Japan, the world’s second largest economy, officially entered into a recession in the third quarter, as growth shrank at an annualized rate of 0.4% after posting a second-quarter contraction of 3.7%. Japan’s downturn is worse than many economists had expected and could worsen, as consumers in the United States continue to retrench.

“Downside risks to the economy are growing further,” Kaoru Yosano, Japan’s finance minister, told reporters. “Japan is in a very serious situation.”

Japan’s domestic economy remains weak with declining wages and rising unemployment. But the greater danger is a sharp drop in exports, especially to the United States. Net exports shaved 0.2% off of growth, as imports outweighed a slight increase in overseas shipments.

Exports rose just 0.7% in the third quarter, less than the 1.2% forecast. Meanwhile, imports climbed 1.9%, as the cost of oil spiked in the July-September period.

Trade accounts for just 17% of gross domestic product (GDP), but it is the country’s only true growth engine. And the United States accounts for more than 25% of Japanese exports, which leaves the economy extremely vulnerable to a U.S. slowdown.

With U.S. demand stifled by the credit crunch, declining exports are squeezing the profits of large corporations and forcing smaller companies into bankruptcy. Japanese companies cut spending on new factories and machinery by 1.7% from the previous quarter, the third consecutive quarterly decline.

Canon Inc. (CAJ), the world’s largest camera maker, last month predicted profit growth would fall for the first time in nine years. The company said it would be forced to cut capital spending for the year by 4.7% to 410 billion yen as a result. Toyota Motor Corp. (TM), world’s largest carmaker, said its profit will fall by almost 70% this fiscal year, forcing the company to fire 3,000 employees by March. Toyota makes more than three-quarters of its sales abroad.

Corporate bankruptcies rose 13.4% to 1,429 in the month of October, the highest level in five years.

“We need to bear in mind that economic conditions could worsen further as the U.S. and European financial crisis deepens, worries of economic downturn heighten, and stock and foreign exchange markets make big swings,” Yosano said.

The Organization for Economic Cooperation and Development (OECD) predicts the Japanese economy will contract by 0.1% in 2009. However, the Paris-based group forecast much steeper declines for the United States and Europe.

The Eurozone – the 15 countries that use the euro – is already in recession, having contracted by 0.2% in both the second and third quarters of 2008. And the economy of the 27-nation European Union (EU) also shrank by 0.2% in the three months ended September. The U.S. economy shrank 0.3% in the third quarter and the fourth quarter is shaping up to be much worse.

The OECD forecast a 0.5% decline for EU next year, and a 0.9% decline in the United States.

“This will be a long but uncomplicated downturn for Japan,” Takahide Kiuchi, senior economist at Nomura Securities, told The International Herald Tribune. “Japan will take a hit on exports, but it has no big structural problems to fix, unlike the United States.”

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• IHT:
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Mitsubishi UFJ Financial Group’s (ADR: MTU) $3 billion bid to obtain California’s UnionBanCal Corp. (UB) suffered a blow yesterday (Thursday) when a shareholder advisory committee determined the offer price was too low.

“The proposed price does not reflect the strength of UnionBanCal’s strong capital position, the superior credit quality of its assets, and its potential for profitable asset and core deposit growth in the current market environment,” Richard Farman, chairman of the special committee said, The Financial Times reported.

Soon after the $3 billion offer was announced, investors bid the share price higher. Shares closed at $65.46, yesterday, over $2 more than Mitsubishi’s offer price.

The $63-a-share offer, “is not in the best interest of UnionBanCal’s minority stockholders,” the bank said in a statement.

UnionBanCal’s majority stakeholder is, of course, Mitsubishi itself. The Japanese financial group currently controls 65% of UnionBanCal shares. Many analysts anticipate a higher bid as Mitsubishi seeks full control of its American investment.

“If Mitsubishi UFJ offers a little bit more, I think the deal will go through smoothly,” Edwin Merner, president of Tokyo-based Atlantis Investment Research Corp., told Bloomberg News. “Both Wells Fargo & Co. (WFC) and Bank of America Corp. (BAC), the other two big banks in California, will have to back off now for a while, so it’s a great chance for Mitsubishi UFJ.”

The advisory committee said it was opened to continued negotiations with Mitsubishi, lending weight to the theory that a sweeter offer might be all that’s needed to close the deal.

“It is pretty much standard form in the U.S. [to reject an offer]. Those independent directors have a legal obligation to protect the interests of minority shareholders,” Brett Hemsley, banking analyst at HSBC in Tokyo, told FT.

Hemsley went on to say that while a $68 per share offer might seem expensive, compared to the average share price of other beaten down American financial shares, many U.S. banks “have problems that Union Bank of California doesn’t have.”

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• The Financial Times:
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Japanese companies and local governments must now measure the waistlines of all employees and family members over the age of 40.

According to this new health-care initiative – which started this week – men whose girth exceeds 33.5 inches and women whose waistlines exceed 35.5 inches are considered overweight.

The new guidelines affect nearly 56 million people, or roughly 44% of Japan’s total population. They’re based on studies done by the International Diabetes Federation in 2005, which looked at size and weight thresholds and used them to identify health risks.

Individuals who fail to meet these standards won’t be penalized or have to pay up personally. But their employers will – in the form of penalty payments and higher health-care premiums for every additional inch – thanks to this new waistline law that’s aimed at slimming down this island superpower.

As reported on CNN, NEC Corp. alone faces $19 million in such penalties. Other companies find themselves in a similar spot and could potentially owe hundreds of millions of dollars in punitive health-care fines.

Naturally, the law is controversial, with many believing that it’s at the very least unnecessary – and perhaps even represents an intrusion on a person’s individual liberties. However, others think it’s a very timely initiative, as well as one that’s badly needed.

Either way, the Ministry of Health aims to achieve its goal of reducing the Japanese overweight population by 10% in the next four years and an enviable 25% during the next seven years. It also intends to dramatically reduce national health-care costs at the same time.

The reason?

"Big" people have never populated the nation – but the people are getting bigger.

