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Friday, September 28, 2007

Finally Some Good News from Japan?

(cross-post from Alpha.Sources)

On the back of a miserable Q2 GDP reading and general uncertainty in markets Japan's economy has not exactly been the harbinger of pleasant data reading as of late unless of course you have been short on the Yen. As I said in a recent small post on Japan Economy Watch this week would bring some pretty interesting data releases from Japan in terms of figures for prices, consumption expenditures, industrial production and unemployment. In this small piece we will take a look at the first two and as prices, consumption expenditures go along I will add the latter perspectives in updates to this post. Beginning with prices the overall picture did not change much in August with the reported benchmark index (general index excluding fresh food) staying flat at a -0.1% rate of deflation. The core-of-core which excludes both fresh food and energy rebounded to a rate of -0.2% from last month's -0.5%.

More generally on prices we are moving into rather uncertain times I would say. Despite what may seem evident from today's overall reading of economic data I am still skeptical as to how much internal activity in Japan as such will drive up inflation through internal demand dynamics. However, even if this question is left out we still have what we might call 'second-stage' inflation which has moved somewhat closer to the realms of the CPI basket as of late with production input prices shooting up significantly. In an excellent note over at Macro Man's place you should check out the graph which plots wholesale inflation and although the time series is somewhat too long term to use gauging monthly trends this is definitely something to watch out for. Also, of course we have all that famed 'anecdotal' evidence about how mayonnaise and Starbucks lattes have seen their prices climb. Yet, as I hint above the key here is whether inflation will be able to take hold in final goods markets which is why the core-of-core index will be interesting to follow. The following quote from Bloomberg sums up well this perspective ...

``Unless large retailers start raising prices, Japan's core inflation won't take hold,'' said Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. ``The closer companies are to consumers, the harder it is for them to increase prices.''

So, this is indeed the case in point here and of course what this tells us about the underlying propensity to consume relative to where in fact the inflation pressures (if any) will come from. This perspective is especially important in so far as goes the potential for energy prices to rise quite significantly on a y-o-y basis in the latter part of 2007.

Turning to readings on domestic demand we also from the basic headline reported in the media that domestic consumption expenditures rebounded to a 1.6% increase on a y-o-y basis. Now, compared to recent months' rather sub par performance this is indeed something of a rebound and for good measure I also reproduce the graph below which contains the figures which are widely reported by the media.

However, since we are after all in the business of doing sound economic analysis (aren't we?) we might also want to look at some more solid measures of the trend in domestic demand. First of all it might be a good idea to incorporate some kind of seasonal adjustment to the data series especially since we are now, as can readily be seen from the graph above, moving into a territory where y-o-y nominal unadjusted figures are bound to get some headwind from what is clearly a rather distorting v-shape as domestic consumption apparently tanked in the middle of Q3 in 2006. In this way, why don't we have a look at the index-2005 series which is furthermore seasonally adjusted. As we can see below domestic consumption did indeed climb in August but in any way did it climb to the extent that we are led to believe. In fact, we see that general consumption expenditures still remain on a downward trajectory relative to the beginning of the year.

This point is also further substantiated if we look at the real seasonally adjusted monthly series which again, without a doubt, show that August saw a climb but that the overall downward trend since the beginning of the year is confirmed.

Finally, and to hammer my point down we could also go back through the underlying consumption indicators (Preliminary Report on the Current Survey of Commerce for August 2007) and take a look at sales for retailers, wholesale, and commercial sales. As Edward notes in a small pointer over at Japan Economy Watch retail sales did in fact manage to clip in a 0.5% increase y-o-y but also that total volumes of sales actually fell from July. In fact, if we look across the board total volumes of wholesale sales, commercial sales, retail sales, as well as sales from large retail stores all fell from July in total volumes in fact extending 3 to 4 monthly declines for all series. So this is just to say then that behind the reported headlines lies a reality which is a bit more differentiated than is many times suggested. Moving on for a minute to corporate capex proxied by industrial production August saw a hefty rebound but we need to remember that this figure also somewhat has earthquake rebound written all over it. As I hypothesised in my previous notes there is a risk that industrial production could begin to trend down as we move into the final months of 2007 on the back of the obvious downside related to the continuous strength of the Japanese export sector.

In Summary

As a first approximation we could of course ask what effect this is going to have on markets and subsequently the probability of a rate hike by the BOJ? Clearly, if the coming months provide the same kind of upward tendencies we can expect the Yen to come under some upward pressure which especially should be seen in the light of what seems to be lingering Dollar weakness in some time to come. However, if we look at the G3 currencies we are pretty much kept out of the loop by the uncertainty surrounding what exactly the ECB is going to do with both inflation and the Euro on the rise at the same time of course as the economic edifice is crumbling before our very eyes as we move in H2 2007. Interestingly and from a Japanese perspective the Nikkei index actually fell today, despite what was clearly narrated as a bullish news release, on what seems to be the 'structural' outlook in Japan. Note especially the following points:

A fundamental perspective does not favor domestic demand companies, as their opportunities for growth look slim,'' said Hiroyoshi Nakagawa, who helps oversee about $1 billion in Asian equities at Societe Generale Asset Management Co. ``The best bets for outperformance are in companies dependent on China such as commodities, shipping and machinery stocks.''

(...)

``Disposable income in Japan is not increasing, and the middle class is shrinking, which indicates that earnings at domestic companies are not going to improve,'' said Societe Generale's Nakagawa.

