Q&A Session

 

Q) Some people think that a super cycle has started in the semiconductor industry. The overwhelming consensus view is that memory demand will increase rapidly. What is your outlook for growth of the memory sector? Also, what is your outlook for industries associated with semiconductors?

 

A) Minamikawa: Many years ago, this was called the silicon cycle. The semiconductor market used to grow slowly while going up and down about every four years. This pattern continued for more than 20 years. Companies made big investments when times were good, but this upset the supply-demand balance by adding too much production capacity. Semiconductor prices plunged by 50% in only one year and memory device prices plummeted by two-thirds.

 

The super cycle is somewhat different. There are no longer periods of ups and downs. Instead, the semiconductor market advances to the next stage in a single leap and then continues to climb. But there are doubts about whether this will actually happen. This super cycle is based on the premise that the growth of the IoT will require an increasing volume of data collection and analysis. However, even if servers and storage grow to meet the IoT’s big data collection and analysis requirements, the estimate for semiconductor memory bit growth is 50% to 70%. This is below the growth rate of about 80% at the semiconductor industry’s peak years ago. Therefore, although this market will continue to grow, saying that the market will advance to a new dimension called the super cycle is going too far.

 

Progress with memory device technologies will continue. But advances will involve data compression rather than higher storage capacities. There will no longer be any need to store everything, such as personal computer data, pictures and videos. In other words, memory capacity will not be important as we previously thought it was. Despite the explosive growth in the volume of data sent using telecommunication lines, as shown in Figure 6, only about 20% to 25% of this information must be stored. The best example is YouTube. Even when a video is played by millions of people simultaneously, the original file needs to be stored only once. The critical point here is that storage is not linked to the volume of data that is distributed. Furthermore, data that is not used very often does not raise semiconductor demand because this type of information can be kept on hard disks and tape.

 

Musha: Even so, there has been an enormous volume of orders from China recently. I would like to hear what Mr. Wakabayashi, an analyst at Mito Securities, thinks about this.

 

Wakabayashi: Manufacturers of liquid crystal displays and semiconductor manufacturing equipment are the primary beneficiaries of high-tech investments in China. Companies in these sectors are reporting record-high orders and sales. Somewhat unexpectedly, Hitachi, Sony and parts companies like Alps and Nitto have raised their fiscal year forecasts when they reported their first half performance. Structural reforms are one reason. But I have the impression that orders from China are making a big contribution too.

 

Musha: Mr. Minamikawa, you said that there will be no change in the semiconductor memory demand cycle from a long-term perspective. But from a short-term standpoint, doesn’t the strong growth in semiconductor demand pose a risk? After all, it is often said that a deep valley often follows a tall mountain.

 

Minamikawa: Demand is definitely too strong right now. Over the past few years, smartphone memory capacity has increased every time a new model was launched. In addition, server solid state drives and semiconductor storage disks are replacing hard disks. All these events have occurred at once, causing demand to skyrocket. Investments at Yangtze River Storage (formerly XMC) and other Chinese companies are higher than ever. Developing the semiconductor industry is a goal of the Chinese government. Consequently, it’s just a matter of time until the supply-demand balance collapses. So I expect to see a very deep valley three or four years from now.

 

Q) Japanese companies are highly skilled in the use of precision processes, the combination of digital and analog circuitry, and other techniques needed to make sensors and other components. I think this superiority will be a valuable strength in today’s age of the IoT and mobility. However, this market leadership does not extend to upstream domains, namely the systems, platforms (like Google and Amazon) and business models (like Germany’s Industry 4.0 vision) that will use these sensors and other components. Isn’t Japan a loser in terms of its overall capabilities with respect to capital, withstanding competition from China and other factors? How can Japanese companies leverage their strengths to extend their operations to more business domains?

 

A) Minamikawa: US platformers account for most of the world’s 10 largest companies in terms of market capitalization. Platformers and application makers are generating a massive amount of profits. At the same time, earnings are low at hard disk manufacturers. But the playing field for hardware is about to change. Until now, manufacturers of products like televisions, personal computers and smartphones have been competing by making the same types of products. Prices and earnings fell as a result. In the age of the IoT, companies will no longer make personal computers and other products that are all about the same. Companies will have to produce many types of products in small quantities. For example, there will be a need for various types of sensors for temperature, pressure, acceleration, angles, humidity, numerous other applications and their combinations. I think we will return to an age where companies can make money by manufacturing hardware. But afterward we will come back to an environment that prevents hardware companies from earning profits. Even though these companies will continue making numerous items in small numbers, there will be integration similar to what has taken place with smartphone functions. But this environment is unlikely to emerge until 10 to 15 years from now. I think Japanese companies will create innovative products that no country can match, such as by combining electronic components or putting actuators and motors together.

