Japan and the U.S.: A Zero-Sum Game?

The study noted Japan's shrinking birth rate, but the country's cost of care for the surging number of elderly is likely to sap any free government finances as well. In that context, an economic slump could prove especially hard on Japanese government finances. The Japanese economy likely shrank 1.9% in the fourth quarter of 2008, according to Credit Suisse, and is expected to contract another 2% to 3% in each of the next three quarters. That's an even deeper slump then is expected for the U.S. in 2009.

Of equal concern, the study predicts that Japan is headed toward deflation of 1.0%-1.5% in the coming quarters. That threatens to set off a vicious spiral of underwater bank loans and even more cautious consumers. Clearly, the U.S. faces economic pressures as well, but the coming stimulus is likely to mitigate any further vicious spiral.

So what does this mean for the U.S. economy?

As a clear negative, we should no longer count on Japan to be a steady buyer of our government debt. It may even look to shed some U.S. bond holdings, and that could push up rates and/or weaken our currency.

But these changes could also serve to strengthen the competitive position of the U.S. worker. Relatively young demographics generally portend higher rates of consumer spending, and for goods and services that are best produced near the consumer, more jobs will be created. That means more Toyota and Honda (HMC - commentary - Cramer's Take) plants in the U.S., and fewer in Japan.

Moreover, if the Japanese currency continues to strengthen, as the above analysis anticipates, then the U.S. will be more competitive in other markets -- relative to Japan. That's good news for John Deere (DE - commentary - Cramer's Take)and Caterpillar (CAT - commentary - Cramer's Take) and bad news for Komatsu.

Although these issues have been discussed for a number of years, they are likely to gain increasing importance in the quarters and years to come. As noted earlier, Japan looks set for an even deeper and more protracted slump than we'll see in the U.S. in 2009. How that affects the U.S. over the short, medium and long term will likely have a bearing on portfolio flows in the months to come.

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Know What You Own: Other Japanese companies that trade on U.S. exchanges include Sony (SNE - commentary - Cramer's Take), Bank of Tokyo-Mitsubishi (MBK - commentary - Cramer's Take), Canon (CANNY - commentary - Cramer's Take), Fuji Photo and Film (FUJIY - commentary - Cramer's Take) and Hitachi (HIT - commentary - Cramer's Take).

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David Sterman has been an equity analyst and financial journalist for 15 years, most recently serving as Director of Research at Jesup & Lamont Securities.