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Sunday, June 29, 2014

Japan Inflation At A 32 Year High?

Just in case anyone was in any doubt last weeks newspaper  headlines blared it out for us loud and clear - Japanese inflation is back, and has even hit levels last seen in 1982. (Click on image below for better viewing).


In fact consumer prices in Japan rose at an annual rate of 3.4% in May according to the Bank of Japan's preferred measure, driven higher from one month to another by the growing impact of the April sales tax hike. The May surge in inflation follows a previous jump to 3.2%  in April, up from 1.3% in March. Apart from the tax hike, the delayed impact of last years yen devaluation is still being felt: electricity charges rose 11.4% year on year in May, gasoline was up 9.6%, while fresh seafood prices climbed 14.3%.


However, stripping out the effect of the higher tax, Japan's core consumer-price index rose 1.4% in May according to statistics office estimates (see BoJ chart below), below the 1.5% increase the previous month. This underlying inflation fell, even while the headline core index rose, which is why I say the "growing impact" of the tax hike, since it is clear that businesses passed on more of the tax rise in May than they did in April. The slowdown in price growth was the first since September 2013, and BoJ governor Haruhiko Kuroda also recognized last week that ex-tax core inflation is "expected to slow to around 1%" in the summer, as the effects of higher imported energy prices diminish.



But beyond the waning impact of rising energy prices, a second factor is likely to put downward pressure on Japan prices: the continuing shortfall in domestic demand. Household spending was down 8% year on year in May, following a 4.6% drop in April.


And it's not hard to fathom why consumption is so weak: wages excluding overtime payments and bonuses fell for a 23rd month in April. In fact real wages fell 3.8% year on year. With the purchasing power of salaries falling, and weak demand for credit it is hard to see how consumption wouldn't be falling - maybe not as sharply as in May, but falling all the same.


On the positive side,  Japan's unemployment rate hit a 16-year low of 3.5%  in May. At the same time, the availability of jobs rose to its highest level since 1992, with the jobs-to-applicants ratio for May hitting 1.09, meaning there were 109 jobs available for every 100 job seekers. The data showed the job market tightening across the economy, from construction to auto manufacturing to education.


In fact it isn't just unemployment that is falling - employment is also rising, and was up by just over half a million workers over the last twelve months taking the number of jobs in the economy to a post crisis high.

But if the number of people employed is rising, why isn't what Prime Minister Abe calls the "virtuous cycle" starting to work, with jobs growth producing income growth to spur consumption, so lifting corporate profits and investment spending? Part of the answer lies in the kind of jobs being created. The growth in the number of workers on short-term or part-time contracts means that total earnings (as opposed to basic wages) across the economy are not rising. Employment was up 0.9% while disposable income among worker households FELL 3.4% in real terms. The numbers just don't add up.


As the Economist (who prepared the above chart) puts it, "workers used to be protected by an expensive system of lifetime employment. But firms place new entrants on short-term, ill-paid contracts. Nearly two-fifths of the workforce now falls into this “irregular” category."

The Price Of Permanent Stimulus

Nothing, as we know, comes free, and Abenomics is no exception. Apart from the problem of inducing consumption on the back of falling real wages, the country's external balances are also suffering.  Japan logged its 23rd successive month of trade deficits in May, as exports and imports both declined. The May deficit  was 909 billion yen ($8.8 billion), as exports to the U.S. fell by nearly 3 percent from a year earlier. Exports fell 2.7 percent to 5.6 trillion yen ($54.9 billion) while imports dropped 3.6 percent to 6.5 trillion yen ($63.7 billion).

The current account surplus is also deteriorating and plunged 76.1% in April when compared with the previous year. The current account balance was the lowest seen in April since1982 according to the Japanese Finance Ministry.


All this notwithstanding, with the Bank of Japan buying almost all new issue Japan Government Bonds, yields remain incredibly low. As the FT's James Mackintosh points out the yield on the 7-year bond fell to just 0.28% last week, only 6bp above its all-time low.


