the business should be jettisoned. This also stands in high contrast with Okura Hotels financials, which state JPY 55.1 billion in sales with JPY 2.1 billion operating profit for 21 hotels. Of course, from a Western perspective, Okura Hotels' operating margin is also nothing to boast of...

There are two points to make in this transaction. First, this transaction is to buy the JAL Hotels operating company and assume its 1,000 employees. Okura Hotels is only gaining two hotels - the rest were sold over the past several years to reduce its balance sheet and to free capital. This makes JAL Hotels' poor financial results look even worse. It also calls into question Okura Hotels' purchase price of JPY 6 billion (Asahi Shimbum in Japanese only). As a sale, this is undoubtedly a great price - and understandably, other potential buyers (private equity firms and domestic and international hotel operators) could not make this bid. But how does Okura Hotels justify this price?

This leads me to the second point - this is a transformational deal for Okura Hotels, adding 400% more hotels to its operations in one swoop. What is Okura Hotels motivation? Do they have the operational ability to increase profitability at JAL Hotels? Will they continue to operate the overseas hotels? Will they maintain the Nikko and JAL City brands?

Regardless of these answers, Okura Hotels will need to turn around this ship quickly; JAL Hotels already has forward commitments for two hotels in Suzhou, China.

Uichiro Niwa

New Japanese Prime Minister Naoto Kan appointed lifetime Itochu salaryman Uichiro Niwa as the next ambassador to China. China has accepted this appointment. Although stodgier elements in the Japanese sphere, such as the Foreign Ministry, may not be pleased - as pointed out by the Mainichi Shimbum - but this is indeed a good move. The Foreign Ministry, like its counterparts in the civil service, typically boast that only their staff can serve these posts to to intelligence, training and experience, but this creates a stiff and inflexible team, which can have the opposite effect of not dealing effectively in a dynamic environment.

Already, the Chinese government has been caught off-guard by the announcement of Uichiro Niwa. But more importantly, Uichiro Niwa's background as a career businessman and ultimately president of Itochu, a major trading company, is highly suitable for the role of ambassador to China. Mutual trade between Japan-China is at an ever-growing level, and the trade vital to Japan Inc.'s future. While the migration of manufacturing from high-cost Japan to low-cost China has enabled Japanese players to remain competitive, this has not been without problems. Contamination of food products with chemicals and other substances has caused waves over the years. Over the past month many have followed employee strikes at Honda factories in China. These are issues for a businessman to tackle. Military expansion by China and accompanying effects such as the promotion of national patriotism at the expense of Japan and its role in World War II are serious concerns. Perhaps a businessman is not naturally suited to undertaking these challenges. On the other hand, the Foreign Ministry has shown no skill in handling them over the years, either.

It is also helpful to look at a model for the businessman-as-ambassador; the U.S. typically sends political appointees as its ambassadors to large and influential countries. While these appointees do not always get along with the foreign service officers, this model allows a President to understand and direct foreign policy more clearly and in line with his platform, and chooses from the best and the brightest (usually someone who has distinguished oneself in the private sector) to represent the country at the highest levels.

Renown

Following sales of struggling firms Laox and Honma Golf to Chinese companies, 40% of Japanese-based Renown, a textile and apparel company, was sold to Shandong Ruyi. This was widely reported, as per the Daily Yomiuri, as a result of poor financial performance by the Japanese firm for several years and the interest in a Chinese textiles-maker in expanding existing Japanese brands in China. The Financial Times shares that Shandong's president, Qiu Yafu, had expressed interest in Renown's brands, distribution network and management expertise. This is in spite of a number of dispositions Renown has made in recent years, including real estate assets and brands such as Aquascutum. The motivations of buyer and seller are also listed and explained in Renown's Investor Relations release (although less accessible since it is only in Japanese).

Of course, this trend of Japanese companies selling themselves to overseas firms (and in particular, to Chinese firms) makes complete sense; many Japanese firms continue 1) to be poorly-capitalized, and 2) need to expand sales - preferably in a high-growth market such as China. Also, for a Chinese buyer, the transaction highlights an M&A play that will increase over the next several years - the purchase of technology and other intellectual property, brands, manufacturing and management expertise, which enables 1) sales of said product/services domestically in China, and 2) moving manufacturing and other functions on-shore to China to lower operation costs and maintain global competitiveness.