So it seems that perhaps a new narrative is emerging here in relation to Japanese export dependence which is clearly, at this point, more than a passing trend before the Japanese economy 'normalizes.' Returning to the inevitable question, no I don't think that the BOJ will raise and I think that future data releases will solidify this call; for instance, I am not at all looking for something positive in Monday's release of the Tankan survey of business sentiment. Lastly and before I close up shop for good let me suggest address some general issues and quibbles I have. First off let me try to wave off the obvious. In this way I am fully aware that my analysis presented above could be seen as a deliberate attempt to talk down what in fact is good news on the Japanese economy. However, such accusations would be a mistake. What I do want to emphasise though is the need to look at the data that is actually in front of us and then to apply sound analysis based on whatever theoretical framework we have to work with. Now, this latter part is of course important and I realize that not all share my view of things which is of course fine. But at the end of the day we should all be interested in progressing with empirical vigour which is what I have attempted to do above.

Japan Retail Sales August 2007

METI have just released the latest retail sales data. The yen value of both retail sales and sales at large stores actually fell from July, although total retail sales did manage to eke out a small 0.5% increase year on year, which was notable since in 9 of the previous 10 months they have actually been down even year on year.


Japan Industrial Output August 2007

Well industrial output was certainly up in Japan in August.


Japan's industrial output surged at the fastest pace in almost four years....Production rose 3.4 percent from July to a record, the Ministry of Economy, Trade and Industry said in Tokyo today.





As I say, the August numbers certainly shot up. The question is what to make of this reading. Claus is preparing a fuller analysis even as I post this.

Japan Employment and Unemployment August 2007

Well, as reported in the Financial Times today, Japanese unemployment crept up slightly last month:

Japan’s jobless rate rose for the first time in 11 months as more people sought work, underlining concerns about the slow pace at which economic growth has translated into higher wages.

The unemployment rate rose 0.2 point to 3.8 per cent in August, while the job to job-seekers ratio deteriorated slightly from 1.07 to 1.06. The unemployment rate for women rose from 3.3 per cent to 3.7 per cent, according to official figures released on Friday.


Here's the monthly chart:




Also the number of persons employed dropped back slightly. As can be seen from the chart this seems to have peaked in May.



A much fuller analysis of the recent dynamics of the Japanese labour market can be found in this post.

Thursday, September 27, 2007

Raising Consumption Taxes To Finance Pensions?

According to reuters today:

Japan may finance its basic pension scheme through a rise in its consumption tax, a senior official from the ruling party said on Thursday.

"We are not going to resort to using the sales tax from the beginning, but in the end I think we will conclude that it's best to finance the pension scheme with the sales tax," said Sadakazu Tanigaki, the Liberal Democratic Party's policy chief.

Tanigaki has said in the past that Japan will need to raise its consumption tax from the current 5 percent to address the problem of its huge public debt.


Japan is an ageing society with an already congenitally weak domestic consumption situation. Raising consumer taxes has one very well known impact on demand (as in elementary economics well known): it reduces it. Japan needs to think very carefully indeed before going down this road. Claus wrote a good analysis of what the likely consequences would be of raising Germany's VAT consumption tax by three percentage points last January to pay for the health system. At the time such arguments were dismissed, but as we can now see, the chickens are coming home to roost. The German comparison is important since, due to rapid population ageing, the German economy is dependent on exports in just the same way the Japanese one is.

Wednesday, September 26, 2007

Japan Trade Surplus August 2007

Well as Claus forecast in his last post, I have indeed been preparing something on the last trade figures. First off, the headline numbers.

Japan's August trade surplus widened to 743.2 billion yen ($6.5 billion). On an annual basis exports rose at more than twice the pace of imports, according to the latest data released by the Finance Ministry today. The surplus has nearly quadrupled - and increase of 287% - from this time last year.

At the same time shipments to both Europe and Asia rose to monthly records. The overall picture is however, a complex one. In the first place exports in July and August were both down on the June peak, as can be seen in the chart:



The big difference between July and August is that imports held up in June, while they dropped back in July. This is undoubtedly the impact of two factors, slowing domestic demand in Japan itself and fluctuations in energy costs. In fact petroleum imports did drop back from 1,137,199 million yen in July to 1,081,920 million yen in August, a drop of 55 million yen or so, or some 50% of the change in the balance.

In fact the monthly fluctuation in the trade surplus is not a very interesting or reliable data point at all (since it in part depends on fluctuations in earlier data), as the following charts will show. Firstly the chart for the monthly trade suplus since January 2006:



So as we can see, the August trade surplus was not particularly large at all, but experienced a fairly large annual increase due to the fact that the August 2006 surplus was very small. Economic data are full of anomalies like this.

The situation becomes even clearer if we look at the monthly year on year changes in the surplus since January this year. The anomalous nature of the August reading becomes even clearer, and we shouldn't take it as a reading on anything very special.



Now for some more interesting data. Exports to the EU, the US and China.



What we should note from this chart is that while exports to the EU have held up reasonably well since the start of 2007, and while they have been strong to China, exports to the US have been wobbling notably, which is understandable once you take into account the relative decline in the dollar (although not especially against the yen) and the fact that the US economy has itself started to wobble.

Another detail which is worth noting before I wind up, and that is that even while exports to China form a vital part of the Japan "recovery" panorama (they are now not that far short of direct exports to the US, and Japan will feel any slowdown in China ) Japan in fact runs a DEFICIT in goods trade with China. Here's the chart:

(please click on image to see more clearly)



In this context it is interesting to ponder what might possibly happen if the yen were ever to appreciate notably against the Chinese yuan. At the present moment however this eventuality seems rather unlikely and the yen was trading at 114.91 per dollar at 12:34 p.m. in Tokyo up from 114.57 before the report was published, but still within an acceptable range from the Japanese export point of view.

At the end of the day, and given what we know about the Japanese economies dependence on exports the future evolution of the export data will be crucial for determining just how well the Japanese economy is able to weather the storm caused by cooling global economic growth following the financial turmoil associated with the crisis in the U.S. subprime mortgage market.

