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Friday, November 24, 2006

Checking up on Japan

(A crosspost from Alpha.Sources.)

Time is indeed a scare ressource and as such I have not been on the spot with some reporting on Japan as the third quarter came out a week ago. This is consequently to make amends on that but also to react on some interesting comments on Japan I have found in the week gone by. Let us begin with the economic data then and to that end Edward Hugh really has the all arguments ready at hand. At first hand we have good news here as Japan managed to expand for the seventh consecutive quarter. Yet the story has not changed much as Edward also points out;

So the picture remains pretty much the same, strong export lead growth sustained by capital investment, with shrinking domestic consumer demand. A big part of the burden was carried by growing investment demand.

Furthermore, the crucial point is that the lack of consumer spending does not seem to want to push up even in the light of increasing corporate bonuses. This obviously links up with the monetary situation in Japan where the central bank just cannot find the justification to raise rates. This, subsequently, is also keeping a lid on the Yen despite talks in high international circles about how the Yen should be a bit more willing to adjust to the fundamentals. More accurately in my book though, some are beginning to speak of being too much in a rush to normalize monetary policy. Another very interesting aspect of the Japanese economy deals with the tightening of the labour market. Many commentators have claimed this to be a result of a recovery in the making but I believe that we should rather look at it as a structural evidence of a shrinkening labour force. Following this is the discussion about why the tightening labour market is not pushing up inflation/wage growth; as Edward explains ...

One thing which is striking here is the way in which, despite the inevitable labour market tightening as the population shrinks, wage drift and inflation remain incredibly tame. This is an indicator of just how far the reform process has actually gone in Japan, since there seems to be absolutely no room whatever for wage-push inflation. This is also something of a warning for those who simply argue that more structural reforms will cure the problem, since in the case of Japan at least they seem to have been tried and found partially wanting.

What is most interesting here is that if we don't look at demographics in Japan's case we end up with a very thin line of argumentation in which we are down to musings about when the positive growth cycle begins in Japan and consumer spending picks up again ... take for example one of the latest pieces on Japan from Morgan Stanley's Global Economics Forum.

As shown in preliminary Jul-Sep GDP numbers, the contrast between the corporate sector and the household sector has intensified, and this gap is not likely to close for some time. We assume that it will take a year or more for a positive growth cycle to develop, as momentum on the corporate front gradually spreads to the consumer and household level.

On what is this assumption above vested, that is the only thing I ask. When, for example, will people recognize that the life-cycle component of the consumer spending behaviour story is important? It seems wholly unreasonable to me to claim that the situation is any better a year from now based on business cycle analysis. Morgan Stanley claims to be bullish on the economy and cautious on prices (wage growth) the latter position mainly driven by high productivity. On this we are approaching the issue from two sides ... we both agree that prices and wages are not going to pick up anytime soon. However, where I, and also to some extent Edward above, are arguing that consumer spending will remain low and thus keep the core index and wages down as a function of the structural and lasting changes in the labour market structure, Morgan Stanley argues that;

Trying to predict when wages will rise and what the catalyst will be is a difficult task, but if the Japanese economy has been running about a year behind the US economic cycle since the bursting of the IT bubble, it should take about the same amount of time as it did in the US. The US economy bottomed out in early 2002 and wages began to rise just this year. This suggests that the labor distribution rate in Japan is not likely to rise until F3/08 at the earliest, and only then if a knock-on effect from increased hiring does in fact finally translate into higher wages. In such a case, we would expect nominal wages to run more or less flat during the forecast period and for real wages to continue to decline during this time. Accordingly, we maintain our cautious stance regarding consumer spending.

The most decisive answer I can provide here is that Japan is not USA; actually far from it and precisely because Japan is such a special case in terms of population dynamics we cannot expect the economy to behave according to the textbook explanation of business cycles. Once again I am ending this with a point about where to begin our analysis. I am not for example dismissing the recent articles from Morgan Stanley; people are definitely scratching some of the right places but if we want to get this right we need to begin with the beginning and in Japan's case that is quite simply demographics.