Let's talk about Japan Hard Power

Japan's defense industrial power-base: under discussed, under appreciated, under valued, but very real

Japan’s hard power — and yes, this means Japan’s military industrial strength — is very real, yet hardly ever discussed openly by Japan analysts, media or policy makers. While personally, I am a big fan of Japan soft-power, my friend and fellow Japan investor Andrew McDermott rises to the challenge and, in this guest column, explains the real-existing hard power Japan Inc. possesses, why it matters, and how a stronger and more openly discussed interplay between soft- and hard-power is essential to build a sustainable foundation for “Pax Nipponica”. What could go wrong? The growing pressures of U.S.-style financialization coming to Japan could easily end up weakening Japan’s industrial power base - just as it did in the United States. Thought provoking throughout…..enjoy -- as always, comments welcome. Many cheers ;-j

Hard-power at its softest — the all-time Sumo great Konishiki in the early 1990s

Let’s talk about Japan Hard Power

by Andrew McDermott

“We've got two global megatrends. The first one is, unfortunately, defense, where budgets are growing everywhere. The second one, which is not as well recognized, is the emerging Asian middle class. Japan is the role model for a lot of Asia Pacific. [The sectors I like in Japan are…] financials and soft power Japan…anything media related.” Jesper in conversation with Maggie Lake: "Unbelievably rich yet super cheap", July, 2025

The first rule of fight club: you don't talk about fight club. Fight club

Jesper likes Japan's soft power and financials. I like the former and hate the latter. Maggie Lake and Jesper, in their recent must-listen conversation, glided over defense as an investment theme in Japan. I found this curious enough to raise with Jesper by email. Be careful what you wish for. He gave me homework: write about Japan's "hard power." Discuss where it rests, why it matters, and why the investment community inside and outside of Japan seems more interested in "fixing Japan" via activism and private equity than in supporting Japan's role as underwriter of a free and open Indo-Pacific. This is my best attempt to describe and explain the curious disconnect between markets and reality as I see it.

It is true that Japan's defense related companies have risen from their lows. However, the overwhelming narrative in Japan remains corporate governance activism and leveraged buyouts turbocharged by negative real rates. For some reason, the defense narrative that has driven global investors into European, Korean and Indian defense companies does not resonate in Japan, even with the Japan Optimist himself.

A brief glance at Bloomberg's "defense peer groups" for market darlings BAE Systems, Hanwha Aerospace and Rheinmettal AG tells the story. These stocks trade at an average PE of 40x with several names exceeding 50x. Analysis of the underlying estimates reveals extremely bullish assumptions regarding sales and margins for the next several years. Notably, not a single Japanese name appears on any of Bloomberg's lists. This is true even though conflicts in Ukraine and Iran have demonstrated that modern warfare depends far more on the sorts of things at which Japan excels than on expensive legacy platforms in which most dedicated defense contractors specialize.

Where is Japan Inc?

Global defense peer groups — per Bloomberg

There are plausible reasons for Bloomberg's omission and for the preferences of global investors. For starters, Japan has no dedicated defense companies. Rather, it has a dispersed group of general manufacturers and IT companies whose defense segments have historically lived on thin margins, limited exports, and low publicity due to domestic and foreign sensitivity to Japan's World War II history. Nobody wants to talk about Fight Club. In addition, the "rearm Europe against Putin as America retreats" theme appeals to most global investors more than the theme of standing up to China. After all, most global investors remain committed to the China story via existing holdings and, especially, the composition of their investment teams.

Journalists much prefer the clean "America vs. China" narrative to the more nuanced multi-polar order predicted by Peter Zeihan and Clyde Prestowitz years ago, an order in which Japan plays a leading role. Finally, the idea of global leadership in defense or anything else does not fit with the cuddly, "Japan is a nice place to visit but I wouldn't want to invest there unless its Hello Kitty, real estate or Super Mario" theme that has begun to emerge as some investors gingerly return to Japan.

Yet Japan's soft power does not exist, and cannot persist, without a degree of hard power that deserves careful evaluation. In the same way that there would have been no dancing Elvises in Japan's Olympic Park without the Seventh Fleet, there will be no Hello Kitty or Mario unless Japan's hard power can deter China, Russia and North Korea from controlling the Pacific. As Jesper noted in his conversation, the US cannot be relied upon to do this work alone, if at all. Fortunately, there is far more to Japan's hard power than meets the eye of a casual observer or a theme-obsessed global investor. Warfare, we are told, is changing from the tanks of the past to the drones of the future.

