GM109: Why Buffett Finally Went All In on Japan ft. Andrew McDermott

0:01 We are so popular amongst ourselves and we think our fancy Ivy League schools are so fantastic, and we think private equity is so obviously superior that we don't realize that outside of our little world, everyone hates us. The only people that hate more are Congress. Welcome to Top Traders Unplugged.

0:22 In markets, success doesn't come from predicting what happens next. It comes from being prepared for what you can't predict. In each episode, we go deep with some of the world's most thoughtful minds in investing, economics and beyond to understand how they think, how they prepare and how they decide, and the experiences that shaped how they see the world.

0:44 No noise, no shortcuts, just real conversations to help you think better and invest with confidence. Welcome back to Top Traders Unplugged. My name is Alan Dunne and this week I'm delighted to be joined by Andrew McDermott. Andrew is the founder of Mission Value Partners and a Japan Focus investment firm which he started in 2010.

1:05 He has an interesting background in the markets. He started off initially in logistics and moved into finance, working with JP Morgan and then moving into asset management with Southeastern Asset Management. He's also a contributor to the Japan Optimist substack alongside our previous guest, Jesper Kahl.

1:24 Andrew, great to have you. How are you doing? I'm good, Alan, thanks for asking. Thanks for having me on the show. No, great. Delighted to have you on and fascinated to hear your perspective on Japan. We had Jesper on previously and I know you've done some work together, but before we get into that, maybe tell us about your background, how you got interested in finance, economics, investing in Japan.

1:51 Well, I would say that this show is a microcosm of my life. I've been following Jesper Cole around for 30 years or so in different ways. I'm not really interested in economics or markets, to be honest. I was a history major and an adventurer who wanted to travel. My first job was in really an IT and I washed up in Hong Kong and got a job in JP Morgan's IT department when they were switching from Lotus 1, 2, 3 to Excel, which you and I probably remember a lot of people don't.

2:20 And my great skill set was I knew how to write macros in Excel, so they trained me in finance a little bit and I just ended up knocking around it for 40 years. But my primary interest really in Japan has been in this whole arc of its story since World War II. The economic development there and how that has interacted with really the liberal Democratic Republic story, all small L, small D, small R and how that's manifested itself and particularly how that provides what I think and what Jesper agrees with is an alternative to the China narrative.

2:59 So that's kind of the big my personal story. And then the investment piece just falls in with that. I had the great benefit to learn a lot about value investing from the stories of Warren Buffett and then get to meet him early when he started looking at Japan. And just to watch him go for 50 years ignore Japan and then go all in at precisely the time that our industry gave up.

3:24 So that that little story has been also very interesting to me and just to watch how his approach to Japan is contrasted with the smart moneys. Interesting. And I know you've collaborated with Jesper, Carl, and have an event, I think it's going to be out today. This is going to be released. So we're recording on the 21st of October and it should be on the 28th.

3:48 And you have an event on the 28th of October, is that right? That's right. And all are welcome. It'll probably it's going to be in the morning on the 28th in Nashville, but it will be recorded. And the title is A Practical Guide to Partnering with Japanese Universities. And Jesper, my partner Yohei Yamada and seven or eight other just great experts on Japan theory.

4:11 Porter, who you may know, he was the CEO of the first, the largest for many years successful transaction in Japan, the Shinsei bank, which you may recall. But our focus is really going to be on universities and helping them refocus away from China towards Japan. And that includes investments, but also engineering and political science and so on.

4:36 So that'll be available to everyone after next week. Good stuff. Well, I know you had sent on a piece you were working on to publish and within that it said the statement that Japan's capitalism works better. So I thought that was an interesting statement and maybe a good jumping off point. So you know what is about the Japanese model that you think is better than the Western model or even the Chinese model?

5:05 Well, I don't think that the things that are that work in Japan are distinctively Japanese. For me, my definition of an economic system that works is one that allows human flourishing without trampling on individual liberty and that distributes the fruits of free enterprise equitably. And those fruits consist both of profits and losses.

5:40 And I think that capitalism, which is a term that's ill defined, but certainly I think in terms of common knowledge is based on actually making things that people need and providing those at a price that compensates the workers and the inventors and so on, and, and there's the risk of loss in that. So I think what right now is taught in American business schools is capitalism is a distortion of that idea in a thousand different ways.

6:18 Starting with the fact that we no longer can actually make things very well in our country and going on to the fact that the so called capitalists are financiers who take no risk personally while reaping enormous rewards. And that's been one of the things that Jesper shows is the wealth distribution within the US and the ccp.

6:43 They're identical in terms of their wealth distribution. Japan is by far the most equitable in the developed world. And so I would say that just on the merits, I'm happy to hear other definitions of capitalism. But on my definition, neither the United States nor China is performing very well and Japan is beating the rest of the world by a long shot.

7:08 Which is why Japan, outside of our academic and financial industries is by far the most popular destination in the world and most popular counterparty for people, whether it's cultural or frankly in business. In terms of making things interesting, I. Mean is that kind of getting to the idea of like what we've called here in Ireland or Europe?

7:33 Social partnership is one term that might describe that for, you know, different parties are better share in the economic gains. Obviously in European, in many European economies you've had that kind of more that type of model or what is it about how society and the economy is set up that yields that outcome?

