Japan: Good News or Bad?

The presentation of the latest set of industrial production figures from Japan is interesting. The consensus is basically upbeat (and here). But read between the lines and things aren't so clear. And if you look at my post here, Japan certainly seems to have been slowing for the best part of a year now.

As Bloomberg have it:

Japan's industrial output rose to a record last month and inflation accelerated, giving the central bank room to raise interest rates by the end of the fiscal year in March.

An index of production climbed 1.9 percent from July, led by autos and electronics output, the trade ministry said in Tokyo today. Core consumer prices, which exclude fresh food, gained 0.3 percent from a year earlier, the statistics bureau said. Both results were in line with economists' expectations.

But

Still, prices excluding food and energy, which haven't risen in eight years, continued falling last month, signaling recent gains in core consumer prices have been largely the result of rising oil costs. Prices excluding food and energy fell 0.4 percent from a year earlier, the statistics bureau said.

``August was the month when energy pressure peaked. We have already seen gasoline prices weaken,'' said Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo, predicting that core prices may resume declining by the year's end. ``That's a very tough situation for the central bank -- it's only energy pushing up the consumer price index.''

Core prices in Tokyo, home to one in 10 Japanese and a harbinger of Japan's nationwide consumer prices, were unchanged in September from a year earlier. Tokyo prices excluding food and energy fell 0.3 percent this month.

and

Today's factory output report showed that production, shipments and inventories of electronic parts and devices all rose to a record in August. A slowdown in global growth may pose a risk for production in the coming months.

``A potential risk is inventory accumulation in electronics parts and devices in anticipation of Christmas sales,'' said Morgan Stanley's Sato. ``This may result in unplanned inventory accumulation due to lower foreign demand.''

Japanese manufacturers cut output in 2004 when global demand for electronics and chips slowed, causing the economy to contract in the fourth quarter and almost pushing it into recession.

Interesting isn't it, the way you can 'spin' data.

Japan: Bulls or Elephants?

Lex has a column on Japan in the FT today. Basically it reflects the growing attention which is likely to be focused on Japan's fiscal situation. One interesting point which can be seen in the graphic he provides is the fact that Japan seems to have peaked in early 2005. This may be the longest running expansion Japan has had in many a long year, but we definitely seem to be in the downswing at this stage. Which makes you wonder about all those 'recovery' arguments we had earlier in the year.

Lex is also right to draw attention to all the uncertainty which there is about the level of the debt. He suggests that it may be as low as 90% if you take into account accumulated assets in the social security fund, although some argue that if you take that into account then you also need to consider the acquired liabilites (all the pensions yet to be paid) and then you end up with something in the region of the 'official' 175% figure.

The numbers don't seem to be the important issue. The important issue is the sustainability of this moving forward.

And don't miss the fact that he gets the main point, namely that "nominal growth could slow as Japan’s workforce shrinks more quickly."


The news that Japan will soon enjoy its second golf course flotation since 2004 should warm the hearts of bulls. Whether Shinzo Abe’s ascent to prime minister this week should do so is less clear. During the tenure of Junichiro Koizumi, his predecessor, the scourges of bad debt, deflation and abysmal confidence were largely overcome. Unfortunately, in spite of slaying post-bubble Japan’s dragons, Mr Koizumi left behind an elephant in the room: the level of public debt.

This can be exaggerated. Gross public debt is a catastrophic 175 per cent of gross domestic product. But deducting substantial financial assets held by the state, but excluding central bank assets, leaves net debt at 90 per cent of GDP – lower than Italy, a fellow fiscal reprobate. And any government which can borrow 10-year money at a rate of 1.66 per cent cannot be said to face an imminent fiscal crisis. Mr Abe’s new cabinet confirms that he prioritises growth over lower debt. Koji Omi, finance minister, a proponent of higher consumption taxes, has said that this revenue-raising measure is off the agenda until after the July 2007 upper house elections.

And in the longer term? As cabinet secretary, Mr Abe signed up to Mr Koizumi’s July plan to eliminate the primary deficit (that is, before interest payments), currently 4 per cent of GDP, by 2011/12. Aside from the leisurely pace and, arguably, the lack of detail, there is one big objection: a primary balance may not be enough to lower net public debt relative to GDP. By 2011/12 the level of gearing will have reached about 100 per cent. For it to fall, the state’s effective net cost of borrowing must be lower than nominal GDP growth – today, at 1.5 per cent, it is at least 50 basis points below. But low real interest rates may well rise, while nominal growth could slow as Japan’s workforce shrinks more quickly.

Once More On The Yen ...

