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MGM Macro

Global MirageStrategy
Credit Research | United States
Global FX Research | EEMEA FX and Rates

F I X E D I N C O M E R E S E AR C H 1 8 M AR C H 2 0 1 1

SPECIAL EDITION: “10” Things We Didn’t Know - Japan


Contributing Strategists
Anthony Morris Jim McCormick Vasant Naik Olgay Buyukkayali Laurent Bilke Swati Aggarwal Irena Sekulska
+44 (0) 20 710 29215 +44 (0) 20 710 26182 +44 (0) 20 710 22813 +44 (0) 20 710 23242 +44 (0) 20 710 30022 +44 (0) 20 710 20583 +44 (0) 20 710 31453
Anthony.morris@nomura.com Jim.mccormick@nomura.com Vasant.naik@nomura.com Olgay.buyukkayali@nomura.com laurent.bilke@nomura.com Swati.aggarwal@nomura.com Irena.sekulska@nomura.com
This report can be accessed electronically via: www.nomura.com/research or on Bloomberg (NOMR)

Topic de jour: Japan – building a more balanced perspective


Today the macro strategy team has commandeered the “10 Things” publication to look at many of the common
misperceptions about Japan and its current crisis. We start with a study of Japan’s persistent external surpluses and its
accumulated wealth. We then look at a few broad comparisons between conditions around the 1995 Kobe earthquake and
how Japan stacks up to these comparisons today. From a business cycle perspective, we highlight that before last week’s
devastating earthquake, Japan’s real wage growth had reached a multi-year high, while orders from overseas customers had
nearly returned to pre-financial-crisis peaks. We look at some stock market metrics – our equity strategy team sees real value
in Japanese stocks. We also remind you of the unique structure of holdings of Japanese financial assets – more than 90% of
JGBs are domestically held and foreigners flows to the Nikkei have been very light in recent years. We note that fears of
major asset repatriation flows are overdone in our view, a point made compellingly by our FX strategy team (see JPY Insights
- Toshin flow: Outflow to slow, but repatriation is rare & FX Insights - Yen intervention is likely to be imminent). Finally, we
remind ourselves Japan is one of the most innovative countries on earth – at least judging by patent density levels.

Nomura’s Macro Strategy Team

Nomura International plc.

See Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures
Nomura | EEMEA Strategy Daily 18 March 2011

1) Did you know that Japan's current account surplus has averaged $125 billion per annum in recent years?
Despite all the talk about its decline and malaise since 1990, Japan has continued to run current account surpluses with the
rest of the world. Japan has averaged USD 125 billion in annual current account surplus, without a single negative year.

Figure 1. Japan current account surplus

250

200

150
bn USD

100

50

0
1990 1995 2000 2005 2010

Source: Nomura, IMF WEO October 2010

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Nomura | EEMEA Strategy Daily 18 March 2011

2) Did you know that Japan’s trade sector is outperforming US and EU in Asia ex Japan?
Japan's economic competitiveness is especially visible in its trade with the rest of Asia. While the US and EU run current
account deficits with this region, Japan runs a sizeable surplus. Not what you would expect from an economy supposedly in
decline.
Figure 2. Current account balance with Asia ex Japan: Japan, EU, and US

150

100

50

-50
bn USD

-100

-150

-200

-250

-300

-350
Japan EU US

Source: Nomura, Bloomberg, US Census Bureau, EC


Note: EU data is only available for the first 3 quarter of 2010 (except Indonesia -first 2 quarters) which has then been annualised. National currencies have been converted to USD at average market
exchange rate

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Nomura | EEMEA Strategy Daily 18 March 2011

3) Did you know that Japan is still the top global creditor, for the 19th year in a row?
Many assume official FX reserves best reflect an economy's international prowess. By that standard China seems to have
surpassed Japan. But considering the private sector in addition to the public sector, Japan is still way ahead of China.

Figure 3. Foreign assets position and official reserves – Japan vs China

7.0

6.0

Japan China
5.0
trillion USD

4.0

3.0

2.0

1.0

0.0
Of f icial reserves Total f oreign assets Net f oreign assets

Source: Nomura, Bloomberg, MoF – Japan, SAFE- China,


Note: Net foreign assets are the difference between external assets and liabilities of the country (both public and private). External assets would typically include official reserves and other assets.
Dollar values are as reported by respective authorities.

