This is my Day-to-Day Weblog on the Japanese Economy. For More Detailed In-Depth Commentary, Analysis and Links on Japan's Continuing Economic Crisis See the Japan Page on My Website

Japan's Job-Loss 'Recovery'


I'v made myself a promise to try and look a bit more at Japan this week, since I'm sure I've been neglecting things there. This piece serves to kill two birds with one stone, since it also relates to the ongoing 'structural reforms' theme. I think the argument demonstrates two things: that job creation is getting harder everywhere, and that the Asia Times (following on from the previous post) is a neglected source of good-quality information. BTW I've put the 'R' word in scare quotes, since that is the topic I will be trying to investigate this week.

Japan: the rising specter of unemployment By Hussain Khan

TOKYO - Higher labor costs, yen appreciation resulting in the outsourcing of production facilities and growing computerization all point to a long-term structural increase in Japan's jobless. Due to heavy losses in labor-intensive sectors, companies are planning further outsourcing of their production facilities to countries where labor costs are much lower.

It is difficult to describe how profound these changes are in Japanese society. They are breaking down a system of lifetime security for the low-paid but loyal sarariman (salaryman) of legend, whose antecedents sociologists trace back to the samurai system in which a warrior class dedicated their lives to their feudal lords. In modern society, the Japanese company has served as the locus of social stability for the sarariman, with loyalty to the firm resembling earlier fealty to nobles. Today, as outsourcing continues and jobs go overseas, the essential nature of the country�s work force and its values are being challenged in an unprecedented way. The office lady, who joined her equally inefficient sarariman colleague in the work force, is also likely to be a victim of the aggressive rationalization of Japan's notoriously disorganized office operations.

Japan's seasonally adjusted unemployment rate stood at 5.1 percent in August, the lowest level since the 5 percent posted in August 2001, according to a report released by the Ministry of Public Management, Home Affairs, Posts and Telecommunications. That means that during the last two years, employment has not improved. Rather it has deteriorated. The number of part-time workers fell for the first time in 20 months, while the total of all people who worked during the month also dropped 100,000 from a year before to 63.61 million, the first negative growth in four months, indicating that the nation's employment situation remains bleak. The number of employed people decreased by 160,000 year on year to 53.47 million.

The number of people out of work due to corporate restructuring and other reasons related to their employers totaled 970,000. This was the first time since January 2002 that the figure had fallen below 1 million, an indication that corporate restructuring may have run its course. But this optimism over a drop of mere 3 percent in one month is not justified after 1 million have been unemployed for the last 20 months.

The weakening dollar and the stronger yen had not taken their toll as the Bank of Japan heavily intervened in the currency market. But after John Snow, the United States Treasury Secretary, criticized Japanese exchange rate intervention in a congressional committee in Washington, the yen rose as high 107 yen to US$1, breaking the psychological barrier of 108 yen. Speculation is for a trend toward 105 yen and more yen appreciation shortly.

Under such a scenario, the pressure is increasing for further corporate restructuring, and with it further job losses. The one-month drop of 3 percent and the 20-month old trend averaging more than 1 million unemployed can be expected to resume with greater force as long the yen continues to appreciate, since a lot of export-related corporations have started fresh plans to outsource their production facilities, especially in the electrical white goods sector.

Even apart from the pressure of yen appreciation, corporate restructuring is continuing, with no signs of abating. Although the banking sector has been the main beneficiary of the recent stock market rise, some banks like the Resona Group expect to cut employees, with the group dismissing some 4,000 employees,reducing its staff from 19,000 to 15,000 by March 2005 in a bid to complete its revised restructuring program two years ahead of schedule.

A draft of Resona's new restructuring plan also calls for reducing outstanding loans to smaller businesses at fiscal year-end next March by 1 trillion yen on the year as an attempt to shift its focus from quantity to quality. The draft fails to set the schedule for repaying public funds, foreseeing that the group's profits will remain flat from fiscal 2004 through fiscal 2006. It also calls for skipping all dividend payouts through fiscal 2004, including those to the government. The latest plan by the banking group, which is effectively under the government's control, is expected to be finalized by the end of next month for submission to the Financial Services Agency.

This is a revised version of the business reconstruction plan crafted in June after the government decided to inject about 2 trillion yen of taxpayer's money into the group. Under the updated plan, Resona group is to also reduce its number of branches to 495 by the end of fiscal 2004, 20 more than called for under the current plan. With these aggressive restructuring efforts, the group's expenses as of the end of March 2005 are projected at 90 billion yen less than those of two years earlier. The ratio of labor and property costs to gross operating profit is to be slashed to 52 percent from 59 percent as well.

The banks are not alone in their restructuring plans. Sanyo is emblematic of the new and unsettling Japan. In the electrical goods manufacturing sector, as a part of its effort to provide secure employment, Sanyo continued to produce white goods at its domestic plants. But with the white goods business unlikely to stop bleeding red ink in the immediate future, Sanyo has decided to downsize its operations in Hyogo Prefecture and another in Shiga prefecture. The Hyogo plant is to cease production of vacuum cleaners, massage chairs and all other products by year-end and focus on research and development. The Shiga plant is scheduled to stop making microwave ovens, washing machines and double-tub washing machines by the end of this fiscal year.

As a result, sales from domestic production are expected to account for about 20 percent of the firm's overall home appliance sales, down sharply from the current 60 percent. Sanyo intends to reduce employees at the two plants from the current 1,250 to around 900 by April 2004 through relocations to other divisions and transfers to subcontractors. The company plans to maintain its product lineup by outsourcing production at the two plants to outside firms and transferring it to overseas factories. Sanyo's home appliance division recorded a 10.5 billion yen operating loss on a consolidated basis for the fiscal year ended March 31, making it the only one of the firm's six divisions to be in the red.

Other companies in the same or related sectors like Futjitsu and Hitachi have also announced losses. Like Sanyo, these companies also must reduce employees to meet their restructuring goals. Fujitsu, the major computer maker, said that it posted a consolidated net loss of 58.5 billion yen for the fiscal first half ended September 30, mainly due to money-losing operations in the computer software service division caused by a general decline in information technology investment among corporate clients.

Profit from the software division, the firm's core operation, declined by more than 40 percent. The manufacturing sectors for electronics parts and for information and telecommunications stayed in the red despite cost reduction efforts, according to company officials. The company reported a special profit of 34.4 billion yen, mainly from sales of its stockholding in Fanuc Ltd, the major industrial robot maker, but the gain was not enough to offset the net loss.

As for Hitachi, growing losses from a hard-disk drive business it acquired the previous year were the main contributor to a 5 percent fall in consolidated net profit to 5.3 billion yen in the fiscal first half, even after Hitachi sold portions of its stock in affiliate Nitto Denko Corp, which generated a special profit of more than 90 billion yen. Hitachi officials said that an increase in pension payments and other factors reduced operating profit by 67 percent to 20.2 billion yen.

Hitachi�s heavy and industrial machinery division also suffered a decline in profit due to cutbacks in investment, mainly among electric power companies. Earnings from refrigerators, washing machines and other household appliances were also weak because Japan experienced an unusually cool summer. Unlike Sharp Corp and Matsushita Electric Industrial Co, neither Fujitsu nor Hitachi is a major player in the fast-growing digital home appliances sector, which is another factor for their poor performance.

The effect of computerization on employment cannot be neglected. On the second day of the Nikkei Global Management Forum, Scott McNealy, chairman and chief executive officer of US computer firm Sun Microsystems Inc, said information technology will bring about drastic changes in the corporate world. Since the spread of IT will render obsolete conventional ways of working, personnel ability and corporate activities, companies will have to adapt to the changes, for example, by reorganizing their employment structure, he said.

McNealy pointed out that companies can enjoy the benefits of a ubiquitous computing environment such as improved productivity and the need for less office space. The Sun executive noted that companies also need to accept the negative aspects of IT, such as changes in working conditions and increases in corporate bankruptcies as the natural consequences of a computerized society. He said that although governments tend to try to stop such changes, companies should be forward-looking.

That means that if Japan's companies are to become more competitive, the job cuts will continue, changing long-held standards of Japanese society. Those changes are bound to be painful for a society not used to pain.
Source: Asia Times
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Japan Pensions: Where is the Incentive?

It seems that, little by little, the world is waking up to the importance of all this. Last week it was the Italian Minister of the Interior, this week it is the director of economic policy in Japan's cabinet office. When I started blogging about this, just over a year ago, it was much harder to get a hearing. This change is positive. OTOH too many people are continuing to fool themselves by thinking of this as a linear process. Here, non-linearities will be everything. Two examples in the report: number one, is the cost of having children, and the inability of society collectively to address this because of the scale of the fiscal problem which already exists coping with the elderly. Secondly, young people are dropping out of the pensions system. It is logical: if you put more in than you are ever going to get back, where is the incentive?

Already mired in its worst economic slump in decades, Japan may well see its growth decline even further as its citizens age and its population shrinks, the government said in an annual economic assessment released Friday. The report suggested Japan needs to take stronger measures to encourage people to have more children, and to make its domestic markets more attractive to foreign investment. "Japan is experiencing aging unprecedented in history," said Jun Saito, the director of economic policy and analysis at the Cabinet Office, which authored the report.


