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Sunday, January 26, 2003

Japanese Interest Rates Briefly Fall Below Zero

Japan's continuing economic problems took the world of economic data into new and previously uncharted territory on Friday as overnight call rates fell below zero for the first time in the country's history.The overnight call rate on Y15bn of funds traded between foreign banks fell to minus 0.01 per cent. Because of the negative rate, borrowers are in effect being paid for borrowing funds because they will have to pay back less than they were lent. however much of a technical one-off this may be, it does serve to attention to the copmplex character of Japan's difficulties in a particularly novel way. Of rather more significance is the continuing fall in long term interest rates. Rates up to ten years are now virtually horizontal, and the curve up to thirty years is now showing signs of flattening out. It appears the expectation of continuing deflation is really setting in long-term


With long-term interest rates already virtually nil under the Bank of Japan's "quantitative easing" policy, bankers said on Friday the move into negative territory was more a symbol of the country's decade-long economic malaise rather than an indicator of future financial chaos. Critics say that the BoJ's ongoing zero interest rate policy and it decision to flood the market with liquidity has been ineffective in stimulating the economy.

"In terms of monetary policy, the BoJ is not doing enough," said Hisashi Sitow, director at Credit Suisse First Boston in Tokyo. "It has to buy more JGBs or foreign bonds to affect the market. Monetary policy is clearly ineffective, as base money is increasing but growth in the money supply is stagnant." Current record low yields on Japanese government bonds indicate that investors are not betting on an economic rebound anytime soon. The 10-year JGB has been skirting new four-year lows for some weeks, while the yield on the five-year bond fell to a record low on Friday."This is all part and parcel of a growing loss of faith in Japan's future," said Marshall Gittler, strategist at Deutsche Bank in Tokyo. "JGB movements are telling a story that deflation is set to continue indefinitely."
Source: Financial Times
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Too Much Saving in Japan?

This piece raises a question which is very much to the point, is there too much saving in Japan? Secondly, if there is, is this structurally related to the demographics of contemporary Japan. This question is very much to the point since most of the current enthusiasm for the appointment of an 'inflation targeting' governor at the Bank of Japan results from a diagnosis that the deflationary savings excess/lack of demand growth is due to a 'bad' IS/LM equilibrium associated with the zero interest bound. Now if the problem went deeper, then logically the solution wouldn't work. Unfortunately the article ultimately backs off, concluding that: "Immigration is not a practical solution today when unemployment is high". Of course if the unemployment is high BECAUSE there has been no immigration (and consequently the slope of the labour supply curve is not steep enough in more technical terms) then we are caught in a vicious circle. Things aren't always as they appear, remember we used to think the sun went round the earth. It's my bet that the injection of a large quantity of cheap immigrant labour at the bottom end of the Japanese labour market would do a lot more to help get things going than any of the other proposals currently on the table.


Japan's economic problems have attracted a lot of attention over the years. They have also exposed a lot of erroneous thinking. Today is no exception. As politicians and academics continue to flounder, they ignore one vital fact: the Japanese economy has a structural savings surplus, and a change in economic policy is needed to deal with it.An unusually high proportion of Japan's population is in its 30s and 50s, when savings for retirement are high. There are still relatively few who are retired and spending their past savings. As a result, the national savings rate is high. At the same time, there are few people under 20, so the workforce is shrinking. This means growth is bound to be slower than in countries such as the US, which has a lot of immigrants and a growing workforce. Even if it is optimistically assumed that labour productivity will rise to US levels, the difference in demographics means Japan can only grow at half the US rate. Japan must either change its population structure by massive immigration or export its capital surplus with a much bigger current-account surplus. The trouble is that the first option is unpopular in Tokyo while the second is unpopular in Washington. Faced with unpalatable choices, the typical reaction has been denial.
Source: Financial Times
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Unfortunately apart from the connection made with demography and growth the article really has little new to offer. Even the association of saving with those in their 30's and 50's is an oversimplification of what is probably a rather complicated picture (and one which I'm still trying to sort out myself). The range of policy proposals appears to be a complete rag-bag including virtually everything except my grandad's old nightshirt, but he is surely wrong that internal monetary easing is likely to be more effective than yen value reduction in provoking short term inflation. But as I said, if the diagnosis is bad, in all probability the medicine won't work in either case.
Japanese Banks Get Nervous about their Capital Adequacy Ratios

