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Friday, February 28, 2003

Meanwhile Back at the Coal Face

Whatever the merits or otherwise of new appointments, whether in the US or Japan, a reality check reveals one thing: things ain't gettin better, and fast.

The pernicious deflation that has plagued the Japanese economy showed no signs of alleviating in January while unemployment hit a postwar high, underlining the challenges facing Toshihiko Fukui, the newly-appointed Bank of Japan governor. Japan's jobless rate rose to 5.5 per cent in January while the core consumer price index tumbled 0.8 per cent from a year ago, its fortieth straight month of decline. Economists said deflation was likely to get worse before it got better, a result of the strengthening yen and "anaemic monetary stimulus". The yen recently rose to a six-month high against the dollar at Y117.Chris Walker, economist at Credit Suisse First Boston in Tokyo, said: "For the next few months, the most likely direction for CPI inflation is down, towards the record rate of minus 1 per cent, year-on-year.
Source: Financial Times
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A Spot of the Right Stuff at the BoJ?

Mein Gott, I can't believe it. Richard Katz, a Japan commentator I don't always agree with but who I do respect, has come out and said the unsayable, Toshihiko Fukui is the right man in the right job. (In fairness many pragmatic commentators inside Japan had been coming round to this view, this and the view that the important thing is not just the head man, but the team). The reason Katz thinks this is that he isn't convinced of the monetary policy can do it alone story (lets call this the helicopter money - actually, I even found one Japanese economist imaging this - dropping money from helicopters to provoke inflation - was actually being proposed: still its a nice idea, it would make what is already a lottery into an even bigger one, somehow this puts me in mind of an old Borges story about Babylon......). Katz's reasoning here is faultless as far as I am concerned. With all due defference to heavyweights like Paul Krugman and Ben Bernanke fuelling a 4% inflation rate isn't a problem, it's keeping it there that is the problem, and maintaining the credibility that it's going to stay there, remember yield curves are now flattening out up to the 30 year mark. There's more to the Japan problem than simply its liquidity trap. Until Japan begins to address its structural problems there will be no lasting cure for the deflation.

My principal difference with Katz: in position number one on the structural reform list I put structural reform of the population, ie opening big-and-wide the immigration tap, without this I feel fiscal policy will be less than useless, in particular with the dead weight of the debt looming just round the corner. One other difference between me and Katz: I'm certainly not prepared to stick my neck out for Fukui-san, nor for Takenaka-san, nor for Koizumi-san. The de facto powers who exert such influence on the day-to-day conduct of economic affairs are far too important to be discounted so easily. Still, in the right circumstances Fukui may prove to be more of a runner than was previously expected. Or are we all just clutching at starws here? One curious detail about the saga is the growing mention of one lesser member of the Bush economic team: John Taylor - he of Taylor rule fame - at the international affairs section of the US Treasury.

It is hard to see how Japan's economy can reform and recover unless reformers are put in charge of vital policymaking institutions. That is why the appointment of Toshihiko Fukui as governor of the Bank of Japan is a positive step. His view is straightforward: deflation cannot be stemmed through monetary easing alone, which makes structural reforms more important than ever.


Even some of those who want the bank to inject "unconventional stimulus" acknowledge it cannot revive the economy by itself. Heizo Takenaka, minister for economic policy and financial services, has made it clear that monetary easing will not suffice without the disposal of bad debts. So has John Taylor, undersecretary for international affairs at the US Treasury. Mr Fukui will bring more to the table than the reformist philosophy he shares with Masaru Hayami, his predecessor. Even critics acknowledge his political acumen, flexibility and a dense network of supporters in politics and business. These assets could make him more effective than Mr Hayami in building consensus for action on bad debts supported by monetary easing. The main alternative is the futile hope that massive money-printing, like government spending on "bridges to nowhere" in the past, can substitute for real reform. Critics claim that the BoJ could create 3-4 per cent inflation at will and that this inflation would, in turn, revive private demand. Some advocates of inflation targeting even suggest that the bank buy up assets used as collateral for bank loans, from equities to office buildings. While many economists sincerely believe such measures would help, it is the opponents of reform who are the most fervent advocates. They hope that raising the price of stocks and property can make bad loans good without restructuring "zombie" borrowers - companies that are essentially bankrupt. The more Japan's leaders grasp at monetary straws, the less likely they are to undertake true reform.

Japan's deflation is not the cause of weak demand but a symptom. Prices are falling because the economy is operating at 4-5 per cent below capacity. The bank cannot create steady, manageable inflation just by printing more money. It has tried. It has increased the monetary base by almost 40 per cent since March 2001. Interest rates have responded - the yield on a 10-year government bond is now at a record low of less than 0.8 per cent. But little else has improved. The rest of the broad money supply has barely changed. Meanwhile, bank loans, prices and nominal gross domestic product have all kept falling. Certainly, the Bank of Japan can boost the price of any asset it buys. If it offered to print unlimited money to buy buildings at double their current price, building prices would immediately double. Developers would construct buildings just to sell them at high prices to the bank. However, when it stopped buying, prices would fall back. Such a move would re-create the late-1980s boom and bust on a grander scale.To his credit Mr Hayami blocked such schemes - and so will Mr Fukui. But beyond rejecting false cures, the bank has to stress what it and the government can do. If deflation is a product of weak demand, the solution is to boost demand directly. The surest initial step is a permanent consumer tax cut in the order of a few per cent of GDP financed by the bank. That would put money into people's pockets without raising interest rates.
Source: Financial Times
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Bank of Japan: the Speculation is Over

Well finally the speculation is over, and Japan has got a new governor for its central bank. Much to the sighs of disappointment across the planet, the newcomer is not an inflation targeter, in fact he is a tried and trusted member of the old guard, so in theory this means more of the same. But since nothing is ever completely predictable, and even less so in Japan, we may still see some surprises. Japan is, after all, mired in deflation, with government debt rising every year and no sign of capacity to repay improving. So, one day or another, something has to give somewhere.