So going back to our charts, rather than simply reading Chinese tea leaves, my feeling is that we need to keep a close eye on the evolution of Japanese exports to those three big customers - the EU, the US and China - if we want to get an early indicator of whither the Japanese economy is headed at this point.

On We Go?

Well, I know that Edward is already preparing something on today's reading on the Japanese surplus which seems to be muddling along just fine even in the midst of ever more uncertain global economic conditions. The question is of course whether this will continue?

Meanwhile, Bloomberg also looks forward this morning to a slew of data due at the end of the week. And the predictions?

On inflation the consensus remains sure that Japan remains in deflation and so do I especially since if we look at the core-of-core index.

Core consumer prices, which exclude fresh food, dropped 0.1 percent from a year earlier, the same pace as the preceding four months, according to the median estimate of 44 economists surveyed by Bloomberg News.

On industrial production however the analysts are rather bullish ...

Separate reports also on Sept. 28 are likely to provide better news on the world's second-largest economy. Industrial production grew 3 percent in August from July, when output dropped 0.4 percent because of an earthquake, according to the median estimate of 46 economists. That would be the biggest gain in almost four years.

Perhaps we will see some seasonal swings on the back of the earthquake in the months to come? Yet, if indeed IP were to grow at 3% it would go some way to falsify my hypothesis that industrial production could be heading for a sustained downward trend in the remainder of 2007. In this light also the recent readings on the trade surplus provides good reading since this is sure to keep those factories ticking. I am awaiting this one with some excitement then.

Finally we have the predictions on unemployment and consumer spending;

The jobless rate probably held at a nine-year low of 3.6 percent and household spending climbed 1.2 percent, the fastest pace since February, analysts predict.

On consumer spending a rise of this magnitude would indeed constitute something of a rebound relative to recent month's meager performance. Once again, there might be some seasonal rebound going on here which of course needs to be smoothed out but I won't be looking for a positive number of the kind we are seeing here. In any case, please do remember my general prediction here in the sense that whatever we attribute to m-o-m readings we are not likely to see Japanese domestic demand push the 1% threshold in 2007.

So, let us wait and see; it is difficult to see just how much importance which can be attributed to this week's readings in themselves since there are bound to be earthquake rebounds etc entrenched in the data but still interesting nonetheless. One thing seems certain which is that if we get an overall positive reading the de-couplers will come back out, the Yen will shoot up, and the BOJ will consequently be pitched to raise before year's end. Luckily, we don't have to believe everything which comes out on the war drums, especially not in these market conditions.

Wednesday, September 19, 2007

No Hike in Sight at the BOJ

(Cross-post from Alpha.Sources)


As Bernanke chooses to cut 50 basis points and as economic growth is visibly slowing in Europe and even contracting in Japan I don't think many of us expected the BOJ to raise rates. As such, Fukui and his colleagues duly chose to stand firm yet again yesterday as the economy contracted in Q2 2007 and remained mired in deflation. In this way it indeed seems as if Fukui is going to find it mighty difficult to end his term at the BOJ on a hawkish stance. The official decision by the BOJ can be found here (PDF!) as well as the accompanying statement from which I quote below.

Japan's economy is expanding moderately.

Public investment has been sluggish. Meanwhile, exports have continued to increase, and business fixed investment has also continued to trend upward against the background of high corporate profits. Housing investment has fallen lately. Private consumption, however, has been firm in a situation where household income has continued rising moderately. With the rise in demand both at home and abroad, production has continued to be on an increasing trend, although it has been flat most recently.

Japan's economy is expected to continue expanding moderately.

Exports are expected to continue rising against the background of the expansion of overseas economies as a whole. Domestic private demand is likely to continue increasing against the background of high corporate profits and the moderate rise in household income. In light of these increases in demand both at home and abroad, production is also expected to follow an increasing trend. Public investment, meanwhile, is projected to be on a downtrend.

Clearly the main narrative above is riddled with hedging and essentially a lot of word salad given the actual trend we are seeing but this I think is the normal nature of these kinds of statements. People should be clever enough to make up their own minds based on the present data. However, I do think that it would be a mistake to interpret the above as a sign that the BOJ will find space to raise rates anytime in the remainder of 2007. Of course, markets don't agree with me completely :) and thus seem to have a bit of difficulties finding their feet at the moment or at least this is the way I choose to interpret the fact that yields on Japanese notes actually rose on the back of 'bad-boy' Atsushi Mizuno's consecutive dissent in the BOJ's voting which is seen as a forward looking sign that the BOJ might just raise before the end of 2007. Clearly, the Fed decision in itself will have had something to do with this but as for the expectation of a BOJ hike in 2007; well, here is to hoping but I fear that this indeed constitutes a fools hope. For a general overview of the recent economic data and commentary on Japan you can check out the latest posts on Japan Economy Watch which almost constitutes a veritable tableau de noirceur over the recent slowdown in Japan.

If you want to get really up to date on Japan I reproduce the list of my most recent notes on Japan below ...

Japan - The Fundamentals Linger

Still Holding at the BOJ

Small Update on Japan

Is Japan Heading for a Recession? (GEM note)

Furthermore, I recommend you to stay in touch over at Japan Economy Watch where yours truly, Edward Hugh as well as Scott Peterson are always busy to keep you up to date on Japan. Lastly, I also want to endorse the excellent Japan Economy News Blog maintained by Ken Worsley which also presents a never ending stream of commentary and analysis on the Japanese economy and society. In fact, you could even say that between Worsley and the JEW team you don't even need Bloomberg, the FT etc. Ah well, that is of course for you to decide.

