Protests in the Arab World continue, and with every passing day, the power grip of the dictators seems weaker, with strong implication for regional geopolitics and the global economy . Today`s main event in the finance world is the downgrade of Japan`s credit rating by S&P.

After nine years of lull, S&P has downgraded Japan to AA-, with a negative outlook, on the grounds that the Japanese government doesn`t have a coherent plan to manage the high risk posed by the mountain of debt that Japan has accumulated over the past 20 years while trying to pursue a similar strategy to that recently espoused by Ben Bernanke in the U.S. Enormous sums have been spent in order to restart the Japanese economy through public spending, but it has not been enough to reverse the mood of the Japanese public, and they have become as pessimistic nowadays as they were optimistic in the years before 1990, when the economy was charging ahead. 

We, like many others, are of the opinion that the  Japanese have their heads in the sand and don`t know what they are doing. Apart from the complete lack of credible political leadership in the country to address immediate issues such as those that exist between Japan and China, or the necessary economic reforms that could help rebalance the bankrupt domestic version of the Asian model, Japan is also clueless with respect to the long-term challenges that it faces over the next decades. A meaningful rise in interest rates would quickly constrain the hands of the Japanese government, leading to  unpredictable results for the country, and of course for the world.

Still, we don`t expect to see the Japanese trigger an Asia wide crisis, although we do not completely disregard the possibility of such a development. The Japanese economy has been running on external dynamics for a long time now, and no one follows trends in the country as a potential indicator for regional or worldwide events. Japan has been living with a liqudity trap, with a stagnant domestic market, and deflation for a long time, but nobody is too worried about any of these otherwise menacing details while purchasing Japanese debt. S&P downgrade is significant in that sense, but as long as the rest of the world is able to recycle JPY to some higher yielding asset somewhere, create growth, and thereby, demand for Japanese products, we believe that the Japanese economy will keep teetering on the edge, threatening to, but never actually collapsing for some time. 

In short, Japan`s performance is tied to factors that are outside of the country`s control, and the most important variable in this context is China. While it is often thought that Chinese competition is detrimental to Japanese performance, any handicap to Japan caused by China`s competitiveness is easily compensated for by the global dynamism that is brought about by Chinese consumption, trade, and investment.  The Japanese know this better than we do, and that is why, arguably, they are always dovish on any confrontation with the Chinese communists, apart from any moral and historical reasons that they may have.

In other events, we were surprised to see in an article on Bloomberg today that our pessimistic opinion on China is not as isolated as it would seem on the basis of the frequency of opinions and articles with a similar bent on news sources. 82% of participants in a global poll organized by the financial news provider have indicated that they expect a financial crisis in China after 2016, with about 42% expecting the crisis to hit within the next five years. Only 7% were so audacious and bullish on the country to say that such a thing would never happen. 53% of global respondents regard the Chinese economy as a bubble, and the concern is even higher among the country`s Asian partners where the proposition that China is a bubble finds approval by 60% of respondents. By contrast very few investors seem to expect a political crisis in the country, with only 27% expecting such an event in the next 2-5 years. We think that this risk is being underestimated, as frustration with the CCP is only hidden by economic strength if the country, and it is but a matter of time before disapproving voices are raised, if the feel-good sentiment of the moment is lost.

Today stocks are weaker, gold and oil are lower, while the USD doesn`t seem to benefit a lot from this situation. We`ll keep you updated with Chinese and Asian issues, as we expect the region to generate the most exciting news for the coming decade.