Is Japan Trying

This question may seem a strange one, but appears to be worth asking since one US economist after another has been suggesting that, one way or another, the Japanese are simply not trying to find a way of getting out of their mess. First Cecchetti got the ball rolling with the following in the Financial Times:

"What about the zero nominal interest-rate floor, the point at which central banks supposedly become impotent? Listening to officials from the Bank of Japan, you would think that once they set their interest rate target to zero, there was nothing else they could do about stagnant growth and falling prices. Again, I do not believe it."(see my article here)

Then Ben Bernanke added his tuppence-worth:

"The claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has Japan not ended its deflation?.......Japan's deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States."

In fairness Bernanke does not suggest that the Japanese have failed to use monetary easing. But his analysis of what the Fed might do almost all revolves around the use of monetary and exchange rate policy to produce inflationary expectations, thus the claim that all will be well in the US 'since the US has the tools it needs' might be thought to ring somewhat hollow. If the problem in Japan revolves around political constraints, constraints like an unwillingness to bear the weight of the impact of structural reform, then perhaps he might have done better to address the reasons these political constraints will not be operative in the US. Absent this, the assurance that the US will be different seems to imply that there is a mix of monetary and economic policy (short of collapsing their economy completely by closing half of it down) which the Japanese are NOT using. This however seems doubtful.

On the fiscal front what Bernanke terms 'the heavy overhang of government debt' is cited as making ''Japanese policymakers more reluctant to use aggressive fiscal policies". Now this public debt overhang is a product of Japan's ageing population, so are we really to believe that the US might not face similar dilemnas as we get further up this decade? Further, as Paul Krugman has suggested, Japan has not been exactly backward in coming forward with fiscal policy:

"What about the second line of defense, fiscal policy? Japan has tried that, and it has worked -- sort of. Let me explain. .....If you have visited Japan recently you know that it does not look like a country in the midst of a depression. There are strong similarities between Japan in the 1990's and the United States in the 1930's, but there is also a big difference. America descended rapidly into depression. Japan's crisis has unfolded far more gradually........

The other reason that Japan does not look like a country in the midst of a depression is that the government has found a concrete solution to the problem of mass unemployment. By ''concrete,'' I don't mean serious, hardheaded, substantial. I mean concrete, as in roads, dams and bridges. Think of it as the W.P.A. on steroids. Over the past decade Japan has used enormous public works projects as a way to create jobs and pump money into the economy. The statistics are awesome. In 1996 Japan's public works spending, as a share of G.D.P., was more than four times that of the United States. Japan poured as much concrete as we did, though it has a little less than half our population and 4 percent of our land area. One Japanese worker in 10 was employed in the construction industry, far more than in other advanced countries.

Now for the bad news: deficit spending has slowed the Japanese economy's slide, but it has not reversed it. That is, the public works programs provide only temporary, symptomatic economic relief. The favorable effects last only as long as the spending itself. They don't seem to lay the basis for a permanent turnaround.
The Fear Economy

Well, you might think that the case was far from clear. So why don't the Japanese complain at all this unfair coverage of their economic and financial policy. Well, that's just what two of their politicians do in yesterday's Financial Times. Of course their solution is not particularly unconventional: stop China. They begin with a scarcely value sideswipe at the ECB:

Monetary policymakers around the world are still fighting the old enemy of inflation, not the new foe of deflation. There is an urgent need to switch to global reflation in order to avoid a deflationary spiral. In order to cope with economic stagnation, there has been aggressive fiscal expansion since the early 1990s. Several years after the collapse of the bubble, the Bank of Japan belatedly shifted to easy monetary policy. Then it gradually guided the short-term money market rate below the discount rate, but without much success in stopping price deflation, let alone reviving economic activity.

Last year, with the short-term rate virtually at zero, the BoJ abandoned the use of interest rates and shifted to a quantitative easing policy by targeting the current account balances of commercial banks held at the bank. Despite the injection of liquidity into the markets, the BoJ has not stopped price deflation. Its ability to conduct an effective monetary policy has also been hampered by a dysfunctional financial sector. Commercial banks, saddled with large non-performing loans and inadequate capital positions, have been unable or unwilling to extend loans even though they have abundant liquidity.The Japanese experience demonstrates that traditional monetary policy can lose potency in a deflationary environment. Since the nominal rate cannot fall below zero, a central bank can lower real interest rates and so provide monetary stimulus only by drastically changing price expectations.
Source: Financial Times
LINK

One Japanese observer who has some experience of watching how monetary policy evolves as interest rates approximate to zero (ZIRP) is Morgan Stanley's Takehiro Sato. In a post in early November in the Morgan Stanley Global Economic Forum he made the following observation in connection with Greenspan's recent 50bp reduction in the Federal Funds Rate.