The plan announced Wednesday by Sumitomo Mitsui Financial Group to issue 150 billion yen worth of convertible preferred shares to Goldman Sachs is expected to lead to similar moves by other Japanese banks seeking to raise capital before the fiscal year ends March 31. According to Japanese sources, banking groups including Mizuho Holdings, UFJ Holdings and Resona Holdings are all considering jumping on the capital-raising bandwagon, with their plans to raise capital expected to be announced as early as the end of this month. The Goldman Sachs deal, widely interpreted in European and American news media as an indication of renewed confidence in the Japanese banking sector seems to have more to do with paying an increased risk premium to secure a cash injection and avoid government control. With banks, and many of their non-performing loans being back by goverment guarantees Goldman Sachs in fact seem to be risking little.

As SMFG President Yoshifumi Nishikawa explained during Wednesday's press conference, the current harsh domestic business environment prompted the group to "rely not on (our) clients, but to improve our capital base independently," with help from a major U.S. investment bank. The sluggish domestic stock market was a major factor in SMFG's decision not to issue shares to Mitsui and Sumitomo group companies as well as to other clients, the sources said.

Ageing Society: Time to Recognise the Consequences

Many western economists still stubbornly fail to recognise that the move to the "ageing society" marks a sea change for our economic systems, with important deflationary consequences. This latest round of debate in Japan over the consumption tax and social security subsidies should serve as a timely reminder to all of us of what is waiting, just round the corner.

Debate over a hike in the consumption tax rate is heating up in the government, ruling coalition parties and business sector as the nation's low birthrate and rapidly graying society are expected to make an increase in the tax rate inevitable to cover the rising cost of the social security system. The government's Tax Commission will begin discussing on Friday what form mid- and long-term tax systems should take, but as the government, ruling coalitionparties and business sector hold differing views on the issue, a conclusion is unlikely to be reached soon. Concerns over a consumption tax hike have mounted since the government spelled out pension system reforms that included raising the portion of basic pension covered by public funding from the current one-third to half. The government must compile a reform plan, including measures to secure financial resources, this year. Consumption tax, therefore, is being considered as a source of revenue. With tax revenues accounting for only about 60 percent of annual revenues, the government has been mired in a financial deficit. To raise funds to cover increasing social security costs, the government will have to rely on the consumption tax, the burden of which is spread widely and thinly over the public.
Source: Daily Ymiuri
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Japan Government Borrowing Set to Soar

Japanese public finances sit uncomfortably somewhere between a rock and a very hard place indeed. This is brought home again this week by the disclosure that the Council on Economic and Fiscal Policy in its final draft of the revised Structural Reform and Medium-Term Economic and Fiscal Prospectus, prepared by the Cabinet Office, estimates that bond issuance will climb to as much as 40.2 trillion yen in fiscal 2004. This will then be followed by an issuance of 41 trillion yen in fiscal 2005, 40.3 trillion yen in fiscal 2006 and 40.8 trillion yen in fiscal 2007.


The document, to be submitted to the council Monday before being sent to the Cabinet for approval, includes two fiscal policy scenarios: one in which state coverage of the national pension costs remains at its current one-third, and another in which the government burden is increased to 50 percent. In the latter scenario, the consumption tax is increased to 6 percent from 5 percent. Even then, the additional tax revenue would not reduce the national debt, as it would be used solely to slash the growing burden of the aging society on the social security system.Though the revised version stays faithful to the original pledge to erase red ink from the primary balance by the early 2010s, it projects a slowing down of the decrease in the budget deficit as a proportion of gross domestic product.
Source: Asahi Shimbun
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It is this increase in the government tax support for the pension system from one third to one half which is provoking all the fuss about the projected rise in consumer tax which would be the knock-on effect (see Richard Katz artice HERE, since a new medium-term policy plan drawn up by the Cabinet Office includes fiscal projections that assume a consumption tax hike from 5 percent to 6 percent in October 2004. Obviously any such tax increases would make it even more difficult to escape the grip of deflation.