7:56 Well, I mean it's funny you mentioned Europe, I almost forgot about Europe in this conversation, which I think is emblematic of the issues here. The short answer is no, I don't. I reject the European analysis as some sort of third way because back to fundamentals and first principles. In order to make things you have to have, I mean the other keys are or energy and geography and the ability to trade on a basis of comparative advantage in free societies.

8:36 And I lived in Europe for, lived in London for five years. I love Europe, but I struggle to think of any area where any European country or company has any sort of competitive advantage. And it's a tragedy. But the through line in terms of what makes Japan capitalism work is that it is organized around competence.

8:57 Whereas I would say right now the US is organized around compensation primarily, not competence. There's nothing that Japan does now that the UK did not do 100 years ago. One of my heroes is Sir George George Buckley, who is as you may know, the chairman of Smiths and in the UK but he was also CEO of 3M and he was the first foreign director of Hitachi.

9:23 And I think reading his works, I don't understand why people don't pay more attention to him. He has a wonderful personal story and everything I'm saying is stuff. He's saying the UK used to be good economically and also good and it could share those brutes socially because it was led by people who were really good at making things.

9:42 And the UK was early in changing its leadership to financiers. And I saw that the early in my career BTR was one of the first things we looked at spun out of Hanson and all that. Basically they stopped making things and you can't over time that just catches up with you. And that's what's happening across Europe and that's what Japan has not done.

10:04 So Japan has first and foremost focused on being competent at making things and continuing continuous improvement. But that was the same way that the US operated until about 1980, until KKR took over the Hudai. That's a marker, the Hudai transaction. And Henry Kravis would say that too. That's what got Steve Schwarzman into finance.

10:25 Hey, we can take a company and leverage it and make a ton of money in the process. We're going to bankrupt the machine tool industry but that's okay, we'll let other people do that. That's not what's important. And that entire construct has been applied everywhere in Europe outside of Germany. So no, I don't think it's so much this so called stakeholder capitalism as it is having leadership based on people who can actually make stuff which is how every country, that's how Italy used to work.

10:59 It's pretty basic. Yeah. I mean around the world there is a little bit of a shift back towards that thinking. Is it fair to say? I mean, okay, there's certainly still the predominance of financial considerations but obviously the US has been trying to re industrialize or reinvigorate its manufacturing capacity.

11:22 Is that a step in the right direction? Similarly in Europe there's more active industrial policy are. I mean do you see the motivation behind that has been somewhat different to what you're talking about? No, I think it's the ultimate vindication of the strategy that Japan has followed. So one of the things we're going to talk about next week, the reason we're having this event on 28th October is that early next week there's an event called Suess Southeastern US Japan Gathering.

11:53 And it's been going on for 48 years. And it will focus on some areas in which Japan has invested in the southeast. And that includes nuclear power, quantum computing and defense industrial complex. And I've been keeping track for the last couple years of the size of those investments. And it's over $20 billion just in my state.

12:14 Ranging from steel to rare earths, to making generation machines to nuclear power plants to automated manufacturing. All many of these things are things that are, that were being made in China even three years ago, that all of these things are coming back. It's billions and billions of dollars. Some of it is state supported, other of it is, is behind tariffs, if you will.

12:39 And this is not a political statement. It's just, I'm just calling it as I see them. Last month's machine tool orders from Japan hit a record in both the United States and China. Those numbers have been trending down for decades in the US Just because everything was being made in China. Apple was spending $50 billion a year training the Chinese to copy Japanese intellectual property, but they were still buying Japanese machine tools.

13:09 America wasn't. And we had flat power generation for 20 years. Well, now all of that's coming back. And I'm not saying whether it's good or bad. I mean, I think it can be good. I just think it's logical. And the good bad part is, well, how do we distribute those gains? How are we going to deal with the inevitable dislocations that come from not generating power at all for 20 years, not adding new capacity to meeting to compete with China, which is in a process of taking its power supply up 8x.

13:52 Now of course, back to Europe. Europe's not even in that conversation. Europe is taking its grid apart, which means it can't have a serious conversation about any of these things. The US can because of the things you mentioned. Whether how that's going to go, we don't know. A lot of depends on how much Japan and Korea will allocate to the United States relative to their other partners in Asia, principally India.

14:19 And I think that's one of the things I want people to understand when they look at Japan, that it's not just sitting around waiting for America to call. It's got other choices. Interesting. I mean, in the piece that you're about to put out, you're talking about why investors have overlooked Japan. And certainly there has been that general sense of, you know, Japan is obviously, I know it's probably about 6% or something of the MSCI world or something like that.

14:45 It seems like a relatively small component Given the size of the economy. And as you say, it's generally, you know, the narrative has been we've had a lost decade or decades in Japan from an economic growth perspective. Obviously the equity market has been performing strongly in the last one to two years.

15:03 But why is that? I mean about international investors, that they have seemingly overlook Japan. We're in a cognitive prison created by the Communist Party of China. And Russell Napier, who I don't know if you follow him at all, but he keeps the library of mistakes. And he's written just a terrific piece that helped me on this.