Here's another guest post from Danish Blogger Claus Vistesen:


Once More On The Yen ... Talk Is In Fact Cheap

Some days ago I reported on how policy makers at the G8 summit in Skt Petersbourg were trying to talk up Yen in the midst of the recent weakening of the currency relative to the Dollar and Euro. The Japanese Finance Minister called the recent drop in the Yen a 'little rough' whereas others talked about how the value of the Yen simply did not reflect the fundamentals of the Japanese economy which after all is in the midst of a sustainable recovery. I obviously diagree here and I believe that the Yen's recent tumbling is very much aligned with the fundamentals of the Japanese economy; that is an economy which is having mighty difficulty escaping deflation, particularly after the CPI index was revised in August, and as such the BOJ is not going to embark on a hike any time soon.

Should we see what the markets have to say about the Yen then despite all the well thought comments from the G8 summit ...

(From Bloomberg - bold parts are my emphasis)

'The yen may fall to a 20-year low as individual investors in Japan join speculators on the Chicago Mercantile Exchange in selling the currency.

Measured against currencies of Japan's largest trading partners, the yen is approaching its lowest value since 1985, an index prepared by the nation's central bank shows. Japanese investors last month bought more overseas bonds than ever before. Traders on the Chicago futures exchange have a $9.74 billion wager the yen will decline.

The currency has fallen 4.3 percent against the dollar in the past four months as a rebound in the economy faltered, suggesting the Bank of Japan won't raise interest rates again this year from 0.25 percent. The prospect that rates will remain among the lowest in the world has prompted Japanese to invest more of their $6.55 trillion in currency and deposits outside of the country.

``We could see more massive outflows,'' said Lara Rhame, a senior currency strategist at Credit Suisse Group in New York. ``It's the yield story that's driving Japanese investors abroad.''

The yen will weaken to 118 against the dollar in three months and 120 in a year, Credit Suisse predicts. Last week the yen gained 0.9 percent against the dollar to finish at 116.56 and declined compared with the euro to 149.

(...)

Back to the good-old yen carry trade ...

'U.S. and European money managers also are putting pressure on the yen by borrowing the currency at low rates and then investing in countries with higher yields, such as New Zealand and Iceland. The prospect the so-called carry trade will weaken the yen has encouraged others to bet against the currency.

Speculative short positions, or bets that the yen will fall, outnumbered long positions by 90,804 contracts on Sept. 19, up from 69,498 two weeks earlier, CME futures trading data show. Futures contracts are agreements to buy or sell a security at a specific date and price. Each contract is for 12.5 million yen.'

There is plenty more interesting points in the Bloomberg piece linked above and it is definitely worth, at least, a quick glance. As for my discourse on this it should come as little surprise for regular that this has a lot to do with the demographics of Japan. Actually demographics can explain much of what has happened in Japan the last decade. However, it seemed as if the end of ZIRP (Zero-Interest-Rate-Policy) a year ago by the BOJ, at least for a time, made people exactly forget about the fundamentals of the Japanese economy; that is that they did not change just because the BOJ shifted course. Let me be as clear as I can possibly be; Japan is not back amongst the leaders in the global economy in the sense that the country has finally escaped deflation (deflation is still a distinct possibillity here) and Japan is not going to experience any sustainable recovery based on a surge in domestic demand as many pundits predict. Given the current population dynamics of Japan the country's relative clout in the global economy will decline and obviously relative is important here since Japan still is one of the world's biggest economies but, I am sad to say, decline it will.

Japan's Trade Surplus

The recent drop in oil prices and the low value of the Yen seem to be sending Japan's trade balance once more spiralling into surplus:

Japan’s trade surplus rose nearly 100 per cent in August, showing that net exports were still contributing to overall economic growth and that the effects of high oil prices were slowly waning.

Although the leap was smaller than expected, economists said the numbers showed that exports to the US, China and Europe continued to expand. Because exporters tend to take a summer break in August, the trade surplus is generally small, making big changes in percentage terms quite common.

Japan, At Last Some Sense

This article about the extent to which the Japanese treasury is dependent on company profits for income is interesting, but beyond that I'm not sure how to interpret the fact since I am not sufficiently knowledgeable about the Japanese fiscal system.

However, a number of points do stand out. Corporate profits now fund the revenue:

Japanese corporate profit tax receipts are poised to overtake personal income tax contributions for the first time in 18 years, a shift that could influence debate among contenders vying to succeed prime minister Junichiro Koizumi.

Wages seem to be flat:

The figures highlight the strong return to profitability of Japanese companies, which have retained most of their gains without passing them on to workers in the form of higher wages. Although the labour market has become tight - with more jobs than job-seekers - wages have hardly risen, although bonuses have improved.