 

Musha: What do you think are the strengths of Japanese industry on a global scale?

 

Wakabayashi: Semiconductors will obviously be critical to the IoT and smart cities, which are concepts that include self-driving vehicles. The IoT and smart cities will require the backing of numerous industries and companies. In addition to the electronics industry, the resources of automakers, companies like Fujitsu and NTT Data that operate systems, and many others will be needed. Although Japan was unable to produce companies like Google and Amazon, the country has maintained an extremely diverse industrial infrastructure since long ago. I believe that Japan can be highly successful once again if the right actions are taken.

 

Musha: I think Japan is the only country in the world with expertise in all semiconductor technology categories, including base, peripheral and digital. This creates opportunities for outstanding synergies among manufacturers. Devising solutions that can satisfy customers calls for more than a single technology. Solutions will require the ability to integrate and refine a variety of technologies.

 

Minamikawa: You are right. However, Japanese companies are unable to make progress with this collaboration because of all sorts of problems concerning companies’ cultures and how they are managed.

 

Musha: Japan has a huge volume of technologies, but Japanese companies are all functioning as sub-contractors of leading finished product manufacturers. Nevertheless, Japanese companies have ties with a diverse array of end users. This gives these companies the advantage of directly obtaining information about the needs of these users. I believe this is what gives Japanese companies a competitive edge. Customers’ wishes tell companies what technologies must be developed. Companies know where to look for breakthroughs. Companies like Samsung, Apple, Huawei and Lenovo think only internally. In contrast, manufacturers in Japan that supply products to these companies are using communication lines with a multitude of customers to acquire insights about needs that even end users themselves are not aware of. Due to this position within the international division of labor, I think Japan has a big advantage concerning the discovery and development of new technologies.

 

Q) Artificial intelligence is likely to alter how programming and system engineering work is done. Do you think AI will end the shortage of system engineers?

 

A) Minamikawa: I think that eventually AI will be able to perform every programming task. Today’s programmers understand the types of processing that will be performed when certain orders are given. Then they rewrite programs while using the trial-and-error process. But AI will be able to write programs that cover even issues that cannot be foreseen. A long time will be needed until all processors have AI chips. Development expenses are high. Furthermore, semiconductor technology has not yet reached the point where processing can match the human brain. Also, existing technologies concerning materials, production equipment and other items involving semiconductors have not advanced to the stage needed for this of AI.

 

Q) How much longer do you think this period of economic growth in Japan, the United States and around the world can continue? What is your outlook for Japan’s economy after the 2020 Olympics? Also, please explain your view of problems involving the Chinese economy and government.

 

A) Musha: I believe the economy will remain healthy for the time being. In Japan, there may be a small downturn after the Olympics, but there is no need to worry about this. China is the key to the economic outlook. I think China is moving closer and closer to a serious crisis at some point in the future. Consumption accounts for just under 40% of China’s GDP. As a result, China relies on investments for about 60% of its GDP growth. If economic growth stops in China, there will immediately be an enormous bad debt problem. The bursting of the country’s asset bubble would spark a financial crisis. I think this would be followed by a currency crisis.

 

To avoid this crisis, it is imperative that China sustain its economic growth. This is why the country must keep making investments. Unfortunately, China has large surpluses in all major categories of investments: public works, housing, infrastructure and capital expenditures. At this point, it is difficult to find places to make investments. According to some estimates, China has consumed as much cement during the past three years as the United States did during the past 100 years.

 

For a country like China that must keep growing, high-tech investments have two big advantages. Making these investments creates demand for more investments and puts China in a better position to capture market share in the world’s most advanced high-tech market sectors. High-tech is a typical increasing-returns industry because the players who continue making investments until the very end will win. More investments have the potential of lowering expenses due to greater economies of scale. This allows companies to sell products at highly competitive prices.

 

In China, government-owned companies have virtually unlimited supply of capital. An inexhaustible flow of money gives these companies a significant advantage in the high-tech industry, where returns generally increase in tandem with investments. From a short-term standpoint, China’s massive high-tech investments are good news for the global economy. But China may use these investments to steadily boost its high-tech market share, just as it did in the steel industry. Therefore, I think that increasingly fierce price competition from Chinese companies may cause serious problems for high-tech companies in other countries.

