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Thursday, September 17, 2009

A Cautious BOJ Stands Pat

By Claus Vistesen: Copenhagen

As the discourse is slowly but surely tilting towards exit strategies, by part of central banks, from ultra low interest rates and unconventional measures the BOJ opted to day to maintain a very cautious stance towards the incoming green shoots and whether they will prove enough to lift Japan out of the mire.

(quote: Bloomberg)

Officials kept the benchmark overnight lending rate at 0.1 percent, and maintained their emergency lending programs to banks and companies. While describing the economy as “showing signs of recovery,” an upgrade from the “stopped worsening” assessment last month, the Bank of Japan said in a statement in Tokyo today that it still sees “downside” risks to growth. Today’s statement reflected global doubts about the strength of a recovery from the deepest recession since the Great Depression. A Bloomberg News poll of U.S. households published today showed Americans plan to refrain from boosting spending even after the biggest drop in consumption in 29 years.

“Most countries are experiencing a recovery, but few can be confident about the sustainability of those recoveries,” said Yoshiki Shinke, a senior economist at Dai-Ichi Research Life Institute in Tokyo. “Japan will be the last country to raise its interest rate” because it has the added problem of deflation, he said. Bank of Japan Governor Masaaki Shirakawa told reporters in Tokyo today that while stimulus measures have helped the economy improve, “we’re not confident about the strength of private final demand after those effects fade.” He added that central bankers are monitoring the appreciating exchange rate, which is contributing to the drop in Japanese consumer prices.

Japan's problems are many fold but the most severe issues in the context of reading the tea-leaves of the recovery is the uncertainty attached to question of whether the current above par environment will linger beyond the last effects of the stimulus (which was front loaded due to the elections) as well as any inventory bounce which may come as Japanese companies rebuild their empty shelves in Q3.

It is difficult not to sympathize with the BOJ in its careful approach here since if you take a look at the underlying demand conditions they are, to put it mildly, sluggish! Only a week ago, I discussed the situation on the corporate level where companies were hit by falling top line sales on the domestic market and, as a result, only very carefully expanding capex. Moving on to other key economic indicators it is pretty poor reading if we look at the domestic economy in isolation.

By far, the most preoccupying problem has to be the fact that Japan's inflation rate is moving beyond sub-zero and essentially into the abyss which is a painful and almost, if you will allow me to be dramatic, tragic outcome after two decades of fight against this very malaise. Now, I know that we are observing one-off effects from high oil prices in the summer of 2008, but try to have a look a the actual numbers. Consequently the index that actually includes energy is currently running (inJuly ) at a rate of decline of 2.2% whereas the index which excludes energy and fresh food is running at an annual decline of 2.6% and thus more than the headline gauge. Clearly, the BOJ would like to see this figure correct or even stabilize over the summer before contemplating tweaking nominal interest rates.

With respect to consumption, the figure tracked as a headline gauge for domestic demand on the consumer side is quite volatile, but it should not escape our attention that despite its volatility, it has been consistent below the 0% growth mark throughout 2009. Thus the average annual growth rate on a monthly basis has been -1.8% so far in 2008 which suggests as a simple yardstick the negative drift we need to apply to the evolution of domestic demand in Japan.

Finally there is the labour market where the unemployment rate has increased rather harshly since the beginning of 2009 following a mean reverting pattern around 4% throughout 2008. 5.7% which was the reading in July certainly won't make any headlines comparing to the eye-popping figure we are seeing in e.g. Spain or elsewhere, but it is worthwhile contemplating this in a relative sense and thus the effect it is likely to have on the behaviour of already cautious households.

Where Goes the JPY?

If the round-up above suggest, in a real economic context, the current shaky condition of the Japanese economy it seems that Japan now has a new issue to deal with; the unduly appreciation of the JPY. Now, of course these days it may be of less use to look at the JPY measured against G7 currencies rather than for example against China, but the graph below should still capture much of the essence.

I think it is very interesting here to observe that in a post-crisis context the JPY has gained about 20% against the Euro and Buck where it has been ranging since the latter part of 2008. Clearly, this has an effect on the real economy in so far as it reduces the competitiveness of Japanese companies relative companies in the US and Eurozone (not to mention the UK); and remember, deflation here is becoming a zero sum game since at the moment the US, the Eurozone, and the UK is also suffering from a bout of deflation or very low inflation.

