Mild Deflation Persists

The yen fell yesterday against the dollar after Chief Cabinet Secretary Shinzo Abe and internal affairs minister Heizo Takenaka both stated that mild deflation persists in Japan. Commentators are speculating that the government may be just trying to delay an earlier end of the BOJ's zero-rates policy, but accept that there is some truth the pace and degree of the forceast increase in prices is still slow (the BOJ forecast in its last semi-annual report that Japan's consumer prices will rise for the next two years and the economy will keep expanding).

he yen dropped to 114.20 per dollar as of 7:33 a.m. in London from 114.11 late yesterday in New York, when it reached 113.84, the strongest since Jan. 16. It traded at 143.19 versus the euro from 143. It will move between 113 and 116 yen next week, Saito said. The dollar was at $1.2553 per euro from $1.2534 after yesterday reaching the lowest since Sept. 5.

Japan's core consumer prices, which exclude food, gained 0.5 percent in March from a year before, the statistics bureau said in Tokyo today, below the median forecast for a 0.6 percent increase. Prices gained for a fifth month and rose 0.1 percent in the year ended March 31, the first gain in seven years.

Abe told reporters at a regular press conference in Tokyo today the government would need to watch price trends to determine whether they are sustainable. Takenaka said the Japanese economy is still in mild deflation.

`Sentiment is Shifting'

The yen is still heading for its best week against the dollar since mid-March after the G-7 called for faster regional currency appreciation and a Japanese government report showed economic growth continues to pick up.

The currency has risen 1.9 percent this week after G-7 officials April 21 said it's ``critical'' for Asian countries, especially China, to allow currency gains to ease a reliance on exports to fuel growth.

``Sentiment is shifting toward yen-bullishness,'' said Akifumi Uchida, a deputy general manager of financial markets at Sumitomo Trust & Banking Co. Ltd. in Tokyo. He said the yen may rise to 113.50 against the dollar today.

Japan's industrial production rose as manufacturers increased output in anticipation of higher domestic and overseas demand. Production climbed a seasonally adjusted 0.2 percent in March, the first gain in three months, the trade ministry said in Tokyo today. The result exceeded the 0.1 median forecast of 39 economists surveyed by Bloomberg News.

`Essentially Hawkish'

Japan's central bank March 9 ended a five-year policy of pumping money into the economy. It kept rates close to zero percent at a meeting today, judging five months of rising consumer prices as insufficient to justify raising borrowing costs for the first time in more than five years.

The BOJ's forecasts indicate the central bank considers Japan's economy, after three recessions since 1991, is becoming resilient enough to withstand higher borrowing costs.

``It still looks like the first rate hike is months away, but the BOJ looks to be signaling its intention to move this year,'' said Adrian Foster, a currency strategist at Dresdner Kleinwort Wasserstein. ``History of these watershed policy shifts in Asia is that the policy makers move earlier than the market expects.''

Dresdner forecasts the yen to rise to 112 per dollar in six months and to 105 yen by year-end, Foster said.

Misread the Statement

The U.S. currency also strengthened today after Federal Reserve Chairman Ben S. Bernanke and Hiroshi Watanabe, Japan's vice finance minister for international affairs, yesterday both said investors misunderstood the G7 statement if they believed it called for the dollar's decline.

The statement ``didn't say that a depreciation in the dollar is needed,'' Watanabe said in Tokyo. ``Gains in the yen and euro signal that the market has misread the G-7 statement.''

Japanese officials may be concerned a stronger yen will hurt the country's exports and delay the world's second-biggest economy emerging from deflation.

``The Japanese make these kind of remarks whenever the yen strengthens,'' said Mitsuo Imaizumi, a deputy general manager of fixed-income sales and marketing at Daiwa Securities SMBC Co., a subsidiary of Daiwa Securities Group Inc., Japan's second- largest brokerage. The yen will move between 113.80 and 114.60 against the dollar today, he said.

``The G7 supports a market determined dollar, not a managed dollar,'' Bernanke said. Reports that the G7 discussed a managed depreciation of the dollar were ``not correct,'' he said.