 

Q) When do you expect global economic growth to stop? Chisako Hardie, who manages an AXA Investment Management Japanese equity fund in Edinburgh, is here today. Would you please tell us what overseas investors foresee?

 

A) Hardie: I have been a fund manager for Japanese equities for about 20 years. Until about five years ago, I could not interest anyone in Japanese stocks. I have had a positive stance about Japanese stocks since seven or eight years ago because of the dramatic shift in the mentality of companies in Japan. I have an opportunity to talk with Japanese executives almost every day. In the past, these executives talked about reductions in the prices of their products and other topics involving price competition. But at one point, the number of executives in every industry who talked instead about differentiation started to increase. Some people said that they would stop making even profitable products when differentiation was not possible.

 

Improving productivity is another theme that I have heard frequently during the past two or three years. I think the reason is the same in every business sector – technological progress. Japanese companies are very well positioned. My fund invests primarily in small companies with the goal of achieving long-term growth. One point I learned today is that even companies that already have high market capitalizations have the potential to become two or even three times larger. Many investors in Europe are still not aware of the big change that has taken place at Japanese companies. Simply looking at macro numbers from the top down leaves lots of important points still unanswered. The general perception is that Japan is nearing 30 “lost years” after the end of the bubble economy and that now the country has at last changed in a small way. People are surprised when I tell them that a large number of Japanese companies are reporting record earnings. I started extensive sales activities four years ago. The volume of money added to my fund during the past two years has been remarkable. I think prospects for Japan are still excellent. Some investors expect Japan to reach a peak in 2018. However, overseas investors have only now started to turn their attention to Japanese stocks, so I think they will continue to buy these stocks.

 

Q) We have heard about the superiority of Japan’s electronic components industry. But Japan seems to have fallen behind in the more critical field of AI. A joint venture of Tokyo University and a few companies may be the AI leader in Japan. How does Japan rank globally in the AI sector?

 

A) Minamikawa: In the AI field, whether looking at the country or its companies, Japan has AI investments that are only 1% of the level in the United States. Only a dramatic breakthrough or other innovative idea could enable Japan to establish a prominent position in the AI sector. But I think Japan has a good opportunity involving the use of AI chips. Japanese companies may produce electronic components, motors and semiconductors incorporating these chips or supply materials needed to fabricate these items. AI itself is not the only element of the AI business.

 

Q) There has been a lot of talk lately about quantum computing. When do you think this concept will be commercialized? Where does Japan stand in the world regarding quantum computing technology?

 

A) Minamikawa: I think quantum computing will become a field that competes with AI chips. Quantum computing is already in use and Japan has a fairly good position in this field. Japan’s resources and capital in the quantum computing field compare favorably with those of overseas research institutions, companies and governments. Quantum computing products are already on the market but I think they will not become widely available for about another five years. Quantum computing may compete directly with AI from the United States to determine a winner.

 

Q) Japan’s steadily increasing monetary base is almost ¥500 trillion. Japanese government has ¥1,000 trillion of total debt including national and other public-sector bonds. This is more than that of the US Federal Reserve Bank. How can Japan reduce this enormous number? Personally, I think there is no problem because of the Japan’s massive volume of wealth and assets.

 

A) Musha: Debt of the national government are only part of Japan’s total liabilities. On the other hand, households and companies have a gigantic amount of surplus savings. After combining everything, Japan ends up with a surplus of assets. In fact, with net external assets of $3.2 trillion, Japan has the world’s strongest external balance sheet (external assets and liabilities). This is almost twice as much as China’s net external assets. This is why I think it is largely pointless to say that Japan has a debt problem by looking only at public-sector debt. Liabilities are always accompanied by assets. A problem exists when liabilities are more than assets.

 

Japan’s net liabilities include expressways and other tangible assets such as Japanese government foreign currency-denominated bonds that underpin the country’s foreign exchange reserves of more than $1 trillion. According to the Ministry of Finance, these total assets are approximately ¥670 trillion. The Japanese government is rich in terms of tangible assets. Deducting assets of ¥670 trillion from the government’s debt of ¥1,200 trillion results in net liabilities of ¥520 trillion. This is less than half of the official figure for total government debt.