If that's the case, then who better than Japan to lead the way? It has deep expertise along the entire supply chain, starting at the power plant, where Japan's small modular, molten salt and breeder nuclear reactors as well as its advanced solar panels and geothermal prospects are head of class. Next, Japan leads in the development of composite materialscrucial for the design of light-weight, stealthy drones, aircraft and ships. Japan's deep electronics experience undergirds everything from advanced radar to specialized naval antennae to an indigenous missile/space/satellite program that has quietly more than tripled Japan's defensive perimeter.

Japan's hard power dispersion throughout the economy is an asset, not a liability.

Freedom's Forge, Arthur Herman's magnificent examination of US industry in World War II, explains that it was the engineering competence of America's general industry, not its dedicated military contractors, who contributed to America's defeat of arguably better-equipped Axis forces (see picture, Life, 1942). The disastrous record of dedicated defense contractors in recent years (particularly Boeing, Lockheed Martin, HHI, and BAE) suggests that generalized competence tested in the commercial marketplace often results in better prices and performance than the contractors can deliver.

At a more fundamental level, access to abundant energy and skilled labor has always been a precursor to military production capacity. This is not the place to debate climate change or energy politics. It is enough to point out that Japan's grid stability and power source diversity has moved in the opposite direction of Europe's in recent years. With multiple nuclear power stations preparing to restart alongside a commitment to emerging nuclear technologies, new sources of LNG, and advanced renewables, Japan is well-placed to meet the power needs of AI, defense and re-industrialization needs. Japan's automation leadership and surprisingly successful immigration and "exsourcing" policies (discussed below) provide a viable solution to the labor problem. Europe is headed in the opposite direction, as political fights over immigration and power challenges in the Netherlands, Spain and Germany attest.

Finally, and most important, there is the issue of quality. Whether defined as reliability, functionality, lethality, stealth or economy (of both operation and manpower), Japanese defense offerings are at the very top of the pecking order.

While US systems have dominated headlines for the last few decades, Japan has quietly built one of the most advanced aviation and naval workforces in the world. By joining with the UK and Italy in the sixth-generation GCAP fighter program, Japan could leap-frog other offerings while jumpstarting an export machine that has attracted attention from Saudi Arabia, Canada and Australia. But the most obvious example of Japan's hard power is in the sea. A quick visit to Australia shows why.

Australia desperately needs replacement frigates. Its collaborations with the US and the UK on Hunter and Independence class ships have been disasters. Both programs are billions of dollars over budget, years late, and, in the case of the US variant, so flawed that several are already being retired despite being the Navy's newest ships. An Australian newspaper summed up the efforts of contractors BAE Systems, Austal and Lockheed Martin by opining that the "Scandalous US [LCS frigate] program would be a shining success in Australia." This sets a new standard of damning with faint praise, as the US "Littoral Combat Ship" has become known as the "Little Crappy Ship," a $100bln boondoggle that has left a gaping hole in US combat readiness.

Unfortunately, the shoe fits: the Hunter, if and when it arrives, will be seven years late and cost roughly twice the original A$3.9bln per ship budget based on the latest estimate of US$40bln for the program. Even more unfortunately, the LCS replacement is already three years late and may be scrapped. Meanwhile, Japan recently launched a Mogami class frigate, the 11th built since 2021 at a cost of $300-500mm/ship. These frigates are widely considered the world's best, with a combination of stealth technology, automated command systems (allowing a 30% crew reduction relative to comparable ships) and a formidable host of manned and autonomous weapons systems.

Australia matters because Japan and Germany are vying to fill the hole in the Australian navy left by the failures of the US, UK and Australia itself to deliver workable ships (an amazing climbdown from 1945). Germany's offering is far less advanced than Japan's, but is backwards compatible with existing Australian systems. Whether or not Japan wins this bid (and it very much wants to win), the superiority of Japanese "hard power" is evident and increasingly relevant around the Pacific. Just this week, Japan agreed to export older destroyers to complement the coast guard ships it has already sold to the Philippines. These deals are considered a precursor to the export of Japan's newest state-of-the art patrol vehicles to the Philippines, Indonesia and other Asian nations.

All of this military technology is downstream of Japan's leadership in AI-enabled manufacturing automation, its current and potential role in critical parts of the semiconductor supply chain, its leadership in quantum computing, and its Deepseek-beating AI ecosystem. [note: after going to press, Japan won the contract with what media sources called "Absolutely the Best Ship." This interview with Australia's defense minister Pat Conroy provides an excellent overview of the decision.]