15:26 It's called the Monetary Non System. And he explains how the way that the deal that China has offered, which no one would have taken if we were. I was just a Bretton woods this last weekend. So I'm thinking about this. If you would come out said, hey, instead of Bretton woods, we're going to do this thing where China fixes its currency, prints $100 trillion of debt and makes everything.

15:51 And in exchange for that, America will stop making things and the west will stop making things, but you'll be able to generate a gazillion dollars in fees on the private equity deals that finance this new project. I don't think we would have agreed to that, but that's in effect what we did. And everyone who has been successful in our financial industry by definition has bought into that system.

16:18 The people who were saying, hey, we shouldn't leverage, we shouldn't go for this genuflect at the altar of Jack Welch and Henry Kravis. I mean, Henry Kravis signature deals are the bankruptcy of the American machine tool industry, the bankruptcy of Cal Sonic, which is a Japanese, twice Japanese auto auto manufacturer, and the investment in ByteDance, I mean, that's a, that's a trifecta.

16:45 And then he took those winnings and personally funded Columbia's business school, which guess what case studies they teach. They don't teach the story of the Japanese company Okuma, which did not buy his machine tool company and has gone on to continue to make the most important machine tools in the world, without which we cannot make Boeing jets or Tesla cars.

17:12 That's not part of his story. In fact, he was in Japan last month saying to the Japanese leaders, you need to look at what I did at Hudai, and I will, so that I can do it for you. And I think we should take him at his word. But if you came in at any time in the last 30 years and said, hey, Henry Kravis and Steve Schwarzman are wrong, they're dead wrong.

17:31 They're wrong about everything. There are not many jobs that you could get in this world. I can attest to that, because that's basically it. Now, I was a big fan of private equity at the beginning, and I'm not. Look, there are people. It's not so much the form as it's the mentality. It's the same idea that intel took.

17:50 And I know people at intel who are on the board of directors who spoke out against it, but. So that's the reason Japan's last decades have not been lost. Unless you're in the financial markets. If you were in any other part of the world, food, travel, rock climbing, marathon running, that is why Japan's so popular.

18:14 It's America whose decades have been lost. If you look at our political dysfunction, our crumbling infrastructure, our healthcare outcomes, that's the other chart that Jesper probably showed. Japan is far and away on all metrics of social well being, a leader. And if you go to Japanese cities and then you go to US Cities, you're like, who had the lost decades?

18:36 It's a complete fabrication. Outside of our industry, our industry equates relative performance with economic success. And they're just dead wrong. That's fair enough. We have pretty blunt tools for measuring economic performance, which is generally GDP or the performance of the stock market. And obviously there's a lot more to it than that.

19:02 Do you think we're now at a tipping point or a regime shift? On our podcast, we talked to a lot of guests about the regime shift from a macro perspective. You mentioned 1980, which was kind of a turning point when interest rates peaked. And then in the four decades that follow, we had falling rates with falling inflation, we had neoliberalism, we had China coming into world trade system, the Berlin Wall, et cetera.

19:32 And that resulted in lower inflation and lower rates and the growth, the financialization of the economy. Now, we have seen a lot of that being dismantled in the last few years. Do you think this predominant influence of private equity and that financialization of the economy, do you see that now on the way in the US or are you just pointing to the drawbacks of that system?

19:56 Well, this is more your baliwake than mine. I observe that in the last jobs report, manufacturing jobs are increasing pretty strongly and finance jobs were in decline. I note that if you really. I mean, the private equity and private credit markets are struggling to generate the sort of deal flow that they've had in the past.

20:29 And I would observe that higher interest rates are not killing Japan Interestingly, because Japan has become a growth market. And the reason that's true is because the sorts of things that Japan does, well, make robots, rare earth metals, build nuclear power plants. I mean, there isn't a single gas turbine that ge, supposedly an American company sells that is not actually forged in Japan because ge, under the leadership of Jack Welch and others long ago, along with Westinghouse, stopped making the actual components of the things that they do because there wasn't enough demand for it.

21:08 Well, Japan kept doing that. So all of a sudden there's a bid for that industrial capacity, semiconductors. Japan is very close to partnering with IBM to make a leap to 1 1/2 nanometer technology higher than TSMC. And then TSMC is aggressively investing in Japan. We had lower rates and low inflation in a reported sense, but I think as everyone knows, as all the elections, as the streets of Paris are showing, that was all false in the real world.

21:43 That was manufactured back to this paper by Russell Napier, by China because they were suppressing rates and suppressing prices for their own purposes. It's obviously true that the low cost that we were paying, for example, rare earths, that was a false price signal. Now General Motors sold its rare earths magnet business to a private equity firm called Sextant, whose partners were Deng Xiaoping's relatives.

22:20 They did that deal against the advice of the Pentagon in order to provide access, at least partly to provide access for General Motors to, to China. Now we were largest shareholders in General Motors. So I heard that whole story, that entire price signal that we use that Alan Greenspan and others were looking at over that 20 year period when we were paying low prices for rare metals and we were paying lower prices for GM cars because we thought they thought they were making profits.

22:53 And China, that was all false. And we're realizing that China, you know, GM just wrote off $6 billion in China. The entire investment there is zero. And all of a sudden we don't have enough rare earth magnets. We can't make them in the US anymore. Well, guess who can? The Japanese, because they invented them at the same time and they continued to make them that entire 40 year period.