The Japanese economy can be viewed as the front runner in a global deflation race with no apparent end. The central banks of other industrialized economies will gradually come to understand the BoJ�s struggle, having completely exhausted traditional policy measures. Central banks fought inflation through the mid-1990s, but the battleground has changed to the uncharted territory of deflation. In some respects, it is positive that overseas policy authorities and academics will begin coming to terms with the tough challenges of fighting deflation in a ZIRP environment, which is something that only Japan has experienced until now. The BoJ should benefit from overseas financial authorities giving serious consideration to the implications of a "purposeless" policy of quantitative easing (basically a zero interest rate with a �15-20 trillion reserve floor) should the FRB and ECB move into the ZIRP realm. The unfavorable scenario for the BoJ would be foreign central banks having unexpected success with quantitative easing and such easing ironically spurring a recovery for the global economy. In this case, the BoJ is likely to face criticism for being slow on the draw with policy action.

Japan�s experience thus far suggests slim chances for the latter scenario. Once the policy rate drops into the lower 1% range, the game is already over for monetary policy. While monetary policy can be effective in restricting total demand when necessary, it lacks the wherewithal for demand creation. Since the elasticity of real money demand from nominal rate fluctuations rises to an extreme level with a zero interest rate, the short-term money market endlessly absorbs liquidity supplied by the central bank, just like spraying water in a desert. Liquidity never makes it to the real economy. This can also be understood in terms of zero opportunity costs for reserve deposits. There is no pain from holding an infinite amount of reserves ("no pain, no gain"). Additionally, the BoJ has gradually raised its liquidity provision mechanism of Rinban operations (which is equivalent to coupon pass). However, these operations wind up strengthening flattening bias on the yield curve, and actually contribute to deflation expectations through the financial market�s expectation formation dynamic. ZIRP poses the danger of getting caught in a policy trap that cannot be easily escaped.
Source: Morgan Stanley Global Economic Forum
LINK

Japanese Unemployment Continues to Rise

Japan's industrial production fell last month and families cut their spending after unemployment rose to a record high, adding strength to the growing view that Japan's economic recovery may be running out of steam. Of course much of the future for unemployment now depends on what really happens in the wake of the NPL debate.

Production unexpectedly fell 0.3 per cent in October from the previous month, the Ministry of Economy, Trade and Industry (Meti) said on Friday. With the second second consecutive monthly decline, Meti changed its outlook for the index from a "gradual upward trend" to "flat". The data suggested that industrial production, which has been driven by exports, and the economic recovery , probably peaked between July and September, boding ill for Japan's already high unemployment rate.

Unemployment in September revisited Japan's post-war high of 5.5 per cent, matching a record high set last December, according to government data on Friday. Although the ratio of job offers to applicants rose slightly to 0.56 - meaning there were 56 offers for every 100 jobseekers - the data showed the labour market remains weak. "With the expected faster disposal of NPLs, corporate bankruptcy and involuntary job losses will likely increase," said Takehiro Sato, economist at Morgan Stanley. "Our calculation suggests a �29,100bn increase in final NPL disposal would lead to 700,000 more job losses and a 6.5 per cent unemployment rate."
Source: Financial Times
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Japan Banks Claim to Tackle Non-Performing Loans

According to the Financial Times there are signs the pressure being put on Japan's banks to deal with their bad loans is starting to bear fruit in the fact that the country's largest lenders used the publication of their first half results to simultaneously announce more aggressive action to tackle the problem. my feeling is it would be better to adopt a wait-and-see approach on this before starting to cheer.

SMBC, Japan's second largest bank, increased its forecast for loan loss provisions for the full year from �500bn ($4.1bn) to �700bn, while UFJ, the fourth largest lender, said it would transfer �1,000bn in bad loans to a new group company. SMBC said net profit for the first half rose 61 per cent to �55bn and added it expected to report a �30bn profit for the full year. It incurred loan loss charges of �266bn for the six months compared to �1,540bn for FY2002. It said in the first half it wrote off bad loans worth �953bn and that it had bad loans worth �5,700bn left on its balance sheet, of which �3,000bn were loans to companies considered in danger of bankruptcy or already bankrupt. UFJ said it made a net profit of �72bn for the period compared to a loss of �67bn for the same period a year ago. It forecast a profit of �70bn for the full year and confirmed it would transfer �1,000bn in non-performing loans to a new company to be set up next March.

Mizuho, the world's largest bank in terms of assets, said net profits for the half dropped to �39bn compared to a loss of �264bn previously but said it now expected to make a loss of �220bn net loss for the full year. The bank added it had bad loans of �4,970bn at the end of September compared to �5,000bn at the end of March. It increased its forecast for loan loss charges from �600bn to �1,040bn. MTFG reported a group net loss for the first half of �188bn compared to �96bn for the same period last year. It cancelled its interim dividend and said it now expected to make a group net loss of �185bn for the full year. MTFG said it had problem loans worth �3,6800bn at the end of September compared to �4,270bn at the end of March.
Source: Financial Times
LINK

Japan: What is The Economist Missing

According to the Economist it WAS just possible to find a nugget of good news about Japan�s economy on November 19th. However rose-tinted glasses, they suggest, were needed to spot it. On a day which saw another round of declines in the share prices of Japan�s biggest bank the Organisation for Economic Co-operation and Development (OECD) changed its mind about the economic outlook. Yutaka Imai, an OECD economist, said the organisation no longer expected Japan�s economy to contract this year. Instead, he said, it was likely to remain flat.