Since World War II, the average Japanese citizen has gained between three and six inches in height, 20 pounds in weight and, evidently, a bit too much around the waist. While the root causes are subject to debate, much of it comes down to more advanced medicine, changes in lifestyle and, to be perfectly blunt, and the introduction of Western foods including – you guessed it – fast food.

For years in Japan’s company cafeterias – long the domain of harried salary men eating quickly in order to get back their desks – a typical Japanese meal consisted of fish, pickles, some rice, and perhaps green tea, a accounts for between 600 and 800 calories. But Western alternatives – a McDonald’s Corp. (MCD) hamburger meal, for example – can tip the scale at nearly 1,400 calories.

My personal favorites includes the Godzilla-sized "Mega Macs," which weigh in at 754 calories and contain a staggering 45.9 grams of fat, and the "Mega Teriyaki" which, thanks to its sweet lemon sauce and sugary teriyaki sauce, muscles up at 903 calories and 64.3 grams of fat all by itself!

(And I’m being sincere in labeling these as "personal favorites" – because they’re really tasty – even though I can practically feel my arteries clogging up as I eat them.)

While I’m not a social scientist, nor do I pretend to have any special analytical powers, I have spent long stretches in this region during each of the past 20 years, meaning I’ve got plenty of anecdotal evidence that seems to support the data.

For instance, many younger Japanese are taller than they were in the past. When I first started going there in the late 1980s, I towered over most of my Japanese counterparts. Now we stand eyeball to eyeball. My wife, who at 5′6" was regarded as tall when she was growing up, is now average height.

In general, Japanese kids are also bigger, which is painfully evident – literally – as modern-day children try to cram themselves into school desks designed and installed in schools across that nation generations ago. Many actually have to duck when entering and exiting buildings with ceilings and doorways that are now too "low." Still others can’t sleep comfortably on traditional tatami mats, which were the measuring standard for hundreds of years, because the mats are now too short.

With change, however, comes opportunity.

Companies that design, manufacture and sell comprehensive obesity-management programs – not just games, or such one-off items as pedometers, scales and the like -stand to make out big.

One such firm is Konami Corp. (ADR: KNM), which we twice rode to profits (once 49.91% and then 39.31%) earlier this year in our sister publication, The Money Map Report. While most people know Konami as a video-game maker, the company actually operates a string of health-care clubs and is at the center of Japan’s new "healthy" movement.

Showing some real forward thinking, Konami has been able to market some of its leading games, like Dance Dance Revolution, as physical-education programs and medical devices. And those products are now being adopted worldwide by frazzled physical education teachers who find themselves faced with unmotivated, overweight kids. The problem is particularly acute here in America, where as many as 17% of our children are now obese, according to various studies.

Not only do such games offer an alternative to traditional exercises, but they’re also approved medical devices. And that means that school systems can introduce them – and count on insurance companies footing some, or all, of the bill.

Nintendo Co. Ltd.’s (OTC ADR: NTDOY) Wii is taking the same approach. With its Wii Fit programs, the company appears ready to duke it out in what may well be a newly emerging class of entertainment – video-weight-management programs.

In China, where Yum! Brands Inc. (YUM) has more than 3,000 restaurants – and where its KFC outlets are the dining venue of choice for many middle class Chinese consumers – we expect a similar onset of obesity. In fact, during my most recent trip there, I observed bigger Chinese in general than I’ve ever seen before.

Weight management is clearly becoming an issue there, too. And mark my words: Obesity will be an ultra-sensitive topic for the Chinese, who have long regarded fatness as a sign of prosperity, wealth and good fortune.

But that neither diminishes its potential impact nor the opportunity when it comes to profiting from the fight against obesity.

While it’s too early to predict choices there, our best guess is that companies like online-game developer Perfect World Co. Ltd. (ADR: PWRD) will adapt the single-player concept to reflect the Chinese predisposition toward massive multiplayer online adaptations. As a result, it will introduce new games that haven’t even been contemplated, yet.

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By Jason Simpkins
Associate Editor

Barclays PLC (ADR: BCS), the United Kingdom’s fourth-largest bank, may get a $927 million cash infusion from Japan’s Sumitomo Mitsui Financial Group Inc. by the end of the month. The investment, which will be made through the group’s Sumitomo Mitsui Banking Corp. unit, underscores an evolving trend among large Japanese banks that have so far been unaffected by the subprime collapse.

Sumitomo Mitsui, Japan’s second largest bank, has not confirmed the agreement, but its 100 billion yen investment will secure an approximate 2.3% stake in Barclays. Barclays was racked by the housing collapse that started last year and has since dragged the U.S. economy to near recession. Barclays’ stock dropped 40% so far this year, as the bank took $3.35 billion in write-downs.

Last week, Barclays said it would seek out $7.8 billion in fresh capital from sovereign wealth funds, in a fresh share offering. Singapore’s Temasek Holdings, China Development Bank, and the Qatar Investment Authority are among the sovereign wealth funds reported to be interested in Barclays.

“This fixes the problem quite neatly for them,” Mike Trippitt, a banking analyst at Oriel Securities told The Independent. “They are signalling that at the moment there don’t seem to be any further writedowns. If you have got sovereign wealth funds buying in with a medium-term view you might argue that it signals some visibility.”

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Barclay’s ratio of Tier 1 capital, a measure of financial strength, was at 5.1% at the end of 2007. Raising $8 billion would lift it to nearly 6%, analysts said.

Banks and securities firms have raised about $303 billion in the past year after almost $400 billion of write-downs and credit losses caused by the collapse of the U.S. subprime mortgage market, according to Bloomberg data.

Sumitomo Mitsui would be the second major Japanese bank to participate in the rescue effort of a Western financial institution struggling to emerge from the subprime crisis.

“This indicates that Japanese banks are in a safer position than their global peers and have surplus capital to invest,” Masafumi Oshiden, a Tokyo-based fund manager at BlackRock Inc. (BLK), told Bloomberg. “It’s a good move for them and I’d like to see them being even more aggressive.”