Of course, this presents Japan with a whole new problem in the sense that while Japan could hitherto expect to get a double boost from an increase in risk aversion as carry trade activity took hold lowering the Yen and allowing Japan to export away, this route is gettingincreasingly crowded. More specifically, Bernanke has entered the scene and as analysts and commentators start talking about the new "victims" of the global carry trade punt in the form of those brave souls among central bankers who dare raise interest rates before movement in the G3, Japan cannot be certain to be the exclusive funding currency. It has a rival in the form of the USD and notwithstanding the obvious consequences for the global economy that Bernanke is putting up a 0% interest rate on the world's most liquid fiat instrument, Japan might find itself pinched here.

Of course, there is a solution here even though it seems unlikely at the moment, I believe, that it will come to pass.

It was still telling that the branch of RBS in Japan (RBS Securities Japan Ltd) was quoted, by Bloomberg yesterday, personified by chief economist Junko Nishioka for noting, rather dryly I'd might add, that the most efficient way to spur growth in Japan would be through a devaluation. Hmm, that would be fun wouldn't ... a devaluation amongst the G3! Once again, we are left guessing as to just what value of the benchmark USD/JPY that will jolt the MOF and BOJ into joint action; 90, 85, 80, 75 ...? I will leave my readers to do the rest of the guesswork, especially since yours truly has burnt his prediction powers once too many trying to call JPY intervention. So far though, most bets seem off as the incoming Finance Minister Hirohisa Fujii made it quite clear that there will no such nonsense of intervention to weaken the Yen. Also, if Macro Man is right and this is predominantly a Dollar story rather than a Yen story, then what can they do as MM put it earlier this week.

In a general sense, it shall be most interesting to following both intra G3 currency movements and FX in general if and when some economies venture into a decisive tightening mode over the second half of 2009. And for Japan, well she will try to muddle through of course. I am watching the inflation picture closely as well as of course we must watch the extent to which Japan can really couple on to the Asian growth spurt we are currently observing. With respect to policy decisions, I feel confident that the BOJ is locked in at this point to, if not continue QE, then at least to keep nominal interest rates at or very close to the zero bound.

---

[1]: Note, if you correct for stationarity the co-relationship dissipates so I may be over-stepping my bounds here.

Wednesday, September 09, 2009

A brief look at the possible economic impacts of the DPJ victory

It appears that the DPJ has not promised much change in economic policy. In analysis leading up to the election the NY Times stated that

"The main opposition Democratic Party, which polls indicate will end half a century of nearly uninterrupted rule by the Liberal Democrats, has not offered much more than piecemeal remedies to Japan’s biggest problems. Neither party has proposed politically difficult solutions, like allowing in more immigrants — a no-no in racially homogenous Japan — or raising taxes to help reduce the big public debt burden.

“Both parties are ducking the hard issues,” said Takatoshi Ito, a professor of economic policy at the University of Tokyo. “What they do present is a Band-Aid for these problems, not the real surgery that Japan needs.”
A Wikipedia analysis of the DPJ's economic policy proposals lists the following:

-a restructuring of civil service (meaning layoffs and pay-cuts)
-a monthly allowance for families with children (at 26000 yen per child)
-a cut in the petrol tax; income support for farmers
-free tuition for public high schools
-the banning of temporary work in manufacturing
-
raising the minimum wage to 1000 yen
-no increase in sales tax for the next four years
I think that most of these ideas have merit, with the exception of perhaps the farm income support. Agriculture is a sector in Japan that has been heavily subsidized in the past, so additional support is not exactly revolutionary.

Recently, Andy Xie expressed a rather negative opinion regarding Japan's leadership:

“Japan is an enigma. It has been locked in a vicious cycle of economic decline with a strong yen and deflation. Most Japanese people have a strong yen psychology. Politicians and central bank leaders reflect this popular sentiment, which is based on an aging population. Wealth is concentrated among voting pensioners for whom a strong yen and deflation theoretically improve their purchasing power. But I think various theories that explain Japan’s behavior are not good enough. The best explanation is that Japan is run by incompetents, and some are downright stupid. They have locked Japan in an icebox and refuse to come out.”
Strong words. If Japanese citizens are in fact holding out for greater purchasing power due to deflationary psychology, the question is what are the pensioners expecting to spend their savings on?

I think a significant policy that Japan implemented over the last decade has been outsourcing production to China, which provides the labor pool that Japan lacked. This benefited Japanese multinationals, but not domestic workers.

I think, though that this could backfire for Japan as quality will be harder to maintain. The main asset that Japanese companies have now is their reputation for quality goods. If that were to slip, the consequences would be serious.

Sunday, September 06, 2009

Corporate Capex in Japan (Q2-2009) - So, is This What a Recovery Looks Like?

By Claus Vistesen (Copenhagen)

Much pomp and circumstance was certainly made in relation to the fact that Japan actually grew in the second quarter at a full annualized 3.7 percent in the second quarter of 2009. Yet, the underlying numbers to suggest a recovery are still sorely missing. Deflation now seem to have taken hold, unemployment is rising fast and although the recent manufacturing PMI provided us with an upbeat signal, the underlying trend still is still that of a very tepid recover, if at all, or just a plain slump.