23:16 And so now you've just got a bid for, for stuff that was always there and that we were acting like wasn't there and that was causing this decline in living standards for everybody except people in finance. So, yeah, I mean, it's a long way of saying that we're, I just think we're back to normal. There are a lot of things that are competing for Capital.

23:38 And right now, the most valuable things are things that the Japanese and the Koreans and the Taiwanese make and that the Chinese also make, but using those tools from those three countries. And so now we just have to rebuild. And that means there's a higher demand for capital. And that means the skills of those of us who have made a living on trading financial assets with a backdrop of lower rates really need to find something better to do with our time.

24:09 Fair enough. I mean, if you were to play devil's advocate, somebody might say, well, fine, you know, we can accept what you say about the financialization of the US Economy. But at the same time, obviously, the US has been a leader in technology. You know, first with the Internet and then, you know, we've had cloud computing and the hyperscalers, and now obviously with AI.

24:32 I mean, obviously in the rollout or in the development of AI, you need to build stuff or you need things that are built by somebody, including Japan. But I mean, what's your perspective on that and how AI will shape the economy going forward and how Japan is placed from that perspective? When did you first hear about AI?

24:55 You, Alan? I don't know. We're talking decades ago, I guess. No, if you were to go back and in your daily and had a transcript of your daily conversations, when did AI start to be something you talked about with people other, you know, like three years ago? Yeah. Well, when. When did ChatGPT come out like that was November, October 23, I think.

25:19 Was this something like that? Maybe, yeah, 23 or maybe 22 might have been. 22, yeah. And this is these. These numbers are old by Internet times, but. Well, let me put it this way. What do you think the highest use of GROK right now is? You mean like who are the highest use of. If you were to just look at its compute and this is secondhand.

25:40 So I may be call it fact check on this. And Grok, we're $2 trillion market cap company, right. So 40% of Grok is used for online porn right. Now, my partner, Yohei Yamada is. He joined our firm in 2013, having worked briefly at Morgan Stanley. And prior to that, he was getting his PhD in Computational Neuroscience at the University of Tokyo.

26:08 And he thought, well, this is not really ready for prime time yet. So I'm going to take a detour into finance. And then last two years ago, his advisor called him up and said, hey, I'm going to retire. If you want to finish your PhD, come, you better come do it. And we agree that he should do it. Like, I'm a history major.

26:25 What do I know? Nothing. Next to nothing. But I do have a partner who's actually getting a PhD in this stuff. He's funded by one of these hyperscalers. He knows a lot more than I do, and he's known about it for a very long time because he was getting his PhD in it in 2013. Now everybody has suddenly become an expert on AI.

26:46 And our version of AI, yours and mine, is using Claude to help me write the music to a country song that I wrote this morning about Japan. Literally. I mean, that's kind of what we don't know, what we're talking about. My daughter is a mechanical engineer, and this is scary. Many of the people in her class are using Claude to cheat on their AI, to not learn the fundamentals of engineering.

27:12 But most of the stuff that we're doing with AI right now is not adding to that capitalism. It's not adding to your human flourishing. It's not creating economic value. It is a gigantic negative return on invested capital. You can see it mathematically on the balance sheets of these companies. You can see it in our social world.

27:39 It is competing for the greatest misallocation of human capital with the financial sector. I don't know. It's a race to the bottle. But for Japan, if you go back and look at our two largest. And I did this, our two largest holdings, I went back and I said, well, when did they start talking about AI? 2015, 2016.

28:02 The reason for that is that in Japan, it's machine learning. It is the application of machine learning to the continuous improvement of manufacturing processes for which the Japanese are uncontested, the world leaders. So to answer that question, I think you just look at the press releases for where US companies are partnering for power, for robotics.

28:33 I mean, Anduril Industries, which is a great AI company, it wants to build a drone without Chinese parts. The only way it could do that was in Japan with 100%, all of the parts were Japanese. So I would say that in the part of AI that is clearly economically redemptive, and I use that word in all its weight, Japan is by far second to none.

29:05 The best. It is leaps and bounds ahead of everyone else. Now, if you want to talk young people into either killing themselves or having weird relationships with animated, ethereal beings, read the Pirate Wire's essay on just kind of the personal views of the people who are creating AI. Yeah, America's great at that.

29:36 We are great at that piece. But in terms of actually taking machine learning and using it efficiently. Japan's really, really good at that. And Jesper has done a great piece on how Japan is very quietly the primary market on which AI models train. So I'm incredibly bullish on Japan's participation in the guts of this machine learning for the same reason that I was bullish on it 15 years ago.

30:09 I'm incredibly skeptical that this gigantic ego boost between five or six tech guys who are spending money on stuff that they can't, that doesn't generate revenues is actually going to be anything like leadership. Just maybe moving on. You've talked about China a few times and people inevitably draw comparisons between China and Japan.

30:42 And for a while in markets there was this concern about the Japanification of the Chinese economy, which had a negative connotation obviously to it. Whereas I guess from your perspective, that would probably sound like a good thing. China has been also moving up the value chain on manufacturing. Contrast the China model with Japan model too.