Toshihiko Fukui has been named by Junichiro Koizumi, Japan's prime minister, as his choice to be the new governor of the Bank of Japan, prompting critics to question Mr Koizumi's qualifications as a reformer and Japan's commitment to tackle deflation. Mr Fukui, former deputy governor of the BoJ before resigning amid scandal in 1998 and currently head of the Fujitsu Research Institute, a think-tank, is a career central banker expected to continue the policies of the incumbent governor, Masaru Hayami.

Mr Fukui's nomination indicates strongly that future moves by the BoJ to tackle inflation will not make use of so-called unorthodox measures such as an inflation target or the purchase of overseas assets, but will continue the current policy of injecting liquidity into the banking system.Peter Morgan, economist at HSBC Securities, said: "Mr. Fukui's views on monetary policy are conservative, and in line with the mainstream of the Bank of Japan. This means that there will be no break in the BoJ's monetary stance, and that the adoption of unconventional policy measures is extremely unlikely. Adoption of an inflation target is also unlikely."
Source: Financial Times
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Japan Prepares to Say Farewell to Hayami

Central bankers are a select group. Some like Alan Greenspan, Wim Duisenberg, Eddie George become household names. Others seem more comfortable with obscurity (the is not the same thing as obscurantism which is undoubtedly Duisenbergs best known attribute). Masaru Hayami, who will complete this month his five-year term as governor at the Bank of Japan, would probably have preferred the obscurity, but Japans continuing economic plight, and its significance in the world economic order have meant that this preference was not to be respected. In particular this has been the case since during his watch at the bank Japan has been the first major economy in recent times to face a sustained battle with deflation, and as a consequence the eyes of the economic world have scrutinised every decision looking both for a way out, and for lessons for the rest of us.

Hayami took control of Japans monetary policy levers in March 1998, after his predecessor resigned following a wining-and-dining scandal involving top Bank of Japan officials. Much was expected of him, and, in the event, criticism of him has been widespread, first and foremost for the fact that he appears to have had more fear of provoking inflation than he did of permitting deflation to continue. His most notorious failure: the decision to terminate the zero interest rate policy in August 2000, right after the NASDAQ bubble burst, only to have to re-introduce it and change course yet again in March 2001. As the eyes of the world turn towards the appointment of his successor, and to whether or not he will be an 'inflation targeter', the Daily Yomiuri offers us this assessment of Hayami the central banker:



With extensive experience in both the private sector and the central bank, Hayami was expected to usher in a new era for the nation's financial guardian. But instead, Hayami failed to recognize that his key mission was to overcome deflation as he was haunted by the specter of inflation, which had troubled the nation's early postwar years. The year that preceded Hayami's accession to the governorship was plagued with financial woes for the nation, including the collapse of former giants including Yamaichi Securities Co. and Hokkaido Takushoku Bank. Yet despite the prospect of far-reaching economic fallout from such financial woes, the central bank failed to quickly respond to the unprecedented situation. It was not until September that year that the central bank reduced its benchmark short-term interest rate--the unsecured overnight call rate--to 0.25 percent. However, the effects of the rate change were minimal, and the central bank was subsequently forced to adopt a zero-interest rate policy in February 1999. From the perspective of a traditional central bank, such a move was unusual in that it had effectively given up one of its most powerful monetary policy instruments. Thereafter the Bank of Japan went on a policy zigzag, bringing an end to its zero-interest rate policy in August 2000 despite warnings concerning the nation's worsening deflation, especially after the bursting of the information technology bubble in the United States. However, the central bank's decision to hike rates was strongly criticized, and the bank reinstated its zero-interest rate policy just six months later. In March 2001, financial uncertainty again rocked the economy as companies closed their accounts for the fiscal year-end. In a last-ditch effort to overcome a deflationary downturn, the central bank changed its policy from targeting interest rates to quantitative monetary easing--a policy of raising the balance of current account deposits held by private financial institutions at the central bank.

But when the new policy failed to work, Hayami reportedly responded to growing criticism by indicating to then Prime Minister Yoshiro Mori that he wanted to resign. Central bank officials seem to have an inclination to accept a certain level of recession on the grounds that an economic contraction is an inevitable consequence of speeding up the disposal of banks' nonperforming loans and hastening structural reforms. Some top officials have openly stated that recent price falls are "good" as they allow consumers to buy quality goods cheaply. The central bank officials' lack of recognition of the problem has resulted in their failure to implement timely antideflationary measures. This has caused deflationary pressures to accelerate, a situation for which Hayami must accept responsibility. Nevertheless, in contrast to general discussion on the topic, Hayami and his experts at the central bank may not have been as timid or conservative as one might have been led to believe. Not only have their adoption of a zero-interest rate policy and quantitative easing been bold steps, but other measures such as the purchase of stocks held by banks should be applauded for having gone beyond the traditional bounds of central bank policy, such as open-market operations and lending to banks.