In January, Mizuho Financial Group pumped $1.2 billion into Merrill Lynch & Co. Inc. (MER) through the purchase of preferred shares. And many analysts believe there is more investment to come as Japanese banks, which find themselves in a relatively strong position, become more assertive with their overseas acquisitions.

“Under these circumstances I think that Japanese financial institutions are in a position to take an aggressive attitude… it is a change that should be very much welcomed,” Yoshimi Watanabe, Japan’s financial services minister, told the Times Online.

News and Related Story Links:

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By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

From my vantage point on my recent visit to both China and Japan, the signs are clear.

China is coming. And Japan knows it.

Major department stores like Takashimaya Co. Ltd., Sogo Co. Ltd. and Mitsukoshi Ltd. are gearing up. In places like Tokyo, Osaka and Kyoto, they’re seeing a new wave of power shoppers at their counters – the Chinese.

A few short years ago, this was unthinkable.

Yet, as my wife and I strolled through downtown Kyoto, we saw it too. Most major department stores have added Chinese signage to the usual Japanese and English placards.

We heard it, as well, from Chinese shoppers who were tromping through the Shijo-Kawaramachi shopping district loaded down with bags sporting the latest designer logos. It’s much the same in Tokyo’s uber-rich Ginza district as well where Mitsukoshi has recently hired store-based interpreters fluent in Mandarin.

I can’t say I’m surprised.

According to the Japanese Department of Tourism, a record high of nearly a million Chinese tourists came to Japan last year. China’s Ministry of Public Security estimates that 34.5 million Chinese headed for foreign destinations in 2006 – up from a mere 4.5 million a year earlier. By 2011 that figure is expected to top 80 million with Hong Kong, Macau, Vietnam, South Korea and Japan predicted to account for 85% of all Chinese tourist destinations according to Euromonitor International.

And they’re spending big bucks, too.

CNN reporter, Kyung Lah, interviewed one group of mainland Chinese tourists recently that had spent $50,000 dollars on clothing and makeup alone on a 3-day trip. Not surprisingly, most of that was on designer brands from Prada Group, Gucci Group NV (PINK: GUCG), Christian Dior SA, and Shiseido Co. Ltd. (OTC: SSDOY).

Which jibes with my personal experience as indicated by Chinese and Japanese I’ve spoke with over the years. Whereas most of them used to only dream about traveling, an increasing number are actually doing it. My good friend Jun Hao and his wife have hit most of Europe’s major cities and a good deal of the United States, too.

Getting back to Japan, however, it may surprise you to learn that most Chinese feel very comfortable there. A fact that stands in stark contrast to how relations between the Japanese and Chinese are often portrayed in the Western media.

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It’s now a common sight in Tokyo to see Chinese who are shopped out make a beeline for Toyota Motor Corp.’s (ADR: TM) showrooms. Obviously, they’re not buying Toyota’s in Japan, but boy are they anxious to buy Toyota’s in China.

And a visit to the showroom is just what the doctor ordered for young, cosmopolitan Chinese yuppies… or “Chuppies” as they’re called.

Not only do they feel more international for having done so, but Chinese tourists tell me they find Japan quite welcoming. And warm, which is another one of those words than can be translated a variety of ways.

Not one citizen of China or Japan that I’ve recently spoken with believes that the political past between their respective countries would prevent an economic future.

Investors looking to capitalize on the blossoming relations between the two countries and the tourism trade specifically need to look no further than Japanese department stores, Chinese credit card companies and, ironically, Toyota to get in on the action.

Of course, there are obvious choices when it comes to computerized travel providers and airlines.

But the value there may be harder to extract given there’s not a clear value proposition and the industry remains largely fragmented… for now. And that’s part of what makes Money Morning’s growth “because” of China – and Japan – investing strategy the way to go for now.

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There’s an incredible story taking place in Asia.

Based on my 20 years of experience in the region and formal academic study, you can believe me when I say that this may well be the most pivotal event in 20 centuries of Sino-Japanese relations.

We’ve reported some of this to you already. But the mainstream Western press hasn’t latched on to it.

That’s not to say they haven’t reported what happened when Japanese Prime Minister Yauo Fukuda hosted Chinese President Hu Jintao during the historic summit the two held in Tokyo last month – the press reported everything that "happened," and did so exceptionally well.

However, like so many things in Asia, mainstream journalists completely missed the subtleties and, not surprisingly, that’s where the real story usually is.

But you’ve got to know how to read between the lines to get at the "real" meaning of what was said.

Here’s why.

When translating both Chinese and Japanese to English, there are both literal and figurative translations to consider. Frequently, inexperienced commentators (and even experienced ones) will provide one without the other.

And that’s too bad, because it’s the context that’s "everything" in Asia – and I mean that literally.

Unlike Western romance languages – which descended from the resconstructible Proto-Indo-European language family, and which are logically oriented – Chinese languages are commonly believed to have descended from the Proto-Sino-Tibetan family while Japanese is understood to have come from a context-driven lexical borrowing process in the region.

As a result, Western languages are frequently blunt and to the point, while both the Japanese and Chinese languages historically rely heavily on context and symbolism: In other words, the "real" meaning is not the words, but is instead found in the symbolism associated with those words.

And that’s not exactly something you can explain in a 10-second CNN sound bite, so most news stations don’t bother.

For instance, during their historic five-day Summit last month in Japan, Prime Minister Fukuda and China President Hu agreed to make 2008 a year for boosting their nation’s "mutually beneficial relationship."

I was sitting in Kyoto when I heard that, and I was stunned. I’ve spent two decades studying, living in and working in Asia, and in all that time I couldn’t recall any of the prior leaders of the two countries ever sharing a more-direct, more-powerful statement.  And neither could the Chinese and Japanese I spoke with that day because the words represents the single most important thaw yet verbalized in the decades old animosity dating back to World War II.

While most Westerners expected them to "settle affairs" by making some reference to historical events that have badly strained bi-lateral relations in recent years, both leaders deliberately avoided doing anything like that during their five-day meeting. And, by doing so, each side was able to state his case to the other’s countrymen without "losing face," which is pivotally important to both countries and cultures.