 

Furthermore, although Japan’s total liabilities are 2.23 times higher than GDP, the country’s net liabilities are only 97% of GDP. This is not extremely high because the net liabilities of the United States and many European countries are generally between 80% and 90% of GDP. Japan’s government bonds have the lowest yield in the world. This can be interpreted as a sign that financial markets view the Japanese government bonds as the safest to invest in the world. Greece is the world’s most indebted country and its government bonds have the highest yield. The ability of the Japanese government to borrow money at low interest rates therefore demonstrates that, although the government has debt, the country is financially sound after combining this debt with the huge surplus savings in the private sector.

 

The Bank of Japan has dramatically expanded its assets (by issuing more money) and the bank has used these funds to buy Japanese national bonds totaling more than ¥400 trillion. This has raised concerns about how the BOJ plans to shed these assets. One view is that government bonds held by the bank should not be regarded as government debt because the BOJ is part of the Japanese government. If we accept this argument, then the government’s actual debt falls to ¥120 trillion, the result of deducting the BOJ’s ¥400 trillion of government bonds from the total net government debt of ¥520 trillion. This figure can be used to say that there is no reason at all to worry about the Japanese government’s debt.

 

Assets of the BOJ can be used to offset government liabilities. After all, the BOJ has the authority to procure funds at no cost by issuing money. That means the BOJ can fund government debt by issuing money that has no repayment obligation. There is no problem with this thinking in theory. But there is a danger of hyperinflation as the BOJ prints vast quantities of currency. This would cause Japan’s productivity to fall and reduce the ability to create private-sector income. Ultimately, Japan’s economy could collapse.

 

The decision about financing government debt is a private-sector issue that depends on whether or not the private sector is able to create value. Japan’s private sector is generating value and becoming even stronger. Therefore, Japanese currency will not lose its value due to its ability to produce value. Mongolia was the first country in the world to issue non-convertible currency. People lost confidence in this currency immediately prior to Mongolia’s collapse. Consequently, the loss of a currency’s value means that the country issuing that currency can no longer create value. Printing more money to finance government debt is regarded as harmful because it leads to hyperinflation. More money definitely lowers a currency’s value. But a weaker currency immediately produces a dramatic drop in government debt. This is why there is no sound basis for any worries about Japan’s government debt and the large volume of BOJ assets.

 

Q) Japan’s GDP was lackluster because of sluggish internal demand for many years. Isn’t there a danger that as the electronics industry advances to the next stage, rising demand will cause only exports to climb and Japan’s internal demand will remain generally flat forever? In the past, consumer demand has increased. But the IoT will be used in infrastructure applications. So conventional measures to create demand will be ineffective and so will tax cuts. I think raising the income distribution ratio will not succeed either. Raising government spending would be difficult, too. This situation appears to indicate that companies and overseas operations will prosper while Japan itself becomes poorer as the country declines in terms of people and goods. Do you agree?

 

A) Musha: Japan’s stock market capitalization is more than ¥600 trillion. I think this is half of the fair value of Japanese stocks. For instance, the PBR of Japanese stocks is below two compared with three in the United States. If Japan’s PBR rises to this level, stock prices would double. This should not surprise anyone. If Japan’s stock market capitalization doubles to more than ¥1,200 trillion, stock assets per capita would double from about ¥5 million to more than ¥10 million. Growth of ¥5 million in household net assets would dramatically alter the perspective of people.

 

One of the key characteristics of the collapse of Japan’s asset bubble was that stock prices fell twice as much as would normally be expected. The bubble’s demise should have cut the Nikkei Average in half. But this index instead plummeted by 75%. This excessive drop made people want to avoid risk even though there was no need to do so. Companies were forced to take unnecessary steps to deal with bad debt and record unnecessary losses. Companies cut jobs and held down wages more than was needed. Declining wages created an unnecessary negative cycle as the public’s deflation expectations and acceptance grew. I think this environment had a particularly severe impact on the mindset of the people of Japan from 2000 to ten years after the global financial crisis. I expect to see an enormous change when this situation has been entirely reversed.

 

Government demand creation and other initiatives are definitely important. But Japan will also benefit from the end of this negative cycle, which exists only in Japan, and switch to a virtuous cycle. The mindset of the public would change significantly if the Nikkei Average climbs to ¥40,000. The abnormal strength of the yen and abnormal drop in asset prices created unnecessary pain for the people of Japan. I think this is what has hurt the Japanese economy.

 

Q) Can fiscal policies change Japan? Shouldn’t Japan be thinking about frameworks for funds that can stimulate demand and other measures? But consumer demand is increasing now.

