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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