Addressing the aging problem for the first time, the annual assessment noted the country's population between the ages of 16 and 54 has already started to slide and added that growing numbers of retirees are trimming the nation's huge savings pool. Economists say Japan's high saving rate was a major factor driving the country's rapid growth in the decades after World War II. The savings households deposited in Japanese banks provided a ready supply of capital that industry borrowed to invest in new plants and equipment. But today, Japan is a net creditor to the world and attracts little in the way of foreign savings - one source of funds countries often turn to when there is a shortage at home, Saito said.


Along with attracting overseas capital and raising labor productivity, the report stressed the need to help women have careers and children, instead of choosing one or the other. Saito said one option would be to set up more day-care centers, a step the government pursues now. The report said the average Japanese woman now faces incentives not to have children: She loses 85 million yen ($772,000) over her lifetime if she quits her job to give birth - even if she returns to work afterward.

Japan's birthrate - which measures the average number of times a woman gives birth during her lifetime - dropped to 1.32 in 2002, the lowest on record, and after peaking in 2005, the population is on track to shrink by nearly a fifth by 2050, the government says. The changing demographic is already straining the country's pension system, with the government forecasting those now in their 20s through 40s will pay more into the system than they will receive due to the large numbers of elderly the country will support in coming years. This is causing more young people to opt out of paying into the system, creating an additional burden on government coffers.
Source: Yahoo News
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Row Over Resona Bailout

This is obviously part of the backdrop to the election campaign, and it is always hard to judge the significance of things in this context. But Resona is interesting, since it is a strange case, and it could give us some clues as to the real determination for serious reform in Japan. On the face of it, not encouraging.

The Democratic Party of Japan, the country's main opposition, is accusing the government of Junichiro Koizumi of "state-sponsored window dressing and fraud" when it bailed out Resona, the Japanese bank. DPJ officials will meet representatives of the Financial Services Agency, the banking regulator, on Monday and will argue that the government was aware that Resona was insolvent when the FSA decided to inject Y1,960bn ($17.9bn) to prevent the bank collapsing. The opposition's decision to accuse the government of acting illegally escalates the potential political fallout from the Resona rescue and is designed to put pressure on the prime minister and his ruling Liberal Democratic party ahead of a general election in November.

The DPJ will argue that the government deliberately used an inappropriate clause of the Deposit Insurance Corporation law to avoid the stigma of an embarrassing nationalisation as well as protecting shareholders from having the value of their holdings completely wiped out. Following the bail-out, Resona's share price rose sharply.

When it bailed out Resona, the government cited a section of the DIC law that can only be used for banks with a positive net worth. Other sections, however, are for use with "bankrupt financial institutions or financial institutions where assets are unable to fully repay liabilities".

An official at a credit rating agency who asked not to be named said: "In Resona's case, if it did have negative net worth at end-March 2003, as is suggested by the subsequent independent audit, it should have been declared insolvent and dealt with either under [sections] 102(2) or under 102(3)." Section 102(2) allows for the failed institution to be merged with another company, while section 102(3) allows for the full nationalisation of the bank, which would result in shareholders' equity being written down to zero.

Controversy over the Resona bail-out intensified after it was announced this month that the bank would report a far higher than expected loss of Y1,760bn for the first half of the year - a figure almost equal to the Y1,960bn injected by the government.
Source: Financial Times
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Japan Still On the Deflation Trail

Japan economy minister Takenaka tells us Japan will triumph over deflation. Just one last question: how? No, this isn't fair, he does offer some pointers. But it still remains to be seen what these actually mean in practice......

Heizo Takenaka, Japan's economy minister, said on Thursday that the country could overcome its persistent deflation because the central bank is working more closely with the government. The key reforming minister of Junichiro Koizumi's government said in an interview with the Financial Times that the co-operation followed the appointment of a new governor of the Bank of Japan in March.

On the eve of US president George W. Bush's visit to Tokyo, Mr Takenaka said the BoJ would aim to raise money supply growth from its current 2 per cent to between 3 per cent and 4 per cent. For its part the government would increase demand through deregulation and clean up the banking system so that the BoJ's looser monetary policy was transmitted to the economy as a whole. Mr Takenaka said: "By combining these two, our calculations say that we will be able to overcome deflation."His suggestion that the BoJ was co-operating with government policy comes after years in which many saw the central bank as a stubborn opponent of price stability............

With the economy growing in the second quarter at an annualised 3.9 per cent according to official statistics, now was the time to press home the advantage. The economy minister said: "We hope to create a virtuous circle."

Mr Takenaka praised Toshihiko Fukui, who became bank governor in March, suggesting that he was more determined than his predecessor to halt deflation. "Since Governor Fukui took office BoJ policy is, in my opinion, moving in a good direction," he said.

The consumer price index for August fell just 0.3 per cent from the previous year although, measured by the gross domestic product deflator, prices are still dropping by about 2.5 per cent a year.

Mr Takenaka said that, "even with the CPI nearing zero", the BoJ had signalled its commitment to easy monetary policy for as long as necessary. The BoJ was "contemplating right now" how to signal its long-term commitment to price stability, with some BoJ members advocating a reference rate, a goal just short of an inflation target, he said.
Source: Financial Times
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Japan: Conflicting Signals?


Along with the renewed pressure from the Bank of Japan against the rise of the yen, here is one more small piece of evidence that all may not be as well as the markets imagine:

Machinery orders placed by Japanese companies fell by a bigger-than-expected margin in August, according to official figures released on Wednesday, indicating an uncertain outlook for capital expenditure which has fuelled Japan�s nascent economic recovery. Orders for machinery made by private Japanese corporations, seen as an indicator of capital expenditure about six months ahead, fell 4.3 per cent in August from July, the Cabinet Office said. On a year-on-year basis, they rose 12.2 per cent, a smaller increase than expected. The weak data, together with the strong yen that on Wednesday traded at Y109.5 against the dollar, accelerated the decline in the Tokyo stock market, which fell for the first time in five days. The Nikkei 225 ended 2.6 per cent lower at 10,542.20.
Source: Financial Times
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Japan: Thrice Fooled?

Why do you blog. Sometimes for the simple comfort of knowing you are not alone. This time the case in point is Japan. I can't remember when I last saw anyone come out and say it straight as Richard Katz is doing here. His reasoning is fairly sound, the NPL problem is still there, structural reform has not gone as far as some claim, and the banking situation only seems sounder because all the speculation about recovery has seen the value of equities rise, and this of course has boosted the value of bank reserves. But I am convinced for another reason which Katz doesn't mention (in fact in the course of two books he manages to mention that Japan has a demographic problem about twice). This is why I'm convinced even his ten year horizon could be way too optimistic. Without a change in mentality towards immigration Japan is unlikely to go anywhere particularly attractive, and this change is the one I definitey don't see coming.

Fool me once, shame on you. Fool me twice, shame on me. How about three times? Japan is now experiencing its third cyclical upturn in the last decade. Once again, we hear that "Japan is back". Once again, investors are betting tens of billions of dollars that this recovery will last. Doubtless a skilled market player can get rich in a stock market that doubles and halves every few years. But unfortunately, this time is not different. One reason we know this is that the arguments being handed out today are the same premature declarations of victory handed out in the previous false dawns: that the non-performing loan (NPL) problem is being solved and that companies are rapidly restructuring. One new rationale is that Junichiro Koizumi, the current prime minister, is a reformer.

But Mr Koizumi was at the helm when, not so long ago, alarmists insisted that Japan was about to crash. Indeed, some of today's born-again bulls are yesterday's doom-sayers. There is also a more fundamental reason for scepticism: Japan cannot recover without structural reform. Japan's long-term potential growth is still about 1.25 per cent. This rate cannot be raised without a productivity revolution born of structural reform. Meanwhile, structural defects that depress household income continue, causing a chronic shortfall in private demand. Certainly, some reforms have been made but not enough to restore vibrancy in the near term.

Bulls point out that NPLs declined in the 2002 fiscal year for the first time in six years. Nonetheless, NPLs still remain higher than in any year except one. More importantly, Japan has done little to weed out the non-performing borrowers behind the debt crisis. Bankruptcies are not rising, but falling. Japan continues to keep zombie companies going via government loan guarantees, sub-market interest rates and debt waivers. Among publicly listed companies, 16 per cent of the debt is held by companies that do not earn enough to pay even today's ultra-low interest rates. Another 14 per cent is held by companies that earn just a tiny bit more. To keep these companies afloat, 10 per cent of all loans charge less than 0.5 per cent, up from 5 per cent a few years back.

As for corporate restructuring, there is less than meets the eye. Most of the improvement in financial indicators is due to cost-cutting measures such as wage cuts - which hurt consumer demand - not genuine increases in efficiency. The average return on assets halved in the 1990s to just 3 per cent. The data to June 2003 show no trend recovery in returns, just another cyclical bounce.Company inefficiency is, in turn, the product of weak competitive pressures. Here some trends are moving backwards. Business start-ups and closures are both down. In most industries, the market share of the top three companies is increasing, partly because of the merger and acquisition activity that some mistakenly hail as reform.