Similarly, President Hu’s remarks that he’s looking forward to a "warm spring" between the two countries were translated quite literally by the Western media, although the comment had an entirely different meaning to Asians. To Asians, the comment is symptomatic of far deeper, and more intimate, nationalist feelings on a variety of personal and state levels.

By stating his desire for a "warm spring," President Hu was making an allegorical reference to the importance of producing a bountiful rice harvest. And the reason why this makes sense to Asians is that rice has been pivotally important to both cultures for a millennium or more. That crop has enabled both cultures to make the transition from hunter-gathers to farmer, and it is also central to religious and social festivals in both countries, as it has been for thousands of years.

By referencing rice farming, President Hu was very deliberately reaching deep down into the core of both nations and sending an important message to millions of Japanese and Chinese citizens that China is ready to put the past to rest and look to the future.

In a more Western fashion, the two leaders also agreed that "long-term cooperation for peace and friendship" is the "only choice left" for both countries.  This, too, is full of hidden meaning: It’s an unprecedented signal that both nations are preparing to (finally) put the horrific events – and the long-lingering bad feelings – of WWII behind them.

By putting this rancor to rest, each country will now be free to make major investments in the other’s economy – much more so than they’re doing even now.

If history is any guide, then some of the most significant Sino-Japanese trends of the future are likely to begin at the intersections of companies just now starting to flourish.

Of course, there will be course corrections along the way, but that didn’t hurt relations 20 centuries ago when Japan and China were very close – and those corrections won’t hurt them, now.

The important thing is to embrace change as it occurs.

For investors, one of the biggest profit opportunities will be with companies that are helping China build out its infrastructure and build up its consumer sector, which is why such companies as solar-ceramics maker Kyocera Corp. (ADR: KYO), and trading giant and independent power plant developer Mitsui & Co. Ltd. (ADR: MITSY), are logical choices.

In addition to seeing Japanese companies like these focusing their sights on the China market, we’re likely to see Chinese companies doing the same with Japan. While it’s not yet clear who those companies will be, it is clear to us that the initial entrée will likely be from one or more of China’s sovereign wealth funds.

Our best guess is that China investors will prefer key targets like those traded on the Tokyo Stock Exchange – especially companies that have an expertise in environmental protection and energy-saving technologies.

We also think China will make a run at construction companies with experience in large-scale infrastructure and national-building projects – all of which are in exceptionally high demand in China.

[Editor's Note: For additional China profit plays, check out this special Money Morning offer that includes a free copy of investing guru Jim Rogers' new bestseller, "A Bull in China." The book details Rogers' investment outlook for China plus his opinion on dozens of China-based public companies.]

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• Wikipedia:
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• All Academic Research:
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• Money Morning Economic Commentary:
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Chinese President Hu Jintao and Japanese Prime Minister Yauo Fukuda met recently and signed some modest cooperation agreements. That doesn’t sound much to get excited about, until you consider how well the Chinese and Japanese economies fit together.

Think of it this way: With China’s boundless supply of low-cost labor and Japan’s superb education system – and an ability to work together that’s clearly founded on considerable commonality of thinking – these two countries, as a pair, will be world-beaters.

In fact, they’ll be world leaders.

The Past has Passed

The summit – while modest – marked an important policy change from the mutual hostility during the premiership of Junichiro Koizumi, whose tilt to the United States and suspicion of Chinese motivations was symptomized by his love of Elvis Presley and visits to the Yasukuni Shrine, controversial because it includes convicted World War II criminals. Nevertheless, while Japan and China have many historical reasons to hate one another, so did France and Germany after World War II, and those countries have now been partners for more than 50 years in the European Union. Thus, a close economic partnership between Japan and China is by no means unthinkable.

Economically, China and Japan have much to offer each other. Both have shortages of raw materials and strong manufacturing sectors. However, the relative shortage of labor in Japan’s aging society, its superb education system and the surplus of labor in China all combine to make them natural partners. Already, Japan is China’s second-largest trading partner, taking 10% of its exports and supplying 15% of its imports. Conversely, China in 2007 surpassed the United States as Japan’s largest trading partner, taking 14% of its exports and supplying 21% of its imports.

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Between them, China and Japan have a population of 1.4 billion people, more than twice that of the European Union or the North American Free Trade Association. Their combined gross domestic product (GDP) of $8.4 trillion at market exchange rates in 2007 was about half that of the EU or NAFTA, but was combined with growth of 7% in 2007, a current account surplus of $560 billion (compared with deficits in the EU and the United States) and foreign exchange reserves of $2.4 trillion.
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Thus, even a loose bilateral trade association between China and Japan would be a powerful economic force. Free trade and free movement of labor between the two countries would enable them to deepen their economic relationship still further, making the Japan-China trade axis the most important in the world – even more so than any bilateral U.S. relationship. Longer-term, an EU-style economic union – perhaps including such neighbors as Korea, Taiwan and Vietnam – could become the world’s leading economic power, surpassing even the United States and the EU itself.

As a U.S. geo-strategist, one worries somewhat about this. The United States has traditionally been able to count on Japan as a counterweight, both economically, and to a limited extent, militarily against a resurgent and aggressive China. That no longer seems to be so certain; an immensely powerful alliance between Japan and China might develop into the United States’ military equal, and would certainly be animated by a world view very different from that of the United States or, indeed, the EU countries.

As an investor, one rejoices in it and seeks to find sources of future profit from the two countries’ deepening relationship. One such source of profits are major Japanese companies such as Toshiba Corp. (PINK: TOSBF). This major manufacturer of computers, medical electronic equipment and telecommunications systems has developed a highly integrated manufacturing capability in China, enabling it to synergize its technical innovation with China’s highly skilled, low-cost workforce. Toshiba’s shares are trading at about 22 times earnings, reasonable for a high-tech company.

