Buffett’s intriguing bet on Japan

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Warren Buffett’s long record of picking winners made him a welcome presence in Tokyo last month. A recent move to increase Berkshire Hathaway’s stakes in five general trading companies has been hailed as a vote of confidence in the country’s corporate sector, which is suffering from a long crisis.

Buffett, who began accumulating shares in so-called sogo shosha three years ago, he sees the equity stakes as a bet on a handful of underserved companies that are poised for handsome profits.

Between audiences with some of the country’s leading businessmen, the famous investor found time to expand his impressions. “I’m just amazed,” he said of the five companies in which he now owns an identical 7.4 percent stake. “Everyone is different, and everyone is the same at the same time.”

It is not easy to provide a more informative overview of Japan’s trading companies. Each is a global corporate empire of bewildering diversity, spanning businesses as disparate as apparel design, convenience store retailing, and construction.

However, one thing all five companies have in common is a focus on commodity trading, a fact that makes their cash flows unusually sensitive to the value of the dollar, as well as to the price of commodities such as minerals, grains and oil. .

The earnings in foreign currency of the sogo shosha, backed by non-perishable raw materials from sources around the world, distinguishes trade groups from companies whose revenues and costs are more dependent on prices in domestic markets. They create multiple ways for Buffett to profit from his investment, even if commercial companies’ plans to reinvent themselves for a world without fossil fuels don’t proceed as planned.

Among the most enticing is the fact that Buffett has bought shares in companies that earn a portion of their profits in dollars, while financing his purchase with long-term yen-denominated debt.

If the Japanese currency were to depreciate, the dollar value of Berkshire’s outstanding yen-denominated debt would fall. At the same time, the value of the sogo shosha holdings in dollar terms may not decline as much due to their foreign currency gains. If the value of debt falls more than stocks, then Buffett could still profit even without much change in underlying business performance.

It is surely not Buffett’s intention to bet against the yen. And using borrowed money to buy shares in companies with significant foreign earnings is, of course, not the most practical way to go. Put that doubt aside, if only for a thought experiment, and you can see how a trade like Buffett’s could, in theory, look attractive to a very different type of investor.

Speculators of an atavistic tendency view the monetary institutions of the developed world with increasing mistrust. Gold is trading near all-time highs, and while a breakdown in the systems of economic exchange may not be anyone’s base case, it is uncomfortably close to the universe of historical possibility.

Ray Dalio, the Bridgewater founder whose investments are based on a close reading of economic history, sees a striking pattern in the rise and fall of “reserve currency empires” over the past 500 years. Throughout that time, he writes, “seismic changes always took the form of overly large debts that could not be paid with real money, so there was a great deal of money printing.” That, in turn, “led to large debt restructurings through debt write-downs and monetization.”

Such prospects seem remote in Japan, which has navigated the highest public debt to gross domestic product ratio in the G7, enduring a stagnant economy but no serious disruption.

For much of that time, your central bankers have tried to ignite the kind of low but steady inflation that fueled economies in the industrial West. Despite trillions of dollars in bond purchases and years of negative interest rates, until recently price increases have proven elusive. Monetary policy is now expected to tighten.

To be sure, Buffett is more focused on increasing the profits of trading companies than on any possibility of currency arbitrage. With the possible exception of King Midas, whose mere touch could turn objects into gold, it’s hard to think of anyone who seems so temperamentally unsuited to shorting any financial asset. However, investors are judged by the money they make, not the stories they tell. When a wise man like Buffett bets his fortune, it pays to pay attention to the circumstances that would make his bet worthwhile.

mark.vandevelde@ft.com