Yet as soon as the economy appears to be on the verge of recovery, the central bank has nipped it in the bud by reimposing a tight-money policy, a habit it seems incapable of shaking off. Market players are well aware that the central bank has no option but to continue its easy-money policy as it has been unable to devise policies to overcome deflation. The central bank's reluctance to act has resulted in the yield on the benchmark 10-year government bond falling to a record low of 0.75 percent at the end of January, indicating that the market expects deflation to continue. The central bank's maneuvering of the overnight call rate formerly acted as an alarm bell for the market. The bank would leak its rate decisions if it judged the economy was overheating, using the announcement effect to fine-tune the economy.

This jawboning of the market by the central bank indicated to market players that the Bank of Japan was keeping a close watch on the nation's financial health. But now, the bank is sending out unfavorable signals that may prolong deflation and its ultra-easy monetary policy for no good reason. If a central bank fails to devise policies to influence the market, its raison d'etre must be called into question. What about purchasing a wider range of assets as the next strategy? If the bank purchased exchange-traded funds or real estate investment trusts, it would boost land and stock prices, helping to improve the banks' balance sheets as they hold large amounts of such assets as collateral. May the new governor be reminded for the last time that deflation is the nation's economic enemy, not inflation or an asset bubble. It is hoped the new central bank chief will be both courageous and flexible in carrying out the policies to overcome such a financial foe.
Source: Daily Yomiuri
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The Economist: Giving Up on Japan?

This weeks Economist piece on Japan almost sounds demoralised and despondent. Are they coming near to throwing the towel in. The article's author doesn't even seem to believe the BoJ will be headed by a deflation targeter any more (they are probably right on this: in fact those like me with a warped sense of humour are begining to imagine the whole Nobuyuki Nakahara affair was 'leaked' to the press to derail any possibility of the candidature ever being presented). Sure, the problems sometimes have a now you see me, now you don't feel about them, but they are real enough even if last weeks official GDP figures confounded all expectations - mine and the Economists alike - by showing that the Japanese economy continued to expand in the final quarter of last year. This news, however, will not make deflation disappear, nor will it take the heat off Japan�s government, which according to the Economist now "appears to be incapable of tackling the country�s deep-seated economic problems".


GOOD news about the Japanese economy is rare these days�and surprising. Most economists had braced themselves for the news that the Japanese economy had shrunk in the final quarter of 2002. So the official figures, released on February 14th and showing that the economy expanded in the October-December quarter, caught people off guard. Growth was modest enough: just 2% at an annual rate. But it means that the economy has now grown for four quarters in succession, and that the country�s fragile recovery is not�yet�over. The figures will provide a welcome breather for the Japanese government, but one likely to be shortlived. The economy�s problems remain daunting and the new data followed hard on the heels of a further slide in business optimism. Moreover, they came just a few days after a new opinion poll showed that the popularity of the prime minister, Junichiro Koizumi, had slumped.


Tackling deflation is a matter of urgency. But even those economists for whom inflation targeting is the preferred solution accept that, by itself, ending deflation will not solve Japan�s problems. What is needed is concerted reform on several fronts�monetary, fiscal and structural. Japanese government debt now exceeds 150% of GDP (more than double the upper limit set by the European Union) and is rising fast. What to some observers seems like an endless series of fiscal-stimulus packages has had almost no economic impact, in part because of a misguided emphasis on wasteful, expensive public-sector construction projects. These have benefited the LDP�s corporate contributors more than the wider economy. Co-ordinated reform seems beyond the current political establishment, and commentators have given up talking about Japan�s last chance to change before being engulfed by a full-blown crisis. The slow speed of the economic decline has meant that the debate within Japan has lacked the sense of urgency that would be needed to overcome opposition to reform. But for Mr Koizumi himself, time might be running out. There is talk of his vulnerability in the LDP leadership election due in September and speculation that he might try to head off a challenge by calling an early general election. What that would do to improve Japan�s miserable economic prospects is far from clear.
Source: The Economist
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Two Views on the Doha Round

It is an obvious truism that how you feel about something is often a result of where you are looking from. Below I post the example of two contrasting views concerning proposed Doha round changes to agricultural tarrifs and farm subsidies, one from Japan and the other from India. Those who are opposed to globalisation in itself will doubtless find here yet more material for criticism. Those, like me, who are convinced of its potential benefits, can and should note that the process in reality is not unproblematic. India has an enormous problem of rural poverty that cannot simply be waived away overnight. It is, however, extremely encouraging to find that the need for change is accepted in principle, and that the Indian economy is becoming more and more open. The European and Japanese case is rather different, tarrifs and subsidies have been used for far too long as a means to preserve activities which often have little economic (but plenty of political) rationale. Change will come, but it is a pity that in the richer economies, where the possibility of gradual change has long existed, things were not resolved earlier. Now the process may be more painful since - on this and many other fronts - reforms will be introduced against a far less favourable economic backdrop.