Another might be a Chinese automotive manufacturer such as Brilliance China Automotive Holdings (ADR: BCAHY), already a strong automobile and bus manufacturer in the Chinese domestic market, which has a joint venture with Bayerische Motoren Werke AG, better-known as BMW, and potentially can benefit from its lower labor costs to attack the Japanese market. As relations between China and Japan improve, and tariff and non-tariff barriers in Japan are reduced, companies such as Brilliance may be major beneficiaries.  Brilliance China trades at a pricey 48 times earnings, as it has only recently returned to profitability in the highly competitive Chinese automotive market, but its long term prospects appear excellent.

There are two categories of beneficiaries from a trading relationship between China and Japan that’s closer and more-barrier free.

The first group consists chiefly of Japanese high-tech companies that are able to take advantage of China’s lower labor costs and more-profitably attack the world markets.

The second group consists of low-cost, China-based manufacturing companies that can sell to Japan as a particularly juicy nearby market with similar cultural and taste characteristics – unlike the unfamiliar west.

Both types of companies are likely to be big long-term winners from this trend.

[Editor's Note: For additional China profit plays, check out this special offer by Money Morning that includes a free copy of investing guru Jim Rogers' new bestseller, "A Bull in China." The book details Rogers' investment outlook for China plus his opinion on dozens of China-based public companies.]

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• Wikipedia:
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• Wikipedia:
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• San Francisco Chronicle:
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• Auto Industry UK:
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• Wikipedia:
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KYOTO, JAPAN – On one of my first mornings at our home here, my family and I headed for the Fushimi Inari Taisha shrine. Built in the 8th century by the powerful Hata family, the shrine is best known for the four consecutive kilometers of orange Torii gates covering the mountain on which it was built.

My wife’s family has been coming here for centuries, making it a familiar and comfortable place that we enjoy very much.

It’s also a spot that tends to put things into perspective – like the Bank of Japan’s recent decision to keep its key interest rate at 0.5%.

So why is this move by Japan’s central bank important? That’s easy.

We’ve been hearing for years how the Japanese economy is poised for a recovery. And each New Year is supposed to be "the" year – yet it just somehow never seems to happen – at least according to folks who don’t spend as much time here as I do.

Sure Japan went to hell and back during the "Lost Decade" that stretched from 1990 – 2000, but this country’s economy is recovering – even if the securities markets don’t yet reflect this: They’re up only marginally so far this year.

But that speaks volumes about what investors should expect when thinking about Japan. For instance, the beautiful young elevator ladies who used to grace Japan’s top department stores have vanished. Yet, individual customer service remains better than ever.

Many of the so-called boutique shops have also faded into the sunset. But those shops have been replaced by multi-sale retailers and Internet shops, all of which are going great guns.

This suggests companies are becoming more cash sensitive even as they’re becoming more aggressive. So are Japanese consumers. It’s a trend that’s moving Japan along quietly, if steadily.

But what’s really interesting to me after having spent 20 years in and out of Japan is the number of students who now are studying Chinese, as well as English.

Like the Japanese companies and consumers that are driving the "stealth recovery" here, students who want to get ahead are doing all they can to learn more about their neighbor, including the language.

They understand that they have to look beyond the labels that say "Made in China," and consider the growing Chinese consumer class – especially China’s emerging middle class, which is already 325 million strong.

While some experts claim that the two nations, Japan and China, will never be friends because of World War II era animosity, those with a far longer perspective acknowledge that the two actually were very close – centuries ago. Much of Japan’s writing system, religious roots and even early architecture came directly from China’s royal courts more than 1000 years ago.

The two nations will be close again.

The best way investors can capitalize on this eventuality is not to buy the broader Japanese indices. Those will merely pick up the has-beens, wannabes and never-wases. It’s far better to concentrate on those companies that are already working closely with China.

The companies in this category firmly understand the regional dynamics at play today. But, more importantly, they understand just what the future is going to look like, and are already preparing for business dealings with China – and the Chinese consumer.

Some great choices if you want to cash in include solar-ceramics maker Kyocera Corp. (ADR: KYO), trading giant and independent power plant developer Mitsui & Co. Ltd. (ADR: MITSY), and even Toyota Motor Co. (ADR: TM), which is now the world’s No. 1 automaker, and (as Money Morning just reported) also has branched out into commercial jetliners.

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Since I’m scheduled to head back down the mountain shortly, I’m going to close this out (yes, for those of you who are wondering, I really am writing on my laptop thousands of feet above Kyoto) so that I can check in on the summit between Chinese President Hu Jintao and Japanese Prime Minister Yauo Fukuda.

It’s the first visit by a Chinese head of state in a decade.

I’ll have more to say about that visit in the days to come. And I’ll be returning to the United States fairly soon, too. I’ll keep you posted.

News and Related Story Links:

• Wikipedia:
  Bank of Japan.

• Bank of Japan:
  Home Page.

• Money Morning Special Report:
  Mitsubishi and Toyota to Lead Japanese Dream Team into a Global Dogfight for a New Regional Jetliner.

• Wikipedia:
  China President Hu Jintao.

• San Francisco Chronicle:
  Japanese Prime Minister Yauo Fukuda.

It’s one of the biggest product-development programs in Asia right now, and it could easily determine whether Japan remains a global industrial powerhouse – or limps into the future as an international has been.

More than 30 years after Japan’s only airliner program since World War II ended as a commercial failure, the country is making a multi-billion-dollar bet that it can succeed in the jetliner market.

Japan’s Mitsubishi Heavy Industries Ltd. (PINK: MHVYF) has unveiled a plan  to develop a "regional" jetliner for use by airlines all around the world.  The controversial project gained global credibility in recent weeks after analysts began to speculate that Toyota Motor Corp. (TM) – the world’s No. 1 automaker by sales – would join the development team. Toyota subsequently confirmed its involvement, announcing plans to take a 10% stake in the venture and injecting $67 million to help get the initiative off the ground. The Japanese government is backing the program.

It’s a big gamble for Mitsubishi and its partners: The regional airliner market is right now dominated by Bombardier Inc., of Canada, and Embraer (Empresa Brasileira de Aeronautica SA) (ERJ) of Brazil. And firms in both Russia and China – each with a major U.S. corporation as a partner and co-pilot – already have targeted this market, and have a solid head start on the Mitsubishi team.