Tuesday, September 18, 2007

Japan Services Activity Down In July

Demand for services in Japan fell in July (slightly).The tertiary index, which is a gauge of money households and businesses spend on services ranging from phone calls to leisure, slipped 0.5 percent from June, according to data from the Trade Ministry released this morning. This data point is significant since services these days form such an important part of domestic consumption (Actually, honest answer, I don't really know how much. This is something I should calculate. Maybe when the next quarterly GDP numbers are released). Anyway here's the relevant chart:



This really confirms my general impression that Japan peaked domestically at the turn of the year. Since that time the general trend has been slightly down. With exports now under threat from the global slowdown this trend should become a little more pronounced as we go into the winter. Also the July reading is significant, since it forms part of Q3. It also accompanies data we have seen about machine orders being slightly down. If this pattern continues a second quarter of negative growth now looks very much on the cards.

Monday, September 17, 2007

Catch-22...Japanese-style

A Google search very quickly turned up an article by William Pesek Jr. from the International Herald Tribune which states that "roughly 96 percent of Japan's government securities are held domestically, enabling officials to avoid capital flight even as they sell mountains of debt." This is a very important factor to consider when reviewing the data and commentary that Edward and Claus have provided in recent posts here. Given that most Japanese government debt is held domestically, will ratings downgrades have any meaningful effect on the valuation and ownership of this debt? I tend to think not.

Another question that comes to mind is where the cash for the increased purchases of US Treasuries by Japanese is coming from. Presumably from the proceeds of recent trade surpluses with the US, as Japan's sovereign debt hasn't been decreasing. However, given that there seem to be few viable domestic investments available to Japanese investors, purchases of US debts aren't surprising.

Unlike Edward, I tend to agree with Richard Katz's assertion that ""Behind this inordinate export reliance is a recovery strategy that suppressed wages and consumer spending. Falling real wages raised corporate profits and helped finance the resolution of non-performing loans." I would note that this strategy is nothing really new. Japan's economic policy has alwas been to keep the greater part of the proceeds from its economic growth since the beginning of the post-war rise out of the hands of the labor force and re-invest them into its export sector. That is why the Japanese populace has a standard of living considerably lower than the citizens of other industrialized nations. Whether the resolution of Japan's banking crisis was assisted by some adjustment of this general policy is beyond me at the moment, but if the case would not be surprising to me.

However, I agree with Edward that analysis of Japan's situation based on life-cycle consumption theory and productivity theory are a necessity and the conclusions we assert here at Japan Economy Watch that Japan is very close to hitting the proverbial wall based on the results of such analysis are really undeniable. I welcomed Edward's quote from the Fitch official that "Japan needs to make difficult decisions about its budget, said James McCormack, head of Asia sovereign ratings for Fitch, following the resignation of Prime Minister Shinzo Abe. ``The government has to raise taxes and cut spending, and it is difficult for a weak government to do either,'' McCormack said, speaking by phone from Beijing. ``The timing of Abe's resignation is odd, although the actual resignation is not.'' I would just say that it is pretty much difficult for any government to raise taxes and cut spending. However, given my first point, the Japanese public have been issuing IOU's to themselves, presenting the tax hike/spending cut as a way to pay themselves might possibly motivate the voters to approve such a policy. But it seems unlikely...

Friday, September 14, 2007

Japanese Appetite For US Bonds On The Rise?

Japanese investors bought more foreign bonds in net terms last week than at any time in the last two years. The appetite for US bonds seems to have been boosted, rather than deterred, by increasing expectations of a cut in the US benchmark interest rate.This would seem to be for the rather perverse reason that if the Fed have to lower interest rates this is probably an indication that the US economy may be rather weak going forward, and since the Japanese economy is effectively dependent on exports to the US - even if via the Asia route - then the likelihood of any kind of raise form the BoJ in the near future drops steadily towards zero.

As predictions of a cut in the Fed funds rate continued to multiply, investors rushed into US government bonds before prices became even higher, analysts said. Net buying soared to Y1,392bn compared with Y140bn the week before, the finance ministry said on Thursday.

News last Friday of a drop in US employment turned the flow to US bonds into a stampede. These were particularly attractive because prices of Japanese government bonds are unlikely to rise further because yields are already so low.

Akihiko Yokoyama, government bond strategist at JPMorgan, said: “Probably US interest rates should be much lower than current levels. [But] can you really believe Japanese yields can fall?”

Moody's Don't Miss A Shot

Following all the stick that they have taken over the sub prime scandal, one should now expect the ratings agencies to use the vocabulary of "strong vigilance" in connection with those sovereign debts whose scale defy the limits of credulity, especially Italy and Japan. Hence, with all the uncertainty surrounding policy direction following Abe's departure (and see the last post for some indication of the spending pressures which are going to come from the ageing electorate). Moody's have not been slow to react:

Moody’s Investors Service, the ratings agency, on Thursday warned about the danger of policy drift amid the uncertainty. Thomas Byrne, vice-president, said the Japanese economy’s 1.2 per cent contraction in the second quarter of this year remained of concern. “If policy slippage were to allow such trends to go unchecked, the government’s goal of restoring primary fiscal balance by 2011...would be jeopardised.”


This is, I think, what we can increasingly expect from here on in.

Richard Katz in the FT

Japan economy expert Richard Katz had an op-ed in the Financial Times earlier this week which is well worth reading in its entirety. Here I will just pick out one or two points:

Firstly he argues most cogently that Japan has not in any meaningful way "decoupled" from the US.

"Despite talk that Japan has “decoupled” from the US economy, the opposite is the case. The turbulence in Japan’s financial markets unleashed by the US credit crisis is just one sign. More fundamentally, Japan’s current recovery is more dependent on US growth than any recovery in decades. That is because this recovery is extraordinarily dependent on exports. While Japan is steadily shifting its exports from the US to Asia, Japan’s ability to export to Asia hinges on Asia’s own ability to export to the US."


and

"......since 2001, there has been a 77 per cent correlation between Japanese GDP growth and exports a quarter earlier...."