Also of interest is the sales price. Shandong Ruyi is purchasing 40% of Renown through new third-party allocated shares. Why 40% instead of a majority-enabling 50%+, or 100% of shares to make a wholly-owned subsidiary? Perhaps it is to maintain a buffer for its public status under Tokyo Stock Exchange listing requirements. Perhaps this allows Renown full control without linking future potential losses to parent company. Or perhaps the buyer believes this is the right value for brands, technology, distribution network and other expertise under a liquidation scenario, and intends to move the aforementioned strengths to China and liquidate the Japanese entity. This is probably too negative a scenario, as Renown's stock continues to surge following the share purchase announcement on May 24th.

Iconiq

The past couple years have been difficult for participants in the Japanese media industry as it has been for their global peers. The global financial crisis exacerbated changing advertising spending allocations due to lower readership of old media magazines and newspapers. In addition, the music industry continues to shrink due to lower CD sales and aging demographics.

While not entirely unique nor pioneering, Avex's experiment with Iconiq is a response to the aforementioned market trends. Iconiq is the not-so-clever name picked by Avex, a major Japanese record label, to fashion an overnight success from an unknown B-level teeny-bopper pop singer. Avex substituted the traditional marketing strategy of a pop act - press, events and publicity to hype up several singles and music videos - with a massive coordinated marketing blitz. Avex lined up seven sponsors in an unprecedented advertising blitz to paste Iconiq's face on billboards throughout Japan. The seven sponsors are Shiseido, ANA, Starbucks, Maserati, Kitson, mu-mo and Rhythm Zone (a division of Avex). Impressively, Avex announced Iconiq's debut by means of a Shiseido commercial where her shoulder-length hair is buzz-cut.

Through pure force of marketing, Avex achieved immediate face recognition through Iconiq's constant presence on billboards, TV commercials, magazine covers, etc. The second phase was Iconiq's music debut - her initial album launched at #3 on the Oricon charts, which may reflect her producer's purchases more than consumer support. Avex has pulled out all the stops and will continue to ensure Iconiq has ample airplay on TV and radio. Unfortunately, the music is an emotionless B-grade pop sound and does not match the name nor the buzz-cut look. While the verdict is still out on whether Avex can make Iconiq a success, it appears even a massive campaign cannot sell mediocre music.

On the other hand, The Japan Times happily delivers Avex's PR line here.

Tasaki Pearls

Two years after being taken over by private equity firm MBK Partners, Tasaki Pearls is completing a full financial re-structuring and design makeover. Tasaki traditionally played a distant #2 from Mikimoto Pearls in Japan, and fell into financial disrepair. Following its takeover by MBK Partners, Tasaki shut down a number of retail outlets and more savvily has hired a number of outside designers to re-imagine the brand. One designer making a difference for Tasaki is Thakoon Panichgul, a favorite designer of Michelle Obama. The Japan Times also has a quick blurb on the makeover here. While the verdict on Tasaki's strategy and aesthetic is still out, perhaps the fear regarding the viability of Japan Inc. is overblown - perhaps Japan Inc. can re-invent itself for the 21st century.

Kyoto Tourism

Kyoto is Japan's leading light in tourism, an industry the government is aiming to boost, in the near term to 10 million inbound tourists annually, and long term o 20 million tourists. The obvious country to market towards is China, and this is happening with easing of visa regulations.

An article in the New York Times takes a look at the debate among vested parties in Kyoto on how and where that city's tourism industry should focus. For some, Orix's proposed aquarium (Japanese only) in the city center is the right approach to draw in new crowds. But for the majority, Kyoto's value and draw for tourists is in presenting traditional Japan to the world. Kyoto was spared the massive carpet-bombing other Japanese cities endured during World War II, and preserves many World Heritage-quality sites. During the post-war decades, the Kyoto people tore down the old city themselves and re-built it in post-modern concrete, as is Kyoto Station itself. Only over the past decade have stronger zoning policies been implemented and an appreciation for the old Kyoto been nurtured. This has fostered a vibrant inner city of old renovated machiya houses, coffeeshops, boutiques and traditional artisan stores, which fills out a tourist's experiences beyond historical site visits and allows them to interact with locals. One such area is the Nishiki market.

Beyond Kyoto, Japan is looking for ways to make itself more tourist-friendly. The big draw this year is Nara's 1300th anniversary, which has had problems in promoting itself and standing apart from Kyoto. The Japan Times has a quick summary here. Perhaps in the end the private industry will need to lead the effort to promote Japan and make the pitch to potential tourists, as the Japan Times reports.