As James notes, rising inflation and falling bond yields don't mix well in the longer term, and don't offer much prospect of a serious market beyond BoJ purchases, unless of course the inflation is not sustainable.  The black line in the following chart shows an index of inflation-linked JGB real yields, while the other two show the 7- and 10-year yields minus inflation.



Really there isn't that much mystery about what is going on in Japan. Falling working age population is steadily reducing the country's potential growth rate (as the chart below from the Bank of Japan illustrates), and while structural reforms may help raise productivity and offset the decline on the supply side to some extent, they won't address the underlying structural demand shortage problem. So it could be that at the end of the day the only lasting legacy of the Abenomics experiment will be a seriously distorted economy and a pile of sovereign debt which will be hard to ever pay down and will make raising interest rates in the longer term really problematic.



More detailed arguments to justify the idea that Abenomics is unlikely to achieve its objectives can be found in my recent short book - The ABE of Economics (for more information visit my webpage). The book is available with Amazon as an e-book. It can be found here. You don't need to buy a Kindle to read this book. You can download a free app from Amazon.

Friday, June 20, 2014

Will Japan Re-enter Deflation in April 2015?

Reading the most recent statements from Bank of Japan Governor Haruhiko Kuroda or Finance Minister Taro Aso you would get the impression that the days of deflation are now well and truly numbered in Japan. Martin Schulz, economist at Fujitsu Research Institute in Tokyo, goes even further. “Deflation is over in Japan,” he told Bloomberg Television First Up’s Angie Lau . Even Japan’s industrial leaders now believe inflation is here to stay: the country’s inflation rate will be 1.5 percent in the spring of 2015, and 1.7 percent in 2017, according to average forecasts in a Bank of Japan survey conducted in March this year.

But is such optimist justified? According to the Bank of Japan's favored index, which includes energy but not the cost of fresh food, inflation stood at an annual 3.2% in April. Sounds good if what you want to do is generate inflation.


But before getting too excited, it is worth bearing in mind that inflation one month earlier has stood at only 1.3% on the same measure. The difference between months is, naturally, the result of the impact of the 3% sales tax hike which came into force on 1 April. Without that, inflation would have been much lower since the base effect of the 20% yen devaluation is now starting to work its way out of the calculation. Indeed stripping out energy costs (which are the principal knock on cost effect of the devalued yen), inflation in April was but 2.3%, notably below the size of the tax hike. So the question which should be being asked is what will the level of annual inflation be in April 2015, assuming that is there are no further yen devaluations or tax hikes to help push the number back up again? Analysts at Credit Suisse seem pretty clear (see chart below), we’ll be back in deflation again.



Leaving aside the sustainability issue, the type of inflation Japan has been experiencing since the advent of Abenomics – driven by rising energy costs and tax hikes – also constitutes a problem. It has been described by Bloomberg journalists Tsuyoshi Inajima and Brian Swint as the "wrong kind", a way of putting things which highlights the amount of confusion there is out there about just what it is that the BoJ is doing and what it is supposed to be achieving.

To back their point they cite Klaus Baader, chief Asia Pacific economist for Societe Generale in Hong Kong to the effect that “this isn’t the kind of inflation we want in Japan to break the deflation mindset. We’d like inflation that is a reflection of higher wages, whereas this is pure cost inflation that decreases purchasing power.” So now we learn that Japan doesn’t need just any old inflation, it needs a very specific kind, which could be described as “demand pull”, but this brings us straight back to the original problem: domestic demand in Japan just isn’t strong enough to generate this kind of inflation, and nudging up inflation expectations for a couple of years won’t change anything substantial in this regard. Possibly the type of cost push inflation Japan is experiencing is the "wrong kind" for adherents of the Abenomics approach, but it is more than likely the only kind they are going to get. If the structural lack of demand argument I have been advancing is valid, then this means there is permanent downward pressure on costs in an environment of constant oversupply making inflationary wage increases difficult to envision. Indeed, as reported by another group of Bloomberg journalists (Masaki Kondo, Mariko Ishikawa and Yumi Ikeda) , reality itself belies such expectations, since Japan's wage index hit a post 1992 low at the start of 2013. And the downward drift has continued. In April 2014 the average basic salary fell for the 23rd straight month, declining 0.2 percent to 243,989 yen, while average real, or inflation-adjusted, wages decreased 3.1 percent from a year earlier, marking the largest year-on-year fall in more than four years.