"Those who say Japan is “decoupling” from the US would reply that, since 2002, exports to Asia have soared 52 per cent, while exports to the US are flat. But this view overlooks the triangular trade. Much of Japan’s exports to Asia and China consist of parts, supplies and equipment used for Asia’s own exports to the US. Japan is able to export so much to Asia only because Asia exports so much to the US. If Japan’s exports to Asia and China, which buy 40 per cent of Japan’s exports, were mainly for the domestic market, they would correlate with the ups and downs of these nations’ GDP. Instead, they correlate much better with Asian/Chinese exports to the US. If a US downturn caused the US to cut imports from Asia, Japan’s own export drive would stop in its tracks."

"Far from becoming “decoupled”, Japan’s economy has become even more dependent on US growth during this decade. America’s high-technology downturn in 2000 sent Japan and its Asian markets into a tailspin and then the US recovery served as the locomotive for recovery. In 2000-2007, the correlation between GDP growth in the US and Japan was 74 per cent. No other comparable period going back to at least 1980 even comes close."


Some idea of the intimate relation which operates between US growth and Japan growth can be observed in the chart below:



Apart from something that happened in Japan during 2004, and the last quarter of 2006 (which is of course exactly when the "decoupling" argument got going, more of this in other posts, there is something decidedly strange about Q4 2006 in more places than Japan) the fit ain't too bad, as they say.

Also, if we look at a chart comparing Japanese GDP growth and exports we can see that there is a strong general relation.



Now all of the above argument which Richard Katz advances I largely agree with - although I think possibly the share of Japanese exports to the eurozone might bear examination, since with the very low value of the yen, exports to Europe have also been on the rise. But this, in part, is beside the point, because of course - via German export dependency - the eurozone is itself partly dependent on US consumption growth (although this is to some extent masked by the current strong East European upswing, on which Germany is also very dependent).

The point is in part all this exporting has been possible due to the very low value of the yen. And why has the yen been so low? Well in large part this is a story of the very low interest rates offered by the Bank of Japan, and the consequent movements of funds out of Japan in search of yield (and in particular recently of retail investor funds, see Stephen Jen in this very interesting piece on the MS GEF last week).

And why has the Bank of Japan been unable to raise interest rates, well largely due to persistent deflation and very weak internal consumption growth, that's why.

Which brings us to why internal consumption is so weak, and to why Japan suffers from such persistent deflation. This is where I really part company from Richard Katz. For Richard the weak consumption is the result of a deliberate policy which has been pursued in Japan:

"Behind this inordinate export reliance is a recovery strategy that suppressed wages and consumer spending. Falling real wages raised corporate profits and helped finance the resolution of non-performing loans."


Now I'm not saying that intentional policy has played no part in this situation, but I seriously question whether it holds the biggest part of the explanation. Normal economic theory offers us two straightforward explanations as to why consumtion might weaken as populations age, and Japan's population (along with that of Germany and Italy) has aged very rapidly over the last couple of decades.

In the first place the standard life cycle saving and consumption theory - for which Franco Modigliani got a nobel prize - indicates that, since populations age just as individuals do, we ought to expect to observe patterns in the levels of savings and consumption as this ageing takes place, with the general feature that credit-driven consumption booms become less pronounced (since there are proportionately less young people to do the borrowing). This is in effect what we observe in all the three above named countries, none of which are likely to have a very strong "sub-prime" default issue on their domestic books, for the simple reason that despite the fact that their populations had access to the same low interest finance as everyone else, they simply did not have housing booms which were in any way comparable with those which occured in the US, Ireland, Spain, the UK or Australia.

In the second place there is productivity theory. This suggests that there is an age related pattern in our productivity profiles, with our level of productivity being comparatively low when we are young, rising to a peak in mid-life and then tapering off slowly as we get older. This produces what could be termed the "prime age worker" effect. This effect means that those societies who have the highest shares of workers in the 35 to 55 age group should be the most productive (in terms of their capacity to generate value added).

The prime age wage/productivity effect is illustrated in the chart below which shows how the age related earnings structure has moved in Japan over the years between 1970 and 1997.



Perhaps the most striking feature of this chart - apart, that is, from the fact that wages generally peak somewhere in the 50-54 range (assuming this wage profile to be some sort of reasonably proxy for what actually happens to productivity) - is the fact there has been little noticeable drift to the right and indeed that the curve has hardly shifted at all between the 1970s and the 1990s. This tends to suggest that while we are all living rather longer (as evidenced by our rising life expectancy) we are not necessarily leading "more productive" lives in the economic sense, or at least not to the same degree as our lives - including our working lives are getting longer.

These curves are of course interesting, since they give some economic explanation for why those societies with very high proportions of the labour force in the 15 to 30 age groups (the very high fertility societies) tend to have a comparatively lower standard of living than those with a high proportion in the 35 to 55 age groups. Equally it is not surprising to find that in a society like Japan, where there are a growing proportion of workers in the 55 to 75 age range (some outline of the employment dynamics of the Japanese labour market and their impact on wages can be found in this post), aggregate average wage levels are trending down in comparison to what they were earlier, rather like the wages commanded by a veteran football team would not be the same as those of a team when their players were at their prime.

These curves also give us something to think about in relation to one of the popular solutions advanced (see OECD, World Bank etc) for maintaining living standards in an ageing society - increasing female participation rates. This is of course entirely feasible as an objective, but it should be remembered that, in the Japanese case, the majority of the available female labour is in the comparatively higher age groups, and have limited education and work experience. So the per capita value of this labour, even if it were put to work, would be more likely to lower rather than raise the average wage level, even though it might raise the overall income generating capacity of Japan Inc as a totality, and might generate extra income for the government with which to pay for the growing demand on welfare services.