Thousands of Japanese farmers rallied Saturday to stop ministers huddled at a World Trade Organization meeting in Tokyo from approving a proposal to slash tariffs. "We are going to send a clear message to the ministers that they must protect Japanese farms,'' Kazuyoshi Fujita who represents agricultural and consumer groups told a crowd of about 8,000 people gathered at a Tokyo park. "Without food, how can people live? Without rice farming, how can Japan survive?'' Delegates from the WTO and 22 member economies are meeting in Tokyo to try to hammer out an agreement on agricultural talks by the end of March, as part of the latest round of WTO global trade talks that began in Doha, Qatar in 2001. The talks Saturday focused on a proposal from former Hong Kong Trade Ambassador Stuart Harbinson, the chair of the WTO farm negotiations, to reduce tariffs by an average 60 percent in five years, reduce subsidies and raise import quotas, officials said. Farmers say Harbinson's proposal would be devastating for Japanese agriculture, which is far more expensive than American agribusiness and the rest of Asia. Japan, which imports 60 percent of its food, protects its rice farms with a 490 percent tariff on foreign rice. "We are fighting hard against the proposal because Japanese farms will be destroyed,'' 58-year-old farmer Yasuhiko Matsunaga said standing among colorful banners that said, "Rice is No. 1.''
Source: The Star Online
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The World Trade Organisation draft proposal on agriculture have come as a shot in the arm for developing countries with many of those attending the mini-ministerial in Japan terming it a small victory, and indicating that it addressed some of their long standing objections related to opening up the farm sector. The latest draft by the chairman of the WTO Committee on agriculture Stuart Harbinson proposed that the developing countries could gradually cut customs duty on agri-products over a negotiated period, and continue with other measures of state subsidy and extraordinary support. But it has also come as something of a jolt to many of the developed countries, including Japan and European Union, which have opposed any drastic reduction of farm subsidy. Delegates from developing countries, including those from India, Kenya and Nigeria said that the outcome could be viewed as a small victory for the strong stand taken by the developing countries at Doha Ministerial gathering against opening up of their agri-market without addressing the problem of the prevailing social conditions. Though India welcomed the draft modalities giving concessions on the state subsidy and special product exemption front, it indicated it would oppose the reduction in the tariff structure as proposed within a period of 10 years, official sources said. The developing countries consider the draft as an important document as it has attempted to take on board the differing views of three major trading blocks - CAIRNS, EU and the developing countries - over the contentious issue of market access in agriculture sector. The CAIRNS countries - including US, Australia, New Zealand, Malaysia, Indonesia, Brazil, Thailand and Canada - being agri-export countries, advocate free market access. Many of these countries have hidden subsidies to boost their agriculture sector. The EU, which gives huge subsidies to the agriculture sector, supports market access but does not agree to link this to a reduction in subsidy. Developing countries fear that their markets will be flooded with products from other countries, which are cheap due to massive state support, thus causing unrest and social tension among the population dependent on this for their livelihood. Explaining the Indian position, the official said 65 per cent of the Indian population was dependent on agriculture and the government views this sector as a means to eliminate rural poverty.Moreover, the total subsidy given by the government through smaller supports in electricity tariff, fertiliser prices and transportations was lower than the WTO benchmark on subsidy. Viewed in this backdrop, the draft modalities proposed by the WTO Committee on Agriculture come at an opportune time. India said that its interests in some key areas had been further protected by the proposition in the draft under the Special Product Exemption category where it could maintain its present tariff.
Source: Redif.com
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Japan Back in Reverse Gear

More bad, bad news from Japan.The economy has begun, once again, to contract. You could call it the incredible shrinking economy, were it not for the fact that humour seems to be out of place here, and that these results may give us a pointer to what's in store for the rest of us if I'm even halfway right about the root cause. Apart from the downturn, also worthy of note is the continuing decline in bank lending and the slow rate of growth in monetary supply.

Figures to be released on Friday are likely to show that the Japanese economy contracted in the December quarter, bringing to an end the shortest recovery in Japan's post-war history, a senior economic adviser to the prime minister conceded on Monday. "I am afraid that the economy is already contracting," said Haruo Shimada, professor of economics at Keio University and senior economic adviser to Junichiro Koizumi, prime minister. He said there was no sign of improvement in domestic consumption, with the only increase in demand coming from the external sector. The concession that the economy has stuttered to a halt came as figures showed last year's mini-export boom beginning to slow. Data for bank lending, also released on Monday, showed the 61st straight month of decline as financial institutions continued to shrink their lending base in an effort to shore up capital adequacy and prevent more loans from turning sour. Bank lending for January fell 4.7 per cent.

"Japan is never going to be driven too much by exports because they account for only 10 per cent of the economy," said Peter Tasker, head of Arcus Investment, a Tokyo-based hedge fund. "There's only so much you can do if the other 90 per cent of the economy is going in reverse." The current account surplus for 2002 rose 34 per cent from the previous year to Y14,248bn ($120bn, �112bn, �74bn), about 3 per cent of gross domestic product. Exports for the year rose 6 per cent thanks largely to a 13.7 per cent increase in shipments to Asia, of which almost a third were electronics goods. "Exports to Asia climbed very steeply in the first half of 2002 and have now levelled out," said Chris Walker, economist at Credit Suisse First Boston in Tokyo. Exports to the US rose just 1 per cent during the year.