31:05 But is China not becoming a major competitor to Japan? Well, obviously, yes. There was an article in FT yesterday about this which Leo Lewis wrote. And I wrote Leo my thoughts on it, which he's I'm sure put in his junk mail folder. It is exhausting for me to have these conversations about, quote, Japan and China because the conversation is always the same.

31:33 It's like, well, what. What is the Japanification of China? If you come back to my first principle, what has happened to Britain and France in the last 30 years? Why isn't that Japanification? We no longer talk about that. You've got industrial production that has just plummeted. I guess they're talking about this giant debt buildup and real estate boom, which again has recurred.

32:02 So I wouldn't call this Japanification. I would say, well, we've had a lot of debt that went into real estate. And you've had deflation, which guess what, that also happened in the US in 1930s. And you can go back through it. So there's nothing really. I would say that the difference between Japan and China, which everyone in our industry just dances around back to this cognitive capture that I talked about, is that since 1945, China has fought major wars with every one of its neighbors.

32:35 It's killed 30 million of its own people, and it has continued to try to expand its geographic envelope and engaged in the greatest military buildup of all time. Japan has made peace with all of its neighbors, has become the greatest exporter of goodwill and cultural exports that people want, and has partnered with the United States to create an alternative in the Indo Pacific that is wildly popular as expressed in the actions of the Taiwanese who are effectively merging with Japan with their historical ally adversaries, Korea and with the Philippines and with India.

33:27 So China, that to me is the difference. Japan is a functioning democracy whose prime minister said to Congress that freedom is oxygen of humanity and China is a totalitarian dictatorship that is not interested in anything that approaches this idea of capitalism. There's no free exchange, there's no freedom of speech and there's no profit.

33:59 I mean, what astounds me. And we saw it. So Ray Dalio is all about how China is the new hegemon and he's supported by these two writers from Harvard and UCSD who say we should bring byd Both. All these guys are saying we need to copy Chinese technology if we're going to catch up. What no one recognizes is that Japan is still at the very top.

34:24 China has still not surpassed Japan. Yes, they're a major competitor, but Japan can take that same technology and apply it to India, which is just as large a country and then we've got an alternative. Yeah, they're a competitor in certain areas, but in the areas that we talk about human flourishing, the Chinese model versus Japanese model, there's no comparison for me.

34:52 I mean, I'd much rather be dead than be in a world in which China calls the tune. But I'm excited about one in which Japan does. Because Japan supports the idea of liberal values on which our whole economy is based and which for some reason our universities and financial sectors have thought that, oh, we can put aside it in the name of diversification.

35:11 And I just think that is a fatally flawed argument. I mean, obviously this Japan model has been been in place, gone back over a number of decades, but we have, you know, in the last number of years had more, you know, aggressive policies. Obviously Shinzo Abe had kind of his three arrows approach and now we have Takaichi coming in and you know, I suppose placing more emphasis on corporate governance, etc.

35:42 I mean, can you give us your perspective on what the most significant change has been more recently? Or do you think that's at the margin and it's just the fundamental way society operates is the more significant point? Yes, I mean, thank you for that last part. The first part. My eyes, if you can see this, my eyes were about to roll out of my head on the whole corporate governance thing because this give me the top 10 examples of bottom of the barrel, worst corporate governance of the last 30 years and we won't have to.

36:14 Everyone can go to write Their own things and then we can compare. I struggle to find one that's Japanese. And I know the Olympus story. I was in the middle of it and there's a big story about that. But they're all American or European. I mean, we got. Hollywood is so grateful to Elizabeth Holmes for creating all this drama and all of this funding ftx, all the stuff that's happened in China, I mean, outrageously bad corporate governance.

36:47 The Japanese model is the exact same model that worked in the US for 30 or 40 years between World War II and 1980. Yeah, people who came up through the company and knew how to run it and who focused on resilience rather than a stated return on invested capital and then evolved. And so what's happened, it's not because of Shinzo Abe, it's because these Japanese companies, in order to survive, had to make a bunch of changes.

37:16 And I like what you said, in the normal course of business. And we, because we're so, I don't know, we're like Gollum with these giant eyes because we're just seeing. We're in the dark. All we see are financial statements. That's all we understand, understand. And so we come in and say, oh, look at your low ROE compared to General Electric's ROE.

37:37 And then now, 30 years later, when General Electric can't make anything and has had to be saved multiple times and relies on Japan for making this stuff, all of a sudden, well, maybe those things made sense. Yeah, I would say maybe corporate governance. Is only part of it. But certainly speaking to, say, Jasper, for example, and he mentioned a number of points around, you know, it used to be jobs for life or, you know, there wasn't a culture of meritocracy.

38:07 You had huge corporate cross holdings which were inefficient. So you have had a number, you know, given returns to shareholders weren't prioritized. So there's been a number of changes that he would have said, okay, this is a new dynamic on top of the, you know, the cultural backdrop. I mean, you're, it sounds like you're placing less emphasis on those and just saying Japan's a better society now.

38:30 Jesper and I generally agree. I think we just see it. Your question was how much of this change was the way I heard it was how much of this change was topped down by Abe? And my answer is zero. Abe was like any good politician seeing what was already happening. And where Jesper and I agree is that the nature of the Japanese stock market, this is objectively true, has changed as the Ownership has changed because for not forever, but 40 years ago, most chairs were cross held.