Still, the potential payoff is hefty enough to warrant the risk. Such key global trends as rocketing fuel prices, soaring global travel, fast growth in Asia, Latin America and the Middle East, and ongoing problems with major air carriers across the world are stoking worldwide demand for efficient, economic regional jets. And that demand could persist until 2030, many experts predict.
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"In terms of the macro picture, demand is there for this type of jet," Mizuho Investors Securities Co. Ltd. senior analyst Yuichi Ishida told the Reuters news service. "Money-losing regional routes could turn profitable by using them. But the real question is whether there is room left in this market for Mitsubishi Heavy."

To date, the so-called NAMC YS-11 – a turboprop airliner built by a Japanese consortium – is the only commercial aircraft made in Japan in the post-World War II era. The program was initiated by Japan’s Ministry of International Trade and Industry in 1954. The aircraft was rolled out in 1962 and production ended in 1974 – hardly qualifying it as a "success" from a financial standpoint.

Toyota’s Desire to Fly

Toyota said its motivation was primarily patriotic – the Mitsubishi jet is being backed by the Japanese government, which is searching for ways to for its smallish aerospace business to become more of a global player, especially after losing other industries to South Korea and China.

Toyota – which edged ahead of General Motors Corp. (GM) in the first quarter to become the world’s top-selling automaker – said it also would be looking for ways to adapt the technological know-how developed in its aerospace activities to its core automaking business. That’s not just an empty claim made to justify its diversification into the aerospace sector: The Mitsubishi MRJ70 (70 seat) and MRJ90 (90 seat) jetliners are to be the first regional jets to make extensive use of high-strength/lightweight "composite" materials, such as those found on the new 787 Dreamliner being developed by U.S. aerospace giant, The Boeing Co. (BA).

Although it hasn’t built a commerical aircraft in decades, it is an experienced subcontractor in that area, and is a veteran defense contracting firm. For example, Mitsubishi already is a key manuacturing partner on the long-range Boeing jet. And it has experience building such military aircraft as the F-1 fighter, T-2 trainer – both supersonic jets that the company built on its own – and the F-2 fighter, a Japanese-built version of the U.S. F-16 Fighting Falcon that was produced in partnership with Lockheed Martin Corp. (LMT)., the No. 1 U.S. defense contractor.

Toyota, too, has some experience, and already operates a small aerospace research team. Analysts say that venture could easily take flight and become a major business operation. That’s just what happened with Toyota’s robotics business, which started out as a fairly tiny research operation, but today is one of the company’s better-known businesses outside its core auto operation.

Honda Motor Co. (HMC), Toyota’s chief rival in Japan, already has expanded into the aircraft business; its futuristic seven-seater HondaJet light business jet has garnered heady praise for its advanced design and elegant lines. The company was supposed to start taking orders for the airplane sometime this month.
Toyota’s investment in the Mitsubishi jet is the largest of any company outside the Mitsubishi corporate network, or "keiretsu" of related companies. Other backers include domestic Japanese trading companies and the government-supported Development Bank of Japan. Foreign suppliers also will be involved.

 To Market, To Market

Why is Mitsubishi – Japan’s largest producer of machinery – getting into the airliner business? In a word: Opportunity.

Over the next 20 years, Boeing itself is forecasting that air carriers worldwide will need to acquire 28,600 commercial aircraft of all types – with a potential value of $2.8 trillion. The Boeing forecast is generally viewed as the world’s best analysis of the future global market for commercial airliners and cargo aircraft.

The huge revenue potential in the global airliner market – combined with the low number of viable competitors and the high barriers faced by new potential entrants – is a big reason that Money Morning’s investment gurus have repeatedly mentioned Boeing as a promising global investment for years to come.
During that same 20-year stretch addressed by Boeing’s market forecast, China will have to buy 3,400 airliners, a requirement worth $340 billion. That will make China the fastest-growing airliner market in the world, and will also rank it as the biggest market outside the United States for new commercial airliners. In fact, if you average it out, from China alone you’re talking about sales of $17 billion a year for the next two decades.

This staggering shopping list will include the globetrotting tarmac queens being built by Boeing and European rival Airbus SAS.

But global forces also are revving up demand for regional jetliners, like those being dreamed up by Mitsubishi.

According to Mitsubishi, the world’s airlines will order 5,000 regional jets over the next two decades as global carriers seek out fuel-efficient airplanes for shorter routes and developing nations expand their airliner fleets to fuel economic growth.

That’s not an arbitrary figure, either: The company spent several years analyzing the market and projecting the potential demand for the jet, and designed the specifications specifically around its findings. The plane will be:

• Small, so it can fly out of regional airports.
• Made of lightweight composites to make it strong and fuel efficient.
• Fast (with cruisng and maximum speeds of between 0.78 and 0.82 times the speed of sound, according to published reports).
• Profitable to operate, carrying 70 to 90 passengers, depending upon the model.
• And with a good range – 920 nautical miles for the base model, although extended-range (1,400 nm) and long-range (1,960 nm) versions will be available.

"Mitsubishi Heavy has always been just a partner of Western aircraft makers," Mitsubishi Heavy President Kazuo Tsukuda said at a news conference that talked up the company’s pet project. "Now we want to take advantage of changes in the marketplace such as high fuel costs and a greater need for environmentally friendly aircraft."

But here’s the problem: Mitsubishi isn’t the only player to see that potential.

And the competition figures to be pretty intense.

Just look at Vietnam: With all the changes that country’s economy is enduring, and with all the aircraft that will need to be upgraded to keep pace with global competition, Vietnam could well serve as a case study for the swirling market dogfight that Mitsubishi is accelerating into.

The Impact of Global Change

The over-under action should be interesting. Vietnam’s domestic carriers – state-owned Vietnam Airlines and joint-stock Pacific Airlines – will soon be forced to make room on that nation’s runways for some privately operated rivals, according to a recent report by the VietNamNet Bridge news service. Vietjet Air will be the first wholly private firm when it launches its domestic service late this year or early next year. When that happens, it will actually be the fourth carrier in Vietnam, joining Vietnam Air, Pacific Air and cargo carrier Vasco (Vietnam Aviation Services Co).