Worse yet, most of the good news is limited to Japan's biggest companies. In the 2002 fiscal year, which ended in March, the 1,200 biggest publicly listed companies enjoyed a 38 per cent increase in operating profits. But they produce less than 10 per cent of Japan's economic output. By contrast, the small and medium-sized companies that produce most of Japan's output suffered a 12 per cent drop in both sales and operating profits. Mr Koizumi does seek reform. However, his priority is not the economy. It is destroying the corrupt nexus linking party bosses in the ruling Liberal Democratic party (LDP), state enterprises in construction and elsewhere, and their bureaucratic protectors. He has split anti-reform factions of the LDP and is now ousting Haruho Fujii, the Highway Corporation president, for allegedly cooking the books.

Time will tell whether Mr Koizumi can go on to privatise some of the main state enterprises, such as the Highways Corporation and postal savings. Some of the new allies he made to secure his re-election as party leader oppose these reforms. Even if he succeeds, privatisation alone will have a marginal impact on growth so long as the resulting entities remain virtual monopolies, as when Nippon Telegraph and Telephone (NTT) was privatised in the 1980s. Markets must be open to new competitors. Reform will eventually return Japan to sustained growth of 3 per cent or so. But that will probably take another decade. As for this year, it takes more than a few swallows to make a spring.
Source: Richard Katz, Financial Times
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The Future of Japanese Savings


Well here's Eddie right on call with this week's Straits Times column, giving details on those Japan unemployment numbers, and some interesting and preoccupying background on Japanese saving:

More and more Japanese are dipping into their savings to make ends meet, according to a survey by the Bank of Japan. A record 51 per cent of Japan's households said their savings had dropped during 2003, while the number of families with no savings at all has risen to a 40-year high of 22 per cent, the survey revealed. The results are the latest indication that a decade of economic stagnation and policy mismanagement has not come without cost and will serve to remind new cabinet ministers appointed on Monday of the urgency of their task.The disclosure also raises questions about policymakers' claims that Japan's Y1,400bn ($12.5bn, 10.9bn, �7.6bn) in personal savings will cushion the effects of a downturn.The poll covered 6,000 households, 60 per cent of which said declining incomes were the main reason they were having to use their savings, an increase of 8.4 per cent compared with last year.Figures released yesterday by the National Tax Agency showed average annual remuneration declined 1.4 per cent in 2002 compared with the previous year, the fifth consecutive year of decline. The agency said the number of wage earners decreased by 490,000 to 52.56m in 2002, the first decline in two years. Unemployment in Japan was 5.3 per cent in July this year, down from a record high of 5.6 per cent earlier this year. However, the period of unemployment is increasing, with one in three now jobless for more than a year, according to the latest figures from the Labour Ministry. Unemployment for those under 24 is about 10 per cent.The BoJ survey also unveiled deep disquiet about retirement, with 80 per cent saying they were "worried", rising to nearly 90 per cent of those under the age of 60. They cited a lack of savings and insufficient pensions benefits as the main reasons. Figures released this week by the National Pension Fund Association revealed it achieved a negative yield of 14.5 per cent on assets under management in fiscal 2002, the worst result since its launch in fiscal 1991 and its third consecutive year of negative returns. According to a recent report from Greenwich Associates, assets at employee pension funds in Japan cover only 62 per cent of future payments compared with 103 per cent in the US.Reversing declining incomes, tackling unemployment and ending the erosion of savings will depend on economic recovery - and there are signs of revival.The latest figures showed growth at an annualised rate of 3.9 per cent, although the gross domestic product deflator is running at minus 2.5 per cent and has been in negative territory since 1995.
Source: Eddie Lee, Straits Times

The Japanese 'Recovery' in Question

Blogging has been intermittent, not to say non-existent these last few days as I have been away on fieldwork. The world, however, has not stood still in my absence, and I have the feeling that some of the US data yesterday could turn out to be quitre significant. Certainly it seems that some of the underlying questions about where the principal OECD economies are headed might now start to be clarified. In this context, the latest info from Japan could be read as the beginings of a return to reality. The unemployment numbers need to be read carefully, since the number of people of working age in Japan is now falling, and the drop is to be expected. Morre interesting are the output figures. My feeling is that Japan had revved-up on the hope (and expectation) of a major global recovery, if the wobbly state of the US economy that was revealed yesterday continues to follow this line this will by no means be guaranteed, so expectations in Japan may need to be revsied downwards. Any such revision would simply open up for all to see those 'old problems' which have certainly not been resolved. One last detail: note the comment about the value of the yen not being so high as it seems because of the price effect of years of deflation. Japanese prices, denominated in yen, are a little more competitive each year. However, whatever the fine detail of the situation, a yen at 110 to the dollar is hardly going to help Japan fight the deflation problem.

Unemployment fell to a two-year low of 5.1 per cent in August but industrial output shrank 0.5 per cent in the same month, sending mixed signals about the strength of Japan's recovery. The number of unemployed fell by 280,000 to 3.33m, down 0.2 percentage points from the previous month on a seasonally adjusted basis. This was the first time the monthly jobless number declined by more than 200,000 since 1990. There was also good news in a survey of sentiment among small and medium businesses which showed a surge in confidence close to peaks of the mid-1990s. This improvement in sentiment among Japan's more vulnerable companies comes ahead of today's Tankan business confidence survey, which is seen as one of the economy's most important leading indicators. Revised figures showed growth in the second-quarter at an annualised 3.9 per cent, adjusting for deflation. However, even after revising its growth estimate upwards recently, the government is predicting nominal growth for this year of just 0.1 per cent.

Signs of business confidence and evidence that the economy is at last creating jobs after six quarters of growth were countered by the fall in output. The 0.5 per cent drop came in spite of an increase in shipments, suggesting that manufacturers are still cautious about future growth prospects. Masaaki Kanno, economist at JP Morgan in Tokyo, said: "Manufacturers still do not have the confidence to accumulate inventory." He said the same trend was visible in the US, suggesting that manufacturers might be moving towards a leaner inventory model. Mikihiro Matsuoka, economist at Deutsche Bank, said: "This is not a strong recovery but the upward slope is real." Fears that yen appreciation might choke off recovery were overdone, said Mr Kanno. Because of continued deflation, even if the yen strengthened to Y105 to the dollar, this was equivalent to Y115 in 1999, a competitive rate. He said there was no correlation between corporate profitability and such relatively minor movements in the currency.
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The Economist and Japan's 'Dysflation'


I've been pretty quiet on Japan recently. This is because I think we need to wait and see what kind of reality there is behind the optimistic projections - and share prices - that we have been seeing recently. I don't think the problem, has gone away by any means. At best we are on the upswing of what remains of the business cycle in Japan. The economist is not too convinced either, and has coined the expression 'dysflation' for the Japanese condition. What I still think is unfortunate is that virtually no-one is prepared to even countenance the idea that Japan's demographic problems (and it's resistance to immigration) could have any part in the explanation. The idea isn't even examined in order to discard it. It seems to be a blind spot pure and simple.

So what exactly ails Japan? Clearly not just the usual sort of business downturn, which can be cured, though painfully, with lay-offs and closures and sometimes with a government shot in the arm. Nor can its chronic weakness be attributed solely to a burst bubble and falling asset prices, though that is clearly part of the problem. Many other countries have been similarly stricken, and have managed to recover. In Japan, the misery has lasted for almost 14 years.

The Economist would like to suggest its own label for Japan's illness. It is �dysflation�: a form of deflation in which dysfunctional economic-policy institutions counteract what would otherwise be good medicine for falling prices. The policies, especially with regard to banks, combine in ways that do more harm than good. More important, policymakers themselves are more inclined to avoid problems than address them; would rather win bureaucratic feuds than co-operate; and base most of their decisions on emotion (such as fear of shame) rather than reason.

It helps to keep all these aspects of dysflation in mind when assessing Japan's problems. Consider, for example, the Bank of Japan. Ordinarily, the best response to deflation�that is, falling prices throughout the economy, and not merely for a few products such as Chinese manufactures�would be lower interest rates and feverish printing of money. Japan has had zero interest rates since 1999, however, and has been boosting the money supply at a rapid clip since early 2001�and prices have continued to fall. According to the most respectable measure, the GDP deflator, they have fallen 7.6% since 1997, and are still dropping fast. Eventually, all the money that the Bank has been printing will be sucked through the financial system and expelled into the economy in the form of higher prices and rising nominal interest rates. But it is taking a perplexingly long time to happen.

The Bank's explanation is that Japan's deflation is a very rare strain indeed. It points to the large quantity of non-performing loans that have piled up in the banking system. Never in the history of human endeavour have so many owed so much for so long. And as the Bank's officials like to point out, new bad loans, at least until recently, continued to accumulate faster than the banks were writing off old ones, and the Financial Services Agency (FSA), which regulates banks, has done nothing to stop this. Banks are lending mainly to their worst borrowers; and with the credit channel not operating properly, the usual monetary-transmission mechanism cannot work either.

There is probably some truth in this argument. What it ignores, however, is the overarching role that expectations�of firms, workers, consumers and investors�play in transmitting the central bank's policies into rising or falling prices, and the need for the central bank to manage those forecasts. The Bank has not only failed utterly in this role, but has refused to take responsibility for trying.