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Nomura | EEMEA Strategy Daily 18 March 2011

4) Did you know that Japan net public sector debt is much lower than gross public sector debt?
It is common to hear talk of Japan's "200%+ debt/GDP ratio" as if Japan will closely follow Greece and Ireland in the path to
insolvency. This belief has multiple deficiencies, but the first is that Japan's net public sector debt is about half of gross debt.

Figure 4. Japan gross and net government debt

250%

200%

150%
% of GDP

100%

50%

0%
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Net debt Gross debt


Source: Nomura, IMF WEO October 2010
Note:. Net government debt is defined as gross debt minus financial assets corresponding to debt instruments. These financial assets are: monetary gold and SDRs, currency and deposits, debt
securities, loans, insurance, pension, and standardized guarantee schemes, and other accounts receivables.

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Nomura | EEMEA Strategy Daily 18 March 2011

5) Did you know that Net public sector debt is only about 25% of private net worth?
Another aspect of Japan's wealth is the net worth of its private sector, which we estimate at about USD 23 trillion as of end
2009. Net public debt is about 25% of private net worth. Japan does not have a "debt problem", but the Japanese government
does. This is a big difference.
Figure 5. Japan’s net government debt and private sector net worth

25

20

15
trillion USD

10

0
GDP Net government debt Private sector net worth

Source: Nomura, IMF WEO October 2010, Economic and Social Research Institute, Japan
Note:. All data refers to 2009 and has been converted at the average USD JPY exchange rate for the year. Private Sector net worth refers to the net worth of households and not-for-profit
institutions. Net government debt is defined as gross debt minus financial assets corresponding to debt instruments. These financial assets are: monetary gold and SDRs, currency and deposits,
debt securities, loans, insurance, pension, and standardized guarantee schemes, and other accounts receivables.

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Nomura | EEMEA Strategy Daily 18 March 2011

6) Did you know that Nikkei is down 73% but Japanese financial assets up 44% in JPY and 112% in USD?
Many assume that Japan's private sector must have been wiped out because the Nikkei equity index is down almost 75%
since the bubble peak. The reality is far different, as private financial assets (ignoring non-financial assets) have increased
44% in JPY terms and 112% in USD terms. The Japanese are not just equity investors. Cash, bonds and FX carry trades
feature prominently in many private portfolios and have worked well.

Figure 6. NIKKEI, private financial assets and private non-financial assets JPY-Terms USD Terms

45000 1800 18

40000 1600 16
44 %
112 %
35000 1400 14

Pvt. non-financial assets (trillion USD)


73%
Pvt. financial assets ( trillion Yen)
30000 1200 12

25000 1000 10
Nikkei Index

20000 800 8

15000 600 6

400 4
10000

200 2
5000

0 0
0
1980 1984 1988 1992 1996 2000 2004 2008 1980 1984 1988 1992 1996 2000 2004 2008
1980 1984 1988 1992 1996 2000 2004 2008

Source: Nomura, Bloomberg, Economic and Social Research Institute, Japan


Note:. All data has been converted at the average USD JPY exchange rate for the year. Private Sector financial assets refers to the financial assets of households and not-for-profit institutions.

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Nomura | EEMEA Strategy Daily 18 March 2011

7) Did you know that Japanese non-financial assets (e.g. property) are down 41% in JPY but down only 14% in
USD terms?
Many hear about the decline in Japan's real estate prices and assume Japan's private sector suffered. This is closer to the
truth, as non-financial assets are down 41% in JPY terms since 1989. But in USD terms, this loss is just 14%.

Figure 7. Japanese Non-Financial Assets (e.g. property) in JPY and USD

2000 18

-41 %
1800 -14 %
16

1600
14
Pvt. non-financial assets (trillion Yen)

1400
12

1200
10
1000

8
800

6
600

4
400

200 2

0 0
1980 1984 1988 1992 1996 2000 2004 2008 1980 1984 1988 1992 1996 2000 2004 2008

Source: Nomura, Bloomberg, Economic and Social Research Institute, Japan


Note:. All data has been converted at the average USD JPY exchange rate for the year. Private Sector non financial assets refers to the non financial assets of households and not-for-profit
institutions.