Signs that the export-led recovery may be petering out came with figures for December, which showed the current account surplus shrinking 1.4 per cent year-on-year. Economists said an improvement in Japan's external performance tended to strengthen the yen, which then choked off further growth. "You had quite a sharp recovery in industrial production driven entirely by the export sector, but momentum peaked in summer and has been easing off since then," said Mr Tasker. He said there had been no collapse in economic activity since growth had never properly got going in the first place. "It's hard to collapse when you're already sprawling on the ground." The Bank of Japan also said on Monday that monetary supply in January grew at 2 per cent year-on-year, its slowest rate of increase since the end of 2000. The central bank's policy board meets on Thursday, but is unlikely to contemplate a radical change of policy before March, when a new governor is due to be appointed.
Source: Financial Times
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Tuesday, February 11, 2003

Japan Preparing to Oppose Agricultural Reform at the WTO

Japan and the European Union look set to be the two holdouts against freer trade in agricultural products when the World Trade Organization meets informally in Tokyo next week.The trade and agriculture ministers of the WTO member states will be gathering as part of the latest round of multilateral trade negotiations that began with the November 2001 agreement in Doha. Their main focus will be on agriculture: an area where the EU like Japan seems extremely reluctant to give anything away, and an area in relation to which third world protests are becoming increasingly vocal.

Japan and the EU will try to stymie efforts to liberalize farm trade at next week's informal meeting in Tokyo. The United States and the 17-member Cairns Group of agricultural exporting nations are calling for sweeping tariff cuts. Japan and the EU are opposed. Agriculture minister Tadamori Oshima even went so far as to say a broader market opening would ``completely destroy'' the farming sector in Japan and other Asian nations. Ministry officials are particularly concerned about rice growers. The government shields them from foreign competition with high import tariffs. The pro-liberalization states propose cutting tariffs on all farm products to below 25 percent within five years. Tokyo currently charges a tariff of 341 yen per kilogram of imported rice-upwards of 300 percent of the price of most imported rice varieties. Domestic rice, meanwhile, wholesales for 200 to 450 yen per kilogram, depending on the brand.

The protectionist impulse sits well with the powerful farm lobby. Isamu Miyata, who heads the Central Union of Agricultural Cooperatives, urged Prime Minister Junichiro Koizumi late last month to resist any calls for drastic liberalization. Miyata invoked ``the nation's self-sufficiency in agricultural products'' in calling for continued trade barriers. The agriculture ministry also sees the EU as a trusty ally in the fight against trade liberalization. Oshima formally announced Japan's support last week for an EU proposal that tariffs on farm products be lowered by an average of 36 percent. The EU proposal would allow each country to decide its own tariff cuts, so long as they are not less than 15 percent. The pro-liberalization camp's tariff cuts offer no such flexibility, which is permitted under a provision of the 1986-1994 Uruguay Round of trade talks. The EU trade regime would, for example, allow Japan to cut its tariff on imported rice by the 15-percent minimum, to 290 yen per kilogram. A 100-yen kilogram of imported rice would therefore wholesale for about 390 yen-as opposed to 125 yen if the Cairns Group and the United States prevail. Tariff cuts are at the center of the dispute over farm trade, which is one of the seven items on the table in the latest round of multilateral trade talks.

The outcome of the agricultural talks will therefore make or break the new round. WTO member states are working toward a March 31 deadline to conclude a framework agreement on farm trade. It will specify means, such as formulas and tariff cut targets, by which agricultural markets are to be opened. The Tokyo ministerial meeting, which runs next Friday through Sunday, will be an important venue for consultations among members. But there are few signs of a consensus emerging from the meeting, with the two camps still far apart. Many negotiators say they doubt the member states will even be able to meet the March 31 deadline. WTO members are eagerly-and cautiously-waiting for the first draft of the framework agreement for liberalizing farm trade, which Stuart Harbinson, the WTO official chairing the agricultural negotiations, is expected to release just before the Tokyo meeting. The report could set the tone of the meeting, to which 25 countries are expected to send their ministers.
Source: Asahi.com
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Japan Pensions: The Unkindest Cut

One of the less palatable consequences of deflation is of course the reality that what goes up can also come down, that systems where wages and pensions are effectively indexed to prices mean, that when prices come down, wages and pensions come down too. Of course, what is less well studied is how such reductions will be received and understood by those on the receiving end. Among other important consequences of today's decision to reduce indexed pensions in Japan must be the implictation that, in the eyes of many with responsibility for decision making in Japan, deflation is now settling in for the long haul.

Japan's retired population will for the first time suffer the consequences of deflation when the government cuts the monthly pension by 0.9 per cent in line with the falling consumer price index. Until now, retired people in Japan have been largely shielded from the effects of deflation, since a political decision to decouple their benefits from the CPI when prices began to fall three years ago. Most retired people, few of whom are exposed directly to the stock market, have benefited from deflation, which has boosted their real spending power. The government's decision to make pensioners share some of the burden amid a stagnating economy and sharply worsening demographics is highly symbolic. It could well presage aggressive moves to renege substantially on promised pension benefits, analysts said.

On Friday, the cabinet re-established the link between prices and pensions, which were first indexed in 1973. As a result, the state pension for an average head of household will be cut by �2,140 ($18, �17, �11) to �235,980 a month. The move could change the psychology of deflation, Jeffrey Young, senior economist at Nikko Salomon Smith Barney, said. "The relinking of benefit back to the CPI may start to convince seniors that deflation is not the greatest thing in the world," he said. "This is the first time that, in a very direct and visible fashion, they can see: 'Oh, falling prices means my income is going to be cut as well'." Explaining the change of policy, a government official said it was necessary to prevent the deterioration of the social security system's finances. The system fell into deficit for the first time last year, a situation that will get significantly worse. The labour force is shrinking by 0.6 per cent each year as baby boomers retire, reducing the size of total premiums and raising the amount that must be paid out in pensions.
Source: Financial Times
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Sunday, February 02, 2003

Japan Actively Intervenes to Keep the Yen Down

So much of the speculation was right. The Japanese yen definately isn't accompanying the euro on it's climb upwards - some things in life you just have to do alone - and they have spent this month alone 5.6 million dollars (in yen of course) to back their determination. The curious thing is that they tried to keep quiet about it. My feeling is that it is now only a matter of time before the ECB gets the message and starts to intervene itself, whether by dropping rates or selling euros, before we have the curious spectacle of three of the four major currencies trying to beat themselves down. Sterling could then be the one with the problem, since with house prices rocketing the BofE certainly won't be looking to bring rates down, except that with Blair backing Bush on Iraq, so the petro dollars won't be heading for London any time soon.


