Japan's Industrial Slump Deepens In January

Japanese manufacturing output fell in January by a record 10 per cent month-on-month while new job offers declined 18 per cent, reflecting the deepening recession in the world’s second biggest economy. Industrial production was down a whopping 30.8 per cent year-on-year, as manufacturers of vehicles, electronics parts and devices and general machinery slashed output to adjust to the rapid fall in global demand.

According to the Ministry of Economy Trade and Industry, which unveiled the figures, production is expected to decrease again in February, by 8.3 per cent, which seems pretty reasonable if you look at the PMI (see below). If production matches forecasts for February and March, we could see a 22.5 per cent decline in output for the first three months of the year, well above the 12 per cent fall in the last quarter of 2008, amd potentially the largest ever quarterly fall in Japanese output. If this is the case Q1 GDP will be a real shocker.


The fall in industrial output is being driven by a fall in Japanese exports, which slumped by a record 45.7 per cent in January.

The February manufacting PMI showed manufacturing activity contracted for a 12th straight month in February, underscoring the fact that the depressed state of Japanese industry is likely to continue. Although the Nomura/JMMA Japan PMI edged up to a seasonally adjusted 31.6 from a record low of 29.6 in January, it remained well below the 50 threshold that separates contraction from expansion.

And if we look at the comparison between PMI and GDP to be seen in the chart below, we can see that Japan may be looking at something like a 5% quarter on quarter contraction at this point, or a 20% annualised rate of contraction.


This is much worse than the Q4 2008 contraction since gross domestic product declined at an annualised rate of 12.7 per cent.

Japan's Exports Collapse In January

Japan’s exports plunged by 45.7 percent year on year in January, producing a record trade deficit, as recessions in the U.S. and Europe, and a sharp downturn in China crushed demand for the country’s machinery, cars and electronics. A drop of this size is truly staggering.

“People are coming to realize that Japan is in deep trouble,” said Hiroshi Shiraishi, an economist at BNP Paribas Securities Japan Ltd. in Tokyo. “Considering what’s happening on the export side, and the implications that has for the domestic economy, the yen is clearly not a buy.”

Japan's trade balance was sent deep into red territory driven, of course, by the 45.7% fall in overall exports to 3.48 trillion yen. As can be seen in the chart below, the yen value of Japanese exports has simply collapsed in recent months.

“The economy already seems to be falling apart,” said Masahiro Eguchi, who manages economic research at Shoko Chukin. Companies are likely to cut production more steeply, he said, and even if they continue to reduce output at the current pace, “many small companies won’t be able to survive.”

Imports, at 4.44 trillion yen, were down 31.7 percent from a year earlier.The declines in both importas and exports widened the trade deficit to 952.6 billion yen ($9.9 billion), the biggest since 1980, the earliest year for which comparable data is available. The drop in export shipments abroad eclipsed the previous record of 35 percent decline set only last month.




Exports to the U.S. fell an unprecedented 52.9 percent from a year earlier, and shipments to Asia and Europe also clocked in their largest-ever declines as the global recession deepened. Shipments to Europe slid 47.4 percent in January from a year earlier, while exports to China fell 45.1 percent and those to Asia dropped 46.7 percent.

Even emerging economy sales in countries like India, Brazil, Vietnam and Russia, which had buoyed up the numbers in the middle of 2008 have fallen rapidly. Exports to India were down by 34.9% year on year, Brazil exports fell 38%, Vietnam 48.4% and Russia 65.5%.

Japan's economy shrank at an annualised rate of 12.7 percent pace in the last quarter, the most since the 1974 oil shock, and it is clear that the worst is yet to come. The consensus forecast at this point is that Japan's economy may shrink by a record 4 percent in the year starting April 1, but even this may now be optimistic. The worst contraction Japan has seen to date was in fiscal 1998, when the economy contracted by 1.5 percent.

And while talk from the Bank of Japan of possible share purchases saw Japanese stocks rebound from quarter-century lows and the yen was trading at its weakest level since last November the Japanese government has still been unable to pass the stimulus package that could help encourage domestic spending in the absence of export demand. Prime Minister Taro Aso is struggling to get approval from the opposition-controlled upper house to spend 10 trillion yen to aid companies and households. But while the politicians dither, Tokyo burns, or almost.

Japan's "Unimaginable" Contraction

Well, it isn't only in Europe that we are having a hard time of things. Last week Kazuo Momma, head of the Bank of Japan’s research and statistics department, warned that Japan’s economy now faced an “unimaginable” contraction, and today we can begin to see just what the unimaginable might look like, since the preliminary data for fourth quarter GDP are now out. And what we find when we come to stare the unimaginable in the face is that Japan’s economy contracted by 3.3 per cent in the three months to December (compared with the previous quarter), effectively the country's worst economic performance in 35 years.

