Shaw Capital Management Korea: Postal Reform Rollback

The Japanese government has decided to revise the

proposed reforms of the postal system …

Shaw Capital Management Korea: One of the world’s largest financial institutions

The government now proposes to absorb Japan Post

Network Co. and Japan Post Service Co. into Japan Post

Holdings on October 1, 2011.

The newly consolidated holding group will continue

to have two financial units, turning the system into a

three-company structure, from the current five

companies (currently, the system consists of Japan Post

Holdings Co. and four units — a postal service, a savings

bank, a life insurance company and a retailer for the

services of the other three).

Under the new plan, the current Democratic Party of

Japan-led government (DPJ) also plans to double the

maximum amount of deposits that Japan Post’s banking

unit can accept per person from the current ¥10 million

to ¥20 million and to raise postal insurance coverage

from the current ¥13 million to ¥25 million.

The government is also likely to hold on to more than

a third of the postal group’s shares in a turnaround

from full privatization — this will enable the

government to veto any major changes in the firm.

The bill with these latest changes, is expected to be

submitted to the Diet.

“We made the bill’s outline with the aim of ensuring

that Japan Post will sufficiently offer universal services

throughout the nation”, Shizuka Kamei, Japan’s Finance

Minister, told reporters at a press conference.

The Japan Post group provides insurance services

through its 24,000 post offices across the nation

especially in rural areas where private banks have little

or no presence or have trouble gaining the trust of

locals, and holds savings accounts for about 57 million

people.

The group as a whole employs about 226,000 people

and, with assets of more than ¥300,000 billion, sits at

the heart of a system of public institutions that own

almost half of Japan’s national debt.

Moreover, it helps to keep the government’s cost of

borrowing low even as its gross debt closes in on 200%

of annual output.

Japan Post was nominally privatised in 2003; with the

reforms spearheaded by former Prime Minister

Junichiro Koizumi, the champion of structural reforms

for a more market-oriented economy.

Under the previous plan, Japan Post’s financial units

were to be fully released from government control by

2017. With these latest moves, Prime Minister Yukio

Hatoyama’s government, which took power last

September from the long-ruling Liberal Democratic

Party (LDP), is halting the sale of its shares to maintain

control over the company’s plentiful assets, long a

source of public financing.

Behind the proposal is the government need for a

growth strategy.

In the fiscal 2010 budget, general-account expenditures

stand at a record ¥92 trillion, so politicians are pushing

for postal savings to be used to finance their policies.

But these proposed changes to postal reform raise

numerous concerns.

First of all, if the massive postal group attracts even

more money with the lifting of the savings cap, it will

hamper private-sector financial businesses and spark

an outflow of funds from private banks.

Tadashi Ogawa, chairman of the Regional Banks

Association, says raising the deposit cap is “truly

regrettable” because small regional banks in particular

will be affected in times of financial crisis because

depositors may flee to Japan Post Bank.

Moreover, the two subsidiaries — the postal bank and

insurance company — are likely to be permitted

substantial operational freedom.

This would, for example, enable them to offer housing

loans or sell cancer insurance policies.

The uneven public-private playing field, however,

would no longer be just a domestic problem. The US

and Europe have already expressed concerns about

these developments.

Also, creating an even bigger public financial entity

will loosen the government’s fiscal discipline through

increased purchases of government bonds (JGBs) and

accelerate wasteful spending on public works projects.

The system of public institutions buying JGBs has been

central to the economic status quo that has kept Japan

afloat since its stock market plunged in 1990.

“The revision will be a turning point for the worse”,

says Naoko Nemoto, a banking analyst at rating agency

Standard & Poor’s in Japan.

The deep misgivings over public spending originate

from the way postal savings were used for years.

The money had long been used to fund unnecessary

public projects such as highways, bridges and airports

in the middle of nowhere via the Finance Ministry’s

fiscal investment and loan program, which was

reformed in 2001.

These expenditures were not only inefficient but also

lacked transparency because they were made through

government-affiliated organisations.

Creating an even bigger public financial entity is also

risky because it will distort the entire interest-rate

structure of financial markets, where loans with higher

risks should reflect higher returns.

If a public institution extends loans with below-market

interest rates to support certain industries, we are back

to the government ‘picking winners’ or worse just

backing losers.

In other words, this is yet another example of how the

DPJ is mis-managing the Japanese economy, pandering

to voters and reversing necessary reforms passed by

the Koizumi government.

Shaw Capital Management Korea: World Trade

The fall-out from the failure of the Doha Round of trade

liberalisation measures, and the impact of the recession,

are continuing to increase the threat of further

protectionist restrictions on world trading activities.