But Jesper is not wrong about the importance of Japan's soft power. The two are symbiotic. As Jesper rightly points out, Japan, not China, is the aspirational role model for the emerging Asian middle class (including the 1mm Chinese who have become permanent Japanese residents). Japan's "scarcity" of labor and its decision to pursue what Peter Zeihan called "exsourcing" has created a strong economic and cultural relationship between Japanese companies and countries throughout Asia where Japanese factories have provided training and jobs while incubating a desire for Japanese culture. In many ways, the same can be said for the US, where Japan's creation of 1mm manufacturing jobs stands in stark contrast to the elimination of 5mm manufacturing jobs by America's own companies.

Japan's ability to deliver the goods, from frigates and aircraft to Hello Kitty and Super Mario, has put Japan in the pole position in Asia as an alternative to both the US and China. This is a relief for American policy makers and a major problem for China.

The PRC prefers to paint the conflict in Asia as one between a resurgent China reasserting its rightful place and a decadent, overbearing America in decline. The centrality of Japan rests in its delicate combination of soft and hard power and in Asia's history of resisting the ascendant hegemon, whether it be Japan in the 40s, the US in the 60s or China in the 2020s. As I write this, a record 19 nations have joined the Talisman Sabre exercises in Australia. While the headlines focus on the role of America, it is Japan who has forged this alliance by mending fences with old foes and steadfastly focusing on a free and open Indo-Pacific.

For investors, very little of this "hard power" opportunity is in the price of Japanese equities when compared to peer companies in other countries who supposedly will be invited to the same party. Based on head-to-head comparisons, Japan has the most to gain and the least to lose from a successful deterrence effort: its systems are optimized for modern conflict and its exports can only go up. More hopefully, Japan's "hard-power" companies have as much or more to gain from peace as from war. Japan is best placed to supply the tools needed to build a peaceful co-existence with China. If the market were consistent, it would afford Japan a substantial "hard plus soft power" premium commensurate with Japan's centrality in the real economy. The fact that it does not raise several intriguing possibilities.

What could go wrong?

Lots. For starters, it may be too little too late. China's military buildup and diplomatic advances have already threatened the critical US/Australia/Japan shipping lanes that defined World War II. The apparent loss of the Solomon Islands to China and China's extension of carrier patrols and live-fire drills to Australia's coast demonstrate that China knows the stakes as well as Japan. China's substantial lead in military manufacturing combined with the knowledge that a Japan-led "hard power" resurgence could worsen China's odds over time could accelerate China's Taiwan timetable. Whether that takes the form of kinetic warfare or some other power play, success could allow China to push Japan and everyone else aside. This seems to be the bet many global investors are making through their actions if not their words.

The private equity and banking firms that are cozying up to Japan remain deeply committed to the PRC–just look at their staffing, portfolios and recent activity (see KKR's first-ever local RMB fund or Bain's successful investment in China's AI-linked data center business or the enthusiasm with which JPMorgan and Bank of America ignored Congressional and Defense Department censure to participate in the CATL IPO). In the media's preferred narrative, only two players matter: the US and China…and China is winning the military and diplomatic game. In this reading, which is also the Xi/Putin line, Japan, Korea, the Philippines, Australia and Taiwan just don't matter. Once Uncle Sam gives up, the game ends.

Following the Japan Optimist's line that Japan can trust neither the US nor China, another possibility exists. Japan's politicians could inadvertently hand Japan's best companies to the US financial engineers responsible for America's own deindustrialization. Currently, Japan has the highest inflation rate in the G10, the second-lowest short-term rates and a trade-weighted FX rate near all-time lows. Japan's politicians and central bankers seem committed to maintaining negative real rates while also trying to transform Japan into an "Asset Management Nation." In today's world, that means that Japan is bending over backwards to attract the likes of Bain, Blackrock, Apollo, KKR and Carlyle, not Warren Buffett-style investors eager to support Japan's best managers in the public markets.

It is curious that the US has dropped its complaints about Japan's weak currency even though a more fairly valued yen and the higher rates that would no doubt accompany it provide the most obvious solution to the trade "problem." Low rates and a cheap yen are catnip to America's financial engineers and to the Japanese financial executives who have convinced themselves that the best path to growth is through the provision of highly leveraged loans to the teams who bankrupted Calsonic (twice), bankrolled China and compromised many of their non-Japanese investees while collecting generous fees.