That zero growth is an improvement is a telling indication of Japan�s economic mess. Mr Imai was in Tokyo to talk about the OECD�s newly published survey of Japan. New data since the survey was completed makes the OECD�s economists slightly more optimistic about this year. But this has not altered their broader assessment: that the economy is in serious trouble. The prospect is for virtually no growth till the end of 2004. There is no sign yet of an end to deflation, now in its third year. And the problems created by Japan�s crisis-ridden banking system are in ever more urgent need of attention.

Besides the banking sector, the OECD identifies deflation, fiscal policy and the burgeoning government debt, and the uncompetitive nature of much of the economy as areas in need of urgent remedy. With the downside risks greater than they were, and no sign of an end to deflation, the OECD thinks monetary policy needs to move into uncharted territory. It urges the Bank of Japan to consider a range of new measures to tackle deflation. It also says that inflation-targeting might eventually have a role to play.But the OECD is far more concerned about the large part of the economy that is not export-oriented. Japan has what the organisation describes as a dualistic economy: the domestic, or protected, part of the economy is �remarkably unproductive�, which reflects poor resource allocation underpinned by, above all, poorly enforced competition law and regulation.

Reform is beginning, in some areas at least, to move in the right direction�though the OECD describes much of this as �timid�. So far, the ambitious reform plans of the prime minister, Junichiro Koizumi, have been more noticeable for their absence than their effectiveness. The OECD is not, on the whole, prone to exaggerate gloom. That is why its report on Japan makes such depressing reading.
Source: The Economist
LINK

Let's run this last paragraph again. The reform is begining. After ten years we can really believe that things are so simple. And even after ten years they remain 'timid'. Plans are ambitious, but remain notable for their absence of effectiveness. Our learning curve doesn't seem to be very steep at this point.

One of the problems with the Japan debate is that much of the material fails to tackle the problem head-on. For instance the well-publicized Federal Reserve research report "Preventing Deflation: Lessons From Japan's Experience in the 1990s" rather surprisingly manages to miss one of the most important factors driving the Japanese deflation: DEMOGRAPHICS.

So all of this is like Hamlet without the prince. And the OECD report which forms the basis for the Economist article isn't any better. It simply ignores the problem. Non of this analysis then really helps us understand why Japan government debt is growing out of control - after all with deflation even government supplied services should get cheaper, and why raising interest rates at any point is going to be difficult.

Many of the arguments rest on the assumption that eventually Japan will solve the slow growth problem. Well, I wouldn't be too sure, if the problem is a wrong diagnosis how the hell do you expect the medicine to work (although they did just discover that statins may reduce c-reactive protein as well as cholesterol, so there is hope, it's just that this reduces economic policy to a lottery).

At one level Paul Krugman is surely right, if Japan could spark inflation then things would get easier (although not necessarily for all those old people who are net savers), trouble is it seems it can't. Japan lived for fifty years on short term credit being wiped out by a steady inflation in land and property values, but when the labour force numbers hit the ceiling all that came to a fairly unpleasant end. I doubt it can start another assett driven buble, if it can't it isn't for want of trying. But if there's no petrol in the bike tank, then all the kick starting in the world won't help.

Another problem is the assumption that the Japanese are simply living on credit. Were things so simple! If you want to talk about debtor nations then you need to talk about the US, and all those dollars the Japanese have on deposit inside the Federal Reserve System which partly pay for those nice fat trade deficits. The IOU's are going from the US outwards, Japan is a net international creditor. And if one day push comes to shove and the Japanese take their money home, the first impact will be on Wall Street.

Another typical misunderstanding seems to relate to the debt service problem, and when it might begin to look problematic. When should we expect a risk premium on Japanese Government Bonds that really starts to bite. The problem here is that the Japanese govt though the postal bank and savings system effectively buys it's own bonds (or constrains savers institutionally to supply the funds which makes this possible) so they are, at present relatively immune to these downgradings. Japan is not Argentina.


That is the Japanese savings rate isn't just cultural, it's also structural, it's been engineered. Which leads to another misconception. The late-great Rudi Dornbusch was prescient enough to foresee that in the case of Japan "one day there will be a creditors strike, the investors leave for foreign assets (just as with any delinquent emerging market) the currency crashes, the debt crashes....".

But with Japan, as ever, things are not so simple. This creditors strike will not be as easy as it sounds. Cultural factors do have a role, and it is hard to see Japanese citizens abandoning their country anytime soon (again the Japanese are not the Argentinians). So they will attempt to keep paying the debt. As for the currency, there are relatively few Yen in international circulation, the MOF has seen to that as part of an explicit policy, so for the time being Japan has more control over its own currency than any other country. If the Yen does come down it will be because the MOF, or the MOF plus Washington want it that way. Of course one day everything will snap. Put another way all this will continue until it can't.