Consumption taxes are soon set to rise:

The finance ministry wants to rebalance the tax system largely by increasing consumption taxes. A central plank in the prime ministerial campaign platform of Sadakazu Tanigaki, finance minister, is a doubling of the sales tax to 10 per cent.

Although not everyone agrees:

Shinzo Abe, who is likely to win the leadership contest, is influenced by policymakers who argue that raising taxes could damage consumption and harm overall economic activity. His policy is to cut spending and try to increase the government’s tax take through promoting growth.

But funding through growth is just what has been tried and failed, that's why the debt is where it is. This view rings hollow.

Most Lopsided Economy in the G7

And then along comes Andrew Smithers:

Andrew Smithers, an economist at London-based Smithers & Co, has said in a recent report that the swing in corporate profits might need to be reversed in the interests of domestic consumption. He argues that Japan is the most lopsided of the G5 economies - the US, UK, Japan, France and Germany - with the lowest consumption and highest investment ratios; the largest current account surplus and budget deficit; the worst demographics and the lowest interest rates.

“These oddities are almost invariably ignored,” he says. “They illustrate how far the economy is from any likely equilibrium and this conflicts with the conventional wisdom which holds that Japan has corrected the past distortions of its economy and is now set on a path of balanced growth.”

Moreover the household savings rate has been falling steadily: from nearly 12 per cent of GDP in 1997 to just over 2 per cent last year. This is also perplexing, does this mean that, following the Life Cycle Theory people do finally get to dis-save in the end. I have long entertained doubts about this, but household saving in Japan is definitely something to watch. But what this seems to suggest is that after the reforms the Japanese are not only not spending, they aren't even managing to save like they used to.

Crunchtime in Japan?

Here's another guest post from Danish Blogger Claus Vistesen:

Crunchtime in Japan?

Well I have pointed to this several times and most recently as the CPI index was revised bringing Japan dangerously close to the 0% inflation mark amidst talks of business cycles topping and whether the BOJ should indeed raise rates any further. This is of course very unlikely now and the future road for Japan might very well be another period of deflation or at least no-one can rule out this possibility at the current juncture I think.

Now, a revision of the statistics might not be important in itself but let us take a quote from and article in The Economist I used as a source in one of my posts linked above.

'This reshuffling of the statistician's shopping basket has rewritten recent history (see chart). Japan, it now seems, did not escape deflation definitively until July, when the core annual inflation rate reached 0.2% for only the second month in a row. As Richard Jerram, of Macquarie Research in Tokyo, puts it “price pressures today are where the BoJ thought they were six months ago.”'

So Japan is not quite out of the deflation spiral it seems or at least trying hard to get off the mark. On top of this the US is slowing which will be sure to dent Japanese exports. China will probably be able to do some heavy lifting here for a while but the main point here is that Japan lacks the domestic demand structure to carry through a sustainable recovery. Why? well a brief look at the country's demographics is of course quite illuminating here as I have argued several times. Another blogger worth mentioning here is Edward Hugh at Bonobo Land who actually was the one who initially steered me into seing Japan the way I do today ... more or less that is. His latest report on Japan is also very telling of things to come ...

Machine orders in Japan is falling rapidly ...

(quote Bloomberg)

'Japan's machine orders fell the most in almost 20 years, dashing expectations that the central bank will raise interest rates before the end of the year.

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. Orders from semiconductor, steel and mobile-phone businesses paced the drop.'

(Quote Edward)

This is what we could call a second stage event, and now has all the hallmarks of a classic domino chain, although it still isn't clear how far it will reach (all the way to Shanghai??). I am not at all convinced that investment in the US will take up the slack given what we know about fixed capital investment in China, and given the way capacity in things like machinery and equipment has just been ramped up so much in Germany and Japan. As we can see, in Japan it is fixed capital investment that is being hit first.

So watch out everyone, 2007 could be a very complicated year.

Update on Monday, September 11, 2006 at 10:25PM by CV

The Yen/Euro relationship also tells an important part of the story here ...

(quote Bloomberg - bold parts are my emphasis)

'The yen had its biggest drop against the euro since April on speculation the Bank of Japan will lag behind the European Central Bank in raising interest rates this year.

Japan's currency also slid from a one-month high after a government report showed machinery orders fell the most in almost 20 years in July. ECB Chief Economist Juergen Stark was reported today as saying inflation in the 12 nations sharing the euro will stay above target this year and next.