Under the previous governor, Masaru Hayami, whose term began in 1998, every constructive policy that the Bank undertook was undermined by a statement that the Bank did not really expect its policy to get prices rising again, at least not quickly. This had a sort of reverse placebo effect. Even as the central bank was administering potent medicine, Mr Hayami said that it was only doling out sugar cubes. A new governor, Toshihiko Fukui, took over in March, and has been an improvement. Conceivably he will do a better job than Mr Hayami of convincing people that all that loose money will not be vacuumed up again at some point by the Bank. But even Mr Fukui has shown traces of his predecessor's dysfunctional approach.
Source: The Economist
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Good, or Bad, News From Japan?

A couple of interesting heterodox pieces on Japan. Michael Hann in the Guardian casts an extremely skeptical eye on what seems to be generalised 'spin' on the 'new tipping point'. Lehman Brothers is "encouraged by the fact that the main contribution to Japan's growth is coming from improved private-sector demand.........This is not simply an export-led recovery." However most of this increased private sector demand seems to have come from Japan's electronics makers producing high-tech toys such as digital cameras and camera-equipped mobile phones. Sharp for eg has said it will raise its capital spending by 20 percent this year, mostly for liquid crystal displays. Sony, meanwhile, raised its capital spending estimates late last month for the current business year by more than 10 percent to 350 billion yen ($2.93 billion), mainly to replace equipment and boost manufacturing capacity for semiconductors: all of which raises the question as to whether this capital spending is economically justified and will lead to real growth or is a 'risk' decision taken in anticipation of a global market which may not deliver. This latter scenario would not, of course, be a 'historic first' for Japan where project evaluation decisions seem to be made using rather different criteria to those commonly applied in, say, the US. (Of course, no sooner do I open my mouth than I want to correct myself. This distinction may well have been a lot more applicable in the past than today, since the tech sector both in the US and Europe is also now swimming in overcapacity. But the substantive point remains: in technology investment the argument risks becoming circular, enterprises invest in anticipation of demand growth, fine, but we can't then read this data off as evidence of coming growth. The expectation/decision may be a bad one, may be disappointed. In which case the outcome will be more deflation not more growth. This is why we still need to be talking about a New Economy dynamic characterised by increased risk, limited visibility, fundamental undertainty, compressed depreciation timescales (the creative destruction hurricane) and, of course, increasing returns. To the victor the spoils, but 'many are called and few are chosen'.)

Analysts at BCA Research in Montreal put out the word last week. Last Wednesday Canada's National Post reported that the firm had just released a report, The Japanese Bull is Set to Run, "advising clients that the Nikkei may be in the early stages of another monster rally, even if the country's economic fundamentals leave much to be desired". On Monday the 225-issue Nikkei Stock Average duly closed above 10,000 for the first time since August last year, 20% up on the index's spring low point.

"While hitting 10,032.97 may seem a feeble victory when compared with the assaults of yore on 40,000, it represents a remarkable turnaround for an index which in March fell near 7,500 as the threat of Iraq war quelled hopes of Japanese economic recovery after a decade of stagnation," said Sally Patten in the Times. "For 14 years after the bursting of the late-80s asset price bubble, the Japanese market has slid inexorably downwards," said Ruth Sunderland in the Daily Mail. "But a growing camp of foreign investors believes the tide has turned." The Wall Street Journal Europe noted the reasons for the change of heart: "Restructuring by corporate Japan is paying off. Companies have cut labour costs, and total corporate debt fell to �185 trillion (�980bn) last year from �354 trillion during 1994."

At Forbes.com, the website of the financial magazine, Lisa Hess was bullish. "Japan's long-awaited revival is getting under way. This is not another false start. Bad deflation is ebbing, business is reviving and the stocks are very cheap." For evidence, Hess pointed to the "Bank of Japan's recently released Tankan survey of business prospects, which covers 10,000 Japanese companies, large and small, [and] shows a meaningful increase in capital spending plans by large corporations. Businesses are not going to spend if executives think they can't turn a decent profit". However, as Sunderland pointed out in the Mail, "Japanese punters have ... largely steered clear of the [share] buying frenzy - perhaps for good reason." The good reason in question is the fact that deflation in Japan is running at 2%.

As the Lex column of the Financial Times pondered: "Should foreigners rush in where locals fear to tread? ... Recent real GDP data have been flattered by deflation - meaning that, in nominal terms, the economy remains flat. Moreover, a key reason for the Japanese investors' caution is that they have been burnt before. On several occasions in the 90s, the Nikkei surged amid a cyclical recovery and reform hopes. But these rallies subsequently faltered because the government backed away from implementing painful policy change, as a sense of crisis ebbed." No wonder the Japanese daily Yomiuri Shimbun - the world's bestselling daily paper - refused to get too excited by the Nikkei's revival. "One of the effects of looking at the world from the bottom of an economic ravine is that we tend to delude ourselves into thinking we have scaled the heights when we get such news, when in reality we have but inched a little higher." The paper criticised ministers for excessive jubilation over the Nikkei's rise and suggested, "the government should not take the rebound of stocks to the 10,000 level as an excuse to rest on its laurels. Rather, it should initiate bold measures to buoy the economy." The Yomiuri reckoned the current rebound was largely down to US economic measures having an impact overseas.
Source: The Guardian
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Which brings us to the real point, is the Japanes economy, as some would have it 'flat', or is it growing, as others don't hesitate to point out, at a reasonably attractive 2.2%. The answer, as always, is it depends (this habit I have of hedging is one of the reasons I try not to mix economics and politics, and try to avoid pronouncing too much on the latter. Big Arny is receiving a lot of stick at the moment for the emminetly reasonable 'never say never' - although of course I'm not saying that Big Arny is emminently reasonable. A politician, maybe, is someone who finds it easy to be sure about something, I only have doubts - even on the euro, honest, I think I'm right, but as they should say: once you stop doubting you're dead.

Anyway to get back on subject, is Japan growing? Answering this takes us back to an earlier debate I had with Dave (and here ) about the uses and abuses of data at current dollar prices. We live in a world awash with numbers, the real problem is what to make of them all. Churchill had it that there were 'lies, damn lies and statistics'. I think this is unduly cynical, but we do need to ask ourselves some important questions in each and every case when we use economic numbers. In particular we should ask why the data has been assembled the way it has. The issue in the present case revolves around the distinction between real and nominal values. Real values are the numbers economists use to compare time series data in terms of a common reference point: constant prices. They is important for constructing such things as consumer price indices and for making comparisons of economic performance between periods. But despite their name they are constructs, the real numbers are the 'nominal' ones. If we go back to my vision of the economic system as the man in the Chinese room interpreting the ticker tape signals fed to him, the data to interpret are the nominal prices, the economy as such doesn't operate through the mediation of a GDP price deflator any more than it matters whether the products exchanged are melons, mobile phones or phone numbers of potential clients (except wait a minute, wait a minute, we have this unfortunate problem of dualism, we have (let's stay Cartesian to keep it simple) brain and mind, so the economy is not a simple machine, we form part of the picture with our tastes and our expectations, and all this enters, economics is a social science. But, again, the main point holds: the real numbers are the 'nominal' ones). Think of the classic businessman's problem in times of deflation: falling stock values. Now is it of any consolation to tell the person who has just lost money that their stock in hand has actually risen in value 'in real terms'. They will just laugh at you, if they don't cry that is.

So getting back to Japan, this is the problem. Prices are dropping at 2%, the nominal value of GDP is roughly constant, so we can derive the idea that there is 'real' growth of 2%. This is true, and it is important, since if nominal GDP was falling the problem would be far worse, but it of little compensation to the Japanese businessman who wants to invest. This is why cracking deflation has to be Japan's number one priority, and the fact that it has not made any progress on this front has to be the most significant piece of information about Japan we have on the table right now.

One last point on the above mentioned Dave. There could be a ripost that with the rise in the value of the yen the whole Japanese economy is now worth more. No, no, no, wait a minute. This is a very complex question (Krugman did his doctoral thesis on just this problem if my memory serves me well), but this is an illegitimate comparison for all sorts of reasons. It is important to distinguish between the traded and the non traded sector. Now comparing the current dollar values of Japanese exports with US exports, Chinese exports, world trade or whatever is, it seems to me, a competely legitimate exercise since these are the numbers which move the economy in real time, viz these are the numbers that matter, and in this sense I feel that the kinds of comparison that Roach makes about world trade shares and growth in current dollars are interesting and legitimate, but maybe the whole idea of changing relative shares of Global GDP would be better left in the wardrobe, since we are never sure what we are comparing with what. Now for Susumu Saito to put some flesh on all this abstract argument:

Chairman Alan Greenspan of the U.S. Federal Reserve Board recently acknowledged the U.S. economy was at risk of suffering Japanese-type deflation and that Washington needs to learn important lessons from the Japanese experience. Japanese prices as measured by the implicit deflator of gross domestic product (GDP) have fallen almost 10 percent since 1994, and GDP at current prices, or nominal GDP, has been on a downward trend since 1997. Greenspan's concern is quite understandable as his ammunition of conventional monetary policy has been nearly exhausted, with the federal funds rate already at 1 percent. The response of the U.S. economy to the Fed's monetary easing has been much weaker than expected by most American economists, probably including Greenspan himself. After the Fed's unprecedented aggressive monetary easing in 2001, nominal GDP rebounded only at a 6-percent annual rate in early 2002 and quickly petered out thereafter. Past upturns showed rates of 8 percent or so. The Fed was obliged to ease monetary policy further last November, and in June of this year. For the past three quarters, however, the growth of nominal GDP has fallen to 3 percent levels.