``He's concerned that a dollar decline may heighten inflation expectations,'' Imaizumi said.

Better, or Worse-Off?

Most people in Japan seem to think that their living standards have deteriorated under Koizumi. That is the surprise finding in the latest Asahi survey. Apart from his commment that "Japan's economy is on solid ground and deflation in its last throes" (which I don't fopr one moment accept), he makes some worthwhile points:

A funny thing is happening on the road to applying ``Reaganomics'' to Asia's biggest economy: A growing number of Japanese don't seem to like it very much.

Forty-two percent of those responding to an Asahi newspaper survey said their livelihoods deteriorated under the leadership of Prime Minister Junichiro Koizumi. Just 18 percent said they are now better off.

That may come as a shock to investors driving the Nikkei 225 Stock Average toward six-year highs amid hopes Japanese households will spend more. It may also surprise those eyeing Japan's property market after 10 years of aggressive avoidance.

No one is likely to be more taken aback than Koizumi, who this week marks his fifth anniversary as premier. In April 2001, he took charge of a deflation-plagued economy, promising ``reform without sacred cows.'' In retrospect, we know that was code for adopting policies Ronald Reagan applied to the U.S. in the 1980s.

Koizumi pushed through a series of Reaganesque steps like spending cuts, tax reductions for the wealthy, privatization and deregulation. Given Japan's preference for consensus over conflict, Koizumi had to move more gingerly than President Reagan did, or Margaret Thatcher did as British prime minister. Still, the direction has been clear enough.

Reaganomics, Japan-Style

Now, with Japan's economy on solid ground and deflation in its last throes, Koizumi is looking for his pat on the back. Here, Japan watchers and investors would be wise to heed the signals coming from the nation's 127 million people.

First of all, China gets most of the credit for Japan's revival, and not just because of its fast-growing demand for Japanese goods. China's real role was as a catalyst for change.

For a decade after Japan's bubble burst in the early 1990s, executives sat on their hands believing asset prices would recover and save them from making hard decisions. The sudden appearance of China and the forces of globalization changed that. Roughly five years ago, Japanese executives realized the Nikkei wasn't going to return to its 1980s levels. They also saw that Japan risked being eclipsed by a nascent superpower.

Quietly, companies began shifting production abroad, cutting costs, selling extraneous businesses and paying down debt. Banks, partly due to prodding by Koizumi's economic team, finally disposed of the bad loans acting as a headwind on growth. Many industries began consolidating.

These actions, largely predicated on China's advance, led to the most organic and convincing recovery Japan has seen in 15 years.

Social Costs

Secondly, Japan is just beginning to consider the social costs of some of Koizumi's policies. During his tenure, the government has trimmed pension and health benefits. Among other changes, inheritance tax laws were altered to simplify the transfer of large assets, and capital-gains taxes were lowered.

It's classic trickle-down economics. While Reaganomics fans think it did wonders for the U.S., its applicability to Japan is questionable. It's leading to an erosion of Japan's cherished egalitarianism and causing considerable soul-searching. The national media are covering the trend with the intensity of a political scandal.

Proponents tend to think the end of Reagan's massive debt buildup justified the means. As long as the U.S. moved toward free-market economics, the thinking went, it's all good. Yet Japan lacks a crucial element the U.S. relied on to offset Reagan's experiment: dynamic innovation.

Innovation Needed

Japan's system is still more about job protection (supporting huge companies that employ tens of thousands) than job creation (new startups that might eventually employ tens of thousands). It's less about tax policies or smaller government than a societal aversion to taking risks; it just seems more Americans are willing to fail than Japanese. Without more innovation, trickle-down economics will have a tough time in Japan.

At the same time, Koizumi hasn't matched Japan's debt sales with the kinds of tax cuts that might benefit the broader economy. Japan doesn't need to make rich people who invest in stocks or real estate even richer; what it needs is babies.

Because of a low birthrate of 1.26 children per woman, Japan's population actually shrank in 2005. If you are going to cut taxes, why not do it for young families to boost the nation's birthrate? Without a significant increase in the number of births, Japan may never get out from under its debt load. Its debt-to- gross-domestic-product ratio is about 151 percent, the highest among developed nations.