The US Commerce Department has recently launched

an investigation into whether certain forms of

aluminium made in China is being dumped, or sold at

less than its fair value, in the US; and the Chinese

Commerce Ministry has responded by launching its

own anti-dumping enquires into imports of

caprolactam, a widely-used synthetic polymer, from

both the US and Europe, and has finalised the ruling

on some nylon imports.

These developments are not likely to lead to early and

dramatic changes; but they do provide a further

illustration of the dangers if the global economic

recovery does not accelerate and lead to a relaxation

of the pressures in the trading system.

Shaw Capital Management August Newsletter: Financial Markets Focusing Europe

The big fall in the euro in recent months is clearly having a significant impact on the performance of the

euro-zone economy.

Shaw Capital Management, Korea - Investment Innovation & Excellence.  We provide the information, insight and expertise that you need to make the right investment choices. Shaw Capital Management Korea typically offers its clients such services as asset allocation and portfolio design; traditional and non-traditional manager review and selection; portfolio implementation; portfolio monitoring and consolidated performance reporting; and other wealth management services, including estate, tax, trust and insurance planning, asset custody, closely held business issues associated with the establishment or expansion of a family office, the formation of family investment partnerships or LLCs, philanthropy, family dynamics and inter-generation issues, etc.

Factory output expanded at a record pace in April, helped by investment spending associated with the export effort, and overseas demand for European capital equipment, and the trend appears to be continuing. The major beneficiary has been Germany, but other northern member countries are also involved.

However the situation is much less encouraging in Greece, Spain, and Portugal, because they are less competitive in export markets, and are being forced to introduce austerity measures to reduce their fiscal deficits.

Domestic demand across the entire euro-zone remains weak, and so, despite the export performance of some member countries, it seems unlikely that the overall growth rate for the zone this year will reach 2%. The European Central Bank remains reasonably optimistic about prospects; but fortunately it has not moved towards an “exit strategy” that might involve reversing the measures that were introduced to counter the recession.

Short-term interest rates have been left unchanged and close to zero, the programme to provide unlimited three-month loans to the banking system is continuing, and the bank is also still intervening in the markets to buy the bonds of weaker member countries that had been sold heavily because of fears about debt defaults. The bank is therefore continuing to provide support for the system; but it is not really doing enough to offset the concerns about the debt crisis.

Greece remains in the eye of the storm; but there have been increasing concerns about the situation in Spain; and the situation has been made worse by the latest warning from the Fitch Ratings agency that it may take further massive asset purchases by the European Central Bank to prevent the sovereign debt crisis in the area escalating out of control.

Shaw Capital Management August 2010: Financial Markets Focusing Europe - There are fears that Spain will need to follow Greece in requesting help from other member countries and the IMF to enable it to avoid a default, and that Portugal, and perhaps even Italy, may also need to be rescued.

The pressures on the euro will therefore be intense; and whilst there may well be further support from the Swiss National Bank and others, the future of the single currency system clearly remains very uncertain. The latest modest rally in the euro must therefore be treated with great care.

Sterling has recovered from the weakness that developed in May, and is ending the month higher. The economic background in the UK has not provided any real support, and the Bank of England is clearly intending to maintain short-term interest rates at very low levels; but there has been some movement of funds out of the euro into sterling, and the new coalition government in the UK has introduced measures to reduce the massive fiscal deficit that have been well received in the markets and led to an improvement in sentiment.

There is clearly a risk that these latest measures in the Budget will depress the level of activity still further, and fail to solve the fiscal problems; but for the moment it seems that the new government is being given the benefit of the doubt.

The evidence on the performance of the economy ahead of the Budget announcement was still pointing to a very slow recovery in activity.

The manufacturing sector is reasonably buoyant, with exports expanding rapidly; and retail sales also increased more quickly than expected.

But unemployment rose again to 2.47 million, and the latest survey from the CBI indicated that the value and volume of business in the services sector fell, and that further weakness was expected in the second half of the year.

However the situation has obviously been changed significantly by the latest Budget measures, and the latest estimates from the newly-formed Office for Budget Responsibility are that growth will now only be 1.2% this year, rising to 2.3% next year, and improving slightly in succeeding years.

The Bank of England has welcomed the decision by the new government to introduce measures to address the problems created by the huge fiscal deficit. The governor, Mervyn King, argued recently that they would “eliminate some of the downside risks…and are desirable to remove the risk of an adverse market reaction.”

Shaw Capital Management Korea: Fresh Pressure on BOJ for Adopting an Inflation Target

Japanese Finance Minister Naoto Kan has recently exerted pressure

on the Bank of Japan (BOJ) to act more quickly to defeat deflation,

saying he wants the falling price trend to end this year. “Two or

three years is too long. If possible, I hope that the consumer price

index turns positive by the end of this year” Kan told a parliamentary

session.