Japanese politicians vs. bureaucrats

Round 2 of the Japanese DPJ politicians inquisition of bureaucrat-led spending（事業仕分け） started a week ago, with the politicians slating 42 organizations for closure and JPY 350 billion worth of spending cuts (article in Japanese). This round continues from May 20th and is being closely watched by the nation, as the interrogative questioning provides excellent television viewing. (The lead "prosecutor", Renho, comes across as the type of firebrand Japan needs. An interview with the Japan Times follows her background) This follows Round 1, which led to substantial spending cuts when concluded in November 2009; highlighted projects can be seen in Japanese here.

In addition to taking some of the national attention off Hatoyama's inability to make decisions on Futenma and Ozawa's money-raising improprieties, the politician-bureaucrat debates on public spending are raising awareness of how capital is allocated by the Japanese government. And further, whether the bureaucracy's allocation of capital is helpful to the country or not. Certain bureaucrat traditions such as amakudari (practice of bureaucrats taking cushy roles in related counterparties upon retirement as gratitude for prior patronage) are now widely frowned upon. But it has taken Japan until the post-Koizumi era to put bureaucratic capital allocations under the magnifying glass.

Chinese real estate

It does appear that China will launch its first REITs in the second half of 2010. This is a positive development, not for the injection of new capital to the real estate market, but for the development of a sophisticated investor market.

Firstly, the Chinese government appears to be taking a cautious path; only a couple REITs will be allowed so that the government can monitor securities firms sale practices, market demand, and REIT managers' abilities to operate. This is the right way for the government to proceed since these three areas are unknown, not least of which is the ability of domestic asset managers. Only a couple REITs will list and only selected domestic institutional investors will be allowed to purchase shares (or units). This will prevent a mass introduction of new capital into the real estate market.

Secondly, the goal is to create a set of professional asset managers where previously there has been none. Part of the lack of asset managers is due to the bubble-like real estate industry which is developer-heavy and amateur investor-heavy. I imagine the large banks and insurance companies will be allowed a head-start to form asset managers, followed by the more savvy and long-term-focused developers.

Hollowing of Japan's interior vs. air travel

Although personally I am a proponent of supporting Japanese regional economies, many regional airports and unprofitable air routes to these regional airports should be closed. There is simply not enough demand to support many of these regional flights. Japan Airlines has run these flights for the past twenty years as part of the greater bureaucratic and political horse-trading with regional prefectures. However, the bankruptcy of Japan Airlines most likely signals the end for many of these regional flights, and therefore, the regional airports. On the other hand, Japan Airlines turnaround is still mired with much politics and it is unknown how this re-structuring will end.

On the positive side, Japan boasts a vast and efficiently-run train system throughout the country, which compensates for lack of air demand. Secondly, there is an opportunity for low-cost carriers to emerge, although Skymark Airlines and Air-Do Airlines have struggled to build momentum since their inception.

Chinese real estate bubble?

Like so much economic analysis, opinion on the current real estate boom in China shifts on a weekly basis like the winds of the Gobi desert. This week's pundits favor the bubble theory, suggesting that there is a bubble and the central government is stepping in. The China Daily goes so far as to title their piece, Real Estate Time Bomb Ticking! Of course, the reality of the situation, as well as the substance of these same published articles, is more nuanced.

The surface statistics point towards symptoms of a bubble; rapidly rising prices, greater inability of the middle class to purchase homes, and trend of developers to sell pieces of newly completed properties as strata-title to the highest bidder. Defenders of the real estate market point to the "China story", which is demographics (1.3 billion people!) and urbanization.

I see the central government's tight grip on financial markets as being the key here. The central government is able to control capital flows to each industry, including real estate, and does so to both induce a boom and to deflate a bubble. As complaints from the middle class increase, one sees signals that the central government is applying the brakes; some key and recent instructions include - all non-real estate SOE's need to submit exit plans from real estate investments, increase of down payment required for second homes and investment properties, and articles in government news organs focusing on potential real estate bubble.

One must not forget that the central government still has several instruments to prevent the collapse of real estate prices, not least of which is pushing forward REIT and CMBS markets, thereby drawing in more capital.

On a final note, one concern I harbor is the central government's ability to keep local governments and prefectural governments in line, and preventing a potential blow up in one region's real estate market to infecting the nation.