 

A) Musha: Economic cogwheels function when the emergence of a virtuous cycle triggers a variety of chain reactions. Until now, Japan has experienced a negative cycle chain reaction. Now I think a positive cycle chain reaction is beginning. The seminar materials include a graph showing the relationship between Japan’s nominal GDP growth rate and the 10-year government bond yield. Between 1991 and 2011, the bond yield was well above the nominal GDP growth rate. This signifies that the cost incurred by risk-takers was always higher than the corresponding returns. This environment justifies the avoidance of risk. A complete reversal occurred during the five-year period that began in 2012 and investors were rewarded for taking on risk. Investors who bought stocks in 2012 when the Nikkei Average was at the ¥8,000 level earned enormous profits. I think that we are about to see a major positive shift in the sentiment of people and companies in Japan.

 

 

Q) I think that the comprehension in Japan of the situation in China is inadequate. China is a country that relies on state capitalism. The country is powerful but the government is neglecting the public. The economy is sound, but can China remain on this course? Aren’t we starting to see things that China can no longer hide? However, bankruptcies don’t happen in China. As a result, a financial crisis is unlikely to start in China. Shouldn’t we more closely monitor the true nature of this type of state capitalism?

 

A) Musha: I think you are correct. China as well has an Achilles heel. As you said, interventions by the national government can prevent companies and regional governments from becoming insolvent. But China has to repay loans from overseas lenders. Failing to repay these loans would make the yuan weaker and increase the outflow of capital. These events would trigger a currency crisis. This is precisely what happened in 2015.

 

When a country with a strong central government continues to issue an unlimited amount of money, it is possible to contain events within the country forever. In some cases, a country may decide to falsify economic statistics and data. Page 105 of the seminar materials shows the external assets and liabilities of Japan and China. Altering or concealing items in this balance sheet, which is linked to other countries, is impossible. Refusing to repay these debts is not an option. This is why I believe that external assets and liabilities show a country’s actual strength.

 

China’s external balance sheet exposes the country’s Achilles heel. China has the world’s largest foreign exchange reserves, an amount that is almost three times more than in Japan. These reserves can be interpreted as proof that China has the greatest international financial strength in the world. In fact, half of China’s foreign exchange reserves are debt, as the table below shows. China has been using an extremely large amount of overseas capital (investments and loans) to pay for investments within the country. The situation is completely different in Japan, another country with a trade surplus. Japan has used entirely internal money for its growth while China has relied on loans.

 

China would immediately suffer a severe currency crisis if overseas lenders demanded the repayment of these loans or if investors pulled their money out. To prevent this crisis, China has tightened capital controls to stop the decline in foreign exchange reserves. Superficially, this policy appears to be succeeding. But at some point, I think China will reach a point where implementing capital controls are no longer effective. First, capital controls will be difficult to implement if China’s economy declines. Second, a tighter monetary policy in the United States would probably increase the flow of money from China to the United States. This would raise the likelihood of a Chinese currency crisis. Third, now the cost of labor in coastal China is the highest in Asia, excluding Japan. As the country’s ability to compete globally falls, its trade surplus is decreasing at an annual rate of 20%. China’s current account surplus could be much smaller only three years from now.

 

Consequently, China’s position in the world and cross-border transactions are its Achilles heel. These factors must be watched closely. When the inevitable crisis starts, I think this Achilles heel will explode. I do not foresee a crisis in the next year or two, so risk involving China can be pushed back for the time being.

 

 

 

 

Q) The mentality of companies in Japan is clearly improving. But what about the mentality of the public? There are ambiguous worries about pensions, including among young people. If the Nikkei Average rallies to ¥30,000 or ¥40,000, do you think that the people of Japan will become more positive?

 

A) Musha: I think you are right. Japan has problems with pensions, the government’s budget, the population and many other issues. I believe the critical point regarding these problems is that they are all dependent variables. Basically, the starting point of this discussion is whether or not companies are creating value and generating profits. Jobs increase and workers receive salaries and bonuses because companies are able to create value. Japan was unable to create value from about 1990, when the bubble burst, until early in the next decade. People were very disappointed with Japan. But now Japan is highly skilled at value creation. Big improvements in the origins of a variety of virtuous cycles are responsible for this turnaround. Higher corporate earnings push up stock prices and eliminate deflation, a process that can dramatically improve the soundness of Japan’s pension system. I believe these events will also lead to improvements in the mentality of the Japanese public and how they lead their lives.