39:09 And that was basically a post World War II reconstruction of the conglomerate structures that worked before. Now the irony, here's where it gets a little bit squirrely. We, the investment world are all wound up about whether Japan is changing. The big question is whether you're going to overweight Japan and go from 3% to 6%.

39:34 And that answer is going to be based on whether they're changing and what we're going to bet. We're going to bet on a bunch of activist guys and private equity guys to make them change. The great irony is that a generation ago, our forefathers, or maybe you and me because we're old, they were all betting on Japan because it was 55% of global markets because of these same structures that we're now saying are unwinding.

40:00 We went from when John Templeton, who's also from Tennessee, started the Templeton Foreign Fund. Here's a pop quiz. Japan was about 12% of global markets. What do you think his allocation was to Japan? Equity allocation, 70s, 1974, 75% and he cut it in half in 75 because the US got cheaper. Warren Buffett's international allocation right now is 100% Japan.

40:36 Well, there's the point. Hang on. You did mention at the start Warren Buffett hadn't invested in Japan for a long time and now he's in. So clearly something has changed. Pique his interest. Yeah. And he would say, he has said, I mean, when my first day on the job, 1998, my boss was a big Warren Buffett fan and endowed a chair of Buffett Dodd Partnership at University of Florida.

40:57 And Mr. Buffett gave a speech and he said, somebody asked him about Japan. He said, well, the returns are terrible and the magnet's terrible and the business, they had great prices but not great companies. Now. And this is consistent, I think, with what Jesper and I have said. These Japanese companies, the ones who have survived, have had to compete.

41:19 They've had to compete in the marketplace for people. They've had to find areas where in a capital constrained environment, they had to invest behind their best ideas and they've had to change. They've had to interact with the capital markets differently. All of those things are, I think, natural, but they were doing pretty well before as well.

41:43 These conglomerate structures that our financial industry keeps trying to unwind because we think we're such great capital allocators. Every industrial company has had conglomerates. It's funny you mentioned, we talked about Tesla or SpaceX. He's trying to integrate everything. He just bought mobile phone spectrum.

42:01 He wants to build both spaceships and gas turbine blades. Guess who already does that? All these Japanese conglomerates. Berkshire Hathaway is the most Japanese company in America in every sense, including the corporate governance part, which all the corporate governance gurus are against his voting shares or so on.

42:23 So I just think that this whole structure about Japan, this narrative about Japan changing and whether it's happening or not, it says more about our industry than it does about Japan. We are incapable of acknowledging that we've just been wrong about Japan and China for the last 30 years and about private equity, because the whole Japan thing has been done in the public markets.

42:47 The biggest investor, the $1.3 trillion investor, is GPIF. They've got, I think, 40% equities, of which 25% is in Japanese equities. And they made a very intentional move to increase their Japanese equity portfolio. They do it all in public markets. Their fees are two basis points. Two. They only have 200 people.

43:10 They don't have any private equity. And their companies have just done great because they've pushed the allocation decision down into the companies. And that's really what I've observed is the best investment managers in Japan are in the companies. And that is a structure that is inimical to our industry, which is founded upon the idea that getting an MBA and going to McKinsey is the path both to being an executive and to being an investor.

43:39 And we all kind of talk this argot that's based on these financial metrics, but nobody knows how to turn a wrench. In Japan, it's the opposite. They might not be very. They're always having this disconnect with investors and conversations, and people get frustrated because they don't talk about, you know, the things we want to hear.

44:02 But that's all. Again, that's about us. It's not about them. Yeah, the corporate governance. And. Okay, do they care about shareholders or not? The question is, do shareholders care about them? And that's a big open question, because right now foreign shareholders own about 35% of the Japanese market just because of this relative growth.

44:21 But most foreign shareholders don't really care about Japan. They're more focused on China, at least intellectually. And that is a major issue. That's a major concern for me, that not that China becomes more like Japan, but that Japan becomes more like KKR's portfolio and it's a huge risk. Just. I mean, just moving to a bit More macro in a sense of the other big kind of, I suppose, negative.

44:50 When people look at Japan as high public debt and people say, well, we don't want to end up like Japan. Now obviously that's one side of the ledger. There are public assets, there's gpif, as you say, as well. I mean, what's your pushback to that? That Japan has just racked up trillions and trillions of debt and could be at the point of unsustainability of that.

45:14 That's the typical narrative you hear in the US or in the West. Yeah, well, I really defer to Jesper on this. He's much better. I think that the entire Post World War II system was based on a false premise, a false premise about growth, about demographics. It is a problem of democracy that we trade off the future for future generations for present consumption.

45:45 I would observe that and I would point people to the Federal Reserve paper that ask exactly this question and that said, what if we were to try to put the US and the Japan, Japanese government on a true apples to apples basis? You will find that when you consolidate public and private pensions which are off balance sheet in the US in the same way that you do with Japan, and when you look at the assets, noting that the Japanese government, as you say, is an enormous net owner of foreign assets, you will see two things.

46:29 First of all, that Japan is not an outlier. And second, that the structure of Japan's balance sheet is very favorable, as is the historic ability to make adjustments. I think all of us know, I mean, I think we know that the US Social Security and Medicare system is two years from moving to a forced reduction, being bankrupt.

