GEM note on Japan

Cross-post from Alpha.Sources

Many clouds surround the coming decision by the BOJ to raise rates to 0.75% or whether to stay put. Today's rather dim data on domestic consumption further adds to the issues facing the BOJ at the August meeting. However, there also seems to be mounting evidence that what seemed to represent a sustainable recovery based on domestic demand at the end of 2006 might well end up being a mere blip as the outlook for the remainder of 2007 is becoming clearer. Over at Global Economy Matters I have a big review and preview note which points forward for the Japanese economy in 2007 as well as the coming BOJ decision. It is well worth a look if anything then for the graphs which I have compiled. Here is my summary ...

The most important immediate point regarding the Japanese economy is whether the BOJ is going to raise to 0.75% come the much expected August meeting. Just a week a ago the implied probability of a hike which could be derived from various market derivatives and indices stood firmly above 70% towards predicting a 0.75% refi rate in Japan by the end of August. However, with the recent disappointing data on wages and consumption expenditures in June out today the overall sentiment towards a hike has cooled significantly in line with expectations as they have been laid out recently on Japan Economy Watch. This does not of course mean that the BOJ could not press on regardless but as I have also argued above the coming August decision will be a test on the acclaimed willingness by the BOJ to raise in the midst of deflation and down trending consumption spending on the back of solidified expectations of future sunshine. I maintain my view that it will be a hold but there is considerable risk attached to this call in the form of how the BOJ could act on future inflation expectations as well as to maintain its image in financial markets of a central bank devoted to the normalization of interest rates.

In a more long term and structural perspective I have also emphasised above how little has changed in the Japanese economy despite many an economic commentator's claim to the contrary. In this way I argue, through my data presentation above, that Japan is not set on the path of a sustainable recovery driven by domestic demand but rather still 'stuck' with the reliance on export and export driven capex to grow. This growth path which in my opinion is a fundamental result of Japan's demographic profile raises important questions and essentially puts Japan in a dilemma which is not, as far as I know, treated in any economic textbook. This dilemma centers around three inter-connected challenges of how to deal with lingering deflation, how to keep the public finances on a sustainable path as well as how to maintain external credibility as regards to monetary governance. In this note this dilemma was conceptualized on the venue of monetary policy where the BOJ needs to factor-in much more than external pressure to unwind the carry trade in an orderly fashion. This is not to say that the current global liquidity situation is not creating distortions which might abruptly unwind but it is to say that it is more complex than just laying the blame at Japan's door.

Blogging The Japanese Elections

Well, since it is a very hot Sunday here in Barcelona, I am going to try and keep cool by live-blogging the Japanese elections. JEW's in-house political analyst Manuel Alvarez of Election Resources on the Internet will also be updating his Global Economy Matters Post as events unfold.

Apart from all the heat - and as Claus indicates in his last post here - these elections come at an especially tricky time for everyone. In the first place, and as the Economist indicates here, an elderly Japan may now be suffering from reform fatigue. The loss of all those pension records means that the Japanese electorate are now in no mood to receive yet another pension reform which downgrades the payout which they can expect to receive after all those years of contributions, although this is all that, even under the best case scenario, what can be expected. As the Economist notes, the young are voting with their feet:

"Can a working population support such a number of future retirees? Today's younger workers appear not to think so. Two-fifths of them are not paying contributions towards the fixed portion of their state pension scheme (current contributions fund present, not future retirees), suggesting they don't believe that the scheme will be viable when they retire. And they may be right."

This is a very clear example of a "self-fulfilling expectations" process, if you don't think something can work you pull out, and as a result the thing certainly can't work.

A second issue which is looming on the horizon is the August decision from the BoJ on whether or not to raise interest rates another quarter percentage point. Personally I had been growing rather skeptical about whether the BoJ would be able to live up to market expectations here, but if this election turns into the rout for Abe that many people are expecting it is hard to see the poor old BoJ soldiering on regardless, and keep a clear head whilst all around them are busy losing theirs.

But losing your head (metaphorically speaking) is one thing, and losing your shirt is another. Which brings me to my third point. As AJP Taylor liked to point out, history is often nothing more than the sum total of a sequence of minor accidents, and on this occasion the governing structure may not be railway timetables but rather stock market opening hours. Tokyo, as luck would have it, needs to lead off tomorrow with the global response to last Friday's drubbing on Wall Street. Right lads, best foot forward now......

The caption-photo I have posted above in fact depicts Tokyo Electric Power Co. President Tsunehisa Katsumata (2nd R) bowing in the company of various other assembled energy sector worthies after Economy, Trade and Industry Minister Akira Amari ordered the Japan's 11 nuclear power utilities to carry out strict checks on safety in accordance with new guidelines already laid down last year. In other words they had just received a giant ticking off following an earthquake. Somehow this is how I picture the LDP leadership at the present moment, bowing under the weight - or seismic impact - of the Japanese electoral verdict. Or maybe this just gives us an idea of the direction their collective eyes will instinctively move the moment someone asks who exactly would like to take responsibility for the debacle.

08:15 GMT

Well, the initial exit poll results are due in at around 12:00 GMT, so we haven't long to go now. This piece from AFP more or less sums up the atmosphere as we approach the starting block:

Japan voted Sunday in an election predicted to deliver a stinging rebuke to outspoken conservative Prime Minister Shinzo Abe and possibly pressure him to quit.

Abe, who has championed building a more assertive nation proud of its past, has come under fire over a raft of scandals including the government's mismanagement of the pension system.

Opinion polls predict that Abe's Liberal Democratic Party, which has ruled Japan almost continuously since 1955, could suffer one of its worst drubbings ever.

"Today may be a fateful day for Japanese politics," the best-selling Yomiuri Shimbun wrote.

08:50 GMT

AP have another useful background article here. Among other interesting points their writer makes is the idea that the LDP has been trying to do some last minute clawing back of popularity - their rating in the latest polls, released Friday, of respondents in a Kyodo News agency survey showed that those who favor Abe's party edged up to 21.5 percent of the total from an earlier 18.3 percent. But here the important thing is not so much the "what" as the "how":

The disapproval rate for Abe rose slightly to 59.7 percent, a record, from 58.8 percent... Hoping to stem that trend, Abe and other party leaders have been retreating from current policy issues to the safer ground of appealing to voters' general fear of change and the unknown. And with memories of Japan's decade-long stagnation of the 1990s still fresh, they were focusing on holding on to the economic status quo.

This is in fact the key issue. If Japan's political leaders shift gear coming out of the elections from reform to maintaining the status quo, then what happens next?

10:00 GMT

Still awaiting initial indications, but I came across some memorable quotes in this AFP article:

Opinion polls predict that Abe's Liberal Democratic Party, which has ruled Japan almost continuously since 1955, could suffer one of its worst drubbings ever, potentially bringing a new era of political chaos.

A defeat would not automatically oust Abe as his Liberal Democrat-led coalition enjoys a large majority in the more powerful lower house inherited from Koizumi. Prime ministers have traditionally quit to take responsibility for defeats in upper house polls, but Abe has no clear successor and his aides have insisted he is not considering resignation.

The opposition Democratic Party has campaigned among rural voters disgruntled with Koizumi's free-market reforms, saying that Japan's vaunted economic recovery has only benefited big cities.