On an annualised basis, gross domestic product declined at a rate of 12.7 per cent, a number which perhaps better than any other highlights the depth and severity of a slump that has surely now dispelled all those early hopes that the global economy might be able to shrug off the effects of the financial crisis just like that. To puts things in a comparative setting, the contraction was three times as bad as that of the US in the same quarter. Year on year GDP was down by 4.6%.



This quarter's big slide in GDP was in fact the second-worst the country has experienced in modern times, lying just a thin hair's breadth away from the record 3.4 per cent quarterly contraction clocked up in 1974, in the wake of the first Middle East oil shock, and well beyond anything Japan's economy has experienced in what is now the "lost decade and a half".



The slowdown was pretty generalised, but lead most decisively by exports which plunged an unprecedented 13.9 percent from the third quarter (see chart below). In fact Japan has become systematically more dependent on sales abroad for growth over the past decade, and overseas shipments make up 16 percent of the economy today compared with about 10 percent in 1999.




Domestic demand, which includes spending by households and companies, made up 0.3 of a percentage point of the contraction, while capital investment fell 5.3 percent. Manufacturers cut investment spending by a record 11.3 percent in the quarter, indicating they have little need to buy equipment as factories lie increasingly idle. Consumer spending, which accounts for more than half of the economy, dropped 0.4 percent on the quater, as exporters began firing workers.

“There’s no doubt that the economy is in its worst state in the postwar period,” Economic and Fiscal Policy Minister Kaoru Yosano said in Tokyo. “The Japanese economy, which is heavily dependent on exports of autos, electronics and capital goods, has been severely hit by the global slowdown.”

After ten years of sacrifice and reform, it must be pretty shocking for most Japanese to discover that their economy is still in "terrible shape".

And The Worst Is Still To Come


Evidence of Japan’s slowdown can now be found right across the economy. On Monday the country’s electric utilities industry association said that power generation had fallen 6.4 per cent in January as the industrial sector rapidly winds down. This was the sixth straight monthly decline and the steepest fall since a 6.9 per cent drop recorded in July 2005. Even Japan's services sector is suffering, and the new Japan Services PMI, compiled by Markit Economics on behalf of Nomura and published for the first time on the 4th February, showed the country’s downturn deepening in January.

In addition the Nomura/JMMA Manufacturing PMI survey indicated that the goods producing sector contracted at a series record rate in January, in excess of the 22.5% annual decline indicated by official Trade and Industry Ministry (METI) data for December, with plummeting export sales leading the sector’s decline. With both manufacturing and service sectors reducing employment at sharp rates in January, consumer confidence – and therefore household forthcoming spending on both goods and services – looks set to deteriorate further moving into Q1, dragging Japan’s economy deeper into recession.

Japan’s consumers remained at their most pessimistic level in at least 26 years in January (see chart below), indicating households are likely to keep cutting back on spending as the recession deepens. The confidence index nudged up very slightly 26.4 from December's 26.2, according to the Cabinet Office last week. December's numbers had been the lowest since the government began compiling the figures in 1982.



Export Dependency Is The Heart Of The Problem

But why is Japan so export dependent? Well here you will find explanations to suit every palate, but if I can just add my 5 cents worth, I would say that the fact that Japan's population currently has the highest median age on the planet is not simply an incidental correlate (nor is the fact that Germany has the second highest median age and is currently struggling with the same problem simply another incidental detail). Basically years of ultra low fertility coupled with relatively unfriendly immigration attitudes means that the median ages of the Japanese and German population (at 43) are now the highest on the planet. Previously it was assumed that we wouldn't see much in the way of economic consequences from all this till much later in the century, but now, to me at least, it is obvious those consequences are already here.

The consequences are, basically, to be seen in very weak domestic consumption growth, which means that economic growth (which is needed to pay all those pensions and health care costs) is totally dependent on exports, and hence the economic well-being of others. And this growth roller-coaster (which can only get worse as the median age rises further) cannot be that much fun for the population at large. One minute you have the best growth in a decade, and the next you go crashing through the floor. Ouch!

So - in addition to the bank regulations fix - something also needs to be done to slow down the rapid ageing of the Japanese and German populations, and as far as I know there are only two ways to do that, get fertility up, and open the doors to immigration.

In this context it is interesting to note that an 80-strong group of economically liberal politicians in the ruling Liberal Democratic Party (LDP), led by Hidenao Nakagawa, a former LDP secretary-general, are pushing for a change in immigration policy (full story in the Economist here). These venerable gentlemen are calling for the number of foreigners living and working in Japan to rise to 10m over the next half century, and for many of these immigrants to become naturalised Japanese. In addition the Keidanren, the association of large manufacturers, is also shifting position, and last autumn called for a more active immigration policy to bring in more highly skilled foreign workers. The Keidanren estimates the present number to be a mere 180,000. The Economist refers to these moves as bold, I would rather term then "baby steps" in the right direction, although we must wait and see what material outcome such pressures lead to, for good intentions have often been expressed in this regard in the past.