So what have been the Japanese lessons in deflation?

Japanese government statisticians have been doing a fairly good job tracking the long-term trend in Japan's economic activity as measured in GDP. As many users of GDP statistics know very well, the ``estimates'' of GDP and its components usually have a margin of error of 1 to 2 percent or even larger. So it is not very meaningful for economists to read too much into the minor quarterly changes in GDP. GDP statistics, however, are a fairly useful tool to track economic activity in the long term, simply because it is very difficult for any group of statisticians to continue producing larger and larger margins of error over many years.

Recently, the Japanese government announced the economy had grown for the past six consecutive quarters. Indeed, real GDP (GDP at 1995 constant prices) is ``estimated'' to have increased by 3.4 percent from the first quarter of 2002 to the second quarter of 2003. In a long-term retrospect, however, the ``level'' of real GDP has been hovering marginally around 540 trillion yen for the past six and a half years since the first quarter of 1997. More important for businesses than real GDP is nominal GDP, or GDP at current prices, because businesses keep their books at current prices.

Especially when prices are falling, real GDP and the rate of economic growth derived from it sound like imaginary numbers. They appear far from the sentiments of business managers who have been hard pressed to maintain sales. Indeed, nominal GDP has remained almost flat for the past six quarters. Under more rigorous terms, the size of GDP minus ``imputed'' rent corresponds more closely to businesses' books and business managers' sentiments on sales and so forth. As a practice in estimating GDP, each homeowner is ``regarded'' to have paid rent at a market price. And such imputed rent is counted as personal consumption, or the largest category of GDP, even though ``transactions'' do not involve any cash or credit.

Misleading and false impression

This statistical practice is a good measure of ``housing services'' for homeowners. Personal consumption and GDP including imputed rent, however, give laymen a misleading and false impression on the level of business activity measured in money terms in two ways. First, imputed rent is very large and accounts for more than 10 percent of nominal GDP: 52.6 trillion yen from nominal GDP of 498.0 trillion yen at an annual rate in the second quarter of 2003. Secondly, imputed rent keeps rising because housing investment does not entirely stop even during a recession, and the resulting rise in housing stock is translated into an ever-rising imputed rent: from 41.5 trillion yen in the first quarter of 1994 to 52.6 trillion yen in the second quarter of 2003 at an annual rate.

After all, GDP minus imputed rent at current prices has been on a downward trend, except for a temporary pickup in the period of the IT bubble around 2000, shrinking by a staggering 6.9 percent to 445.4 trillion yen in the second quarter of 2003 from 478.3 trillion yen in the final quarter of 1997 when financial panic erupted in Japan. The latest figure of GDP minus imputed rent is actually lower than the corresponding figure in the first quarter of 1994. It is no wonder most Japanese businesses are still bothered by an ever-sinking feeling. Through 1997, however, both nominal and real GDP kept growing in Japan despite the crash in asset prices early in the 1990s.

Two factors in particular distinguish the pre-1997 period from the 1997-2003 period. The first is fiscal policy. Fairly expansionary fiscal policy, though insufficient in retrospect, supported the growth of GDP, nominal and real, in the pre-1997 period. Thereafter, public demand was frozen at around 120 trillion yen per year on a GDP account basis, and has been cut further in the latest three quarters. The switch in fiscal policy, of course, has worked as a powerful brake on nominal GDP. The second is the current financial restructuring plan that has forced Japanese financial institutions to sharply-and quickly-cut back their outstanding loans. The resulting credit squeeze quite naturally has shrunken aggregate demand, and hence, nominal GDP. Actually, the current financial restructuring plan is a major culprit in the acceleration of Japan's deflation. The greatest irony is that the switch in policies in 1997-2003 has not achieved its objectives. It has rather aggravated the problems it purported to alleviate. Fiscal austerity was intended to restore the balanced budget. But the shrinkage in nominal GDP has sharply reduced tax revenue, resulting in a much sharper deterioration in the budget balance. The shrinkage in aggregate demand due to the financial restructuring plan has actually made it harder for more Japanese companies to service their debt from banks. The resulting increase in bad loans has cornered more banks, and the vicious cycle goes on. It is no wonder that financial restructuring under the current plan does not appear to be drawing to an end.
Source: Asahi.com
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Doldrums Japan

Japan continues its weary path. Nothing especially new or surprising here, but clearly with the number 2 and the number 3 economies heading stubbornly downwards, you have to give some though to what might be the implications for the number 1 economy. Also there's more for Joerg's list here: the rising youth unemployment as the big firms flexibilise and re-structure.

Economic data released on Friday showed that the Japanese economy remains locked in a low to no-growth pattern, with unemployment hovering near post-war highs and consumer spending continuing to fall amid a decline in wages. The April core consumer price index (CPI), a key gauge of deflation in Japan, remained unchanged at negative 0.4 per cent, year-on-year. Economists said deflationary pressures were likely to worsen amid the current trend of declining wages.

"Going forward, we see little possibility of a sustained rise in consumption and upward push on prices amid the downward trend in wages," said Mamoru Yamazaki, chief economist at Barclays Capital in Tokyo. "To the contrary, we expect retailers to continue lowering prices as they see consumers pinching pennies." Against this backdrop, May consumer spending fell 1.8 per cent, year-on-year, as households pared expenditures amid salary reductions and continuing high unemployment rates. The May unemployment rate remained unchanged at 5.4 per cent, just shy of a post-war high of 5.5 per cent last reached in January. The percentage of 15-24 year-olds who were unemployed reached 11.1 per cent, a rise of 30,000 from a year ago, almost double the unemployment rate of any other age bracket.

The increasing number of youths out of work reflects the increasingly stringent hiring practises of firms, which are cutting back on taking on new graduates amid cost-cutting and restructuring measures. It also reflects a social shift, as high school and college graduates increasingly shun the Japanese tradition of lifetime employment at a single company in favour of part-time jobs or pursuing creative interests.The one bright spot amid the dreary data were May industrial production figures, which showed output growth of 2.5 per cent, month-on-month, about 1 percentage point better than market expectations. Economists pointed out that over the past six to nine months, Japanese industrial production has been stable, whereas US output has been weakening.
Source: Financial Times
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Japan Continues Its Weary Path


I suppose there are some crumbs for Joerg here, the Japanese economy did in the end actually grow, if only by a measly 0.1%, during the first three months. It is important to remember that these are real figures, in nominal (money) terms, with deflation continuing, the economy actually shrank. Although, of course, with the Yen rising, the share of the world economy may have increased. The only conclusion to be drawn from all this, economic statistics are complicated things. Bottom line, Japan seems to be moving back into recession.

Japan's economy grew slightly in the three months to March, according to revised figures released early on Wednesday which showed that while the pace of growth is still slowing, the economy did not contract in the first quarter as economists had predicted. Revised gross domestic product figures showed that GDP grew by 0.1 per cent in the first quarter. Provisional data released last month indicated the size of the economy stayed the same over the quarter, and economists had forecast that Wednesday's revision would reveal a contraction. But the revised figures provide only crumbs of comfort as they did not point to a turnaround in the economy, which has been slowing steadily in the past year. Some economists still say Japan's economy may be slipping back into recession - which is defined technically as two consecutive quarters of contraction. The loss of growth momentum has been blamed on a fall in exports to the US, where consumption in the first quarter was subdued in the run-up to the war in Iraq, and a pre-Sars drop in shipments to Asia. Household consumption in Japan, however, remained surprisingly strong as people dug into savings so they could spend and maintain the same standard of living. GDP grew 0.5 per cent between October and December, 0.8 per cent in the quarter before that and 1.4 per cent between April and June last year.
Source: Financial Times
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Tunneling the Bottom of Japan's deflation Trap


A really rather unusual article from MS's Takehiro Saito, which argues that the decline in personal savings is not alarming since it is matched by a rise in corporate saving. This corporate saving will continue, he argues, since in deflationary times with a rising currency, and weak demand, cash, or domestic bonds (and in particular JGB's) are about the best investment corporate Japan can make. This is of course an extremely vicious circle, which explains why we should be so wary of deflation, and why talk of Germany only being in danger of 'benign' deflation is complete tommyrot. As Saito suggests: "a powerful equilibrium exists with close links among deflation, private-sector savings surplus (current-account surplus), and home country bias supported by yen appreciation and expect ongoing stability in the government funding base."

Despite considerable anxiety about the future of fiscal deficits premised on the loss of saving-investment surplus, we do not view stress applied by the declining household savings rate as a difficult challenge as long as corporate debt repayment continues spurred by asset price deflation. More disconcerting is the quietly advancing evaporation of the yield curve, which has easily surmounted all challenges thrown its way thus far. We believe all of the factors defining yield curve shape are tied together by the central concept of deflation. For example, sustained strong home-country bias exhibited by domestic institutional investors stems from deflation and the zero interest rate. Since real interest rates at home are always positive under zero interest rate policy (ZIRP) and deflation, investors have less incentive to move capital into foreign-currency-denominated assets. Furthermore, in contrast to the rise in real asset value and decline in cash and bond actual value under inflation, real asset value declines and cash and bond actual value increases under deflation. It therefore makes economic sense to hold home-currency-denominated bonds in a deflationary environment despite extremely low nominal interest rates. Forward discount bias from the constant positive discrepancy between domestic and foreign nominal short-term rates in a zero nominal interest rate situation also places upward pressure on yen value. From this perspective, domestic institutional investors are behaving in an economically reasonable manner within the context of deflation and zero interest rates.