FT Deutschland make a similar point:

The public works budget - one of the main ways of providing money and jobs to the provinces - has been slashed. Mr Tamura says that, over the past few years, spending on construction in Kochi has been cut by two-thirds, dragging down many of the prefecture's building companies. Public works are not just make-work schemes, he insists, but are needed to maintain roads and defences against the heavy rains that threaten Kochi's isolated mountain communities.

So the first things to note will be:

i) Just how bad the defeat actually is.
ii) Just how long, and with what measure of success, Abe actually manages to cling on in there
iii) How the financial markets respond to (ii)

12:20 GMT

Well the first exit poll results are now out, and they give us some sort of order of magnitude reading on (i) above:

Japan's ruling party suffered a major loss in parliamentary elections on Sunday, while the leading opposition party made huge gains, according to exit polls broadcast by Japanese television networks.....According to NTV, a major commercial network, the ruling Liberal Democratic Party was set to win only 38 seats, compared with 59 for the main opposition Democratic Party of Japan. The network based its forecast on exit polls broadcast shortly after the voting ended Sunday night.

So now we await confirmation and initial reaction.

13.30 GMT

Well the English language Japanese isn't exactly quick of the starting blocks here, but Reuters, AFP and AP have it coming in thick and fast. This piece from Reuters writer Linda Seig has some early initial comment:

Private broadcaster TV Asahi said the ruling camp was set to win only 46 seats, with the LDP winning only 38 of these. LDP senior executive Nobuteru Ishihara refused to be drawn on whether Abe should resign. "All the media exit polls are showing severe results. We are watching," he told reporters......Abe's allies have said he need not step down after a coalition loss, but analysts said he would be pushed to quit. "It confirms the worst expectations for the LDP. It is a very clear vote of no confidence," said Koichi Nakano, a political science professor at Sophia University in Tokyo. "I don't think he can continue as leader." Some, however, said Abe might try to cling to power. "Abe might stay, at least for a while, but there will be criticism, definitely," said Martin Schulz, a senior researcher at Fujitsu Research Institute. "He will get a lot of pressure."

So the most probable outcome would seem to be no early resignation, and a tug-of-war battle to try and stay on, in which case the financial markets will undoubtedly have their say.

It may be worth noting at this point that only half of the 242 seats are up for election, and that the LDP is in alliance with New Komeito, and that between them, to retain the government majority, they need to ensure themselves of 64 seats, something which seems well beyond their collective grasp at this point in time.

14:00 GMT

Ken Worsley from Japan Economy News draws attention in comments to the low turnout level and the fact that absentee ballots went over 10 million for the first time ever.

Just before polling closed, turnout was 0.5 per cent down on the 39.9 per cent seen in a similar poll held in June 2004.

Also, AFP is now informing us that Abe insists he is staying:

Japanese Prime Minister Shinzo Abe said Sunday that he did not plan to resign despite a crushing election defeat, as quoted by domestic media. Asked outside his office whether he planned to stay in charge, Abe said, "Yes," Jiji Press reported.Officials in his ruling Liberal Democratic Party said Abe did not see the election defeat as a rejection of his signature policy goals, such as the rewriting of the country's pacifist constitution.

"I don't think people have judged that Prime Minister Abe's policies have failed or have rejected his basic directions, such as enhancing economic growth, decentralisation and the national debate over the constitution," said secretary general Hidenao Nakagawa.


Basically this is what I both expected and feared. I fear this, not because I am either pro- or anti-Abe (I am but a mere economist in all of this), but because with the delicate background we have out there in global markets, several weeks of arguing and uncertainty in Japan are the last thing we all need right now. In this Bloomberg article, one Don Alexander, director of fixed income in New York at Citigroup Global Wealth Management, is cited as saying that:

The election will have ``limited impact'' on investors, who are more concerned about the unwinding of the yen carry trade and the timing of a rise in interest rates by the Bank of Japan since ``Credit events are more critical now,'' he said. ``Any unwinding of carry trades would have more impact than the election.'' Citigroup expects the interest rate rise to come in August or September, he said.

Now with all due respect, this is to put things the wrong way round, since, given that rate rise decisions really are in the balance at this point, the election result can precisely act as an influence on the decision whether or not to raise. So basically, the possible unwinding of the carry trade (which I don't really see, but still) depends on how the election is resolved, so market participants are *condemned* to follow this election, and since uncertainty about the outcome will only lead (in the minds of those who are given to this view) to uncertainty about a possible carry trade unwinding, what we could see is even more volatility in the coming weeks, which I think is precisely what emerging markets do not need right now. I hope I am not being too obtuse.

14:30 GMT

And of course Linda Sieg of Reuters implicitly responds to Abe, and ups the anti, just what we need!

Japanese Prime Minister Shinzo Abe's conservative ruling camp suffered a devastating defeat in upper house elections on Sunday, a result that could well force him from office and paralyze policy-making.

So here we have it, Japan could well be "paralysed". Is that a promise, a prediction, or a threat. I don't know. Meantime back at basecamp, Hidenao Nakagawa, is unruffled. It was a "complete" defeat, but on we go:

"If the outcome is in line with projections, it was a complete defeat," Hidenao Nakagawa, the LDP's secretary-general, told reporters. But he added that he wanted Abe to stay.

AP's Hans Greimel also rubs it in:

"Prime Minister Shinzo Abe's ruling party suffered humiliating losses in parliamentary elections Sunday after a string of political scandals, exit polls showed, but Abe said he did not plan to resign."

"Humiliating", it will be remembered, still has a rather special connotation in the context of Japanese society.

And now Abe has appeared on TV:

Abe told Asahi TV in a live television interview from his party's headquarters that he intends to stay on despite the disappointing results. "We tried our best and felt we made some progress, so the results are extremely disappointing," he said. "I must push ahead with reforms and continue to fulfill my responsibilities as prime minister." Kyodo reported that the party's No. 2 official may resign to take responsibility.

and now its AFP's Shaun Tandon's turn:

Japanese Prime Minister Shinzo Abe's government suffered a crushing defeat in upper house elections Sunday but the conservative leader insisted he would stay in power. Exit polls said that Abe's Liberal Democratic Party, which has ruled Japan almost continuously since 1955, was set to suffer one of the worst drubbings in its history, meaning a rocky road ahead for the hawkish premier's agenda.

So this time the defeat is "crushing" (I can just see them cringing there inside LDP headquarters) and we have a "rocky road ahead". That should help keep everything nice and calm over the next week or so.

15:10 GMT

Ken Worsley is back in comments again to inform us that NHK news is now projecting the LDP with 36 seats, while LDP heavyweight and Upper House Party Chief Katayama looks set to lose his seat:

LDP Upper House Party Chief KatayamaToranosuke Katayama, secretary general of the upper house caucus of the ruling Liberal Democratic Party, is set to be defeated in Sunday's election, Kyodo News projects. Katayama, 71, was seeking a fourth term in the House of Councillors and contesting a seat in the Okayama prefectural district where he faced a major challenge from Yumiko Himei, a 48-year-old rookie fielded by the main opposition Democratic Party of Japan. Katayama was first elected to the Diet in 1989 and served in the Cabinet as minister of public management, home affairs, posts and telecommunications from 2000 till 2003.