And state-run Vietnam Air is soon to be privatized, meaning it will have to modernize its fleet of 45 aircraft, a mix of aging Airbus, Boeing, ATR and Fokker commercial planes if it’s to compete against the new domestic rivals – and the host of foreign competitors that count Vietnam as one of their stops.

"We want to be one of the leading regional carriers," Bach Quoc Thang, Vietnam Airlines’ general manager for corporate affairs, said in an interview earlier this year. "Singapore Airlines and Cathay Pacific are the examples we want to follow."

According to some industry sources, Vietnam’s main carrier also may look to transform subsidiary Vietnam Air Service Co. into a low-cost carrier, to take on Pacific Airlines, part-owned by Australia’s Qantas Airways Ltd., and Malaysia’s AirAsia Berhad, now in partnership with Vietnamese shipbuilder Vinashin.
To secure financing for any new planes, Vietnam now has a newly established leasing company – its first – which has been capitalized with $200 million from Vietnam Air, Vietindebank, Petrovietnam and telecom group VNPT.

Here’s where it gets interesting. Vietnam Prime Minister Nguyen Tan Dung must soon decide which long-range jets to buy for Vietnam Air; that’s why both Boeing and Airbus have intensified their lobbying efforts.

Canada’s Bombardier has zoomed into the fray, as well, boasting that its newly launched CRJ900 NextGen regional 90-seater jet could fly domestic Vietnamese air routes and even key Asian routes at the lowest fuel cost per passenger seat – a key industry metric. It even flew one of the jets to Vietnam recently, to put the aircraft through its paces for this possible buyer.

"This would be an ideal feeder aircraft for Vietnam’s domestic and regional air transport needs," Trung Ngo, a vice president of Bombardier, told a Vietnam news service, adding that airlines such as Deutsche Lufthansa AG and Air France KLM have used its jets since the 1990s.

That would also be the ideal use for the Mitsubishi jet. But here’s the problem for Mitsubishi: Its airplane won’t be ready until 2013. That makes it too late for the initial sales push that will be taking place in this market, although experts say there will be many more opportunities in Asia and other parts of the world as markets abroad continue to open up to capitalism.

Big Returns Often Demand Big Risks

Demand for smaller jets is expected to increase rapidly as carriers bolster domestic routes and look to offset surging oil prices with aircraft that consume less fuel and are more likely to have their seats filled.

But Mitsubishi is not the only newcomer in the market.

Russia’s United Aviation Co. has teamed up with Boeing to build a jet for 75 to 95 passengers. China’s ongoing effort to build a midrange commercial jetliner got a boost recently when the leasing arm of U.S. giant General Electric Co. (GE) signed a preliminary agreement to buy five of the airplanes when they’re finished by the state-run venture in charge of the project.

China has broad ambitions in jet manufacturing, starting small with its 70-seat ARJ21-700, reports the trade journal Aviation Week & Space Technology. Flight testing has slipped a bit and now the certification of the aircraft isn’t expected until the middle of next year. Russia has a big aerospace sector, and wants into the regional market with its Sukhoi Super Jet 100, which will be in flight-testing soon.

Mitsubishi has set up a special subsidiary to oversee development of the jet. It capitalized the project with an initial outlay of $30 million, although it expects that total to climb to nearly $1 billion over the next year. Two-thirds of that money will come from Mitsubishi.
And that billion dollars is just the first installment.

Total development costs are projected to reach $1.5 billion to $1.8 billion – roughly equal to three years’ worth of the company’s profits. And that estimate is almost certainly short of what will really be needed, given the company’s newness to the sector and the new technologies involved.

Mitsubishi Heavy expects to lose money on the aircraft business for the next decade, and will underwrite the development costs with money from such cash-flow-positive business units as those that make and sell nuclear reactors and turbochargers. Many analysts question the wisdom of the strategy.

"It seems there are various sectors they’d be much better concentrating on, such as nuclear reactors," Takeshi Osawa, senior fund manager at Norinchukin Zenkyoren Asset Management, told Reuters. "There is demand for the planes, but the competition is tough."

Mitsubishi Heavy said it would buy 60% to 70% of the components for the new airliner from suppliers outside of Japan. For instance, it sees the Pratt & Whitney unit of United Technologies Corp. (UTX) as the engine provider.

Ironically, up until now, Mitsubishi’s aerospace business has filled that supplier/provider role, developing and making parts for Boeing and Airbus jets. It makes cargo doors for Airbus jets and the composite wing box for Boeing’s new Dreamliner.

Support and Opposition Abound

All Nippon Airways Co. Ltd., Japan’s No. 2 air carrier, gave the Mitsubishi jet project a vote of confidence recently when it committed to purchases of 25 of the jets. And Steven F. Udvar-Hazy, chief executive officer of aircraft leasing giant International Lease Finance Corp. (ILFC), told Aviation Week that his firm has met with Mitsubishi and has made a series of recommendations for improving the design of the MRJ jetliner. ILFC also has been in talks with Bombardier about buying that company’s proposed C-Series jet.

"What I have told [Mitsubishi] is … if you guys can pull it off and do what Toyota has done in cars, you can be a formidable player," Udvar-Hazy told the influential aerospace-industry trade journal. "But it has to be done right."

Needless to say, Udvar-Hazy’s major concern is the price of the airplane.

One potential rival says Mitsubishi can expect to face some real marketplace turbulence. Although it already has one airline backer in Japan-based All Nippon Air, the technology Mitsubishi is offering may not be unique enough to differentiate it from all the other marketplace offerings, Frederico Pinheiro Fleury Curado, the CEO of Brazil’s Embraer, alleged during a recent interview with Aviation Week..

When it comes to the Mitsubishi project launch, "the timing is not ideal," Curado said. "It will take a few years to see what should be included on next-generation aircraft, which is not clearly defined right now."

Aircraft with true next-generation technology won’t hit the market until 2016 or 2017, he contends. That means the Mitsubishi jets will hit the market a few years before new technology redefines the market that the Japanese firm hopes to capture.