As for fertility, again there is a lot of debate about how to encourage people to have more children, and I am sure there is no easy answer here, but I can think of one thing which would help, and that is a change in the national mindset. You see, maybe it isn't true to say that countries like France, the United States and Sweden will have no problems with population aging, but they will certainly have a lot less than many others, since their underlying pyramids are much more stable. And you know what? Few people in these three countries would question the fact that having enough children to maintain national economic stability is important, while in the worst affected countries - Japan, Germany, Italy, Russia, China etc - we find precisely the opposite situation, with few people thinking of the fertility topic as an important one. Indeed many people in very low fertility countries attempt - often vociferously - to deny that long term demography has any economic significance at all. No wonder then, that people in these countries have less children. So when you make your long list of all the lessons which need to be learnt from all the hurting we are just about to get, be sure to remember to add this one.

To Print Or Not To Print, That Is The Question

Well in a week which has seen Kazuo Momma, head of the Bank of Japan’s research and statistics department warning that Japan’s economy now faces an “unimaginable” contraction, and Prime Minister Taro Aso's approval rating dropping to a mere 14 percent according to the latest Asahi newspaper survey, it should not surprise us to hear reports that yet another set of "exotic" proposals have been put forward in the search for ways of dragging the Japanese economy out of the mess into which it seems to have fallen.

The proposal I am referring to is the latest "initiative" being quietly cooked up by some members of the ruling Liberal Democratic party. According to reports in the Japanese press the politicians in question, who include Yoshihide Suga, deputy chairman of the LDP’s election strategy council and a close aide to prime minister Aso, have set up a working group and are quietly dusting down plans (first advocated by Nobel economist Joseph Stiglitz on a flying visit to Tokyo) for the government to introduce its own private currency - yes that's right its own currency - to run in tandem as a rival the country's already existing official one (aka the Yen) which is essentially exclusively issued by the Bank of Japan.

The plan would seem to involve the printing of some Y50,000bn ($546bn) worth of a new currency to fund government pump-priming projects and arrives at a time of rising frustration among politicians about the posture being taken by the Bank of Japan who have been notably reluctant to bow to pressure and let the yen printing presses run ever faster in a desperate attempt to stimulate the economy.

Among proposals they have on the table are Y30,000bn of the new money to fund programmes supporting new industries and infrastructure projects, including doubling the size of Tokyo’s Haneda airport. The remaining Y20,000bn would be earmarked for government purchases of stocks and real estate.

“We are facing hyper-deflation, so we need a policy to create hyper-inflation.
We have to do something to undermine the central bank and government’s
credibility or else we won’t be able to halt the yen’s rise. So, while we know
this is drastic medicine, we will do it,” said Koutaro Tamura, an upper house
Diet member who will chair the new group.

The proposals are causing all sorts of controversy in Japan. Prime Minister Taro Aso said on Monday evening that "We are not at all at the stage of considering such an idea", while Chief Cabinet Secretary Takeo Kawamura warned that if the government prints money, it could lead to inflation and weaken the yen against other major currencies. BOJ Gov. Masaaki Shirakawa was also pretty critical of the proposal, saying it could "cause great damage" to the central bank's balance sheet and monetary policy as well as market confidence in the yen.

"The plan would require very careful consideration because it could result in jumps in Japan's long-term interest rates, with market participants losing trust in the government's commitment to repaying its debts," Shirakawa said.

Of course, what may lie behind such thinking is an extremely literal reading of a very influential academic paper by IMF economist (and former Paul Krugman PhD student) Gauti Eggertsson How to Fight Deflation in a Liquidity Trap: Committing to Being Irresponsible - right down to the small print. The basic idea is that as expectations of intensifying deflation set in deeper and the economic contraction intensifies a short sharp shock of irresponsibility is needed to convince people that inflation is inevitable.

Weakening the yen, and raising market participants inflation expectations (or their fear that government will irresponsibly monetise its debt), is just what the Eggerston proposal is all about, so fears of such an outcome - as expressed above - would hardly seem to constitute objections, and while it is unlikely that the plan will get very far in the short term (rather than prodding the BoJ into more aggresive action), Japan's crisis is very severe, and getting worse by the day, so clearly they are something out of the ordinary needs to be considered.

Industrial output plunged by a record 9.6 per cent month on month in December,and the consensus opinion among economists suggests GDP may have fallen more than 3 per cent compared with the previous quarter at the end of 2008 – an annualised decline of over 12 per cent.

“From October to December the scale of negative growth [in GDP] may have been unimaginable – and we have to consider the possibility that there could be even greater decline between January and March,” Mr Momma said in a speech.

So perhaps the unimaginable in negative growth may also call for what would previously have been unimaginable policy as a response.