15:15 GMT

Well here comes the first of the casualties that the venerable Don Alexander (see above) was telling us would not be of interest to investors, the proposed increase in sales tax looks set to be scrapped. Of course, you will tell me how they are going to start to address that huge government debt if they go down this road (perhaps I should republish on this site what I have just written on Credit Rating Agencies and Italy's back-peddling on pension reform). Is there a lesson from all of this? Yes, if your society is still young enough get your house in order now, do something about it before you start to run into all these kind of problems:

Big defeat for ruling camp likely to make hike in sales tax difficult
TOKYO, July 29 KYODO

A projected major defeat for the ruling coalition in Sunday's upper house election is expected to make it difficult for the government to raise the consumption tax in the near future and to promote farm trade liberalization. Since taking office last September, Prime Minister Shinzo Abe has said the government will start full discussions on tax reform from this fall. Shortly before the start of campaigning for the House of Councillors election, Abe hinted at the possibility of raising the consumption tax from the current 5 percent. But he later downplayed the remarks and did not express a clear position on the issue during election campaigning.


15:30 GMT

Voter turnout stood at only 44.82 percent as of 7:30 p.m., down 1.02 percentage points from the corresponding time in the previous upper house election in 2004, according to the Ministry of Internal Affairs and Communications and as reported by Kyodo.

17:40 GMT

As of 1:20 a.m. Monday (Japanese time), Kyodo is reporting that the LDP has 82 assured seats, including 46 that were uncontested this time (which means that so far today they have 36), in the 242-seat upper house, while the DPJ is assured of becoming the largest party in the chamber with 108 seats, compared with the 81 it held before the election.

There is also some more reporting of Abe commentaries:

"Our nation building has just begun,'' he said in one of the programs. ''I would like to continue to fulfill my responsibility as prime minister.''

There is also a change in the turnout predictions:

Voter turnout in Sunday's House of Councillors election as of 1:30 a.m. Monday was estimated at 58.61 percent, up roughly 2 percentage points from the previous upper house election in July 2004, according to Kyodo News projections.

19:00 GMT

Kyodo have now given the final turnout result. Also there appears to be one seat left to be declared and the LDP now have 37.

The final voter turnout in Sunday's House of Councillors election came to 58.64 percent for the prefectural constituency section, up 2.07 percentage points from the previous upper house election in July 2004, according to the election management committees of the nation's 47 prefectures. It is the sixth consecutive time that voter turnout in the upper house election has fallen below the 60-percent level. An upper house election is held once every three years.

20:30 GMT

David Pilling of the Financial Times has an election round up. Perhaps the most interesting quote I have seen all day is this one from Nobutero Ishihara, deputy secretary-general. Ishihara said Mr Abe was not dircetly to blame for the defeat since:

“It just so happened that Abe was the helm of the government” when the pension scandal hit, he said. “We had to devote half our speeches to this issue, meaning we were constantly on the defence. I’ve never seen anything like it.”

This seems to me to be a very relevant point. A significant part of this whole situation has to do with pensions, and the natural unease of Japanese people before a very uncertain future on this front. The hard bit is, at this stage in the game I'm really not that sure what anyone can do about this. Not the lost documents, but the much bigger issue of guaranteeing people what they would consider to be a "fair" pension.

OK, well that's it. I'm shutting up for now tonight. I will be back tomorrow to see how the markets react to all this though.

Monday 30 July: 08:00 GMT

Kyodo now has a final breakdown of the results. The LDP took 37, and New Komeito 9, which gives them a combined total of 46. The DPJ took 60.

These elections were, of course, only for half the seats. So the LDP now has a total of 83 and New Komeito 20, making a combined total of 103. DPJ now has 109. So noone has an overall outright majority, and it will all be down to pacts and agreements with independents and others I suppose.

But as all the commentaries are emphasising, the elections really aren't about political control, they are about credibility, and support for reform policies, and on that count Abe and LDP have lost out mightily.

Kyodo also reports that the LDP board has met and confirmed that (for the time being) Abe will be staying on. The Japanese press, naturally enough, don't quite see eye-to-eye with the LDP board on this:

Two of Japan's four nationally circulated newspapers have called on Prime Minister Shinzo Abe to dissolve the lower house for a general election in their Monday editorials. The calls by the Mainichi and the Nikkei follow the ruling Liberal Democratic Party's devastating defeat in Sunday's election. The Asahi Shimbun newspaper urged Abe to step down, and the Yomiuri Shimbun said the prime minister needs to rework the way he runs the government while exploring the possibility of cooperating with the Democratic Party of Japan.


The English language version of Asahi offers their analysis of what went wrong for Abe, and of course pensions loom large:

The crushing defeat that voters handed to Prime Minister Shinzo Abe and his Liberal Democratic Party on Sunday demonstrated the degree to which Abe and company are out of touch with the public. Before the July 12 start of the Upper House campaign, Abe said he would make constitutional revision the core issue of the election. During speeches for LDP candidates, Abe stressed the fact that his administration had passed into law legislation for a national referendum that was the first procedural step toward constitutional revision. He also pointed with pride to the revision of the Fundamental Law of Education, the first such amendment since its enactment in 1947. The fundamental law's revision heralded the possibility of revision of the Constitution. However, voters on Sunday were obviously far more concerned with bread-and-butter issues that directly affect their daily lives. Key among those issues was concern about the state of the public pension system. Even though the government passed legislation to reorganize the scandal-tainted Social Insurance Agency, the public was clearly not convinced that everything had been done to address their concerns about 50 million or so missing pension accounts or whether the new entity would operate in an efficient manner that would ease their fears about retirement.

Asahi also indicates that all those ideas of constitutional reform are now more or less dead in their tracks.

Another topic which does seem to be coming out in the elections is the growing disparity between Tokyo and many of Japan's regions. This disparity has a significant demographic underpin, as younger more educated Japanese are pulled in by the attraction of better jobs and higher wages in the capital, leaving a rather older and poorer population in the provinces. The Japan Times has a piece on the Kansai region which to some extent reflects this:

Voters in the Kansai region went to the polls Sunday with not only the pension scandal on their minds but also the growing disparity between rich and poor.

Reaction on the Japanese stock market has been mixed, after last weeks sharp decline. The Nikkei 225 Stock Average initially fell 1.4% but then recovered to end fractionally up on the day, while The Topix was up 0.4% at the close of trading after a 1.4% slide at the start. This performance was in part the result of some strong profit numbers from Japanese companies (especially in steel) and better than expected industrial output numbers for June. According to the METI:

Industrial Production in June increased 1.2% from the previous month, showing a increase for the first time in four months. It showed an increase of 1.0% from the previous year. The index in June was 108.4 (seasonally adjusted). Industries that mainly contributed to the increase are as follows: 1. Electronic parts and devices, 2. Transport equipment, 3. Information and communication electronics equipment, in that order.

Now if we look at the chart I prepared in connection with the May industrial production numbers, we will see that while the 108.4 reading is a decided improvement in the fall of the last few months, the level is still significantly down on the very good Q4 2006 performance. So while this data will obviously influence BoJ thinking to some extent, it is evidently far from decisive.

At this point in time the Asian stock markets seem more focused on the US situation and the ongoing story of the sub-prime mortgage market:

Japanese investors seemed shrug off a big setback for the ruling coalition in Sunday's parliamentary elections, focusing instead on the uncertain outlook for the U.S. market.

So now we move on to see just what the level of political fallout will be in Japan over the coming days, whether the pressure on Abe to go will mount or subside, and just what the policy impact of yesterdays vote will be on the current Japanese government.