Another factor is that excessive competition among financial institutions under debt deflation interferes with the correct economic behavior of setting loan interest rates based on credit risk. We expect long-term yields to stay at extreme lows as long as loan interest rates are inappropriately restricted to lows from the standpoint of arbitrage between bond and loan markets. The abnormality to us is loan interest rates, not long-term interest rates. We have repeatedly stressed the importance of rectifying loan interest rate levels. Yet this is not happening in reality with steady expansion of the overextended government-affiliated financial institution presence. We believe government policy is actually encouraging long-term interest rates to move even lower.
Source: Morgan Stanley Global Economic Forum
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Technological Solutions to the Zero Bound?


Thanks to Brad Delong for putting up this link to a zero bound article by two economists at the Dallas Fed. It is clear that, with a little imagination, the technology exits to overcome this as a technical problem. But if the deflation problem is not, essentially, a monetary one, the substantive problem still remains: what to do about it? Let's just hope there's a learning curve in there somewhere, and these are esperiences we have to go through before we get to grips with the real problem. Question is: how much time have we got?

The most daring suggestion for escaping the zero-interest-rate trap is one that eliminates the zero lower bound altogether. How can this be done? As noted in the first part of the presentation, the zero bound on interest rates exists because money pays a sure nominal interest rate of zero. No one would be willing to hold any asset that pays a negative nominal rate, as long as zero-interest money is available as a store of value. The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate, by imposing some type of "carry tax" on currency and deposits.

It�s easy to envision such a system with regard to deposits at the Federal Reserve or transactions deposits at banks; for the most part, the technology to implement such a system is already in place. A tax or fee on Reserve deposits of 1 percent per month, for example, would mean that those deposits, in effect, pay a nominal interest rate of roughly minus 12 percent. The technological difficulty lies mainly in imposing such a tax on currency. In the 1930s, Irving Fisher of Yale University, one of the greatest American economists, proposed such a system, in which currency had to be periodically �stamped�, for a fee, in order to retain its status as legal tender. The stamp fee could be calibrated to generate any negative nominal interest rate that the central bank desired. While the technology available for implementing such a system is more sophisticated today than in Fisher�s time, enforcement still seems a mammoth problem, involving physical modifications to currency and some means of tracking the length of time each piece spends in circulation.Given the technological hurdles involved in its implementation, a carry tax on money may not be feasible as a response to any events that might transpire in the next year, though it certainly merits study as a possible response to events that might transpire in the next decade. This is particularly the case if achieving and maintaining price stability makes bumping up against the zero interest rate bound a more frequent event.
Source: Federal Reserve Dallas
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Beware the Dreaded Mr Yen


It seems there are more deflation doubters, doubters that this is simply monetary. Welcome to the world of Mr Yen. In dismissing his views, we wouldn't be running the risk of ethno-centrism, now would we? Oh, never mind........

'Mr Yen' proclaims new era of deflation


Japan is the forerunner in a global shift from an era of structural inflation to one of structural deflation, according to Eisuke Sakakibara, the former vice-finance minister who is still referred to as "Mr Yen".Mr Sakakibara, now a professor at Keio University, said in an interview that Japan had been the first economy to fall into chronic deflation but that the US and Europe were likely to follow. Whether the consumer price index fell below zero depended on factors such as the price of oil, but was essentially beyond the power of monetary authorities to prevent, he said. "Even if we don't yet have [global] deflation, you have to concede that we have disinflation," he said, attributing falling prices to rapid productivity gains in manufacturing, particularly in China. "Deflation is a structural, not a monetary phenomenon."

"Alan Greenspan never used the word deflation," he said, referring to the chairman of the US Federal Reserve. "He called it an increase in productivity. But it's the same thing." On currencies, Mr Sakakibara said that calls for the weakening of all three currency blocks - the dollar, the yen and the euro - were dangerous. If governments started taking unilateral action to weaken their own currency, it could lead to competitive devaluations, protectionism and growing hostility. He foresaw a continued strengthening of the euro as funds flowed out of the dollar, but a stabilisation of the yen in the �116-Y121 range.


In calling deflation structural, Mr Sakakibara is part of an increasingly vociferous intellectual movement that thinks Japan has been unfairly blamed for failing to tackle deflation with conventional monetary policy. The Bank of Japan, he said, had vastly increased money supply but this had merely fuelled a bubble in the government bond market, in which interest rates on 10-year JGBs have dropped to 0.575 per cent. Credit had shrunk. Robert Feldman, chief economist at Morgan Stanley, has also argued that following classical monetary policy is inappropriate for Japan. "There's something new going on out here and I would hope the economic theorists would be able to think about it without being poisoned by what they're teaching their students," he said.

Mr Sakakabara said governments would have to learn to think of deflation differently. This new wave of price falls had more in common with that of the 1880s, associated with huge productivity gains, than with that of the recessionary 1930s, he said. "I think we must learn to co-exist with mild deflation," he said, adding that in Japan's case this would mean writing off much of the bad debt that had been built up over decades. This would require a big capital injection of funds either into the banks or into the companies themselves, he said. The existing pension system, unsustainable in a deflationary environment, would also have to be rewritten. Efforts led by Heizo Takenaka, economy and financial services minister, to force banks to accelerate the disposal of non-performing loans were suicidal, he said. They had already led to a dangerous credit crunch. "Squeezing banks and suggesting nationalisation is not the way to increase credit." Globally, governments would have to change their policy objectives, he said. "During the period of inflation, policy leaders had to avoid hyperinflation. During this period of structural deflation, we have to avoid spiralling deflation."
Source: Financial Times
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Japan the Next Big Success Story?


Joerg is asking awkward questions. What is happening in Japan? But not the normal, nice conventional questions. Joerg has the temerity to ask whether Japan is really so bad as everyone is saying. I'll let him explain:As you know, I disagree with your determined pessimism regarding Japan.

Recently, I came across an antiquarian economic history of Germany - more than a hundred years old. It contained a passage that compared Germany�s output statistics to, among others, the US and Russia. The author commented on the future prospects of those three countries and Britain. What really caught my attention: he claimed that the US had reached its zenith and that the next big success story would be Russia. Reason given: the extended deflation the US had gone through! Remember your "avalanching rice pile" post? I then checked US and Japanese data for the last few years: Since early 2000, Japanese real private-sector GNP has risen 3.5% overall. The per-capita gain amounted to 2.9%. The annual rate averaged to 0.9% - not exactly constituting overwhelming growth, but still qualifying as a substantial advance. On the other hand, U.S. real private-sector GNP increased by an almost identical 3.6% between 1999 and 2002. However, since the US population rose four to five times faster than in immigration-adverse Japan, income per head in the U.S. barely grew at all over the period.

Now all of this is going to open a nice can of worms, so let's do it. Firstly Joerg is raising some important points. One of them is about the Japanese use and misuse of statistics. Now Joerg is quite right to note that economics is, in one sense, the pursuit of war by other means. It is important to remember that following Pearl Harbour, and all its consequneces, there has been a tacit understanding that has governed all US-Japan relations: Japan will never risk a frontal confrontation. So things have to be done another way. This is Joerg's point about the Japanese data, whereas data in many countries has a tendency to downwards revisions, the Japanese data tends to be revised up. So as not to offend, you understand.

Now I would make two points. I am sure Joerg has a point, Japan is 'enjoying' its ill health. It is a lot easier to explain an excessively bad economic performance to the US than it is to explain an excessively good one. But I am equally sure that 'measurement problems' are more acute in Japan than they are in the US or Europe. Japan is not only 'risk averse', it is also 'information averse' (everyone really should read Karel van Wolferen ). So the tricky stats argument cuts both ways, and it is difficult to draw any decisive conclusions here.

Now for the middle argument. One of the points about deflation is, of course, that nominal prices fall. This is something of a curse, since we are all accustomed to deflating inflated nominal prices, and it really is a switch of mindset. The point is you need to add the rate of deflation to the nominal GDP numbers to see what is really happening. Indeed (leaving aside deflation as a problem) shrinking nominal GDP in Japan and a rising yen are pretty much compatible as a way of maintaining relative global GDP shares. I said leaving aside deflation as a problem, since of course the rising currency means there is no change in the deflation process. Having said this Joerg is absolutley right in pointing out that the Japanese performance is not half as bad as is sometimes suggested. A glance at the statistics will show this. The bad years were 97/98 and 2001, and of course 2001 was a problem everywhere. So Japan, is not quite as bad as it seems? Well, not really, because the Titanic has a big hole in it, and is taking in water. I think that is the essence of the two types of deflation argument, some of us can see that nothing good can come of this. Quite another thing would be a generalised drop in prices and sustained economic expansion. My analysis (Mr Yen notwithstanding) is that this is not what we have in Japan.