Shaw Capital Management Korea: Fresh Pressure on BOJ for Adopting an Inflation Target. The finance minister also said that the BOJ may have to set an

inflation target aimed at dragging the economy out of grinding

deflation … a policy where a central bank declares a target for

inflation and guides actual price levels toward that goal through

monetary policy such as interest rate changes.

BOJ Governor Masaaki Shirakawa made it clear he had no intention

of taking such a step, and explained in detail why he considers it

inappropriate. “There is a mood to reconsider the use of the

framework of inflation targeting following the recent financial

crisis," Mr. Shirakawa said at a recent news conference.

“If a central bank concentrates only on achieving a short-term

price goal, that could have an adverse effect on sustainable economic

growth, which is the final goal of monetary policy”, Shirakawa said.

Moreover, “such a mechanism would reduce the BOJ’s flexibility

on policy”.

Inflation targeting has become a favoured policy among many

central banks worldwide, but since the start of Japan’s deflationary

era in 1999, the BOJ has stoutly resisted calls to set an inflation

target against which it can be judged, and by which it can be

embarrassed if it misses it.

Shaw Capital Management Korea: Fresh Pressure on BOJ for Adopting an Inflation Target. Instead it has relied on softer price guidance in determining policy.

Its inflation objective is defined in the loosest terms, as a rate

between zero and 2% for the core consumer price index, as one

that meets its “understanding of medium- to long-term price

stability”, with no time-frame to achieve it and no penalty for

failure.

Still, core consumer price index, which excludes volatile fresh food

prices, fell 1.3% on year in December, dropping for the 10th straight

month.

Shirakawa’s comments suggest the central bank will not embark

on any further easing for now to put a stop to deflation. However

the BOJ might be forced to loosen policy toward the middle of the

year if the domestic economy loses momentum from its recent

strong performance … recent data showed the economy grew at a

4.6% annualized pace in the final quarter of 2009.

And with a key upper house election coming up in the summer, at

which the ruling Democratic Party of Japan hopes to win a majority

in the chamber, political pressure on the BOJ to do more to improve

the economic picture could rise.

Can the introduction of inflation targeting under deflation and

zero interest rates contribute to the Japanese economic recovery?

Generally, inflation targeting has been increasingly viewed as a

good monetary policy framework and widely applauded by

economists and policymakers.

In the literature, there are benefits of inflation targeting for both

inflation and output behaviour.

Inflation targeting should stabilise the level of inflation, reduce its

variability and persistence, and also decrease the variability of

output.

Shaw Capital Management Korea: Fresh Pressure on BOJ for Adopting an Inflation Target. A recent study by Daniel Leigh, an economist at the IMF, shows

that had Japan introduced an inflation target in the 90’s its

economy’s performance would have substantially improved and

the BOJ would have avoided the zero lower bound on nominal

interest rates.

But the essence of the question is to what extent the introduction

of inflation targeting will enhance credibility of the BOJ’s reflation

policy in a deflationary phase and help economic recovery.

More importantly, whether or not the BOJ monetary policy is

credible enough for inflation expectations to be anchored to an

inflation target.

Takehiro Sato of Morgan Stanley says that, unlike the Federal

Reserve, which has won a high degree of respect for its handling

of monetary policy, Japan’s central bank is not yet trusted by

markets because of its past moves. “The BOJ’s policy track record

is bad.

A target for inflation helps to anchor future expectations of

monetary policy, but BOJ lacks credibility.

The mere announcement of an inflation target would not change

expectations”, he said.

Indeed, the introduction of inflation targets among advanced

countries tends to be accompanied by an institutional framework

that makes inflation targeting credible and accountable.

In several countries, including New Zealand and Australia, inflation

targeting is an agreement between the government and the central

bank, and both are committed to policy that is consistent with the

inflation target.

Shaw Capital Management Korea: Fresh Pressure on BOJ for Adopting an Inflation Target. In several countries, including New Zealand and the UK, when

inflation exceeds the target by a wide margin, the Governor is

required to provide an explanation to the parliament. With

accountability and commitment, inflation targeting does become

credible.

A central bank in a deflationary environment

is subject to a time-inconsistency problem: it

cannot credibly commit to “being

irresponsible” and so continue to shoot for

high inflation.

Furthermore, there is a concern that once the Japanese economy

has emerged from a deflationary spiral and starts to recover, the

central bank will be tempted to renege on its commitment to a

high inflation target, because it would like the economy to return

to an inflation rate consistent with price stability.

Thus a central bank in a deflationary environment is subject to a

time-inconsistency problem: it cannot credibly commit to “being

irresponsible” and so continue to shoot for high inflation.