Some policy watchers are taking the estimates as a tacit acknowledgment by the government that a hike is inevitable. The calculations were included by Cabinet Office officials in a revised draft of the Structural Reform and Medium-Term Economic and Fiscal Prospects, considered an outline for the government's policy on midterm economic management.The document will be submitted Monday to the Council on Economic and Fiscal Policy, a key advisory panel headed by Prime Minister Junichiro Koizumi. It is expected to be approved at a Cabinet meeting this month.......... Some officials say the government has no choice except a hike if it ends up expanding state coverage of basic pensions from one-third to one-half, as planned under fiscal 2004 reforms.Observers say the projections reflect the prevailing mood in the government on a tax hike.
Source: Asahi Shimbun
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Japan: Don't Sqeeze Me Too Tight

Japan economic specialist Richard Katz, writing in today's Financial Times, questions the advisability of turning the fiscal pressure screw in Japan. It's difficult to see how a country suffering deflation (or the imminent threat of it ) can benefit from further fiscal tightening. If in doubt ask the Germans.


It is not easy for a rich country to get itself into as much economic trouble as Japan has. In the postwar era, only Switzerland has stagnated as badly for as long. While the root cause is structural defects, policy blunders have repeatedly made a bad situation worse. They are at it again. Once more, the Ministry of Finance wants to raise taxes in a time of economic weakness. Last week, MoF officials and some business leaders discussed raising the 5 per cent consumption tax by 1 percentage point in 2004 and then another percentage point each year until it reaches 16 per cent. This comes on top of a permanent increase in government fees, equal to 0.5 per cent of gross domestic product, beginning in April that outweighs temporary tax cuts now being considered. In short, Tokyo exhorts consumers to spend more even as it takes away their means of doing so.

The last time Tokyo raised the consumption tax - from 3 per cent to 5 per cent, in 1997 - it triggered Japan's worst postwar recession to that point, caused the ruling Liberal Democratic party to lose the 1998 upper house elections and toppled the prime minister. Since then, GDP has grown a miserable 0.3 per cent a year and private domestic demand is still below the pre-tax peak. Why does the MoF propose to repeat the fiasco? The MoF argues that unless Japan begins closing its fiscal deficit - 7-8 per cent of GDP each year since 1998 - government debt will spiral out of control. Already, the debt-to-GDP ratio has soared from 80 per cent in 1995 to a projected 150 per cent this year. This trajectory, argues the MoF, will ultimately make mounting social security costs unpayable and could lead to financial calamity.The MoF reasoning is flawed. To be sure, Japan cannot keep expanding the debt-to-GDP ratio for ever. Nor can fiscal stimulus alone restore economic vibrancy. But the time is wrong for a contractionary fiscal stance - a cure worse than the disease.
Source: Financial Times
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Katz is obviously right about the likely negative impact of an increased consumption tax in Japan. He is also right in pointing out that, thanks to ultra-low interest rates, government interest payments today add up to 2 per cent of GDP, compared with 3 per cent in the late 1980s. Whatsmore, for some years to come, the burden will continue to lessen since the average interest rate currently paid on outstanding bonds is 2.2 per cent, which is far above the 0.9 per cent rate on 10-year bonds in the secondary market. So as old high-interest bonds mature and are replaced with new low-interest ones, the average interest burden will continue to fall. Where Katz goes astray, in my opinion, is in not seeing the impact of this on debt dynamics. As government debt continues to rise the cost of eventually raising interest rates becomes horrendous. Thus there will be no incentive to work to produce inflation since the impact on interest rates will be likely to hit government financing so hard that the most probable effect would be to send Japan straight back into recession! At the same time doing nothing, and continuing to sit back and watch the deflation process at work (even if at a rate of only 1% or 2% per annum) will see the debt/GDP ratio moving steadily upwards until it finally becomes unsustainable, even if the cost of servicing the debt remains small. When will people finally wake up and realise that it is the demographic processes itself which lies behind all this, and that if Japan does nothing about its demographic problem (eg opening the doors to immigration) then there will continue to be be no end in sight.
Dollar Up, or Dollar Down

So which way is it this year for the greenback? A bevy of commentators (including the IMF and the OECD) regard the dollar as seriously overvalued. In principle I agree. The real problem is to identify a sound substitute. In this piece Morgan Stanley's Stephen Len argues for the dollar downside effect dominating. (Why is their global economic forum so full of talent, is this another example of a networking effect? Nine times out of ten I would certainly back the 'instinctual' economics of Roach's team over their aforementioned more heavyweight institutional rivals). What makes his argument interesting, and out of the pack, is that he justifies this by countering the weak yen view.