46:57 We're seeing this in France, we're seeing it in Germany. Japan has already restructured its liabilities a number of times and when it did so, it structured those pension liabilities so that they are nominal while its assets are real. The US is a reverse. We can get into the details of this, but Japan, it had the worst of both worlds demographically because it was having a lower workforce or shrinking workforce at a time of deflation.

47:28 When benefits were fixed, they did not drop with inflation. But, and this is very intentional, it's what Jesper calls intergenerational equity. Those benefits do not grow with inflation. And the massive growth that we're seeing right now is very favorable to the Japanese balance sheet, unlike the US Social Security fund is all invested in T bills which are getting killed.

47:56 The Japanese, they're in equities which have been great. And that balance sheet situation is very Favorable. And then on top of that, if you look at the intangible factors, the OECD PISA scores just came out. Japan is number one in the world in educational outcomes. The US is, I don't know, in the 20s and getting worse infrastructure.

48:22 Just go to any subway in the US Japan has what I call a return on qe. Let's just assume that we're going to have to write everything off or restructured this debt somehow. Japan has spent its capital over the last 30 years on a world class tangible infrastructure, whether it's airports, trains, whatever it is, and intangible in terms of its education system and cultural program and everything else.

48:49 The return on that for the US and Europe has been broadly negative. So I don't know, my friend Luke Groman is a big argument argues that we're going to have to rebase everything on some sort of gold standard. We're already seeing a non US system trading system between China and our adversaries. They're trading with Iran for commodities with net settlement and gold.

49:15 If you were to rebase the financial system right now, if you just look at Japan's tangible and intangible assets and the value of the things that they have, I think they come out pretty well. Which is not to say that they don't have a debt problem. Everybody has a debt problem. I just think the US is much worse than acknowledged.

49:37 And when you mentioned that restructuring the liabilities give us a sense in some of those things, I mean, is that the pension through retirement age and obviously not indexing pension payments, is that it? Well, I mean, part of it, but the creation of the gpif this is if I'm dating myself. But there was something.

49:54 Today's AI was Daikyo Henjo of about 15 years ago. Everybody knew those words real quickly for a brief moment. And that Daiko Hengo period was a period in which the Japanese government said, hey, we've got an unsustainable scenario. It was a bit like when California realized that when they based their Equity returns on 20% annual increases and then all of a sudden we had 2,000 come, they had this giant hole.

50:26 Well, Japan had the same thing, right? They had these negative returns and they went from inflation to deflation. And we were shareholders in NTT at the time. So I remember this very vividly because we would calculate the off balance sheet pension liability because it was assuming a 6% annual increase.

50:45 And the way that the Japanese pension plans were organized is that the government portion of Japanese liabilities were managed by the companies. It'd be as if I don't know. Diageo's employee Social Security benefits were also managed, were commingled in the Diageo pension fund, Daiko Henjo. The Japanese government took that back and restructured it.

51:11 That created the GPAF and then they became an independent shareholder. That was all part of the unwinding across holdings. And they reduced the benefits, extended the retirement age and made these companies whole with the quid pro quo that NTT and all these other companies would invest the difference primarily in making better products, not share buybacks.

51:35 So that was already a gigantic restructuring. It'd be the equivalent of going in and saying, you know, adding five years to Social Security and cutting the benefits in half. So they've done it. They had to do it. And that gives me confidence that they will be able to make those hard choices later. Not absolute confidence.

51:57 It's hard everywhere as France is showing. But they invested. The big difference is they invested that in their ongoing productivity, which is especially in manufacturing level, very, very high. I mean, you've touched on gpif. I mean, they have been kind of back in the news again of late and speculation that we will see them invest even more in Japan now at these levels of JGB yields.

52:28 Is that something that you're anticipating that we will see? They seem to already have a large equity holding, is that right? It's more on the fixed income side that, that people are anticipating more flows, is that fair to say? Yes. And again, I'll defer to Jasper. The GPAF very sensibly has a real return objective and that is tied to, I think it's 1% over real wage growth now.

52:57 Wage growth is increasing also, but the, the relative attractiveness of JGBs at 3, wherever they are now to a hedged US treasury against that absolute return objective has clearly improved at a time when compared to when things were flat as a pancake at 25 basis points. And when you've got a fixed objective, and this is true across the board for investors, when you've got a fixed objective like that, why, why take that overseas currency risk?

53:38 So now the GPIF itself, I don't know about this but, but it's, I think the, the big issue that everyone's been talking about is what's Japan going to do when rates get to 3%? They're going to go bankrupt. The real question is really what's the rest of the world going to do when Japanese lenders start pulling their money out because they can make as much at home as they could abroad.

54:01 France being the number one outlier in terms of allocations from Japan to fixed income and the biggest area where on a relative basis the Japanese are pulling out. Now, this is. My friend Grant Williams has done a lot of work on this, so I can't speculate in terms of. Based on knowing any of these investors.

54:21 I just look at the numbers and I would say, yeah, Japan's fixed income returns and equity returns are all very attractive prospectively. And if you were to suddenly put in even stability, let alone an increase in the value of the yen, that would be a big tailwind as well. The Japanese leaders, and this is not unique to Japan, everyone is saying, why is it that our country's savings are disproportionately invested in the United States equity market, particularly when that money is being.