Japan's Ministry of Finance intervened in the foreign exchange market this month to weaken the yen, but did not tell investors until monthly data on Friday uncovered the transactions. The Bank of Japan used some Y678bn ($5.6bn) in a series of actions to buy dollars for yen to stem the Japanese currency's appreciation. An official on Friday said the move was designed to stabilise the yen rather than actively weaken it.Despite the weakness of Japan's economy, the dollar's renewed slide has led the yen to strengthen in spite of officials' attempts to talk it lower. The Japanese currency has gained some 6 per cent in the past two months, prompting concerns about the damage a stronger currency will do to exporters' balance sheets and its possible impact on Japan's struggle against deflation.

The dollar stood at Y119.3 against the yen on Friday, up from three-month lows at Y117.5 earlier this month. Analysts said the covert nature of the BoJ's actions was a surprise. The bank, which holds massive reserves, has frequently intervened publicly in the market to limit yen strength and last acted in a series of moves between May and June last year.
Source: Financial Times
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COMMENT

Why Japan Matters

Morgan Stanley's Robert Alan Feldman points out, at a time when many seem to have forgotten that Japan exits, why Japan continues to matter.


Yet another way Japan matters is in helping to integrate China into the world economy. Compared to other countries, Japan trade with China is more complementary. Japan produces many things that China cannot produce for itself yet, and China produces many things in which Japan has no comparative advantage at all. The gains from trade between capital-intensive Japan and labor-intensive China are huge. Of course, the commodity producers will also reap major gains from trade with China. However, compared to many manufacturing-oriented economies, Japan is in a rather good position, even if there are still some industries where Chinese products will replace Japanese ones. In addition, Japan is one of the few countries that benefit from the interaction of demographics and trade. The working-age population in Japan has already begun to decline, and so inexpensive Chinese products are crucial in supporting the Japanese standard of living. The business opportunities from this trade complementarity are legion. True, many in Japan are scared of China. Surprisingly to me, these fears are shared -- and amplified -- in other countries. My colleagues who cover Latin America were particularly anxious about Chinese competition in some of their industries.

Finally, Japan has a prominent place in the debate about how macroeconomic theory should be applied in financial markets. Is deflation solely a monetary phenomenon, or is it also a real phenomenon -- e.g., due to insufficient structural adjustment that has prevented the absorption of redundant workers? Countries around the world, faced with structural rigidities (e.g., Germany) or rising imports from China (everywhere), will face the same problem that Japan has grappled with for a decade. Japan�s experience is precious. Moreover, investors in many markets now face the issue of valuation of equities in a deflationary world. Who has more experience in this than Japan?
Source: Morgan Stanley Global Economic Forum
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The Bad News From Japan Continues

Unemployment up, GDP and consumer prices down, there certainly doesn't seem to be any end in sight for Japan's economic woes. Add to this the fact that industrial production contracted in December for the fourth consecutive month, and that the Nikkei touched 20 year lows this week, and it's easy to see there's little cause for optimism. Nevertheless some still seem able to call bad news good, even if the little glimmer of hope, the changing ratio of applicants looking for work to jobs, may be more a reflection of the fact that older people are leaving the job market than anything else. The good news, that is, is that the unemployment problem can be thought by some to be improving because as the population gets older more peolple are retiring, or staying at home to care for the elderly!!

Unemployment in Japan reached a post-war high in December while the deflation that has racked the economy for three years showed no signs of alleviating. Economists are forecasting the economy to contract in the fourth quarter. December unemployment reached 5.5 per cent. Though the ratio of new job offers to applicants rose to 1.04, its highest level since June 2001, the percentage of employed people in the workforce and those actively seeking work declined to 60.6 per cent. In a comedy of errors, Masajuro Shiokawa, the country's finance minister, initially said the jobless figure was "good news". He then retracted the comment after a ministry official whispered in his ear, presumably that the news wasn't so good. Mr Shiokawa said the rise in employment in certain sectors was a positive development.