"Even using today’s technology and doing everything right, the MRJs will not be materially better than the Embraer 170/190 family. They will be caught between two generations of aircraft," Curado contends.

While conceding that Mitsubishi will be a strong competitor, Curado insists the company is not the kind of threat that could jeopardize Embraer’s future. At the same time, however, he sounded concerned about the Japanese government’s deep pockets – and what financial backing of that magnitude might do to Embraer.

"And a point we made strongly to the Japanese press is that it would not be tolerable for its government to subsidize the [MRJ]," he warned.

Because Japan is a member of both the World Trade Organization (WTO) and Organization for Economic Cooperation and Development (OECD), there are rules the country must follow – and that includes no subsidies, he stated.

Mitsubishi Heavy said it hopes to have the jet in the air by 2013 and will aim to sell 1,000 over the next 20 to 30 years, grabbing one-fifth of expected new demand in a market that is projected to roughly quintuple to more than 5,000 planes by 2026.

News and Related Story Links:

• Corporate Web Site:
  HondaJet.

• The Financial Times:
  Toyota funds passenger jet.

• Reuters:
  
  Japan’s $1 billion plane project gets off the ground.

• Aviation Week and Space Technology:
  Embraer Chief Questions MRJ70/90 Launch.

• Aviation Week and Space Technology:
  Mitsubishi Leads Japanese Aircraft Resurgence.

• Money Morning Special Investment Report:
  China’s Growth Will Clear $340 Billion Worth of Airliner Sales for Takeoff Over the Next 20 Years.

• Money Morning News Analysis:
  Boeing Earnings Surprise Wall Street Just One Day After Weak Dollar Forces Airbus to Raise Prices.
• Forbes:
  Boeing, Airbus, Bombardier compete to sell jets to Vietnam.

• VietnamNetBridge:
  Private airlines ready for take-off.

• AerospaceTechnology.com:
  Bombardier CRJ900 Regional Jet, Canada.

• Wikipedia:
  NAMC YS-11.

• Wikipedia:
  F-2 Fighter Jet.
• Money Morning Economic Forecasting Series:
  Outlook 2008: Three Ways to Profit From Sovereign Wealth Funds – the "Next Wall Street."

• Wikipedia:
  F-1 fighter.

• Wikipedia:
  T-2 Supersonic Trainer.

• Wikipedia:
  F-16 Fighting Falcon.

• Wikipedia:
  Fokker.

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

From my vantage point on my recent visit to both China and Japan, the signs are clear.

China is coming. And Japan knows it.

Major department stores like Takashimaya Co. Ltd., Sogo Co. Ltd. and Mitsukoshi Ltd. are gearing up. In places like Tokyo, Osaka and Kyoto, they’re seeing a new wave of power shoppers at their counters – the Chinese.

A few short years ago, this was unthinkable.

Yet, as my wife and I strolled through downtown Kyoto, we saw it too. Most major department stores have added Chinese signage to the usual Japanese and English placards.

We heard it, as well, from Chinese shoppers who were tromping through the Shijo-Kawaramachi shopping district loaded down with bags sporting the latest designer logos. It’s much the same in Tokyo’s uber-rich Ginza district as well where Mitsukoshi has recently hired store-based interpreters fluent in Mandarin.

I can’t say I’m surprised.

According to the Japanese Department of Tourism, a record high of nearly a million Chinese tourists came to Japan last year. China’s Ministry of Public Security estimates that 34.5 million Chinese headed for foreign destinations in 2006 – up from a mere 4.5 million a year earlier. By 2011 that figure is expected to top 80 million with Hong Kong, Macau, Vietnam, South Korea and Japan predicted to account for 85% of all Chinese tourist destinations according to Euromonitor International.

And they’re spending big bucks, too.

CNN reporter, Kyung Lah, interviewed one group of mainland Chinese tourists recently that had spent $50,000 dollars on clothing and makeup alone on a 3-day trip. Not surprisingly, most of that was on designer brands from Prada Group, Gucci Group NV (PINK: GUCG), Christian Dior SA, and Shiseido Co. Ltd. (OTC: SSDOY).

Which jibes with my personal experience as indicated by Chinese and Japanese I’ve spoke with over the years. Whereas most of them used to only dream about traveling, an increasing number are actually doing it. My good friend Jun Hao and his wife have hit most of Europe’s major cities and a good deal of the United States, too.

Getting back to Japan, however, it may surprise you to learn that most Chinese feel very comfortable there. A fact that stands in stark contrast to how relations between the Japanese and Chinese are often portrayed in the Western media.

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It’s now a common sight in Tokyo to see Chinese who are shopped out make a beeline for Toyota Motor Corp.’s (ADR: TM) showrooms. Obviously, they’re not buying Toyota’s in Japan, but boy are they anxious to buy Toyota’s in China.

And a visit to the showroom is just what the doctor ordered for young, cosmopolitan Chinese yuppies… or “Chuppies” as they’re called.

Not only do they feel more international for having done so, but Chinese tourists tell me they find Japan quite welcoming. And warm, which is another one of those words than can be translated a variety of ways.

Not one citizen of China or Japan that I’ve recently spoken with believes that the political past between their respective countries would prevent an economic future.

Investors looking to capitalize on the blossoming relations between the two countries and the tourism trade specifically need to look no further than Japanese department stores, Chinese credit card companies and, ironically, Toyota to get in on the action.

Of course, there are obvious choices when it comes to computerized travel providers and airlines.

But the value there may be harder to extract given there’s not a clear value proposition and the industry remains largely fragmented… for now. And that’s part of what makes Money Morning’s growth “because” of China – and Japan – investing strategy the way to go for now.

News and Related Story Links:

• Money Morning:
  Lost In Translation: The Subtle Dealings Between China and Japan Can Lead to Powerful Profits

• Money Morning Investment Travelogue:
  The View From China: The Freedom to Change Also Means There’s a Freedom To Fail

• Money Morning:
  GM Tries to Reverse Course, but Can it Catch Toyota?