The topic of the month is the change of governor at the Bank of Japan (BOJ). There is a kind of will-he, won't-he debate over whether this will mean that the BOJ will go for that flavour of the month: inflation targeting (IT). What Len suggests, and I think this is a good argument, is that whoever is chosen the likelyhood of IT in the near term is extremely small. This is not only due to conservatism and lack of reform spirit at the BOJ, but because they seriously doubt it is credibly attainable on a sustained basis, hence their reluctance to jump for it. Many American commentators suggest that they are wrong (in fact too often they suggest they aren't even trying which is absurd) and that what they need to do is systematically (and in duly non-sterilised fashion) purchase government debt. Len is a Japan finance and in particular a Japan Government Bond (JGB) specialist and he strongly doubts this would work. The only clear strategy for provoking inflation he argues is by the BOJ purchasing foreign securities, and this they are still far from ready to do (again with reasons which could be argued). Maybe by the time they get round to doing it Bernanke will be leading the Fed into acquiring JGB's so they could do a straight swap. Bottom line: this year it's more probable that the dollars tendency to go down will dominate, but in currency markets sometimes anything can happen! Since I have long held that monetary factors only give part of the story for the thirtees depression, and that beggar-thy-neighbour devaluations and protectionism (especially in the case of labour mobility) also have their part to tell, I can only view all of this with growing concern. When will we get round to discussing the real problem, in the real economy? Meantime watch out Euroland, up you go.


The term of the current Governor of the Bank of Japan (BOJ) ends on March 19. From recent official statements, there is strong support within Koizumi�s government to replace Governor Hayami with someone who is sympathetic to the idea of inflation targeting (IT). If such a candidate is indeed appointed as the next BOJ Governor, the currency market�s initial knee-jerk reaction is likely to be a modest rise in USD/JPY -- modest because the market has already priced in a high probability of this outcome. (Conversely, if it turns out that the new Governor is not a strong supporter of IT, USD/JPY could fall!) However, whether USD/JPY rises further and stays high, against what I expect to be a broad downtrend in the USD this year, depends on a number of considerations. One key point in this note is that, for USD/JPY, the instrument that the BOJ uses to achieve an explicit inflation target is more important than whether there is an inflation target. Only if the BOJ decides to buy large quantities of foreign bonds would USD/JPY rise over the medium-term, in my view. In all other cases, I believe that any rise in USD/JPY will be temporary and psychological, and will eventually be overwhelmed by economic reality, which, in my view, justifies a lower USD/JPY.

The most compelling argument against the BOJ adopting an inflation target is that such a policy objective lacks credibility because it is simply not achievable under the current circumstances. Japan is suffering from "real deflation", not "monetary deflation". Money printing alone cannot get Japan out of this liquidity trap. Having been implicitly targeting an inflation rate of at least zero, the BOJ has already failed at achieving this target. Adding a time frame and making this target explicit would actually hurt the Bank�s credibility, in my view. Further, what if inflation does rise during this period? Should the BOJ tighten to keep inflation contained, given the likely continued weakness in the Japanese economy? Clearly, there are both theoretical and practical complications of adopting IT at this point.
Source: Morgan Stanley Global Economic Forum
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Japan About to Try to Lower the Yen

Signals coming out of Japan, difficult as they are to read at times, seem to indicate that a change in exchange rate policy may be imminent. On Mondayprime minister Junichiro Koizumi added his voice to a growing body of evidence that his government, which regards the yen's rise as reflecting external weaknesses rather than any significant improvement in its own economy, would welcome a currency depreciation. He said the new governor of the Bank of Japan should support an aggressive anti-deflation policy. Mr Koizumi must choose a new BoJ governor by March. Since Japan has all but exhausted the possibilities of fiscal and monetary policy a substantial depreciation of the yen remains one of the few policy options open to the government.


A senior official warned on Monday that Japan would take decisive action against rapid fluctuations of the yen, reflecting growing concern that economic recovery is being stifled by a strengthening of the currency. The signal from Toshiro Muto, vice-finance minister, of possible intervention came on the same day that the Nikkei average notched up its longest losing streak in 11 years, with yen-sensitive exporters particularly heavy casualties. On Friday, the yen rose to a one-month high against the dollar at �120.3, and was hovering around �120.6 on Monday, prompting investors to unload shares of Japan's biggest exporters, including Sony and Canon. The Nikkei average lost 0.8 per cent to 8,450.94, its first nine-day losing streak since September 1991.
Source: Financial Times
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