Due to the long time it takes to pick winners, Warren Buffett was happy to be in Tokyo last month. Berkshire Hathaway’s recent move to increase its stake in five general trading companies has been hailed as a vote of confidence in the nation’s long-ailing corporate sector.
Buffett, who started accumulating stakes in the so-called sogo shosha three years ago, he sees the stake as a bet on a handful of neglected businesses poised for attractive profits.
Between conversations with some of the country’s top businessmen, the famous investor found time to share his impressions. “I’m just amazed,” he said of the five companies in which he now owns a 7.4 percent stake. “They are all different and all the same at the same time.”
It is not easy to give a more informative description of Japan’s trading companies. Each is a global corporate empire of staggering diversity, encompassing activities as diverse as apparel design, convenience store retailing and construction.
One thing all five companies have in common, however, is a focus on commodity trading — a fact that makes their cash flows unusually sensitive to the value of the dollar and the price of commodities such as minerals, grains and oil. .
The foreign currency income is a sogo shosha, supported by hard commodities from around the world, differentiates trading groups from companies whose revenues and costs are more dependent on domestic market prices. They create many ways for Buffett to profit from his investment, even if the trading firms’ vaunted plans to reinvent themselves in a world without fossil fuels don’t go according to plan.
Most exciting of all is the fact that Buffett bought shares in companies that earn a portion of their profits in dollars, while financing his purchases with long-term yen-denominated debt.
If the Japanese currency depreciates, the dollar value of Berkshire’s outstanding yen-denominated debt would decline. At the same time, the value of sogo shosha the stake in dollars cannot fall that much because of their foreign exchange earnings. If the value of the debt falls more than the equity, then Buffett can reap a profit without much change in the underlying business performance.
Buffett certainly has no intention of betting against the yen. Of course, buying borrowed shares in companies with significant foreign income is not the most practical way to do this. Put that doubt aside, if only for a thought experiment, and you can see how a trade like Buffett’s might, in theory, look attractive to a very different kind of investor.
Speculators with atavistic tendencies are increasingly suspicious of the monetary institutions of the developed world. Gold is hovering near all-time highs, and while the disruption of economic exchange systems should not be a basis for anyone, it is still uncomfortably close to the universe of historical possibilities.
Bridgewater founder Ray Dalio, whose investments are informed by a close reading of economic history, notices a striking pattern in the rise and fall of “reserve currency empires” over the past 500 years. During that time, he writes, “seismic shifts always came in the form of too much debt that couldn’t be paid with real money, so they printed a lot of money.” This in turn led to “major debt restructurings through debt write-offs and monetization”.
Such prospects seem remote in Japan, which has the highest ratio of public debt to gross domestic product in the G7, while experiencing a stagnant economy but no major upheaval.
For most of that time, central bankers tried to ignite the kind of low but steady inflation that fueled the economies of the industrial West. Despite trillions of dollars worth of bond purchases and years of negative interest rates, price increases have proved elusive until recently. Monetary policy is now expected to tighten.
Buffett is undoubtedly more focused on the growing profits of trading companies than on the possibility of currency arbitrage. With the exception of King Midas, whose mere touch can turn objects into gold, it’s hard to think of anyone whose temperaments seem unsuited to short selling any financial asset. However, investors are judged by the money they make rather than the stories they tell. When a sage like Buffett puts his fortune on the line, it’s worth paying attention to the circumstances that make his bet pay off.