31 July

Well the campaign for Abe to go has started to gather a little momentum. Asahi has an article today by their political news editor under the header "Voters send Abe message: Resign" which notes the following:

Abe's focus on issues with a strong conservative bent distanced the prime minister from voters more interested in issues closer to home. These voters recognized the huge gap with Abe on what the government's priorities should be. While there have been examples in the West of neoliberalism and neoconservatism co-existing within the same government, the Abe administration failed to find a proper balance between the two schools of thought.

They also publish the findings of an exit poll conducted on Sunday showing that 56% of those questioned thought Abe should go. I guess the interesting point to watch will be whether this figure goes up in the coming days. This is especially the case since it really isn't clear where, policy wise, Abe can go from here. At the present point in time Abe is simply considering a cabinet reshuffle.

At the present time the main threat to Abe would seem to come from divisions within the LDPs own ranks, divisions which may become even more pronounced if the policy balancing act lurches one way or another. The Financial Times has an article documenting some of the disident voices. It also has a leader explaining why it doesn't consider the DPJ a serious opposition party:

Unfortunately, the DPJ does not look like the right party to usher in a period of genuine multi-party democracy for Japan. Formed only in 1998 out of a merger of four political groups, it lacks consistent policies, let alone an ideology. The party members include nationalists not unlike Mr Abe, economic liberals, leftists and various cast-offs from the LDP. Since it was founded, it has had six leaders.

These boundaries between "neo-conservatives" and "neo-liberals" seem to run right across the party frontier, as if each party really needed to have its quota to attract a broad enough voter base. It does turn the formulation of a policy programme to really address the important underlying issues facing Japan into one very big headache, at least IMHO.

The FT's David Pilling also piles it on (in subscription only unfortunately):

The image that will endure from Shinzo Abe’s first, and possibly last, national election campaign is not of the prime minister. Rather it is of Norihiko Akagi, his beleaguered farm minister, who mysteriously appeared in front of an astounded press with giant bandages stuck all over his face. Mr Akagi, who is at the centre of the latest dirty-money scandal to eat at the Abe administration’s credibility, refused to reveal what had happened to his face or even to admit anything was wrong. “Don’t worry about it,” was all he had to say.


Meantime on the economic data front the unemployment number continues to fall, now standing at 3.7%. (and here). Average aggregate wages however continue their steady decline, clocking up the seventh consecutive month in which they have fallen. Unsurprisingly consumption year on year is almost completely flat (a meagre 01.% increase over June 2006).

The Japanese stock markets seem to be holding more or less steady, while the rest of Asia is staging a recovery from last weeks sell-off, and, oh yes, the carry trade is once more alive and well in Australia and New Zealand.

Japan Goes to the Polls

Japanese voters go to the polls this Sunday to decide the future composition of the upper house of the parliament. As you will read in the analyses this election is not of major importance regarding the government of Japan (see more of the political system at Manuel Alvarez' Electionressources) but the election is still an important test for the ruling party LDP which is set alongside its partner New Komeito to endure a trouncing. At the heart of the matter, as you can read below, lies many issues but first and foremost is the discontent with the Japanese Prime Minister Shinzo Abe. First off, I recommend our own Manuel Alvarez' note over at GEM.

Voters in Japan go to the polls this Sunday to choose half the members of the Sangiin or House of Councillors - the upper chamber of the Japanese Parliament, the National Diet. A total of seventy-three seats will be filled in forty-seven constituencies by the semi-proportional Single Non-Transferable Vote (SNTV) system, while forty-eight seats will be allocated on a nationwide basis by proportional representation: Parliamentary Elections in Japan has further information on the House of Councillors' electoral system.

Also the British magazine the Economist has a primer on the election in its Global Agenda as well as BBC's short article here furthermore serves as an entry point to much interesting information of the coming election in Japan. For even more commentary I also recommend Morgan Stanley's Robert Alan Feldman's recent piece which carries valuabe information on the electoral mathematics of Sunday's election. Finally, before I leave you to digest all this information for yourself I should also note the FT's article today which also links to many interesting sources of information on the Japanese upper house election.

Why Japanese consumers are feeling even worse off than US consumers

I just discovered Japan Economy News & Blog, mentioned by Edward in a previous post, which has a recent post concerning "Increased tax burdens, consumer pessimism, excessively low interest rates, and the BOJ’s June Standard of Living Survey." That is certainly a mouthful; the gist of the article is that

"With many households nervous over future prospects, a potential rise in the consumption tax, sluggish (if negative when normalized) gains in wages and decreased consumer confidence in June, economy watchers should now be worrying whether these two reports might prove to be a nail in the coffin of an August interest rate hike by the Bank of Japan."

My sense from a US perspective, is that an arcane topic such as Japan's tax policy just doesn't cut it at the editorial desks of US media outlets at this time. Trade issues with China, the housing/mortage collapse, the Iraq war, oil prices, the seeming free-fall that is taking place at the three US automakers are all affect the US investor much more directly.

It is no wonder that domestic GDP in Japan is weak, given the factors listed above. I can understand the poll results showing that the public thinks interest rates are too low. The BoJ's interest rate policy at this time is to ensure that exports are not damaged by yen strength, particularly due to an unwinding of the carry trade. Significant rate hikes by the BoJ would almost certainly spark an unwinding of said carry trade, jacking up the yen and damaging the profitability of the country's export sector (which is the only thing holding Japan's GDP in positive territory). This is a continuation of Japan's long-standing policy of short-changing its domestic markets to benefit the export sector.

The Japanese public would obviously like to see interest rates higher so that they can realize better returns on their savings without exposing themselves to exchange rate risk. However, as various news reports indicate, the public is starting to engage in the carry trade themselves, as they likely don't see the BoJ's interest rate policy changing anytime soon. In addition, the impending collapse of the Abe government is seen as delaying any interest rate movement in the near term as well.

Japan is in an economic trap at this time; any major changes in policy will cause extreme volatility for the public, business, and the government. The current policy of not making any significant changes may provide short-term stability, but eventually difficult changes will occur.

June Trade Surplus

Well, Japan's trade surplus powered ahead again in June, up 53.4% from June 2006, according to Bloomberg.

Japan's trade surplus surged in June as a weaker yen and higher overseas demand for electronics and cars helped exports rise at the fastest pace in five months.The surplus expanded 53.4 percent to 1.23 trillion yen ($10.2 billion) from a year earlier, the Ministry of Finance said in Tokyo.

Other points of note were that while exports climbed 16.2%, imports gained only 10.7% which was significantly below market expectations. The weaker import reading reflects both the weakness in the yen (and hence the relative cost of imported products) and ongoing weakness in domestic demand.

It is also worth bearing in mind that export volumes, which don't take into account price and currency fluctuations, rose only 6.1% y-o-y in June, and thus that a significant part of the increase in the surplus comes not from increased output, but from the increased yen value of sales prices in other currencies.

Exports to the U.S. rose 6.7% y-o-y in June after barely rising in May and falling in April for the first time in two years. This slower rate of increase to the US is in part a result of the fact that domestic demand has been weaker there of late, and of the fact that the USD has also been falling relative to other currencies, so the "cheap yen" factor isn't so important there. Exports to the European Union, OTOH, climbed 16.3% to reach a total of 1.08 trillion yen, the second highest value on record, and here of course the relative currencies values really do matter, as both the euro and the pound sterling have risen sharply in recent months.