The result of the time-inconsistency problem is that the markets

would not be convinced that inflation would remain high, and

inflation expectations would not be high enough to lower real rates

sufficiently to stimulate the economy out of the deflation trap.

To overcome deflation and restore economic activity Japanese

policymakers may not need to adopt an inflation target.

They could simply use unconventional instruments, such as

purchases of riskier assets and foreign assets, more aggressively

so to persuade the markets and the public that there will be higher

inflation.

Salamat Shaw Capital Management Korea: Portfolio Recommendations

We have made no changes in our portfolios this month.

The latest developments in the government debt

markets have increased the uncertainties about

prospects for both the bond and financial markets.

However, although the pace of the global economic

recovery may be affected, there appears to be enough

momentum to enable it to continue.

We have therefore maintained the level of our exposure

to the equity markets; and we have left 10% of the funds

in the portfolio in cash deposits as a contingency

measure. Bond exposure is zero.

Shaw Capital Management Korea: Portfolio

Recommendations - The UK Hung Parliament

The bond markets are totally calm about the hung

Parliament, as they are about both UK and US bond

prospects, with yields still below 4%, in spite of the

huge deficits both countries are running.

What is going on?

The first point is that both countries are recovering,

and seem set for growth rates in the 2–3% range.

Such growth is not ‘V-shaped’ but a V was unlikely

given the shortage of oil and raw materials, which

continues to limit world recovery potential. It does

give a prospect of improving tax revenues and falling

benefit expenditures.

As growth goes forward it will be possible to work out

more accurately how much of the current deficit is

‘structural’ — i.e. will not disappear with returning

growth.

For the UK the current estimate is that about 8% of

GDP is structural: still requiring a huge programme of

retrenchment.

The second point is that neither the UK nor the US has

ever formally defaulted in modern times.

Indeed for the UK, they can date this from the end of

the Napoleonic Wars when public debt reached around

300% of GDP.

The third point is the new unwillingness to use higher

inflation to bring down the debt in real value. Inflation

(implying an ‘inflation tax’ on government monetary

liabilities which thereby lose their value) is now

proscribed after the poor experiences of developed

countries during the ‘great inflation’ of the 1970s.

Electorates have rejoiced at the new inflation targeting

policies that have formally ended governments’

experiments with this form of taxation.

The electorates hated the messy and unintended

redistributions of wealth this tax implied — often from

the weak such as pensioners to the wealthy and the

unionized.

In this context bond markets have treated Mr. Obama’s

delays and the UK’s election result as simply policy

deferred.

In that they are likely to be right.

Shaw Capital Management Korea: Portfolio

Recommendations - The state of the eurozone

By contrast the situation in the euro-zone looks

increasingly difficult.

The problem is that Greece and Portugal — the two

main current problem cases — joined the euro in the

expectation that low interest rates would keep their

public finances under control.

Internally these countries have difficulty in raising

taxes and curbing expenditure but joining the EU and

then the euro gave them the authority to insist on fiscal

discipline as the ‘price’ of joining.

Now the discipline is becoming harsh and yet interest

rate premia are rising, as the risk of default increases.

Germany and the other euro-zone countries are

unwilling to transfer resources to them — and even to

provide loans on terms below these market rates.

Germany’s position in particular has hardened

massively under hostile home reactions to perceived

‘bail-out’.

Germany is simply unwilling to make transfers after

the huge costs of its integration policies for East

Germany.

There will come a point where the advantages of being

in the euro are outweighed by the disadvantages for a

country like Greece.

Once interest rate premia get high enough inside the

euro, the attraction of floating the currency down

outside it and still paying similar interest rates will

become overwhelming to governments faced with

public hostility to further sacrifice.

A large devaluation is a way of allowing the economy

to recover and produce extra revenue.

Furthermore reintroducing the local currency will

allow the government to re-denominate the debt in

that new sovereign currency … so effecting a de facto

partial default.

These exits would not spell the end of the euro. But

they will remind markets that the euro is bound

together by political convenience only and not by some

deep commitment to European integration.

Up to now there has been a general belief in such a

commitment; however, Germany’s recent actions have

destroyed this belief.

It was this belief that kept interest rate premia down

on sovereign debt of euro-zone countries; rather like

the debt of UK local authorities — formally underwritten

by the UK government, it was felt that these countries’

debt was being implicitly underwritten by other eurozone

members. No longer.

But of course what can happen to Greece could happen

to any other country. If so its risk premia too would

rise and it too would face the same trade-off between

staying in or exiting with the freedom to float at similar

interest rates outside.

Hence the chances of more break-up would get larger

and the system would become gradually closer to a

system of ‘fixed but adjustable’ exchange rates like the

old European Monetary System.