So the bottom line is that while it is clear that increasing participation can to some extent offset the decline in collective earning capacity, this process has limits and limitations. In particular these limitations mean that Japan is likely to be an export driven economy for many a year to come.

Which brings me neatly to the latest version of the "Concerned About Life" survey which is conducted annually by the Japan Cabinet Office and which was published last week in its 2007 version (Japanese only).


A record 69.5 percent of people surveyed (across the whole of Japan) were concerned or anxious about life, and this reading is up 1.9 percentage points from the previous survey last year. Among those who expressing concern, 53.7 percent felt anxious about life after retirement and 48.3 percent felt anxious about their health while 72.4 percent of total respondents called for the government to reform the social security system, particularly in the medical and pension fields.

When asked what they wanted from the government, 72.4 percent called for social security reform, 55.8 percent called on the government to take measures to deal with the aging of society and 49.6 percent urged the government to take measures to revive the economy.

Now I think it is reasonable to assume that a significant proportion of those people who want health and social security reform from the government don't want less health care and lower pensions, but this is precisely all any Japanese government can offer them give the export dependent growth and given the large government debt (as a % of GDP) that has already been accumulated.

So when 55.8 percent call on the government to "take measures to deal with the aging of society", the only measures that I know of which can help slow down the ageing process are accelerating immigration and raising fertility, but both of these issues needed to be addressed 20 years ago, and reacting now is going to be very hard work indeed. That is Japan's tragedy.

Wednesday, September 12, 2007

Japan Consumer Confidence Index August 2007

The Cabinet Office today released the August consumer confidence survey results. I think they speak for themselves. Here's the general index:



and here are the various sub-components:



Of course, could it be any coincidence that all of this is announced on just the day that Abe decides to resign?

The Ratings Agencies and Japan Government Debt

As explained here, with outstanding Japan government debt variously estimated to be somewhere in the region of 150% of GDP, and structural liabilities growing as Japan's population ages rapidly, the fiscal situation in Japan has to be a matter of growing concern. In particular given the recent severe criticism that has been leveled against the ratings agencies, we can increasingly expect them to be anything but generous in the way they handle those with extreme problems in this area like Italy and Japan.

Fitch Ratings ruled out an upgrade to Japan's investment-grade credit ratings because of concern about the nation's ``extraordinarily high'' debt burden.

Japan needs to make difficult decisions about its budget, said James McCormack, head of Asia sovereign ratings for Fitch, following the resignation of Prime Minister Shinzo Abe.

``The government has to raise taxes and cut spending, and it is difficult for a weak government to do either,'' McCormack said, speaking by phone from Beijing. ``The timing of Abe's resignation is odd, although the actual resignation is not.''

Japan's yen-denominated notes carry Fitch's fourth-highest ranking of AA- and the foreign-currency debt is one level higher at AA. The nation has the most public debt in the world, estimated by the Ministry of Finance to reach the equivalent of $6.8 trillion by March 2008.

Abe, 52, said at a news conference today that it had become difficult to win public support for policies and that a successor will be decided soon. Party officials said a leadership election will take place on Sept. 19.

Calls for his resignation intensified after the ruling Liberal Democratic Party lost control of the Upper House in July. His approval rating dropped below 30 percent after four ministers resigned and one committed suicide because of financial irregularities, inappropriate remarks and a pension-fund scandal.

``Difficult political decisions on fiscal issues have to be made and they don't look like they are going to happen soon,'' Fitch's McCormack said.

Standard & Poor's

``The reputation of the LDP is not going to be very good whoever the new prime minister will be,'' Takahira Ogawa, credit analyst with Standard & Poor's, said in an interview from Tokyo. ``Abe's resignation is really symbolic of the unpredictability of the government.''

Ogawa declined to comment on whether S&P is inclined to change Japan's credit rating. The company ranks the country's local-currency debt at AA, the third highest.

The government needs to promote a ``more flexible and more competitive'' economic system to boost growth and tax revenues, he said.
Source: Bloomberg

Machinery Orders Fall in July

Yes, that's right, fall. This isn't the impression you would get from reading Bloomberg though:

Japan's machinery orders surged in July at three times the pace forecast by economists, easing concern the economy will contract for a second quarter.

Orders climbed a seasonally adjusted 17 percent to 1.12 trillion yen ($9.9 billion) from June, the Cabinet Office said in Tokyo today. The gain was led by demand for electronic machinery.


Well this isn't what the Japan Cabinet Office actually say. Here is chapter and verse:

"The total value of machinery orders received by 280 manufacturers operating in Japan fell by 0.6% in July from the previous month on a seasonally adjusted basis."


but as they also indicate:

"Private-sector machinery orders, excluding volatile ones for ships and those from electric power companies,rose a seasonally adjusted by 17.0% in July."
"

So domestic private demand is up, but the total is down (go check for yourself if you want).

The discrepancy is due to the fact, as Bloomberg themselves admit, that:

In a sign that demand outside Japan may be slowing, overseas orders fell 10.8 percent in July, the second monthly drop, today's report showed.


So the real story is that domestic demand picked up significantly, but not enough to offset the strong fall in exports. So the conclusions one would draw are quite different from those we find in Bloomberg. In fact if we look at the estimate the Cabinet Office make of anticipated orders during the third quarter, we will find it is -2.4%, ie they are actually expecting orders to be down over the second quarter, when, we will remember, the Japanese economy actually shrank. So basically, and cteris paribus, we can simply expect more of the same in Q3, and looking out globally, the downside risks on this not very optimistic forecast are quite significant, I think. Anyway, such as it is, here the relevant chart for seasonally adjusted machine orders.

Tuesday, September 11, 2007

Yen vs Dollar: recent trend

Here is a chart produced by Yahoo Finance of the dollar-yen exchange rate:
This would seem to reinforce Claus's assertion that the BoJ will do nothing with interest rates, as that would only exacerbate the strengthening of the yen versus the dollar. Given that the export sector is supporting Japan's GDP, Japanese officials aren't going to want to touch anything that would damage exports with a ten foot pole...