Now this raises yet another question. Are we facing a global deflation scenario? The IMF thinks we are not, and I think we may be. If this is the case then continuing deflation in Japan is inevitable, and we, and they, will have to learn to live with it. This will be a 'phase transition'. You see this is the meaning of a dynamic system, things change. Solutions which were available yesterday, are not available today. I am sure the G7 are not listening to me, obviously had they been we would still have had the same problems, but maybe we would have had some palliatives, and maybe more options would be open. They are not, and the gardens are now closing, and not only in the west. Time is running out. This is not a 'funny' game. I, reluctantly, think that the most sensible thing now is to accept the inevitable. The 'liquidity-viscosity trap is a real problem, but there is no 'push this button' solution. Maybe, maybe if we were to do a big 'helicopter money' drop on the third world, but this, realistically, is not on the agenda.

So the questions, and here Joerg may be right, may become: how to learn to live with it? Many may wish to take issue with those luminaries of economic theory who said it would never happen. My pragmatism pulls against this, it is better to get on with the job, and look up river. Now Japan seems to be adapting. The question then is:can this last?

This is where I really take my difference from Joerg. Athena will not rise from the head of Zeus. All we are likely to find is a lot of rubble. You see, Joerg mentions the per capita growth question, what he does not mention is the dependency ratio: this must surely be the key productivity measure. And it is an assymetric one, since looking to the future, under 15 is better than over 65. So the first move should be to check out the population pyramid. In the table above the pyramid it can be clearly seen that population over 65 is growing (absolutely and as a percentage), while the other two groups are both declining. Now if we look at the labour force survey we can see that the labour force and the participation rate is declining, while the unemploymenbt rate is rising. This tendency seems unlikely to be reversed, ever (well maybe the unemployment rate may stabilise, but the participation rate will not. Conclusion, inevtiably we will have secular decline in both nominal and real GDP.

Now, to anticipate a little, I imagine Joerg will come back with the inevitable 'what if': what if the value added of the reduced workforce increases sufficiently to offset the decline in workforce. This is where the on the fly vs accumulated experience comes in. With things getting faster faster, the 'youth premium' goes up, and if you have lproportionately less young people, then you aren't in the high-end-value class. Ok that's it. Japan is sinking, we're all sinking, now what are we going to do?

Shooting Blanks in the Air

So the Bank of Japan has been caught in the act: intervening to no effect. Of course so long as the US authorities continue to be 'comfortable' with the fall, there is really little that the central banks can do. Mind you, these dollar denominated assets could be a real investment for the future. I mean printing yen and getting a peice of the US action, that has to be one of the best business deal on offer right now.

The Bank of Japan this week set two apparent records relating to the currency markets, but the impact on its main aim - to weaken the yen - appeared to leave currency strategists and investors less than impressed. On Thursday, weekly custody data released by the US Federal Reserve - seen as a proxy for overseas central bank holdings - showed a sharp increase in US Treasuries owned by overseas institutions to a record monthly total of $35.4bn. For holdings to have risen that much, strategists believe one or more central banks must have been actively intervening. Bank of Japan data released on Friday appeared to confirm suspicions that almost all of the Treasury buying came from Tokyo. The BoJ's figures implied a record Y3,983bn ($33.4bn) was spent by the bank in May to stem the yen's appreciation - a bigger sum than many in the market had estimated.

Some said the BoJ's spending underlined its commitment to stemming the yen's appreciation against the weaker dollar and would serve as a warning to any investor preparing to short the dollar against the yen. Most, however, noted the limited impact of the bank's action. "What this shows is how significant the pressure on the dollar is - spending $30bn plus only moved the yen less than 4 per cent," said Mitul Kotecha, head of FX strategy at Credit Agricole Indosuez. The dollar fell to a two-year low of Y115.1 on May 19 and by the end of this week, had climbed to a month-high of over Y119.
Source: Financial Times
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Tightening the Deflationary Screws

Long term interest rates are dropping across the planet. Japan 10 year bonds are now at 0.555 per cent. Looks like we're settling in for the season:

A leading Japanese business daily warned long-term interest rates were falling to historically low levels in Japan, the United States and Europe, amid fears of a deepening global deflationary trend. The yield on newly issued 10-year government bonds, a benchmark of Japanese long-term interest rates, has fallen about two-thirds in a year, the Nihon Keizai Shimbun said. The rate declined to 0.555 percent on Friday, down from the 1.400 percent return offered a year earlier. The daily noted that the yield on 20-year bonds sank to 0.860 percent and that on 30-year instruments dropped to 0.980 percent. This means that the yields on all key Japanese long-term bonds are now lower than one percent, Nihon Keizai said, adding that long-term interest rates are close to future nominal economic growth rates predicted by investors. Private-sector economists have predicted the Japanese economy will suffer negative growth of minus 1.3 percent in nominal terms in the year to March 2004. Japan's price index for consumer goods, excluding perishables, had steadily fallen from year-earlier levels for the past three and a half years, it said.


The deflationary trend is spilling over into the United States and Europe with China emerging as the world's largest manufacturing base with cheap labour and technological innovation, it quoted an analyst as saying. US and European interest rates were already declining rapidly, with the yield on the 10-year US treasury bond touching 3.28 percent on Friday, the lowest level since 1958. The yield on 10-year German federal government bonds slid to 3.6 percent, the lowest return since January 1999. The US consumer price index dropped 0.3 percent in April from the previous month. The US Federal Reserve Board has pointed to a disinflationary trend in which the pace of price growth declines.


The direct cause of recent drops in Japanese long-term interest rates has been the growing movement of funds from stocks to bonds by banks, life insurance companies and pension fund managers, who predict a fully-fledged economic recovery will not occur for some time, it said. Those investors are expecting deflation to adversely affect stock prices through falling corporate sales and income, and are rushing to shift their funds to bonds to protect themselves against that risk, it said. The concentration of investment in government bonds causes a serious distortion in the overall flow of funds, the daily warned. But even if financial authorities relax their grip on credit, most of the funds made available will make their way into government debt instruments, with lending to corporate borrowers continuing to drop and little money being funneled into stock purchases
Source: Yahoo News
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Japan, Hong Kong, Taiwan: Indefinite Deflation


Obviously things look pretty different in Hong Kong to the way they seem in New York, Washington, Brussels and Frankfurt. Andy Xie again:

Excess supplies of labor and capital continue to exert powerful deflationary pressure on East Asia. Export performance or the credit cycle may give the appearance for short periods that inflation is returning. When cycles peak, inflation tends to disappear quickly and deflation either gets under way or resumes. Korea�s inflation in 2002 was largely due to its rapid credit growth. The high oil price nudged inflation higher in the first quarter of 2003. It is now trending down and is likely to reach new lows. China is experiencing some inflation because of the increase in its raw material costs. The surge in investment demand is the main cause. As we have observed previously, deflation usually follows investment driven-inflation. A high savings rate, surplus labor, and lack of entry barriers always allow the benefits from productivity gains to be passed on to consumers in China. Japan, Hong Kong, and Taiwan seem to be in deflation almost indefinitely. Their interest rates are already near zero. They do not appear to have income drivers to solve their demand problems. It is difficult to visualize any scenario under which deflation in these economies would end. East Asia must resist currency revaluation. There are no obvious policy tools for combating its contractionary effect. Interest rates are close to zero except in Korea. Fiscal deficits are quite large already. A major revaluation would just crush the economies in the region, in our view.
Source: Morgan Stanley Global Economic Forum
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Japanese Bank Bailout


The decision to inject an estimated $17.7 billion into Japans fifth largest bank has set-off all manner of questions about the future of the 'reform' process, including questions about the survival of key economics minister Heizo Takenaka whose attempts to accurately reclassify the book value of bad debts are thought to have provoked the capital adequacy problem. On the back of the latest GDP deflation figures, the pressure certainly seems to be building up.

Anxiety about the state of Japan's banks, rekindled by the government's weekend decision to bail out the nation's fifth-biggest banking group, has turned up pressure on the administration to kill profit-destroying deflation. The rescue of Resona Holdings also reignited calls to oust Financial Services Minister Heizo Takenaka, an academic closely identified with Prime Minister Junichiro Koizumi's reform agenda and a target of old guard discontent. "Prime Minister Junichiro Koizumi...must do his utmost to prevent the crisis from spreading," the Yomiuri Shimbun newspaper, Japan's biggest, said in an editorial on Sunday. "At the same time, we should not forget Resona's case has been influenced by the hard-line financial reconstruction policy championed by Heizo Takenaka...which has gone astray," the conservative newspaper added. The government said on Saturday it would rescue Resona with a huge injection of funds after tougher accounting rules pushed its capital adequacy ratio below limits needed to do business. Media reports said the infusion of public funds could be as much as two trillion yen ($17.17 billion). Ruling politicians on Sunday generally endorsed the decision. But Taro Aso, policy chief of the ruling Liberal Democratic Party, and others called on the government to address the persistent decline in prices that is likely to get worse as the nation's banks struggle to dispose of an estimated 40 trillion yen ($345 billion) of problem loans now on their books. Aso attributed Japanese banks' dismal situation to declines in the value of real estate, which was used as collateral for many loans in during the late 1980s "bubble economy" and is now a major cause for soured loans, as well as falling stock prices."Asset deflation is the biggest problem," he said.