The core consumer price index for December fell 0.7 per cent, year-on-year, though it held steady from the previous month. For the year, the CPI fell 0.9 per cent, its biggest year-on-year decline. Falling prices have plagued the economy for three consecutive years, making it harder for businesses to repay loans. "Deflationary pressures are still very strong, and with the cut in winter bonuses, final demand will be subdued for some time," said Ryo Hino, economist at JP Morgan in Tokyo. Peter Morgan, economist at HSBC in Tokyo, said that the Japanese CPI underestimated the actual degree of deflation by about 0.7 percentage points. Economists have long questioned the accuracy of Japanese economic data, which led to a re-vamp in the way gross domestic product is calculated. "The main reasons are that CPI does not include prices for short-term sale items, despite the fact that such sales are becoming increasingly common, and it does not adjust adequately for quality changes," said Mr Morgan.
Source: Financial Times
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Japan - The Chinese Connection

The news that China is now the world's number one exporter to Japan has provoked considerable commentary inside Japan. From calls for a revaluation of the Chinese Yuan to recognition that the economic futures of the two countries are now inextricably linked. In particular proponents of the latter view draw attention to the fact that demand from China allowed Japan to increase its trade surplus in 2002, for the first time in four years. Among the factors that have caused the value of Japanese imports from China to rise for four straight years since 1999 is the trend among Japanese manufacturers to shift production to China to take advantage of cheap labor and resources or, to put this another way, to increasingly rely on Chinese outsourcing. And while Chinese products grab an ever greater share of global markets, as their economy shrinks under the impact of deflation Japanese products are gradually losing theirs. Japan in 2001 supplied the United States with 11 percent of its imports, down 1.4 percentage points from the year before. Over the same period, its share of South Korea's import total fell 0.9 point to 18.9 percent.

Some see a threat, others opportunity. But all agree-China can't be ignored. Already in Japan, made-in-China goods are everywhere, accounting for 18.3 percent in value of all imported goods last year. At one major supermarket chain, a full third of all imports come from China, having replaced the United States as the top source five years ago. A company executive said technical assistance from Japanese trading houses helps ensure the quality of the cheap Chinese products. The phenomenon affects all industries. Machinery accounted for 33.5 percent of total import value from China last year. Computer imports from China grew 81.7 percent in 2002 from the previous year, while semiconductor imports grew 21.5 percent.

Masaki Yabuuchi of the Japan External Trade Organization said Chinese manufacturers have become more competitive ever since a strengthening yen drove Japanese manufacturing to their shores in the latter half of the 1990s. Japanese direct investment in China surged in 1995, when the yen appreciated to 79 against the U.S. dollar, he said. The result was a massive increase in manufacturing capacity. One Japanese firm taking advantage of that capacity is NEC Corp. The company plans by March to import about 1.2 million Chinese-made personal computers, or 70 percent of its consumer PC sales for the fiscal year. By fiscal 2004, the electronics giant intends to raise that figure to 85 percent.
Source: Asahi Shimbun
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The constant inflow of Chinese products whose low prices reflect China's cheap labor and other manufacturing costs may intensify Japan's deflation problem. To cope with rising imports from China, government officials intend to seek a revaluation of the Chinese currency. Japanese calls for such a move may draw international attention. According to a preliminary report on the nation's trade in 2002 released by the Finance Ministry on Monday, imports from China rose 9.9 percent from a year earlier to 7.72 trillion yen, surpassing those from the United States at 7.22 trillion yen. Such sharp rises in imports of cheap Chinese products have provoked some observers to voice strong concerns, saying inflows of cheap Chinese goods may exacerbate deflation. Although China has enjoyed high growth rates, its inflation rate has remained almost zero. In addition, the value of the Chinese yuan is "too low compared with the currency's actual capacity," said a senior Finance Ministry official. If China's exports continue to rise, this would be tantamount to China exporting deflation to other countries, the official added. At a meeting of finance ministers and central bank governors of the Group of Seven leading industrialized nations, to be held in Paris next month, the ministry intends to place the value of the yuan at the top of the agenda, as calls mount for a concerted effort to see off the growing threat of deflation in the world economy.
Source: Daily Yomiuri
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Preoccupation Grows at Japan Government Debt


Judging by the historic low yields on Japanese government bonds (JGBs), the deflation that has racked the country's economy for almost four years is set to continue indefinitely. In interest rate terms it seems more a question of 'how low can you go'?

Expectations of a sustainable recovery are clearly nowhere in sight: the yield on the benchmark 10-year JGB on Tuesday fell to an intra-day low of 0.775 per cent, a level last seen in October 1998. It was nearly three years ago that Japan overtook the US to win the dubious honour of being the world's leading issuer of debt. This year's budget, set to total Y36,450bn ($308bn), is to be 45 per cent financed by the issuance of new bonds. But despite concern regarding the sustainability of Japan's debt - set to total a staggering 150 per cent of gross domestic product this year - JGB yields have been skirting new lows for nearly 11 months. That underscores the voracious appetite of investors, particularly banks, for government debt despite the minuscule returns. Each successive dip in yields has merely been the precursor of another rally in prices as investors bet on deflationary pressures to continue in the near-term. But that may be a brave gamble considering that the governorship of the Bank of Japan will be up for grabs in March when the incumbent, Masaru Hayami, steps down amid debate as to whether the central bank should adopt an inflation target.

Japan's city banks increased their JGB holdings - most of which are shorter-term - by one-third from January last year to about Y43,000bn at the end of December, fuelled by a dearth of attractive investment options and a decline in loan demand. Ahead of the fiscal year-end in March, banks are due to unwind cross-shareholdings and further increase their JGB purchases, which now comprise about 10 per cent of their total assets. The adoption of an inflation target would probably result in a 25 basis point rise in both the two-year JGB yield, now close to zero, and in the five-year yield, which closed on Tuesday at a record low of 0.245 per cent, according to Mr Kato. "While the banks may be the greatest linchpin of the JGB market, they are also one of its greatest sources of instability due to their weak capital structures, poor operating results and overhang of non-performing loans," says John Richards, director at Barclays Capital in Tokyo.
Source: Financial Times
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Koizumi's Now You See Me, Now You Don't On Inflation Targeting