Monday, September 10, 2007

Japan Contracts in Q2

(cross-post from Alpha.Sources)

I see not reasons to mince my words on this one with the recent stark downward revision of Japanese GDP in Q2.

(From Bloomberg)

Japan's economy contracted at almost twice the pace forecast by analysts in the second quarter, reinforcing speculation the central bank will leave interest rates unchanged this year.

The economy shrank at a 1.2 percent annual rate in the three months ended June 30 as business spending slumped, the Cabinet Office said in Tokyo today. The government initially forecast a 0.5 percent expansion.

Bond yields fell to the lowest level since February last year on expectations the central bank will keep its overnight lending rate at 0.5 percent to prevent the economy from falling into recession. Any rebound in growth depends on the severity of the housing slowdown in the U.S., the biggest export market for Japanese companies including Toyota Motor Corp. and Sony Corp.

``A move by the Bank of Japan is out of the question,'' said Takehiro Sato, chief economist at Morgan Stanley Securities Japan Ltd. in Tokyo. ``A cloud is hanging over the domestic and global economy.''

And for the graphical version ...

For a general assesment of the current economic situation I recommend you to re-visit my recent notes.

Japan - The Fundamentals Linger

Still Holding at the BOJ

Small Update on Japan

Is Japan Heading for a Recession? (GEM note)

As for the immediate outlook in Japan it clearly seems evident now that whatever plans the BOJ might have had to continue normalization must now be shelved. Regarding the general annual growth estimate the current Q2 numbers will obviously weigh negatively in the overall balance. I will however be looking for somewhat of a recovery in Q3 relative to the curren q-o-q -0.3% contraction. The key as is also mirrored in the Q2 figures' steep downward revision of corporate capex will clearly be to what extent business investment will recover. As I argued in my recent GEM note (see link above) a downside has opened below industrial production especially if the US economy continues to linger in the subprime mess; something which seems very plausible at this point. In short, no de-coupling I think. Domestic consumption will likely continue to stay in positive territory but as always with Japan the positive contribution will be most modest. In the end Japan could very well be looking at a H2 which on a q-o-q basis will fair very close to stagnation.

GDP Q2 2007 Downward Revisions

"Is Japan Heading for a Recession?" Claus asks us in his last post, and the answer looking at the latest set of GDP revisions may well be yes.

Japan’s economy shrank more sharply than expected in the second quarter, and revised growth domestic product data released today show an annualised contraction of 1.2 per cent. In general we had been expecting a downward revision following evidence last week that capital spending, a big driver of growth, had slowed sharply. But the fall of 0.3 per cent in quarter-on-quarter terms against a preliminary estimate of 0.1 per cent growth was deeper than even we expected.

The reversal from annualised growth of 0.5 per cent to a decline of 1.2 per cent in the second quarter is explained almost entirely by a change in the assessment of capital spending. Preliminary data indicated that this had grown at an annualised rate of 4.9 per cent, but this figure has now been revised down to a contraction of 4.8 per cent.

This kind of data has lead JPMorgan to revise down its estimate for annual growth in the year to end-March 2007 from above 2 per cent to 1.6 per cent. Even more to the point they now expect the central bank to refrain from a rate rise until at least next year, with the implication that there would be minimum a one-year gap between quarter-point rate increases. And this is at the earliest!

Anyway, here's the revised chart.




My personal feeling is that the Japanese expansion has been steadily losing momentum since the end of 2005. Exceptional global conditions in the last quarter of 2006 gave a hefty push to Japanese exports, and, as a consequence, to capital spending (domestic consumer demand has hardly budged). Since I doubt in the current environment that these global conditions will be reproduced this autumn (indeed, the opposite may hold if the US now goes into recession) I am not anticipating a recurrence of what happened in Q4 2007. It remains to be seen, at a global level, how much of the expansion which took place during the back end of 2006 was really sustainable (on Eastern Europe, which was an important part of the picture I certainly have my doubts) and how much was an "excess" which is now in the process of being corrected. Only time will tell. But in the meantime I am certainly not forecasting any further rate hikes from the BoJ, either in what remains of this year, or during as far forward as we can see into 2008.

Thursday, September 06, 2007

Is Japan Heading for a Recession?

By Claus Vistesen

While financial markets are gazing firmly towards the US economy shadowing Ben Bernanke's every word and gesture for a hint of future rate decisions economic fundamentals in Japan are trending firmly and steadily downwards into worrisome territory. At this point however the headline chosen for this entry might still seem rather alarmist but given the nature of lag of economic data relative to the present time I don't think that this question is entirely worthless to entertain. In this light, this entry should be seen as a small update relative to the large review and preview note on Japan posted recently here at GEM. This entry consequently gathers data from recent entries at Alpha.Sources as well as Japan Economy Watch to bring our readers fully up to date with the economic situation in Japan.

Let us begin with some simple charts which plots Japanese GDP in quarters as well as annually since 1995 so that we can get an idea of where were are. Based on the quarterly measures it is of course impossible to discern a trend but as we turn to the annual figures we can see how Japan indeed is currently enjoying what seems to be a persistent positive trend in GDP from 2001 and onwards. Yet, if we look at quarterly figures we can see that Japan in Q2 2007 was seriously flirting with the dreaded 0% mark (quarterly!) and with the recent revision of corporate capex we might even be looking at a contraction. This does not of course indicate that Japan is heading for a recession but it means that we are likely to enter a period where Japan very well could be flirting with the probability.