The drop in machinery orders `` confirmed the market's expectation that the Bank of Japan is likely to raise rates at a very slow pace this year,'' said Kamal Sharma, a currency strategist at Bank of America Corp. in London. ``The yen is likely to remain under pressure.''

(...)

``We'll see widening interest-rate differentials from here,'' said Benedikt Germanier, a currency strategist in Zurich at UBS AG. ``The key for euro-yen are the machinery order numbers which came in weaker.''

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. The median forecast of 30 economists surveyed by Bloomberg News was for a 5.4 percent decline.'

Japan Machinery Orders Slump

Wow, get this from Bloomberg today:

Japan's Machinery Orders Drop Most in Almost 20 Years

Japan's machine orders fell the most in almost 20 years, dashing expectations that the central bank will raise interest rates before the end of the year.

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. Orders from semiconductor, steel and mobile-phone businesses paced the drop.

``With risks over the U.S. economy looming large, we don't think the Bank of Japan can raise rates'' before March 31, said Yoshimasa Maruyama, an economist at BNP Paribas Securities in Tokyo. ``While part of the drop is a correction from several months of strong data, this was still a considerable decline.''

Today's drop ``is payback for strong orders in recent months,'' said Itsushi Tachi, director of business statistics at the Cabinet Office. ``The trend is for growth.''

The government forecasts machinery orders will increase 4.9 percent in the quarter ending Sept. 31.

``To reach this target, we need growth of 16 percent in August and September,'' Tachi said.

I will write and post more on this as and when I have some time. For now I would just point out that on both this and the German front I have long forseen what was going to happen and in a certain sense the data is now 'coming home to Daddy', although I can't say that this makes me especially happy: I would prefer to have been wrong.

More fuel on the fire will definitely comes from this news last Friday in the US:

"The Federal Reserve reported Friday that consumer borrowing rose at an annual rate of 2.8 percent in July, down from an increase of 7.3 percent in June."

"The slowdown was led by a sharp deceleration in credit card debt, which rose by just 3.4 percent in July after gains of 13.2 percent in June and 13 percent in May."
Associated Press

This is what we could call a second stage event, and now has all the hallmarks of a classic domino chain, although it still isn't clear how far it will reach (all the way to Shanghai??). I am not at all convinced that investment in the US will take up the slack given what we know about fixed capital investment in China, and given the way capacity in things like machinery and equipment has just been ramped up so much in Germany and Japan. As we can see, in Japan it is fixed capital investment that is being hit first.

So watch out everyone, 2007 could be a very complicated year.

Basically the whole Greenspan/Bernanke hand-over was bungled, they should have had one token pause back in November, then Bernanke wouldn't have had to prove his inflation fighting prowess so, and advance over what seems to have been a bridge too far. (I was in fact arguing this back then on this blog).

Also the central bankers collectively should carry some of the can, if what looks like it might happen actually does, since all this 'inflation fighting' jargon has really been quite stupid. As Rogoff has been arguing, what we really have is a change in the terms of trade.

Yen Up, Yen Down

This one in Bloomberg brought a smile to my face:

Yen Jumps After Mirow Says IMF to Discuss Currency's Weakness

The yen jumped after German Deputy Finance Minister Thomas Mirow said the currency's weakness will be discussed when finance ministers and central bank governors meet in Singapore next week.

``The yen has clearly weakened against the dollar but also against the euro, and in so far this will surely be discussed,'' Mirow told reporters in Berlin today.

``There's growing unease outside Japan about the yen's weakness and government officials will have something to say about it,'' said Carsten Fritsch, a currency strategist at Commerzbank AG in Frankfurt.

The yen advanced to 116.26 against the dollar at 7:15 a.m. in New York, compared with 116.65 late yesterday. It also had its biggest gain against the euro since May, climbing to 148.17 from 149.39. The euro fell to $1.2727 from $1.2806.

Japan's currency has slid 6 percent since reaching 109 per dollar on May 17, the highest since September 2005. It also dropped to a record 150.73 versus the euro on Aug. 31.

Now the 24 hour change isn't that great, but the timing IS impeccable. So you can put two readings on this, either markets reacted anticipating changes, or someone somewhere threw a switch to try and ward-off criticism.

There are sort of wheels-within-wheels here, because of course it was a little strange that the yen should be so low against the euro if the Japanese economy was in the process of powering back into the growth arena.

So again you could read the low yen in a number of ways. It could be a sign that many in Japan don't believe the recovery story, and are hedging just in case, or it could be that the disappearance of deflation is in part produced by a policy of steering the yen downward. Choices to suit all appetites, so take your pick. Mind you, if it was the latter, then that *would* explain it if there had been a little hand reaching out discretely to throw a symbolic switch :).