Rising inflation and falling wages don’t seem like the sort of combination to make for a sustainable recovery. Indeed it seems so off-mark as to make you wonder whether official sector economists really thought through what they were doing before embarking on this experiment.

The thing is this, given all the doubt which exists about the real roots of Japan's problem, and the fact that it may well be a permanent structural problem and not a temporary liquidity trap one, is it really justified to run such a high risk, all-or-nothing experiment? Even Paul Krugman seems to have changed his assessment various times since the  problem started and while he still fully supports the general approach being taken he now thinks the natural rate of interest may remain permanently negative and that fiscal stimulus might be necessary on a permanent basis (liquidity trap without end, amen).  What makes people nervous is the thought that if the central bank can't deliver on its promise to deliver inflation then a loss of confidence might ensue, and all those dubious risky asset positions might unwind suddenly, just like an earlier set did in 2008.

And there are plenty of people in Japan who have been pointing this out all along. Seki Obata, a Keio University business school professor for example, who in 2013 published a book "Reflation is Dangerous," argues exactly this, that "Abenomics" is exposing Japan to considerable risk without any clear sense of what it can accomplish. Obata also makes the extremely valid point that there is simply no way incomes can rise across the entire economy because the baby boomers are now retiring to be replaced by fewer young workers with post labour reform entry-level wages. Japan's overall consumer spending power will therefore fall, rather than rise as Abe hopes. "Individual companies may offer wage increases, but because of demographics it is simply impossible to increase the total amount that is paid out in wages," says Obata. "On the contrary, that amount will shrink." Simple logic you would have thought, but logic in the face of irrational exuberance scarcely stops people in their tracks.

As far as I can see, all of this  points to one simple and evident conclusion: that Japan needs deep seated cultural changes, especially ones directed to greater female empowerment and more open-ness towards immigration. Hardly matters for central bank initiatives, and indeed ones for which Shinzo Abe, who naturally has given his name to this new economic trend, is singularly ill equipped to carry through. Japan needs a series of structural reforms – like those under discussion around the third arrow – but these would be to soften the blow of workforce and population decline, not an attempt to run away from it. Monetary policy has its limits. As Martin Wolf so aptly put it, "you can't print babies".

The above is an extract from my new "mini book" the A B E of Economics.

The book is available with Amazon as an e-book. It can be found here. You don't need to buy a Kindle to read this book. You can download a free app from Amazon.

Sunday, March 02, 2014

The Growing Mess Which Will Be Left Behind By The Abenomics Experiment

According to wikipedia, "overdetermination is a phenomenon whereby a single observed effect is determined by multiple causes at once, any one of which alone might be enough to account for ("determine") the effect.That is, there are more causes present than are necessary to generate the effect".  In this strictly technical sense Japan's deflation problem is overdetermined - there are multiple causes at work, any one of which could account for the observed phenomenon. Those who have been following the debate can simply choose their favourite - balance sheet recession, liquidity trap, fertility trap - each one, taken alone, could be sufficient as a cause. The problem this situation presents is simply epistemological - in a scientific environment the conundrum could be resolved by devising the requisite, consensually grounded, tests.

But I would here like to use the term "overdetermination" in another, less technical, sense, since it seems to me Japan's problem set is overdetermined in that we always seem to be facing at least one more problem than we have remedies at hand.