Aso sidestepped the issue of whether Koizumi -- whose central policy pillar is fiscal reform -- should adopt an extra budget to fund public works as suggested by some LDP heavyweights and their partners in the three-way ruling bloc. "When you are suffering from both diabetes and consumption, you have to treat the consumption first," was all he would say. Koizumi, who meets President Bush later this week for a bilateral summit, also faces international pressure to tackle a four-year slide in core consumer prices. Japan pledged at a weekend meeting of Group of Seven finance ministers in France to step up efforts to fight deflation. But Finance Minister Masajuro Shiokawa offered few clues as to how Japan, burdened by massive public debt, could do so.

Shiokawa said Japan would ensure ample liquidity in financial markets and diversify the way it provided liquidity, although the Bank of Japan (BOJ) already pins interest rates at near zero and floods the money market with far more liquidity than it needs. The central bank is set to hold a policy-setting meeting on Monday and Tuesday. The maverick Koizumi sprang to power in April 2001 on a wave of public support for his agenda of painful reform, including reining in the nation's ballooning fiscal deficit and lifting the heavy hand of government from Japan's long-stagnant economy. Criticism of his policies from within the LDP has been harsh, but some on Sunday urged him not to cave in. Calling for a "comprehensive policy" focusing on deregulation and tax reforms to nurture new business and create fresh demand, the liberal Asahi Shimbun newspaper said the massive stimulus policy adopted after a 1997 financial crisis had inflated government debt without fixing the financial system. "We cannot walk that same path again," the newspaper said. Still backed by about half the nation's voters despite plummeting stock prices and a stagnant economy, Koizumi vowed on Saturday to carry on with his reform agenda. "There is absolutely no change in our reform stance," he said after the government held its first emergency financial crisis council meeting to approve public funds for Resona. "We took measures so that a financial crisis will not occur."

Koizumi, who must be re-elected as LDP president in September to keep his premier's job, stood by his controversial minister. "I have no intention of changing him," he said, when asked about calls for Takenaka's resignation. "He is doing a good job." Resona's call for help underscored longstanding suspicions that Japanese banks have overstated their capital by taking advantage of accounting loopholes. Auditors had declined to sign off on the group's earnings estimates, which were deemed to be far too optimistic. Stock market investors can expect a volatile day on Monday in reaction to the rescue deal if it's perceived that Resona's problems are just the tip of iceberg, analysts said. If bank shares get slugged, the Nikkei average could drop toward the 20-year lows it reached last month -- putting even more pressure on the banks, which have huge shareholdings.
Source: Reuters News
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Japan's Deflation Gathering Speed


David Pilling from Tokyo, on how the rate of deflation in Japan is accelerating. Not good news.And just as I was getting used to talking about the 'slow burn' deflation.The rise in the yen isn't going to help any, either.

Japanese deflation gathered pace in the first quarter with year-on-year prices falling 3.5 per cent - their fastest drop on record. The fall may fuel fears that Japan, which has managed to co-exist with relatively mild deflation since the mid-1990s, could be sliding into a deflationary spiral. Japanese prices - as measured by the gross domestic product deflator, considered a more accurate measure than the consumer price index - have been falling more or less continuously since 1995. Annual price falls have averaged between 1 and 2 per cent for most of that time. Friday's figures showed deflation accelerating in fiscal 2002, a year in which Japan was growing out of recession, to minus 2.2 per cent, a record for a full year.

The figures were released along with GDP data showing that growth in the first quarter fell to almost zero, leading some economists to conclude that the economy was on the brink of yet another recession. Nominal growth fell 0.6 per cent in the March quarter, or minus 2.5 per cent on an annualised basis. Paul Sheard, economist at Lehman Brothers, said: "If you look at the chart it looks horrible. It looks as though deflation is going through the floor." However, the headline figure exaggerated the picture, he said, because the GDP deflator in the first quarter of 2002, when Japan began to pull out of recession, was positive. "It's something of a statistical fluke, though deflation is deflation and it is not a good sign."Shuji Shirota, economist at Dresdner Kleinwort Wasserstein, said "unprecedented deflationary pressure" had been stoked by a big cut in the winter bonuses of government employees, as well as by a fall in the price of PCs and other electrical machinery.

The issue of deflation has split the government, with officials disputing its causes and disagreeing over its effects. Heizo Takenaka, economy and financial services minister, on Friday said falling prices posed a threat. "Deflation remains severe. While pursuing structural reform we must also press on with efforts to end deflation." This week, Eisuke Sakakibara, former vice-finance minister, said Japan could live with mild deflation so long as it prevented the economy tipping into a destructive spiral of falling prices. He said deflation was the structural result of global productivity gains and would likely spread from Japan to the US and Europe. Mr Takenaka drew some comfort from the fact that real growth for fiscal 2002 was 1.6 per cent, above the 0.9 per cent the government had predicted. Much of that was based on exports, which have begun to slow, and on surprisingly robust consumer spending. In the first quarter of this year, consumer spending, which accounts for 60 per cent of GDP, rose 0.3 per cent quarter on quarter. Mr Sheard said real growth of about 1 per cent a year over the past decade was welcome, but he pointed out that the economy was shrinking in nominal terms. Nominal GDP for fiscal 2002 fell to �499,000bn, the first time it has dipped below �500,000bn in eight years.
Source: Financial Times
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The Liquidity Trap: A Sticky Problem

Brad has a number of posts this week on the liquidity trap problem (and here and here . Two points occur to me: firstly, is it more than a merely semantic point whether we are 'fast approaching' or "already caught in the orbit" of one; and secondly whether (as Joerg asks me) the name is not a misnomer, wouldn't 'viscosity trap' be a better description? Meantime, John Irons recent post is as good a start for the 'unintitiated' (we still await the 'guide for the perplexed') as any you will find:

The recent FOMC statement by the Federal Reserve (Fed) included the line that "... the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level" (emphasis added.) It occurred to me that this statement might be a little confusing - isn't inflation supposed to be bad? Why would a fall in inflation be "unwelcome"? The answer has to do with what economists call a "liquidity trap." (Note: the full analysis of a liquidity trap is considerably more complicated than below, but this should convey the basic idea.)

The basic argument is that the interest elasticity of money demand increases, and monetary policy becomes less effective, when the nominal interest rate approaches zero. Ok, here's the English version...........
Source: ArgMax
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Money To Burn

Too much money, that's Andy Xie's explanation of where we are. I suspect he may be right, understanding why there may be too much money is another matter altogether.

You are holding cash and the interest rate is zero. The bank in which you keep your money pays dividends equal to 5% of the stock value. Then your friendly private banker calls you up and confidently explains that you would be better off if you owned the bank�s stock than if you continued to deposit your cash with the bank. Aha, you saw through this one! The bank�s stock price could fall but your deposits are protected, first, by the bank�s capital, i.e., shareholders, and, second, if the stock price falls to zero, by the government that regulates the bank.

We saw the same situation in the Tokyo property market. The rental yield rose above the mortgage interest rate in the 1990s. For some reason, the property value always seems to drop a bit more than the pickup in the yield for owning the property. This also happened in the Hong Kong property market. The property market was more sophisticated in Hong Kong than in Tokyo and had the affordability index to show why property was worth buying. Waves and waves of bottom-fishers braved the market. They now have no cash. However, they are proud owners of high-yield assets but at much-reduced capital values.

Asset markets have been cash guzzlers in East Asia for years. The cash goes to maintaining growth in value-subtracting GDP. Hong Kong property provides the best illustration of this point, in my view. Buyers effectively subsidize an industry that faces declining prices. Their past savings subsidize the property industry, which in turn keeps up GDP. Without the massive destruction of savings, the Hong Kong economy would have shown a much greater decline.

The stock market is a less obvious example. It can attract money through volatility. Even though most markets in Asia have been merely fluctuating for the past ten years, they have raised money to fund one industry after another. Investors have poured money into a series of growth industries. However, the high profitability of a growth industry generally proves to be ephemeral, I believe. As capacity expands, most ex-growth industries are plagued by excess capacity and low profitability.Too much money is at the root of the problem. It causes speculative spasms in asset markets and excessive capacity formation in production. The two conspire to generate high GDP growth and value destruction. Economic growth generates high profitability in an industry, only to be destroyed by easy capital for capacity formation.

The Asian experience is spreading. The world has too much money, I believe. Money with zero maturity (MZM) has grown at 12% a year in the US since the NASDAQ peaked in March 2000, 62% faster than the average for the preceding ten years. Much of the surplus liquidity in the global monetary system will be destroyed, in my view, either through (1) deflation bubbles or (2) stagflation. The world currently seems to be on the first path. The world�s asset markets are behaving increasingly like their Asian counterparts. Stock markets experience periodic speculative spikes up with little change in fundamentals. People give more and more of their savings to governments to spend. Rising fiscal deficits coincide with falling interest rates.

The relationship between markets and the economy has fundamentally changed in the current environment. Falling interest rates provide the justification for pouring more savings into low-profit activities, which keeps up GDP. Giving money to the government to spend is the ultimate expression of supporting low value-adding GDP. In a normal environment, rising profitability attracts more capital.
Source: Morgan Stanley Global Economic Forum
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