Look Ahead, Not Back

The brilliance of Reaganomics is that it was partly a head fake. In 1983, the federal budget deficit reached 5.9 percent of GDP, a record that still stands despite President George W. Bush's best efforts. And when Reagan left the White House, federal spending had almost doubled. Many ignored the mountain of debt being created because they believed the economy would be better off.

The widening gap between Japan's rich and poor may actually do the opposite: leave households less optimistic, less inclined to spend their savings and less open to globalization.

Koizumi will step down in September. His successor will quickly find that, in many ways, the heavy lifting on Japan's economic modernization is just beginning. The next premier will have to trim debt, shore up the national pension system, boost entrepreneurship and make high-cost Japan more competitive in low-cost Asia -- things Koizumi hasn't bothered with.

Japan should look ahead to new and innovative solutions to its challenges, not back at Reaganomics.

Japanese Trade

Japan's long term economic surplus continues to weaken, it is down by 11.9% year on year. Of course the main culprit is the rising cost of oil imports (on which Japan is heavily dependent). Exports rose 18.1 percent, but imports rose 25.2 percent to a record 5.8414 trillion yen, continuing a string of double-digit rises since April 2005.It is this part of the process we need to watch, as any global slowdown will affect exports, and thus raise issues about the sustainability of internal demand and the growing import dependence. The 34% jump in exports to China should also draw attention to the way in which Japan is benefiting from Chinese growth, and serve to put Japan's own performance in somewhat better perspective.

The trade surplus fell 11.9 percent in March from the same month a year earlier to 978.1 billion yen ($8.34 billion), Ministry of Finance data showed on Thursday. Still, the surplus exceeded the median market forecast by 35 percent.

Exports rose 18.1 percent from a year earlier, marking the fifth consecutive month of double-digit rises, to a record 6.8195 trillion yen, helped by vehicle shipments to the United States.

Overall, U.S.-bound exports rose 16.4 percent compared with a year earlier, while exports to China, Japan’s biggest trading partner, jumped 32.4 percent on higher shipments of automobile parts and semiconductor products.

Japanese Labour Market: Running on Half-Empty?

Well, things certainly have been moving quite quickly in Japan recently. The recovery seems to have just started to gain some traction, and now we are being told that internal capacity limits may be being reached due to the presence oF labour shortages:

"Japan’s large manufacturers are short of capacity for the first time since the bubble era of the early 1990s, while employers across the country also face the worst staff shortages since around that time, according to the Bank of Japan’s Tankan survey."

This should really hardly be surprising, since with a stagnant and ageing population I am not sure where people imagined all the extra labour that was needed to sustain the recovery was going to come from.

The survey’s capacity index for large manufacturers - a measure of whether they have enough plant - swung from plus 2 in December 2005 to minus 1 in Monday’s March survey. This was the first negative figure since 1991. The Bank subtracts the percentage of companies complaining of insufficient capacity from the percentage reporting excessive capacity.

The survey’s economy-wide employment index - excessive employment minus insufficient employment - fell three points to a 14-year low of minus 7.

Signs of labour shortages tally with government employment figures announced on Friday, which showed a fall in the unemployment rate to an eight-year low, and a rise in the jobs-to-applicants rate to a 14-year high.

This labour market tightening would seem to have three logical outcomes.


Firtsly a growing inflationary pressure inside Japan (viz the FTs comment that "The gaps ......strengthen the case among the hawks at the central bank who want to end the BoJ’s zero interest rate policy as soon as possible to forestall inflation).

Secondly, a growing pressure on the trade balance from the increasing introduction of more competitively priced imports.

Thirdly, and outsourcing drive in search of more abundant labour (or lets move to China):

Japanese companies are turning to China as a manufacturing base to benefit from low labour costs, but are also relying increasingly on the burgeoning Chinese consumer market as a destination for exports as well as goods produced in China.

Japan’s economic recovery is still largely export-based and continued Chinese buying is acknowledged by policy-makers as a key component in ensuring the recovery is sustainable, despite occasional political tensions.