Moving further I present a quick extension of the short-term charts on prices and domestic consumption presented in the previous Japan note. As we can see, the trend continues with stagnating domestic demand as well as continuos and persistent deflation. Note in particular the core-of-core rate which slumped to -0.5%. Regarding household consumption the trend has been trending steadily down towards stagnation after beginning 2007 on a bright note.

Finally and before I leave you I want to note two further aspects of the Japanese economy. The first relates to the much debated issues surrounding industrial production; Edward provides the relevant data and commentary here. It is still too early to say anything but it clearly seems that industrial production, while it has somehow abated on the back of the peak in Q4 2006, still is situated on a high ground relative to the beginning of 2006; the latest incoming data point show how industrial slipped slightly in July with -0.4% drop on a seasonally adjusted basis. As I have stressed before the gauge for industrial production is intimately related to the evolution of the trade surplus and in this context the mounting and lingering uncertainty surrounding the US and indeed global economy represents a notable downside from the point of view of corporate capex. In fact, if the recent downward revision of corporate capex is a sign of things to come we could be looking at a correction of industrial production which could fare well into H2 of 2007. This call is of course perfectly falsifiable since the future monthly readings will tell us what to expect. I don't quite think it is safe to lay out this rather bearish forecast but a second monthly decline in August would indicate, I think, that industrial production very well could begin to correct in the quarters to come. The second and thus final aspect I feel the need to note is the general tendency on the labour market where tightening continues alongside the trend of falling wages, something which of course runs counter to what we learn from economic textbooks. In stead of moving into a detailed assessment at this point I am taking a shortcut by pointing towards the recent analysis provided by Edward over at JEW.

Conclusively, the following bullit points sums up the current trends in the Japanese economy all of them intimately related to the ageing of Japan's population as well as the ongoing turmoil in financial markets.
  • Don't expect the BOJ to raise anytime soon. Of course and in terms of invesment decisions the traditional disclaimers apply but I honestly have a hard time seeing how the BOJ can justify a raise in this context even if Fukui is determined to finish his term on a sound footing whatever that means.
  • Japan remains well entrenched in deflation and even though headline inflation (which in this case include food) is set to nudge up we should be looking at the underlying trend which is generated from domestic Japanese activity and thus the core-of-core index.
  • Domestic consumption remains depressed. This does not mean that we are witnessing a secular decline but rather that the trend is low and overall negative. Increasingly, we also need to realize that whatever terms we apply to the current trend of domestic demand it does not conform with the idea of an economy being driven by internal dynamics.
  • Regarding cyclical indicators downside risks seems to have emerged regarding the external demand for Japanese goods and thus also industrial production and more general corporate capex. The main culprit here is of course the mounting uncertainty surrounding the strength of the US economy and with industrial production currently sitting on a high plateau Japanese growth rates are particularly sensitive at this point given the de-facto reliance on corporate investment as a derivative of net exports.
  • Japan's labour market continue to defy conventional textbook wisdom as the ever declining unemployment rate fails to spur wage inflation. In fact, wages are now clearly set on a lingering downward trend on an aggregate basis. In order to come to grips with this fact and thus also in order to align expectations with reality we need to take a long hard look at Japan's population structure. I know this is indeed one of the recurring tedious claims of mine but it is equally as tedious to see how the discourse is not budging; even if this is not entirely true but there is still some distance to travel I would say.

Monday, September 03, 2007

Japan July 2007 Wages

Japanese monthly wages, including overtime pay and bonuses, dropped 1.9 percent in July, the eighth monthly decline and the fastest pace in three years according to the Labor Ministry in Tokyo today.



This development in Japanese wages is by no means new, as can be seen from this chart for annual changes over the last 4 years. In fact total earnings went down in both 2003 and 2004:



Comment

The failure of Japan's strengthening job market to translate into higher pay is hindering growth in consumer spending, which accounts for more than a half of the economy. That leaves the nation reliant on exports at a time when a U.S. housing recession is threatening global growth.

``Falling wages could jeopardize the recovery in consumer spending, leaving Japan more dependent on foreign demand,'' said Yoshiki Shinke, chief economist at Dai-Ichi Life Research Institute in Tokyo, before the report was released.

One reason average wages have slipped since December is the replacement of retiring baby boomers with younger, cheaper employees. Another is the increased hiring of part-time workers, whose pay is on average less half that of full-timers, Shinke said.

Average pay fell about 10 percent between 1997 and 2005. One in three Japanese workers is a part-timer today, compared with one in five a decade ago.
Bloomberg

Investment In Plant and Equipment Q2 2007

Corporate investment in Japan declined in the second quarter of 2007 following a sharp fall in spending in the predominantly domestically focused non-manufacturing sector. According to data released by the Ministry of Finance in Tokyo today, capital spending sank 4.9 percent in the three months ended June 30 after advancing 13.6 percent in the first quarter. Here's the chart.


We can also see that this was the lowest reading since Q2 2005, and gives us some indication of one of the factors responsible for slow Q2 GDP growth, although it does seem that there is some possibility that the Q2 data may now need to be revised downwards. The big question, of course, is what is happening during Q3. But do note this quote in Bloomberg from Hiroaki Muto - senior economist at Sumitomo Mitsui Asset Management in Tokyo - ``We can't rule out the possibility that the economy shrank last quarter, though such a dip would be temporary. "

So in fact, the longest Japanese expansion in recent history may have already ended.

Comment

The report may hinder the Bank of Japan's case that the economy is strong enough for it to raise the key overnight call rate in two weeks. Companies may pare investment even more in the coming months if the U.S. housing crisis curbs demand in Japan's largest export market.

``The U.S. housing recession is a risk factor and may slow foreign demand,'' said Naoki Iizuka, senior economist at Mizuho Securities Co. in Tokyo. ``It is too early to conclude that capital spending will be a problem for the Japanese economy,'' he said, adding that a change to the sample used by the finance ministry may have distorted the reading.
Bloomberg