After a series of false dawns, Japan seems capable of introducing reforms to dismantle the antiquated keiretsu system

PUBLISHED : Sunday, 22 October, 2000, 12:00am
UPDATED : Sunday, 22 October, 2000, 12:00am

Japan had a system which worked miracles to revive the economy after World War II. But now it is finally wising up to the fact that the system needs to be torn down, Dean Cashman believes.

The post-war Japanese economy was directed by government planners and dominated by keiretsu - powerful industrial groups operating in diversified businesses centred on a bank. Keiretsu ties were cemented by a complex web of cross shareholdings.

'Japan has a system that functions pretty well for a narrowly defined brief,' said Mr Cashman, who oversees Principal Capital Management's IF Japanese Equity Fund.

'In this case, it was really the rebuilding in the 1950s and 1960s, the direction of scarce resources and paying the workforce on a promise. They had a young workforce and they couldn't afford to pay them a lot so they paid them on a promise of lifetime employment.

'The system clearly ran past its use-by date when you have an economy that matures and goes to a slower structural level of growth. That process that encourages asset accumulation and, ultimately, falling returns on assets just became completely unviable.'

The system of chasing market share and accumulating assets while offering lifetime employment culminated in the bubble years of the 1980s, when stock and real estate prices went through the roof. The bursting of the bubble in 1990 had led to a decade of stagnation with the government and corporate Japan refusing to face up to the reality that no amount of patching up could save the system.

'Japan, the way it seems to function, [is that] when that system goes past its use-by date it takes a long period, in this case a 10-year period, to realise it was a far more fundamental problem. Then you start to get the acceptance that the system needs to change,' said Mr Cashman.

Two recent high-profile bankruptcy cases are good examples of how things are changing and the keiretsu system is breaking down. Department store Sogo was finally cut loose after years of being propped up by the bank in its group.

'Ultimately, it was a case where the Industrial Bank of Japan reneged on their role as the main bank to that company,' said Mr Cashman.

'Traditionally, the main bank would step in and support that company and facilitate the restructuring and swallow extra bad debt from other organisations.

'The fact that the main banks are starting to step away from that role is an indication that the banks are having to change their practices and is a necessary part of the changes in the capital-allocation process in Japan.'

Tokai Bank, meanwhile, refused to support bankrupt insurance giant Chiyoda Life because it was under pressure from merge-partner Sanwa Bank.

The big changes in Japan have made Mr Cashman the most optimistic he has been about the country in the nine years he has covered it, during which time the country's economy has gone nowhere.

Sydney-based Mr Cashman admits this is not the first time he has been excited at the prospect of a resurgence of the once-powerful Japanese economy. But this time it really is different.

'It has been an interesting slog. There has probably been a couple of times in that period where we thought we were seeing the seeds of improvement but then we have really slipped back again, he said. 'I think the difference between then and now is that we were inherently less confident in the long-term outlook because it was more a near-term macroeconomic call. The reason why we are far more confident in a longer-term view now is that we are getting a far stronger and far more consistent message from the companies.'

Foreign investors recognised the upturn last year, pushing the Nikkei 225 Index past 20,000 points. This year it slipped back to below 15,000 as foreign investors sold their Japanese shares and took their money elsewhere after economic worries resurfaced and a boom in technology shares ended.

Mr Cashman's fund was no slouch in last year's rally. It put on 147.12 per cent, according to figures from Principal. The average of 90 SAR-authorised funds investing in Japan was 136.86 per cent, according to Lipper Asia.

But Mr Cashman believes it is a mistake to treat Japan as a hot money play. Investors should be more patient to get their rewards, he said.

'We are prepared to say that 1999 was a typical initial strong momentum year. There have been a lot of doubts this year but we are far more committed to seeing a long-term improvement than we have at any time in the past 10 years,' he said.

'The issue in Japan is to make sure what is going on long term and then to position yourself to take advantage of those significant swings in momentum.'

The basis for Mr Cashman's optimism is not so much a general upturn in the economy but the reform going on at corporate level that has led many firms to upgrade their profit expectations, a bullish sign for the market.

Recurring corporate profit growth of 30 per cent 'is quite achievable this year', Mr Cashman said. Another 20 per cent is on the cards next year.

'If you take that back to three to six months ago, the companies themselves were saying 'maybe we will get 20 per cent this year'. A lot of people in the market at the time were saying 'I don't think that is very realistic'.

'Corporate leadership is clearly there. That is the area of the economy which is improving,' said Mr Cashman. 'The winners are starting to see an improvement in their businesses. That is adding sustainability to the [economic] improvement.'

A recovering Japan is very much worth a bet as markets can be quick to discount improvements once they become apparent.

'If you are waiting for the process where this is all completed and everything is as it should be, well, by the time you can sit here and say that, it is probably all too late,' said Mr Cashman.

Graphic: meet22gwz