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Nomura | EEMEA Strategy Daily 18 March 2011

8) Did you know that Japanese households hold a majority of their wealth in financial assets?
Private net worth in Japan is relatively liquid, mainly in financial assets. Non-financial assets are only 40%

Figure 8. Japanese households’s financial and non-financial assets

Non financial assets, 40%

Financial assets , 60%

Source: Nomura, Bloomberg, Economic and Social Research Institute, Japan


Note:. All data refers to 2009 and has been converted at the average USD JPY exchange rate for the year. Private Sector assets refers to the assets of households and not-for-profit institutions

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Nomura | EEMEA Strategy Daily 18 March 2011

9) Did you know that Japanese growth looks low according to total GDP, but Japan's GDP growth per capita is in
line?
It is common to use total GDP growth as a proxy for economic dynamism, leading to assumptions that the US economy is the
most dynamic of the major countries. But the US has also had high population growth. We believe GDP growth per capita is a
better reflection of real growth. On this basis, the US is not as impressive and Japan is pretty much in line, slightly ahead of
Switzerland.
Figure 9. GDP growth and per-capita GDP growth

3.0% 3.0%

2.5% 2.5%

Per-capita GDP growth (1989-2009)


2.0% 2.0%
GDP growth (1989-2009)

1.5% 1.5%

1.0% 1.0%

0.5% 0.5%

0.0% 0.0%
United Canada United Germany Switzerland Japan United United Germany Canada Japan Switzerland
States Kingdom Kingdom States

Source: Nomura

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Nomura | EEMEA Strategy Daily 18 March 2011

10) Did you know that Japan's ratio of tax revenue to GDP is among the lowest in the G10?
Many forget that Japan's tax revenues are relatively low as a portion of GDP, about the same as that of the US, but lower than
the UK, Germany or Sweden. Its capacity to increase taxes eventually seems ample.

Figure 10. Japanese tax revenue as proportion of GDP

50%

45%

40%
Tax revenue (as a % of GDP)

35%

30%

25%

20%

15%

10%

5%

0%
Sweden Italy Belgium France Netherlands Germany UK Canada Japan US

Source: Nomura, OECD


Note: All figures are for 2009 except Japan and Netherlands for whome latest figures available are for 2008

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Nomura | EEMEA Strategy Daily 18 March 2011

11) Did you know that USD/JPY is not a very good measure of yen valuation today?
Using nominal USD/JPY levels as a comparison for 1995 is a stretch from a valuation perspective. Back then, both
USD/JPY and the yen’s real effective FX rate were at extremes. Today, the yen’s real effective FX rate is near its long-
run average and more than 30% below 1995 levels.
Figure 11. Real trade-weighted JPY vs USD/JPY

BIS real ef f ective exchange rate USD/JPY, inverted

160 JPY Real Ef f ective Exchange Rate 50


20-year average real ef f ective exchange rate
150
USD/JPY (rhs, inverted) 70

140
90

130

110
120

130
110

100 150

90
170

80
190

70
'90 '92 '94 '96 '98 '00 '02 '04 '06 '08

Source: Nomura, BIS, Bloomberg

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Nomura | EEMEA Strategy Daily 18 March 2011

12) Did you know that relative policy between the US and Japan is very different than in 1995?
In 1995, the fundamental case for a strong, co-ordinated intervention to strengthen the US dollar (rather than
weaken the yen) was compelling. US monetary policy had been tightened significantly starting in early 1994, yet
USD/JPY kept falling. Today, the policy gap is growing, but small. That said, actual cycle differentials (RHS) are at
reasonably elevated levels (meaning the US cycle has been outperforming Japan lately).
Figure 12. USD/JPY vs 5y US-Japan rate differential Figure 13. USD/JPY vs US-Japan business sentiment indicators (spread)

Spread
% USD/JPY
160 7.00 40
USDJPY 5y US-JN rate dif f erential (rhs)
190 USDJPY
150
6.00 Spread between US PMI and Japan Small Business Sentiment Indicator (rhs)
30
170
140

5.00
130 150 20

4.00
120
130
10

110
3.00
110

100 0

2.00 90

90
-10
1.00 70
80

50 -20
70 0.00
'87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11
'91 '94 '97 '00 '03 '06 '09

Source: Nomura, Bloomberg Source: Nomura, Bloomberg

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Nomura | EEMEA Strategy Daily 18 March 2011

13) Did you know that Japan wage growth has recently turned positive?