It is almost possible to say that in some measure Japan now has an automatic hedge here, since, as long as the BoJ rates don't rise too much, and as long as Japanese retail investors keep sending funds out in the search for yield, then the yen should stay at a comparatively low level, and if the value vis-a-vis the euro rises this can only be because the US economy starts to pick up again, the dollar starts to rise again, and hence the Yen-dollar crossover moves in the direction of a weaker yen. In other words, at the present time Europe is picking up the slack for weaknesses in the US economy.

Shipments to China also continue to be important, and these surged 22.6% to a record 1.13 trillion yen while exports to the rest of Asia gained 15.8%.

The Eternal Yen Waiting Game?

This is UBS' Jonathan Anderson writing on the Yen (hat tip; RGE's Economonitor) ... This is a well written piece which point to a number of important structural characteristics of the Japanese economy ... the question then becomes, why are we seeing these structural characteristics?

Here is Jonathan ...

(...)

Every one of Japan’s neighbors is strengthening against the dollar ... what will it take to get the yen going again?

At this point, our answer is: it would take a near miracle. And we don’t see one occurring any time soon. Perhaps things will be different in 2008, but for 2007 the most likely outcome is continued doldrums for the yen.

Consider the following four prerequisites for a strengthening yen:

1. A vibrant economy. Everywhere in Asia, currencies have strengthened in direct proportion to confidence in the domestic recovery process: rising incomes, a buoyant credit cycle, increasing domestic investment, etc. And sure enough, the last time the yen rallied was late 2003, when real GDP growth exceeded 4% y/y and investors around the world were getting excited about Japan’s “rise from the ashes”. Since then, however, the economy has continually disappointed, straining towards 3% real growth but then falling back before picking up and falling back once again. Of course the economy is accelerating in the middle of 2007 – but the 2.6% real growth pace of the first quarter of the year is still well below what we need to see to initiate a sustainable yen rally.

2. Inflation. We thought we were finally seeing the end of deflation a few times over the past five yers, when headline CPI growth broke through zero in 2004 and again in 2006, but every measure of goods and services prices is back in negative territory today. In fact, “core” inflation (excluding food and energy) has never once been positive since 1998, and the overall GDP deflator is still falling at a visible clip. Things have been almost as bad on the asset price side; the 2005 Nikkei recovery quickly petered out, and since then Japanese stocks have been the worst performers in Asia. Nationwide land prices are still falling, and new commercial and residential construction starts have slowed visibly over the last four quarters. These are not exactly the most compelling trends to support the value of the national currency.

3. Rising interest rates. The current 450 basis-point gap between short-term Japanese rates and short-term US rates is a powerful incentive for global investors to play the “carry trade”, borrowing in yen and investing in US or other high interest economies – which, of course, pushes the yen even weaker. With moderate growth and no sign of positive inflation, it’s nearly impossible for the BoJ to undertake anything more than very token rate hikes – and while we’ve been waiting for the US consumer to show signs of weakness so the US Fed would be encouraged to cut rates, so far there’s no real indication of a consumer slowdown (and inflation remains on the high side in the US economy as well). Even the recent sub-prime debt turmoil has not yet made a big dent in US economic strength.

4. Domestic support. Finally, we need Japanese residents to invest their portfolio assets at home. For the past few years, however, the trend is just the opposite: Japanese firms and households have discovered other high-yielding markets, for example New Zealand debt and Indian equities, and have started to move assets offshore in ever-larger amounts. The resulting portfolio outflows are a constant source of weakening pressure on the yen as well – and they also discourage foreign exchange traders from taking long yen positions, since they don’t want to be caught betting against 127 million Japanese citizens going the other way.

And the key is that none of this is going to change any time soon. We do expect continued recovery in the overall economy, but weakness in crucial areas like domestic construction suggests that the recovery will be moderate. As we noted above, inflation remains a disappointment, and the Nikkei index is still a big underperformer. The Bank of Japan may well undertake another small rate hike in the second half of this year, but so far the Fed shows no sign of throwing in the towel, which means it will be a long time indeed before interest rate gaps close in a meaningful way. And those domestic portfolio outflows are still accelerating. The bottom line is that it’s going to take a lot of work from here to push the yen into a sustained, significant strengthening .... so please don’t hold your breath.

A Bit of Both from the Domestic Economy

This small snippet is really a recognition of the fine job by Ken Worsley who maintains the Japan Economy and News blog. Between him and JEW you should be able to find top notch economic commentary and coverage on Japan. So what is in store this time? Well, as I have argued before regarding the much hailed August meeting at the BOJ much will depend on the outlook of domestic demand. In fact, I have argued that the BOJ might feel vindicated to sneak a raise past the post on the back of a potentially strong reading in June's consumption and inflation figures. On that note, what might we expect on this accout then?

Firstly, as Ken Worsley reported recently department store sales rose rather briskly in June which underpins the probability of an above average reading in June's overall figure for domestic consumption out at the end of this month.

After having seen sales drop 0.4% in May, the nation’s department stores saw a rise in sales for the first time since February of this year as June sales increased by a whopping 5.5% to 634.9 billion yen versus June of 2006.

The survey covered sales at 278 department stores operated by 94 companies nationwide. The surveyed shops reported employing 95,220 people, up 6.4% from a year ago. The total amount of shop space (measured in square meters) was unchanged.

However, as we see today (once again via Ken Worsley) sales in supermarkets were down 1.5% in June which marked the 40th consecutive drop.

On the heels of last week’s strong supermarket sales data [edit: I am pretty sure he means department store sales here], we still have not such good news coming from the supermarket sector. In June, supermarket sales across Japan were down 1.5% year on year, showing a fall for the 18th consecutive month, and now for 39 of the last 40 months.

This month’s data covered 8,645 shops owned by 79 companies employing 446,515 workers - 129,599 full time and 316,916 part time. Interestingly, while 31.5% of the full-timers were women, that group made up 90.87% of the part-time work force.

As we can see the evidence of a sustained pick up in domestic demand is far from decisive in Japan and neither as it were is the evidence from June where we just have to wait a little more to see I guess. In this respect, note that Ken points to Friday this week for data on retail sales and to Thursday next week for the aggregate household spending data for June. Another very interesting point here is Ken's remarks on part time jobs. I can tell you that he is not the only one who has been scratching his head lately on this. Remember that Japan, despite ever tighter labor market conditions, is still seeing decline in real wages and the relative weight of part time jobs could have something to do with this.

Price Measurement in Japan

Cross-post from Alpha.Sources


If you have been following my notes on Japan's economy you might have noticed that the measures of inflation represent something of a maze. Basically, I usually cite three measures of inflation in ny notes on Japan as can be seen from the graph below from one of my recenc posts ...

Regarding the official data which comes out of the Japanese statistical office and which is subsequently cited by Bloomberg, Reuters etc we are looking at the green line which measures the general index less fresh food. This also means that the official Japanese inflation measure includes headline inflation represented by energy prices. Now, the measure of inflation in Japan is of course far from trivial since in an economy cruising very close to deflation the central bank and thus markets are using even small fluctuations in prices as a base for migthy important and far reaching decisions. But what prices should we be looking at and is Japan currently in deflation or inflation? Regarding the former this is set, I think, to hit headlines very soon as it seems as if structural inflation pressures are set to mount. Remember here that while the recent surveys indeed show that inflation expectations are rising in Japan much of this is due to a perky headline. As such, there is a risk that inflation measures in Japan might very well diverge in the coming months something which could indeed help the BOJ but if domestic demand does not follow back up then of course the BOJ will be stuck between a rock and a hard place.