Japan watching can be a very frustrating business for economists. Last year we had economy minister Takenaka prjecting himself as a hard-landing specialist to sort out once-and-for-all the country's non performing loan problem. Then everything went quiet and we are still waiting to see whether the current round of inspections will prove effective or not. Now it's the turn of the Bank of Japan to draw the headlines. World opinion has it that the new governor should be an 'inflation targeter'. Now leaving aside the fact that, as dedicated followers of this blog know, my opinion is that Japan's deflation problem could prove much more intractable than the now popular 'inflation targeting' mantra assumes, it seems the Japanese themselves are not really buying it. Or at least this could be the interpretation to put on Koizumi's latest comments on the topic. Speaking to a parliamentary budget committee, he said: "A target of merely achieving higher prices is not desirable." A new BoJ governor will be appointed for a five-year term from March 19, and this has triggered a great deal of speculation that Japan may be about to embark on a more aggressive monetary policy. The prime minister himself had stoked such speculation at the end of last year by saying the battle against deflation, now in its fourth year, was the most important challenge of 2003. He also allowed several close colleagues to talk openly about the benefits of an inflation target, a policy strongly opposed by the BoJ. Now it seems that opponents of this policy (or opinion polls) are having more success in winning Koizumi's ear. Of course, this oposition to provoked inflation political could be far more political than economic, in a country where there are a lot of old people (and hence votes), and where many of these have savings which would be devalued by any inflationary process.

However yesterday, Mr Koizumi said that unless higher prices were accompanied by increased economic activity, it would erode living standards. "If salary levels stayed the same and only prices rose, there would be side effects. That is why I am pursuing economic reform to reinvigorate the economy." The LDP is also thought to be concerned that an aggressive inflation policy would be electorally unpopular, since it would erode the savings of many retired Japanese on fixed incomes who are benefiting from deflation.The prime minister's comments are the clearest indication yet that he is not keen to appoint an aggressive inflation-fighter as BoJ governor. When the name of Nobuyuki Nakahara, who advocates an inflation target, was floated, Mr Koizumi received a flurry of e-mails and faxes claiming Mr Nakahara was unsuitable for the job. Several BoJ officials have said privately that Mr Nakahara, or a similar candidate, would have difficulty in leading the central bank, since the six remaining members of the board are suspicious of an inflation-or-bust policy. Of the nine-member board, the governor and two deputy governors come up for re-election in March. Minutes of the December policy board meeting, released this week, show that all but one of the existing board are opposed to an inflation target, which would set a specific goal for price rises within a specified time.
Source: Financial Times
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China Now No1 Exporter to Japan

In another sign of China's growing importance in world trade, figures released this week officially confirm what was aready becoming obvious, China is now the world's number one exporter to Japan. Given the size of the Chinese economy, and its rapid growth rate this picture is likely to be repeated across the developed world. China, despite its currently low per capita incomes is enormous due to its population size. Currently the world's number six economy, this decade should see China steadiliy climbing the ratings on all fronts. Meanwhile in Japan the deflationary forces continue their along their energy draining path as retail sales mark a 2.3% drop Y on Y in 02. Of course with the Japanese economy shrinking at 1 - 2 % a year and the Chinese one growing at 7 - 8% a little work with the calculator will show that the day when China's economy is bigger than Japan's is not too far off.


China outsold the United States in Japan for the first time in 2002, according to yearly import-export statistics released by the Finance Ministry on Monday. In a year that saw imports from China jump 9.9 percent to 7.72 trillion yen, U.S. imports fell 5.9 percent to 7.22 trillion yen. China's success was driven in part by brisk machinery sales while U.S. sales were hurt by a stagnant information technology sector.Though Chinese exports to Japan rose nearly 10 percent, Japan did even better, lifting its sales to China by 32.3 percent-a figure that helped reduce Tokyo's trade deficit with the Asian giant by 15.9 percent to 2.75 trillion yen last year.
Source: Asahi Shimbun
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Department store sales and supermarket store sales in calendar 2002 fell 2.3 percent and 2.1 percent, respectively, industry associations announced Friday. Sales at 292 department stores operated by 103 association member companies last year fell to 8.34 trillion yen, the Japan Department Stores Association said. Sales at 9,137 supermarket stores run by 102 member companies last year dropped to 14.37 trillion yen, the Japan Chain Stores Association said. In December alone, department store sales fell 4.9 percent to 972.1 billion yen, marking the ninth straight month of year-on-year decrease, the association said. Sales of clothing, especially high-priced clothing, were sluggish. Sales dropped 6.5 percent from a year ago, marking the fourth consecutive month of decline.
Source: Daily Yomiuri
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Japanese Government Bonds at Four Year Low

The yield on the benchmark Japanese 10 year government bond returned to a four-year low of 0.795% on Monday after the central bank governor reiterated his long-standing opposition to inflation-targetting. More built-in deflation expectations to work with.


Bond sentiment remained bullish after Masaru Hayami, BoJ governor, repeated his objections against the central bank adopting an inflation target earlier in the day. Mr Hayami said the measures will create a "substantial risk of destabilizing the financial market and the overall economy." Investors have been concerned that the successor to Mr Hayami, who is retiring from his post in March, may adopt an inflation target, which is seen as bond negative. Analysts said that bond prices are also supported by a pessimistic outlook for the economy and a lack of attractive investment alternatives for domestic institutional investors.
Source: Financial Times
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