Weak nominal wage growth has been a defining characteristic of deflation. An improvement in 2006 was
interrupted by the crisis but, since the beginning of 2010, both nominal and real wage growth have turned
positive in y-o-y terms, for the first time since then.

Figure 14. Real trade-weighted JPY vs USD/JPY

y-o-y
10.0

8.0

Nominal Wage Growth Real Wage Growth


6.0

4.0

2.0

0.0

-2.0

-4.0

-6.0
Q1 1990 Q1 1992 Q1 1994 Q1 1996 Q1 1998 Q1 2000 Q1 2002 Q1 2004 Q1 2006 Q1 2008

Source: Nomura, Japan Cabinet Office

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Nomura | EEMEA Strategy Daily 18 March 2011

14) Did you know that BOJ could do much more to help end deflation?
The BOJ has not played its trump card in fighting deflation: expansion of its balance sheet (or QE). If there began to be a
“buyer’s strike” in the JGB market, the BOJ would start buying JGBs in size in our view. If it expanded its balance sheet
roughly in the way that the Fed has (buying treasuries financed by creating excess reserves), the BOJ could go out and buy
about ¥250trn of JGBs tomorrow. And the BOJ, not the Fed, is the central bank with the deflation problem, so if “printing
money” were to cause inflation, that would be solving Japan’s biggest macro problem. If it doesn’t, it is a free lunch.
Figure 15. US vs Japan – GDP deflator Figure 13. US vs Japan – central bank balance sheet

Index (Q1 2006=100)


Index (Q1 2006=100)
400.0
110.0
Fed
BOJ
350.0 QE2 Forecast

105.0
300.0

250.0
100.0

200.0

95.0 150.0

100.0
US GDP def lator
90.0 Japan GDP def lator
50.0

0.0
85.0
Jun-06 Mar-07 Dec-07 Sep-08 Jun-09 Mar-10 Dec-10
Mar-06 Dec-06 Sep-07 Jun-08 Mar-09 Dec-09 Sep-10
Source: Nomura, Japanese Cabinet Office; US Bureau of Economic Analysis; Bank of Japan; Source: Nomura, Japanese Cabinet Office; US Bureau of Economic Analysis; Bank of Japan;
Federal Reserve; Nomura Securities Federal Reserve; Nomura Securities

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Nomura | EEMEA Strategy Daily 18 March 2011

15) Did you know that Japanese households have rarely repatriated Toshin holdings?
Investment trusts (Toshins) have consistently been net purchasers of foreign currency assets since April 2002, turning
net sellers in only seven of the 107 months during that period (7% of the time). In fact, outflows declined and only
briefly turned negative after large risk-off events such as 9/11, the sub-prime shock of August 2007 and the collapse of
Lehman Brothers in September 2008 (see Toshin flow: Outflow to slow, but repatriation is rare)
Figure 16. Toshin flow and major risk-off events

(USD billion)
Lehman shock
-10
LTCM Paribas shock (Sep '08)
(Aug '98) (Aug '08)
Asian crisis
-8 9.11
(Jul '97)
(Sep '01)

-6

-4

-2

6 Bonds

Equities
8
Greece crisis
total (May ' 10)
10
'96/4

'97/4

'98/4

'99/4

'00/4

'01/4

'02/4

'03/4

'04/4

'05/4

'06/4

'07/4

'08/4

'09/4

'10/4
Source: MOF, Nomura.

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Nomura | EEMEA Strategy Daily 18 March 2011

16) Did you know that less than 10% of Japanese government debt is held by foreign investors?
While the level of government debt to GDP is an important barometer of fiscal health, it is clearly an incomplete one.
Here, we consider the distribution of government debt between foreign and domestic holders. On this metric, Japan
has the lowest share of external ownership (less than 10%) and appears well insulated from a “run” on the government
debt by foreign investors.
Figure 17. Share of government debt held by foreign investors

% of total government debt held abroad

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
JPY CHF KRW CAD GBP CZK EUR SLK USD PLN BUL SPA ITA NOK GER HUF LVL EST NED FRA POR GRE BEL IRE LTL FIN AUS

Source: The World Bank, IMF

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Nomura | EEMEA Strategy Daily 18 March 2011