Chinese and Japanese navies

It is widely understood that control of global waterways has allowed empires mercantile advantage. As the sole naval power of the 20th century, America was able to control the flow of global trade and profited immensely. During the 21st century, will America be able to maintain this grip on waterway traffic, or will it have to share with other naval powers?

Immediately, Somalian pirates come to mind. Since the outbreak of pirates off the coast of Somalia, national navies have escorted their commercial vessels. While this allows the U.S. a lesser financial burden for protecting all commercial vessels, this also signifies the end of American naval dominance as other countries gain modern naval know-how, including operation of equipment and vessels in a hostile environment, in addition to logistical and supply-chain management.

In Asia, both Japan and China are watching each other closely. Japan's domestic politics have discouraged direct Japanese naval support. On the other hand, Japan does keep a close tab on Chinese military movements, and build-up of a naval presence. Perhaps most threatening is the construction of Chinese aircraft carriers. The development of a modern Chinese navy will break America's monopoly, and will create the threat Japanese hawks have been waiting for as an excuse for Japan to re-deploy its own navy. The U.S. will also have to work hard to maintain its strength in the Pacific to protect its interests; as one strategic point, the fate of the U.S. bases in Okinawa is far from certain.

China's naval build-up is starting to attract new interest - watch this space, as are Japan, Korea and the U.S.

Theories on Japan's ability to finance debt

In light of Greece specifically, and other European sovereign debts issues in general, a new spotlight is shining on Japan and its substantial national debt. Is there a coming debt shock for Japan?

As Japan enters the Golden Week holidays, there seems to be no worry of such a debt shock. In fact, TV pundits are claiming more Japanese holiday-makers are going on long, overseas and more expensive vacations then the preceding several years. Foreign media about a coming debt problem seems like much ado about nothing.

There are two schools of thought on Japanese government debt; 1) no national debt problem, and 2) current national debt is unsustainable. Let's explore the two ideologies:

First, the Japanese conventional wisdom on the subject is that since over 95% of Japanese Government Bond ("JGB")-holders are domestic individuals and institutions who are happy to roll over the debt, there is no problem. Due to low yield and international consensus that the Bank of Japan will not raise interest rates significantly, most foreign investors would rather place their capital in higher-yielding products. The potential cancellation of Japan Post's privatization scheme will also re-open a large pocket of capital for the government to use.

Secondly, there is a much smaller voice sounding out the unsustainability of the national debt. This group points to demographics and the decreasing labor force vis-a-vis a growing pensioner population as an insurmountable problem. In effect, the ability to pay down the national debt is canceled out by pension obligations - in fact, it is not only canceled out but the debt must increase to fulfill these obligations. Therefore, either government revenue must be increased or obligations decreased.

A hike in the consumption tax is often discussed and subsequently discarded; memories of the institution of the consumption tax during a period of economic weakness is still strong. However, there appears to be new interest in near-term need to raise taxes, as recently raised by Naoto Kan. How this will be politically feasible is anyone's guess.

Attacking the other side of the equation, the DPJ is holding fiery debates televised live with bureaucrats and attacking wasteful spending projects. Many of these pet projects will be canceled - the ramifications of this are more political than economic - the DPJ hopes to break the bureaucrats' regional power bases. However, a real issue which must be discussed is lowering pensioners' entitlements. As the country quickly progresses from 2 workers providing for each pensioner to 2 pensioners depending on each worker, something has to give. Stay tuned.

In conclusion, managing the national debt also concerns how the Japanese government re-distributes capital throughout the nation. Japan, post-World War II, has subsidized and supported national champions of industry, while maintaining its social contract of pensions, health care and regional support. Perhaps the most important agenda under re-distribution of capital is to subsidize children and re-build a worker population?

Japan needs to focus on inbound tourists from China

The Japanese government's plan to increase inbound tourists to 10 million in 2010 is fundamental to propping up regional economies (and of course the major metropolises). Regional economies continue to lose workers to the big cities. With fewer agricultural and manufacturing work done in the regions, tourism is the last hope to prop up local economies without government subsidies.

This is undoubtedly one of the key reasons for visa restrictions for Chinese tourists continue to be lowered.

The first step for Japanese retailers who have seen the light - meaning the need to aggressively court Chinese tourists - is to accept China UnionPay, the form of payment most accessible by Chinese.