Turning to the latter and whether Japan is in fact in deflation or inflation and how gauge this we move to the real impetus for this entry. In this way Christian Broda and David E. Weinstein recently had a paper published at the NBER on price stability in Japan which highlights some of the important issues with the measurement of Japan's inflation rates. Now, if we disregard the implicit narrative (true as it may be) that US methodology is superior I think that there are some important points most notably of course the general point about how Japan's inflation index is biased upwards. Here is the abstract ...

Japanese monetary and fiscal policy uses the consumer price index as a metric for price stability. Despite a major effort to improve the index, the Japanese methodology of calculating the CPI seems to have a large number of deficiencies. Little attention is paid in Japan to substitution biases and quality upgrading. This implies that important methodological differences have emerged between the U.S. and Japan since the U.S. started to correct for these biases in 1999. We estimate that using the new corrected U.S. methodology, Japan's deflation averaged 1.2 percent per year since 1999. This is more than twice the deflation suggested by Japanese national statistics. Ignoring these methodological differences misleading suggests that American real per capita consumption growth has been growing at a rate that is almost 2 percentage points higher than that of Japan between 1999 and 2006. When a common methodology is used Japan's growth has been much closer to that of the U.S. over this period. Moreover, we estimate that the bias of the Japanese CPI relative to a true cost-of-living index is around 2 percent per year. This overstatement in the Japanese CPI in combination with Japan's low inflation rate is likely to cost the government over 69 trillion yen -- or 14 percent of GDP -- over the next 10 years in increased social security expenses and debt service. For monetary policy, the overstatement of inflation suggests that if the BOJ adopts a formal inflation target without changing the current CPI methodology a lower band of less than 2 percent would not achieve its goal of price stability.

Economic consequences of July 16th earthquake

The AP is reporting that

"Japanese automakers, including No. 1 Toyota Motor Corp., called production halts Wednesday at factories in Japan because of quake damage at a major parts supplier.The temporary closure of auto parts maker Riken Corp.'s plant at Kashiwazaki city, near the epicenter of Monday's magnitude 6.8 quake, has forced Toyota, Nissan Motor Co. Mitsubishi Motors Corp. and Fuji Heavy Industries to scale back production. Toyota, Japan's top automaker, will stop production lines at a dozen factories centered in central Aichi prefecture Thursday afternoon and all day Friday, said Toyota spokesman Paul Nolasco.The company will assess the situation at Riken, supplier of key transmission and engine parts to Toyota, before deciding whether to resume production on Monday, he said."

Also, another AP report describes how "the world's largest nuclear plant in power-output capacity...[was] ordered...plant be shut down until its safety could be confirmed after a long list of problems -- including radiation leaks, burst pipes and fires -- came to light." The reactor plant "generates 8.2 million kilowatts of electricity" according to the same AP report.

So the combination of a major shutdown in auto production and the loss of significant electrical production capacity might just put a visible dent in Japan's GDP numbers for July. The one thing about just in time production systems is that they are vulnerable to transportation failures. Fortunately for the automakers, they likely have plenty of inventory at car lots in the US or on ships bound for foreign ports that this production shutdown won't damage their July sales numbers.

Update: The Economist followed up with an article in the same vein as this post..."After the quake, the fallout"...the article states that "Following the quake, carmakers such as Toyota, Honda and Nissan found that their system of “lean”, just-in-time manufacturing, called kanban, made them over-reliant on a single parts supplier"...

Upping the Pressure on the BOJ

Well today's economic news continues to pile on the pressure over at the BoJ:

Demand for services in Japan unexpectedly fell in May, suggesting waning consumer spending is slowing growth in the world's second-largest economy. The tertiary index, a gauge of money spent on phone calls, dining and shopping, dropped 0.1 percent after climbing a revised 1.6 percent in April, the Trade Ministry said today in Tokyo.

I'm not sure that this was entirely unexpected, especially in the light of the recent confidence index reading, and the trend downwards in wages in Japan.

All this makes me think that my view on the possibility of a BoJ rate rise in August may be excessively cautious. When I wrote this post last week, I though that it was maybe 40-60 that they would not raise, now I would bring that down to 50-50.

There are a number of reasons for this. In the first place, and as Bloomberg notes:

Japan's growth probably slowed in the second quarter as consumers, whose outlays account for more than half of the economy, reined in spending.

Now since the BoJ explicitly mention Q2 GDP as a key test, this will give them problems, although that doesn't mean that they can't change the story and carry on regardless.

But then there is this:

The Social Insurance Agency said in May that its mishandling of pension records could result in billions of yen in unpaid benefits. Bank of Japan Governor Toshihiko Fukui said last week that the pension issue and higher taxes might prompt consumers to spend less.

The pensions scandal has caused much more upheaval in Japan than most external commentators seem to recognise, and you need to remember that Japan is going to have elections later this month. Things don't look at all good for the LDP, and they look simply disastrous for Abe. So, as the IHT says:

Electoral defeat would not immediately threaten the ruling coalition's hold on power because it has a commanding majority in the lower house. But a loss would cause embarrassment and likely prompt party leaders to force Abe from office.


In other words electoral defeat would not immediately threaten the ruling coalition's hold on power, but it would shake things up a hell of a lot, and this will not go un-noticed over at the BoJ, which will certainly come under the accusation of having paid more attention to image maintenance at the G7 meets, and less to the real and perceived needs of the Japanese people.

Bank of Japan Governor Toshihiko Fukui seems to be living more in the ethereal than the real world right now, since he reportedly said last week that slower growth wouldn't decide the outcome of the bank's August policy meetin since ``Private consumption is solid, though by no means spectacular,'' (verbatim).

He is also holding fast to the opinion that "At present, there's no evidence these problems have had a negative effect"

According to a Japan government report out today "Japan's economy is 'recovering'. It remains to be seen for just how much longer this position remains sustainable.

Summer Hike at the BOJ?

Cross-post from Alpha.Sources

Things are suddenly getting interesting in Japan and at the BOJ with markets solidifying for a August hike on the one side and somewhat deteriorating economic fundamentals on the other. Yesterday, the BOJ chose to hold rates steady with a vote of 8 to 1 but by taking a quick sweep across market indicators they all indicate that an August hike is in the bag or at least in September where swap contracts on the overnight call rate indicate a 96% probability of a hike; in August the corresponding probability is 73%. Yet, you cannot but wonder that feelings are getting increasingly more itchy across trading desks as regards to the timing of the next BOJ move and whether in fact it will come in 2007 at all? This then brings us into my statement above concerning 'somewhat' deteorating economic fundamentals a topic which I also elaborated in my last note on Japan.

Let us however begin with the good news represented by the latest data on Japan's external balance which showed that the current account surplus widened to an all time high in May 2007. The big story here is however not so much the trade surplus which indeed is thundering along just fine with a 1% increase but rather the income surplus which also posted a healthy gain. It is of course difficult to say to which degree Mr. and Ms. Watanabe are responsible but in a more general perspective it is amazing to see the sea change in Japan where domestic investors traditionally exhibited notable home bias something which is undoubtedly contributing to the recent impressive growth in the income surplus. This small snippet from Bloomberg is very much to the point ...