17) Did you know that Japanese companies have been coping with the strength of the Yen?
Japanese non-financial companies are now generating significantly higher levels of Free Cash Flow (relative to equity)
than their peers in the rest of the world. Furthermore, prior to the current crisis, and despite the strength of the Yen,
earnings revisions for Japanese companies were amongst the best in the world. The outperformance in terms of
revisions, and key macro data, relative to their key competitors, suggests that Japanese companies have been coping
with the strength of the Yen.
Figure 18. Japanese and World ex-Japan non-financial companies’ free cash flow yields Figure 19. Japanese Earnings Revisions

Net earnings revisions %, (up -down) / total


12
20
10 FW Japan - FCF Yield

10
8 FW World Ex Japan - FCF Yield

6 0

4
-10

2
-20

0 Japanese Earnings Revisions


-30
-2

-40
-4

-6 -50

-8
-60
'88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10
Source: Worldscope, Nomura Equity Strategy research Source: IBES, Nomura Equity Strategy research

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Nomura | EEMEA Strategy Daily 18 March 2011

18) Did you know that foreign investor shares in Nikkei are going up?
....but equity inflows to Japan are very small as proportion of GDP.

Figure 20. Proportion of Japan Equity Market Value held by Foreigners Figure 21. Net equity inflow to Japan as % of GDP

% 3.0% Net Equity Flow to Japan Equity Market f rom Foreigners % GDP
% of Japan Equity Market Value (Listed) held by Foreigners
30 Nikkei Index (rhs)

33000

25 2.0%

28000

20
1.0%

23000
15

0.0%

18000
10

-1.0%
13000
5

-2.0%
0 8000
1996 1998 2000 2002 2004 2006 2008 2010
1985 1988 1991 1994 1997 2000 2003 2006 2009

Source: Nomura, Bloomberg, EMED Source: Nomura, EMED

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Nomura | EEMEA Strategy Daily 18 March 2011

19) Did you know that Japan is 2nd in the world in patents adjusted for the size of the economy?
...only South Korea has a higher patent density and the gap between the next eight worldwide is significant – US
patent density is ¼ of Japan’s. On the flip side, parts of periphery Europe – Greece and Spain, for instance – score
among the worst.
Figure 22. resident patent appilcations per $billion of GDP

2008 figures; resident patent appilcations per $billion of GDP

120

100
Top 10 Bottom 5

80

60

40

20

0
Korea Japan China Germany USA Belarus Russia Armenia New Georgia Czech Spain Greece Turkey Chile
Zealand Republic

Source: World Intellectual Property Organization

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Nomura | EEMEA Strategy Daily 18 March 2011

20) Did you know that some estimate that 94% of Tokyo women in their 20s have a Louis Vuitton handbag?
... On a somewhat lighter note, Japan is the largest consumer of luxury goods on a per capita basis. We proxy this
demand with 2010 revenue figures from LVMH’s fashion and leather goods division (which includes the Louis Vuitton
brand), adjusted by population.
Figure 23. Population adjusted revenue for LVMH

%
10
Population adjusted measure of luxury good consumption

0
Japan France US Europe ex France Asia

Source: LVMH 2010 annual report

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Nomura | EEMEA Strategy Daily 18 March 2011

Disclosure Appendix A1
ANALYST CERTIFICATIONS
We, Anthony Morris, Jim McCormick, Vasant Naik, Olgay Buyukkayali, Laurent Bilke, Swati Aggarwal and Irena Sekulska, hereby certify (1) that the views expressed in this report accurately reflect my
personal views about any or all of the subject securities or issuers referred to in this report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific
recommendations or views expressed in this report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc.,
Nomura International plc or any other Nomura Group company.
Online availability of research and additional conflict-of-interest disclosures:
Nomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG and THOMSON ONE ANALYTICS. For clients in Europe, Japan and
elsewhere in Asia it is available on NOMURA.COM, REUTERS and BLOOMBERG.
Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page http://www.nomura.com/research or requested from Nomura Securities International, Inc., on 1-
877-865-5752. If you have any difficulties with the website, please email researchportal@nomura.co.uk for technical assistance.The analysts responsible for preparing this report have received
compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities.
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Nomura | EEMEA Strategy Daily 18 March 2011

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