Chinese capital allocations to real estate

During the financial crisis of 2008, I mistakenly thought part of the Chinese stimulus package would be the creation of various real estate finance vehicles (ie REITs, CMBS), but this is not happening. In fact, the reverse appears very much the Chinese government's current course of action. The question is how the central government plans on diverting the real estate market in the near future.

A massive amount of capital has already found its way into real estate; the stimulus package caused capital to move in the following direction, from government-sponsored banks -> large corporates and state-owned enterprises -> real estate. Due to lower global consumption, many companies were almost forced to take on loans without a need to invest or re-invest in factories or the like. Due to strict capital controls, this abundance of capital has only two outlets in China, real estate and public equities. Real estate has become the beneficiary of choice for both individual and corporate investors with perceived capital gains. This flow of capital to amateur real estate players has caused several bubble-like phenomenon, one of which is the sale of new Grade A office and multi-use developments by strata-title. In the residential property market, soaring apartment prices have caused middle-class angst and concern. One manifestation has been the popular Dwelling Narrowness television drama.

The government is responding; both to appeal to the masses worried about housing costs and to counter a speculative commercial market. Recently, the government has taken steps to reduce flows to real estate, including an order to slowly push large SOE's with non-real estate core businesses to exit real estate positions. In addition, the government continues to change capital gains taxes with an eye on reining in speculation. It remains to be seen whether the central government can control local governments in respect to new developments and new supply of real estate; local governments are a big beneficiary themselves of a booming real estate market through land auctions.

Real change will happen as the central government directs a guanxi (connections) driven business into a professional-managed industry. Part of this requires more mature financial markets, and talk of a Chinese REIT is still just that, talk. The government continues a comment period with major law firms and financial institutions. The next presumed step will be to allow insurance companies to invest in real estate. Presumably, the introduction of government-sponsored institutional investors (in this case, insurance companies), will encourage the creation of professional asset managers who will operate real estate for long-term yield, not short-term capital gains. In fact, this may be the central government's preferred strategy, since presumably the central government will maintain stronger supervision of insurance companies rather than public-listed REITs.

Hollowing out of Japan's interior

The hollowing out of Japan's interior has been a slow and steady process. Over the past ten years, Greater Tokyo/Yokohama has consolidated political, economic and social power to a greater degree and now provides a home to roughly of fourth of the population. Osaka/Kyoto/Kobe continues to be the great metropolis of west Japan, despite a stagnant and stuck economy. In addition, with continued improvements in transportation, such as the bullet train, regional economies are aggregating among four centers, Sapporo in Hokkaido, Sendai and Nagoya, and Fukuoka in Kyushu. Together, these six metropolises represent a majority of the population and an even greater proportion of gross national product.

I would like to highlight one reason for this trend: the need to maintain economic competitiveness both domestically and internationally. Therefore, regional economies have fought for relevance by concentrating around one city that is blessed with good transport connections. The losers are both the rural areas and second-tier cities. For example, Sapporo is the focal point of Hokkaido, while smaller cities such as Asahikawa, Otaru, and Hakodate struggle. Sapporo provides the main international airport in Hokkaido, so while Sapporo (Chitose Airport) and Hakodate are roughly equidistant from the ski slopes of Niseko, traffic (ie tour groups) exclusively land at Chitose Airport.

It seems a foregone conclusion that these six cities have emerged as the survivors of modern Japan. Other cities may maintain a manufacturing base which is difficult to move (ie Kokura in Kyushu or Hiroshima), but by and large the die has been cast and capital investment over the past ten years has concentrated among these six. Even though the bullet train has been extended to Hachinohe in Aomori prefecture, businesses and capital have congregated in Sendai, from which businessmen can take an easy day trip to visit clients in Aomori. This is illustrated by Mori Trust's massive 37-floor multi-use development coming to completion.

Perhaps this hollowing out has spurred the tremendous interest in an otaku sub-culture of haikyo (廃虚) "ruins", which entails visits to buildings and other man-made projects long forgotten and abandoned.

Introduction

Welcome to Logical Progressions in Asian Development. This is a forum for me to express ideas on progress Japan and Asia has made over the past 200 years in becoming part of the modern world. As Japan has led this transformation, I focus on Japan's development, which is instructive of the greater Asian experience. My background is in finance, but it is essential to look at development through a multi-disciplinary lens, encapsulating economics, finance, politics, demographics, international relations, science, and religion. Although touching on all facets of the greater human experience is beyond my scope (and capability), I hope to raise relevant issues.