55:03 The returns are much more questionable. Back to Tesla, $2 trillion, where as a S and P component, I'm forced to own Tesla or X or SpaceX, whatever he calls it, at $2 trillion valuation. And it's losing whatever. It lost hundreds of billions of dollars. Why do I need to finance that? And so this is. It was actually France that started this conversation.

55:26 So the biggest issue for Japan, back to Jesper's point, is because it's such a net investor elsewhere, even a small change in asset allocations across the fixed income portfolios of Japanese investors can have a major impact on other markets. And I think we're seeing, we'll continue to see that. Good stuff.

55:51 Conscious of time. We're coming up to the hour. I mean, obviously you've presented a compelling case for, you know, the merits of the Japanese model, etc. And I mean, I'm curious to get your thoughts. I mean, if you were to look forward 10 years, I won't ask you for any stock tips or anything, but I mean, what do you think?

56:08 How do you think the Japanese economy will look like relative to the rest of the world? I mean, clearly you're upbeat on Japan as a model, as an economic model. Do you think we'll see just more stable growth there? Or what is it about it, do you think, or kind of what evidence that it is a superior model do you think we might see over, say, over a longer period of time like that?

56:33 Well, we had a preacher say not long ago, who you follow tells a lot about where you're going. And I said the last time I was with Jesper that the number one thing I was watching was whether MIT continues to educate Chinese engineers at a ratio of 10 to 1 for Japanese engineers. If our leading Engineering school undervalues the academic output of our number one ally, who also happens to be the world leader in math and science and continues to partner with our principal adversary even as we as shareholders are putting literally tens of billions of dollars into competing across semiconductors, robotics and so on.

57:28 And MIT and also Oxford continue to partner with the CCP to train their engineers. Then it's game over. Not just for Japan, but for all of us. And I say game over. I mean, whatever. I'm a Neil Howell guy. It's a fourth turning, fourth turning. And I know that I'm not optimistic. Now. About three weeks ago, MIT announced a comprehensive partnership with the Tokyo Science Consortium that follows everything from venture investing, commercialization of technology, to within research to student exchange to faculty exchange.

58:14 Now that to me is a great sign. Vanderbilt University, where my daughter goes. The head of Vanderbilt was at Tokyo University last week, and his number two, whose work you really should read because he's the guy who's detailed a lot of the cognitive attacks that China is doing on America and Japan. He sat with Yohei and Jesper at an event called G1 that I encourage all of your people to talk about.

58:42 It was about how Japan can lead in an AI age. This ship is starting to turn. Thirty years ago, there was a joint Japan US program called the US Japan Technology Exchange. It was at Vanderbilt, Stanford, Michigan, five or six other schools that coursework within the MBA program was all about Japanese manufacturing techniques, how to program.

59:08 The head guy was a guy named Kaz Kawamura, who was a leading robotics guy. We defunded all of those programs so that Steve Schwarzman could fund a China program. But we've got the template. So if we, as a group of democracies decide to start partnering with Japan in a big way, and India and Korea and Taiwan, I am wildly optimistic because there's nothing that the Chinese are doing right now that the Japanese can't do.

59:37 And that story, that story of reconciliation, redemption is a good one. At a time when democracy and capitalism, quote, unquote, are unpopular. We, our financial industry, we are so popular amongst ourselves, and we think our fancy Ivy League schools are so fantastic and we think private equity is so obviously superior that we don't realize that outside of our little world, everyone hates us.

1:00:07 I mean, all three of those things have never had lower. The only people that hate more are Congress. But what do they love? They love Japan and they love the model it has, the products it makes, the things it does. So we can do that again. And Japan's opened the door to that. That's why they've done these deals on nuclear power and quantum computing and so on.

1:00:31 Now, what does that look like? There's a book called Japan Restored by Clyde Prestowitz. He answers that question. It imagines Japan in 2035 in a world in which the internal problems of China force it to retrench on its, its aggressive military expansion and China and Japan form a peaceful joint administration of Taiwan.

1:00:58 And we've moved on in a world which is basically Pax Naponica, which is Jesper's idea. And that's my best case. And I think that should be all of our best case. I think we should start working on it today. And every minute we spend invested in ByteDance and saying, oh, China has some things we can learn from too, is wasted opportunity to partner with Japan.

1:01:23 But I'm optimistic that if that works, that we could be sitting here and Japan's participation in our financial markets could perhaps reflect its importance in the real world. And of course, that's the bet that Warren Buffett's making. He's betting that what Japan does for his portfolio is also good for his country.

1:01:48 And ultimately, I think that's a very helpful case for Europe as well. Very good. Well, we've gone a little bit over an hour, so that's great. Appreciate you coming on, Andrew, and fascinating to get your perspective. Needless to say, very different to a lot of the guests that we have on. But that's makes for a good conversation and obviously people can check out the event that's going on and it will be available for replay the one that you referenced.

1:02:18 So people should check that out if they're interested in learning more about your work and your thoughts on Japan. But from all of us here at Top Traders Unplugged, thanks for tuning in. We'll be back again soon with more content. Alan, thanks so much. Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to your favorite podcast platform and follow the show so that you'll be sure to get all the new episodes as they're released.

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