The case of the country's ongoing energy dependency which is producing a growing trade and current account deficit would be a good example. Notionally the problem forms part of the legacy of the tragic tsunami which hit the country in March 2011 and lead to the decision to phase out  nuclear energy capacity.  But now  that decision has been reversed, and starting this summer nuclear generating capacity is once more to be "phased up". The issue is, from a strictly economic point of view would that be good news? Well, it would certainly help with the deteriorating trade balance:


But what about deflation? Would having cheaper domestically produced energy help here? Wasn't generating inflation supposed to be the whole point of the Abenomics exercise? Don't rising energy costs constitute the lions share of the country's recent, much heralded, inflation? Damned if I do, and damned if I don't would seem to be the only conclusion to draw. A win-win policy which both closes the trade deficit and foments inflation (if that's what you think Japan needs) doesn't seem to be on the table. The trade deficit could also be corrected by reducing the fiscal deficit, but that would lower domestic demand, possibly send the economy back towards recession and almost certainly ignite deflation yet one more time.

The remainder of this post can now be found in my Kindle e-book published with Amazon.

You don't need to buy a Kindle to read this book. You can download a free app from Amazon.

Monday, May 13, 2013

The Real Experiment That Is Being Carried Out In Japan

The future never resembles the past - as we well know. But, generally speaking, our imagination and our knowledge are too weak to tell us what particular changes to expect. We do not know what the future holds. Nevertheless, as living and moving beings, we are forced to act. - John Maynard Keynes

Discussions of the population problem have always had the capacity to stir up public sentiment much more than most other problems. - Gunnar Myrdal

Last Thursday the yen broke through the psychological threshold of 100 to the US dollar. On Friday the slide continued (see chart), even dropping very close to 102 to the USD at one point before strengthening slightly on the run in to the G7 finance ministers meeting.


The ostensible source of the sudden shift was a news release from the Japanese Ministry of Finance detailing the fact that Japanese investors bought a net total of 514 billion yen ($5.2 billion) in foreign bonds during the two weeks to May 3. Speculation had been rife that Japanese money funds would start to respond to continuing yen weakness and low Japanese yields by investing abroad. It is still far from clear that this is really going to happen in the short term, but nonetheless the news was sufficient to spark bets on more yen weakness.

Naturally the fall has drawn comment, especially during the run up to last weekend's G7 meeting. US Treasury Secretary Jack Lew told CNBC that while Japan had "growth issues" that needed to be dealt with its attempts to stimulate its economy needed to stay within the bounds of international agreements to avoid competitive devaluations."I'm just going to refer back to the ground rules and the fact that we've made clear that we'll keep an eye on that," he said in a comment that was widely seen as drawing a red line in the sand.

But really, what else do external observers expect? On 4 April Bank of Japan governor Haruhiko Kuroda announced he was going to increase the money base by 1% of GDP per month for the next two years. That is to say Japan's monetary expansion will be incremental and continuous. Kuroda has even stated he will continue to increase the money base beyond the initial 24 months if the targeted inflation doesn't come. It was always clear that the country was going to have a difficult time trying to generate inflation and that one of the knock-on consequences would be to continually weaken the yen. So you can't realistically expect him to turn round and say now, "sorry, we didn't know it would offend you so,  I'm cancelling the policy". Anyway, that move would throw financial markets straight into turmoil. Didn't they understand what they were signing up to when they accepted "Abenomics" at the last meeting?

Obviously there is still a considerable amount of confusion around about what exactly Japan's problem is, and what the policy is trying to achieve. I have tried to examine the more theoretical background to the problem in my  A-b-e of economics post, but looking through the comments to that piece I realised that I was very tightly focused on one, examining only one aspect of what has come to be known as Abenomics, the inflation targeting component and its theoretical justification. Since ideas about what exactly it is the Japanese government is trying to achieve seem to be many and various, I thought it might be worth coming back and taking a second look at the experiment.

The remainder of this post can now be found in my Kindle e-book published with Amazon.

You don't need to buy a Kindle to read this book. You can download a free app from Amazon.