The income surplus exceeded the trade surplus for a fifth month in May, the Finance Ministry said. The difference between money earned abroad and payments made to foreign investors in Japanese companies surged 36.6 percent to 1.79 trillion yen, the second highest on record.

Returning to the domestic economy we don't yet have real data from June which makes my previous note on the May data pretty much up to date, at least when it comes to inflation and domestic consumtion data. However, we do have some confidence indicators which do not exactly make August's BOJ any easier to the extent that we were pretty certain that a hike would be on the menu. Firstly, we have the confidence measure for merchants which fell in June and secondly we saw, rather worryingly, that consumer sentiment also dropped. However, as a last data point we also recently saw that machinery orders rose briskly in May which perhaps suggests that corporate capex is ready to nudge back up over the summer although as Edward notes in this post and accompanying graph, corporate capex/industrial production is still on a high level in relative terms.

In Summary

As per usual we have a bit of good and and a bit of bad news from Japan this time around. Coupled with yesterday's decision to hold rates steady markets still seem convinced that August will see the BOJ move to 0.75%. Everyone seems more or less certain on this and even the always duly skeptical (and excellent) Takehiro Sato from MS' GEF also recently noted that the BOJ could raise in August although whether they actually should is of course another question. Regarding my own call I feel a bit of deja vu pointing back to February where markets were snubbed by the BOJ in what was also, at the time, an almost sure move. And in thread with Edward I really do not hope for MS that they have to apologize again come August. No tongue in cheek should be detected here, Japanese economic conditions and monetary policy are not at all easy, at this point, to forecast and this is especially the case when it comes to the BOJ's rate decisions. In line with my recent explicit call for a hike to 0.75% I am sincerely wobbling at the moment; especially, given the recent signs that the modest yet, by Japanese standards, impressive spurt in domestic demand is coming to an end in Q3 and Q4 2007. As such, and dare I say it, I am moving back into hold territory for August with the important qualifier that domestic demand and inflation figures for June could swing me back in line with the consensus if they exceded expectations which in this case would represent a mild improvement over May. Before I leave, I should also note the increasing uncertainty surrounding the general rate policy discourse at the BOJ where both Fukui and other prominent members of the committee have noted how the current gradualism might give way to a willingness to raise even as inflation remains subdued. This would then point to a more forward looking course with an explicit assumption of inflation pressures building in 2008. However, this is also the whole issue here at this point and August will be a test to whether this discourse will also translate into action, I have my doubts but the outlook is clouded indeed.

BoJ Rate Decision Vote

The fact that the BoJ vote on holding the interest rate were it is came in at 8-1 is causing a bit of a stir:

"The 8-1 vote left an impression that BOJ board members were more cautious about a rate hike than previously thought, spurring short covering in bonds," said Takeo Okuhara, a bond strategist at Daiwa Institute of Research.

Now back at the end of June Morgan Stanley's Takehiro Sato announced on their Global Economic Forum that they were finally throwing in the towel and coming into line with the rest of the pack in forecasting another rate hike in August. Let's just hope they won't have to apologise to their readers yet one more time. Looking at what is happening to consumer confidence and domestic demand right now, I can't help feeling that they may well have to.

We had expected a pace of one rate hike every six months but no rate hike in the summer because of the negative CPI rate. It has become clear, however, that the current price trends matter less to the BoJ than we expected. In addition, the BoJ maintains that it can smoothly realize sustained economic activity and prices in line with its forecasts if it adjusts its policy rate as the market expects. We thus find it difficult to continue to ignore the fact that the OIS market has priced in an almost 100% probability of a summer rate hike, and we abandon our previous, out-of-consensus forecast, and now expect the next rate hike to come at the August 22-23 meeting, more or less as we expected before the February rate hike. As difficult as it is to take losses on negative-carry positions, it is we who must take responsibility for having misjudged the BoJ’s level of conviction.

Japan's energy dependency

A key quote from the Bloomberg article that Edward referenced in the previous post is the statement that "rising food and energy prices are eating into the cost of living." While the USA's dependence on foreign oil is frequently discussed in mainstream media, it is important to remember that Japan is even more dependent on foreign supplies of essentially all fuels; whether it be oil, natural gas, or uranium for the country's nuclear power plants.

The country's export manufacturers can to some degree pass on higher energy costs to buyers, particularly since the yen remains weak and energy makes up a relatively low fraction of the final cost of most manufactured exports. The consumer in Japan, on the other hand, has little alternative. Many, many homes in Japan still rely on kerosene fuel for heating, and are poorly insulated, with the potential for conversion to another source of heating such as electrical systems being minimal. So the fuel bill will reduce the consumer's cash available for discretionary spending.

Also, the Japanese agricultural sector is heavily subsidized, and inefficient compared to other countries. A drive through rural parts of Japan will reveal many small plots of rice fields. The retail price of a bag of rice at Japanese supermarkets is far above that of the same quantity in the US, and likely the same in relation to other countries. A policy that could be implemented in short order that would benefit Japanese consumers immensely would be to eliminate import restrictions on foreign agricultural products, particularly rice. Food prices in Japan would quickly drop radically, freeing up disposable cash.

This policy option is unlikely to be implemented, as the balance of power in the Japanese legislature lies with agricultural and rural interests who would obviously suffer as the result of such a policy. Although Japan's population obviously is highly urbanized; due to the way that their political systems are set up, seats in the legislature have not been reapportioned to reflect demographic changes. I highly recommend Karel van Wolferen's "The Enigma of Japanese Power" for an explanation of Japan's political system. While somewhat dated at this point, the book gives the reader a lot of insight into how the country's political system works.

In particular, the book illustrates how Japan's economic policy has been to subsidize export industries at the expense of the domestic consumer. The continuing weakness of Japan's domestic consumption is a case, so to speak, of the chickens coming home to roost. The country's policy makers at this point have little ability to shift this policy, as reduced exports would negatively effect GDP more quickly than the benefit to domestic consumption would appear, particularly given the prospects for a rapidly shrinking population.

Consumer Confidence on the Slide

According to Bloomberg this morning:

Japan's consumers were the most pessimistic in more than two years last month as higher taxes, falling wages and lost pension records chipped away at people's confidence in the economy. An index that measures confidence among households with two or more people dropped to 45 in June from 47.3 in May, the Cabinet Office said today in Tokyo. Sentiment was the lowest since it fell to 44 in December 2004.

Wages have fallen every month so far this year, and rising food and energy prices are eating into the cost of living.

Confidence among consumers including single-person households slumped to 45.2 from 47.4, also the lowest since December 2004. That survey has only been available since 2004.

Japan has struggled to emerge from a bout of deflation that has plagued the economy since the 1990s. Companies are gradually raising prices to reflect higher costs as the economy expands, stoking inflationary pressure, said Masaaki Kanno, chief economist at JPMorgan Securities Japan Co. in Tokyo.

Wages have failed to grow so far this year, even with unemployment at a nine-year low and companies reporting labor shortages. Average pay only rose 0.3 percent, or 10,000 yen ($82), in 2006, after sliding 10 percent in the decade before that.

Well. I think all of this just about confirms what Claus, Scott and I have been saying on this blog for some considerable time now. The big news is that maybe the mainstream discourse is now about to pick up on the underlying reality:

As Seiji Adachi, a senior economist at Deutsche Securities Inc. in Tokyo, says:

``Consumer spending probably won't become the main driver of the economy anytime soon....You can't expect consumer sentiment to rise while wages are falling and taxes and prices are increasing.''