Noted Japan expert Alicia Ogawa recently predicted that "in five years time, we could be in a situation where 30% to 40% of Japanese, particularly small companies, are owned by KKR." My views on the impact such an ownership change would have on Japan's long-term competitiveness have been expressed in earlier pieces. As an American with four Japanese-American children, I can only hope that KKR and its friends will not do to Japan's industry what it has done to America's. But from a Japanese perspective, it won't matter. As wiser heads than mine have long observed, the country that loses control of its ability to make things will, sooner or later, lose control of its ability to do things. David Murrin of Global Forcaster, commenting on the reasons Japan can still build ships while the US, UK and Australia cannot, put it this way:

The lesson from history and industry is clear: leadership by engineers and builders produces lasting strategic strength; leadership by financiers alone optimises for short-term gains at the expense of long-term readiness.

The corollary is clear: whether the financialization of Japan leads to industrial decline that invites PRC aggression or to an American resurgence on the back of acquired Japanese capabilities, Japan's financialization will lead to the loss of Japan's autonomy, a future gleefully predicted by pro-CCP media organs eager for a return of the "glory days" of the Tang Dynasty's dominance of Japan.

What then, shall we do?

For starters, run, don't walk, to urge passage of the SHIPS act and repeal of the Jones act, allowing the US to outsource shipbuilding to our allies Japan and Korea the same way contractors like RTX have (inexplicably) outsourced critical weapons systems to our adversary China. Had we "let Japan do it," our $140bln could have bought us (conservatively) 200 lethal, stealthy frigates that would have made keeping the IndoPacific free and open a much easier proposition. Instead, we have zero...and we have sent China everything it needs, from iron ore to technology, to build its own navy.

At a higher level, the Japan Optimist is planning two gatherings to discuss how we can better partner with Japan. The first, the Globis G-1 Global conference in early October, will highlight Jesper’s “Pax Nipponica” and the many areas in which Japan leads by action, if not by words.

The second, on October 31 hosted by Asia Society Tokyo Center, will discuss how Japan's public markets can serve the public good.

Jesper's most trenchant comment to Maggie was that "Japanese are great at math and science, they just can't express themselves." Sadly, there's much truth here. If Japan wants to play the global role that it must play to preserve its freedom of action, Japan must begin to tell its own story…to talk about Fight Club.

It's not enough for Warren Buffett, Rham Emanuel, the Japan Optimist and yours truly to talk about how Japan can, and should, lead a Pax Nipponica. Japan's own leaders in all fields need to step up and tell their stories on their own terms. They need to do it in fluent English…it's not fair, but that's the way the world works today. Japan's labor force is massively underpaid, its foreign policy needlessly hamstrung, and its financial markets mercilessly mocked or ignored because Japan's leaders can't express themselves in a world that increasingly needs Japanese stewardship. If Japan loses Australia, it won't be because of the quality of the Japanese offering, but because of communication difficulties. In the short term, Japan needs to do a much better job with what it has. In the long term, Japan needs to reverse its decline in educational exchange programs and bring in-country English levels up to those in Taiwan, South Korea and the Philippines without losing its world class math and science skillset. Most of all, it needs to empower its younger generation to buy into and improve Japan's model of "capitalism that works" in a way that can inspire the rest of Asia, if not the rest of the world, to follow a third way between the US and PRC models. In short, Japan needs to start talking about Fight Club…thereby reducing the need to fight in the first place.

Can this be done? When I first came to Japan, my boss at the NEC subsidiary where I worked gave me Bushido, the elegant work by Nitobe that explained Japan's code ethics in flawless English to a curious world. Nitobe emphasized that the best parts of both Western and Japanese cultures drew upon the same virtues, that both "samurai" and "knight" derived from the word for guard, or steward ("sty-ward" in Old English). That both cultures, at their best, prized peace through strength, not conquest. President Teddy Roosevelt was so taken by the book that he distributed copies to his entire White House staff, all of whom were expected to participate in mandatory judo lessons. Nitobe and his peers so impressed Roosevelt that he wrote the following to Congress:

[The Japanese] have won on their own merits and by their own exertions the right to treatment on a basis of full and frank equality…We have as much to learn from Japan as Japan has to learn from us; and no nation is fit to teach unless it is also willing to learn.

Today, Japan has, once again, earned the respect of the world through its own merits. Who will be today's Nitobe? The sooner he or she steps forward, the better for everyone, including the people of China and America and the rest of Asia.

The opinions expressed are my own. They are not intended as investment advice. I currently own and may in the future own positions in securities mentioned in this article. Andrew McDermott, Nashville 9/23/25

Here a link to the October 31 event at Asia Society in Tokyo: Can Japan keep public markets working for the public good? — a lifestream sign-up is available

Here a link to Andrew’s previous guest contribution Buffett & Japan which includes his bio & photo