Machinery Orders and the Economy Watchers Index

Data coming out of Japan at the moment is really mixed at the moment. Really, as Claus Vistesen notes here, we are all busily holding our breath right now.

The latest news on the machinery orders front seems, on the face of it, quite positive on the surface:

Japan's machinery orders, a key indicator of corporate spending plans, rose at triple the pace economists predicted, reinforcing expectations the central bank will raise interest rates as soon as next month.

Orders climbed a seasonally adjusted 5.9 percent in May from the previous month, the Cabinet Office said in Tokyo today, a second monthly gain.

Manufacturing equipment orders rose at the fastest pace in almost a year, led by electrical machinery, transportation and textiles industries, signaling industrial production is likely to recover.

On the other hand industrial production, as Bloomberg also note, has been on a downward trend of late. Evidently we are in "wait and see" mode.

Meanwhile the Economy Watchers index has come in with a quite negative reading for domestic demand. The index, which gauges the strength of domestic demand via a survey of about 2,000 people who deal directly with consumers, fell to 46 points in June, a third monthly decline, the Cabinet Office said today in Tokyo. According to Bloomberg:

Slumping wages, higher taxes and concern over lost pension benefits may hobble consumers, whose spending makes up more than half of the economy. Japan's longest postwar expansion has been driven by business investment and exports of cars and electronics.

Wages have failed to grow so far this year, even with unemployment at a nine-year low. Average pay only rose 0.3 percent in 2006, after falling 10 percent between 1997 and 2005.

Last month's final rollback of tax rebates instituted by former Prime Minister Junichiro Koizumi will add about 14,000 yen ($110) to the average tax bill for a family of four. The Social Insurance Agency said in May that the mishandling of pension records could result in billions of yen in unpaid benefits.

Prospects for consumer spending may deteriorate in coming months, today's survey showed. The outlook index, a measure of expectations for the next two to three months, fell to 48.4 in June, below the optimism threshold of 50 for the first time this year, the Cabinet Office said.

Household spending rose 0.4 percent in May, the slowest gain so far this year.

What all this means is that the outlook on the upward blip in domestic consumption may now, once more, be headed south.So we have a two tier Japan economy right now, a domestic Japan, which really struggles to move forward, and an export sector which, for the time being, continues to March from strength to strength. At least this is how it all looks on the surface.

Savvy Housewives and Mum and Pop Investors

This time Bloomberg has a new angle on all this:

Yen sales by Japanese mom and pop investors this week exceeded professional traders' bets against the currency on the Chicago Mercantile Exchange.

Net short positions on the yen against the dollar, or wagers Japan's currency will fall, reached $1.1 billion among traders using borrowed funds on July 4, according to Tokyo Financial Exchange. Based on estimates of the exchange's market share, the total position of Japanese individual investors is about $19.15 billion, compared with a record $19.07 billion of bets by traders on Chicago's market.

This comparison gives a measure of the scale of what is happening. As they say:

Japanese pensioners, businessmen and housewives are taking advantage of the Bank of Japan's 0.5 percent benchmark rate to borrow yen to buy higher-yielding currencies in New Zealand, the U.K. and Australia. The growing popularity of so-called carry trades has added to declines in the yen, which dropped against all of the 16 most-active currencies in the past year.

and there is more to come:

``The yen will fall further due to the growing presence of those Japanese retail investors,'' said Toru Umemoto, chief currency strategist at Barclays Capital in Tokyo. ``Those mom- and-pop investors have invested only 3 percent of their total financial holdings of 1,500 trillion yen in overseas assets. They will invest more.''

In Japan, individuals have opened 664,802 margin trading accounts at brokerages that lend money for currency bets, almost double a year ago, according to Tokyo-based Yano Research Institute Ltd., publisher of an annual report on the business. The number may exceed 1 million by the end of March, said Kaz Shirakura, senior researcher at the institute.

``The arrival of Japanese households as major investors seems to have affected foreign-exchange markets,'' Nishimura, 54, said in a speech at a meeting at the Brookings Institute in Washington on July 2. ``The gnomes of Zurich were accused in their day of destabilizing markets. The housewives of Tokyo are apparently acting to stabilize them.''

Japan's Leading Index

Well, the latest reading on the leading index seems to be causing some controversy. Earlier this week the Tankan came in with an unexciting but basically positive reading.

The Bank of Japan's closely watched Tankan survey of business confidence showed the large manufacturers' diffusion index, which subtracts pessimists from optimists, unchanged at +23. However, the index for medium and small manufacturers fell three and two points respectively to +13 and +6, suggesting some weakness in companies less exposed to export markets.

On the other hand wages continue their downward path:

Separate figures from the ministry of health and labour showed that total cash earnings fell 0.6 per cent in May from a year earlier, their sixth consecutive monthly fall. The numbers underlined the seeming paradox of Japan's "no-wage recovery" in which employers, even those making record profits, have been slow to pass on the benefits to workers.

That partly reflected the retirement of high-earning baby boomers, who were being replaced by women, pensioners on cheaper contracts and previously discouraged jobseekers returning to the labour market, economists said. Lehman Brothers said there were some indications in the Tankan that the labour market could tighten again, including strong plans for graduate hiring and a prediction of labour shortages in coming months.

and also note this part:

Mr Jerram said labour market data included in the Tankan survey showed that employment conditions had stopped tightening for the first time during the five-year recovery. That could be a temporary blip, he said, but it suggested that the bank might have to rethink its central assumption that tightening labour conditions would inevitably spark higher wages and prices - one justification for its pre-emptive rate rises.

The stock market was not very impressed with the implications for the property and construction sectors:

Property stocks continued their downward trend, hit this time by the tankan survey, which pointed to weakness for the sector. Mitsui Fudosan, Japan’s biggest property company, sank 1.2 per cent to Y3,420 while Mitsubishi Estate, its largest rival, slid 1.2 per cent to Y3,310.


Meantime back to Bloomberg and the leading index:

Japan's broadest indicator of the outlook for the economy signaled for a seventh month that the longest expansion in more than 60 years may slow.The leading index was 30 percent in May, the Cabinet Office said today in Tokyo, lower than the 40 percent median estimate of 27 economists surveyed by Bloomberg News. A number below 50 indicates the economy may cool in three to six months.

As I say by no means all economists are agreed on what this means, but looking closely at this and the details of the Tankan, it is hard not to reach the conclusion that the Japanese economy is slowing at this point, and that in this environment the BoJ will be very hard pushed to raise rates.

This impression is also strengthened by the news that Moody's is contemplating upgrading their Japanese sovereign debt rating. It isn't so much the fact that they are thinking about this that is important, but rather the reasoning behind the news:

Prime Minister Shinzo Abe has pledged to balance the budget by 2011 by cutting spending and possibly raising the national sales tax from 5 percent. The government will probably reduce bond sales for a third year in the 12 months starting next April, Chikahisa Sumi, director of debt management policy at the Finance Ministry, said last week.

So Japan is going to raise taxes and practice fiscal tightening. If we examine what is happening on the domestic economy front, which may well already be noting the end of the monetary easing policy, and the direction government policy on the fiscal front may evolve after the elections, then it is very hard to see the BoJ raising much, and indeed in the mid-term we may well be moving in the opposite direction.