(quote Bloomberg)

Japanese businesses cut spending for a ninth quarter as the global recession squeezed profits, underscoring the challenge for the incoming government to sustain a recovery from the country’s worst postwar slump. Capital spending excluding software fell 22.2 percent in the three months ended June 30 from a year earlier, after dropping a record 25.4 percent in the previous quarter, the Finance Ministry said today in Tokyo. Profits slid 53 percent.

Sales fell 17 percent, the second-biggest drop on record, indicating global demand hasn’t recovered enough to encourage companies to buy more plant and equipment. Sanyo Electric Co. and Seven & I Holdings Co. are among businesses scaling back. “Companies have too many resources, and until that situation changes, they won’t have to invest in more equipment and they won’t need to hire more people,” said Seiji Shiraishi, chief economist at HSBC Securities Japan Ltd. in Tokyo.

(click on graphs for better viewing)

On a y-o-y and q-o-q basis, the sales of Japanese companies fell 17% and 4.5% respectively. Especially, manufacturing in general and machinery and equipment producers saw a rapid decline in sales. Investment in plants and equipment fell back sharply on an annual as well as a quarterly basis at 21.7% and a full 39.1% respectively. The pronounced fall in Q2 investment owes itself to an abnormally large outlay in Q1 2009 which has consequently been paired in the period just ended. As can be seen in the graphs to the right, the manufacturing sector has been hit much harder than the non-manufacturing sector which is not difficult to understand if you think about the fact that it is this sector of the Japanese economy which is most exposed to the external environment. This is to say, that the manufacturing sector's top line is very sensitive to external conditions on the margin. Between Q4-08 and Q2-09 the cumulative drop in Japanese manufacturers sales was a whopping 35% almost double that of the non-manufacturing sector's corresponding toll of a drop of 18%.

With respect to investment in plants and equipment (corporate capex) the picture is, interestingly, the reverse with the investment by the non-manufacturing sector falling much more sharply during the present turmoil. On a four quarter moving average basis, the change in investment in plants and equipment for of the non-manufacturing sector has been falling ever since the first quarter of 2006 with a cumulative drop of 37%. The corresponding number for the manufacturing sector shows that the investment of plants and equipments have been falling since the third quarter of 2007 with a cumulative drop of 19%.

Finally, in the context of operating profits (that is, profits derived soled from the company's primary operations), the non manufacturing sector is still well in the black whereas the manufacturing sector has moved from a figure much below average in Q4-2008 to outright red figures in Q1-09 and Q2-09. Between Q1 2000 and Q3 2009 the average quarterly profit (nominal) for Japanese manufacturers was a little over 4 billion Yen.

In Q4 2008, the consolidated profit read 761 million yen and in Q1-09 and Q2-09 the numbers had turned into an outright decline with negative profit of 3.5 billion and 645 million respectively. Conversely, the non-manufacturing sector was, albeit still below average, performing much more strongly with solid black numbers throughout the crisis.

No Recovery Here

While there certainly may be places the newly elected party to rule Japan can look for green shoots and evidence of an impending recovery in Japan, corporate capex and profit numbers are not one them. Neither are, of course, the labour market, the deflation debacle, as well as the household sector which leaves us with the obvious question of where then? Second quarter clocked in better than most had expected and ironically, despite the analysis fielded above, upbeat signals from industrial production and the manufacturing sector in general are cited as the main reason. I will let my readers judge for themselves by perusing the graphs above and then also note the following crucial point made by Soc Gen's Gleen B. Maquire in one of their recent economic outlook reports (my emphasis);

The bulk of the contribution to growth came from net exports. Exports increased by 6.3% qoq while imports declined by 5.1% qoq. Overall, net exports contributed 1.6ppt to Q2 growth. The recovery in the Japanese economy is starting to look eerily similar to the 2001-03 recovery when Japan emerged ahead of Europe and the US. This is largely a China dynamic with Japan’s exports to China (and indirectly to the rest of Asia) recovering in step with China’s stimulus measures coming on line.


(...)

Industrial production is responding to robust demand from China for capital equipment and
industrial goods as well as tentative signs of a recovery in the durable goods cycle within Asia and globally.

So, this appears to be an export story in which case positive news from Japan should not surprise us at all. Macquire goes on to argue that since Q2 did not see a bounce back in inventories from the sharp de-stocking of Q4-08 and Q1-09 this, expected, bounce in inventories. I remain skeptical of this claim since I don't necessarily believe that the new level of growth will necessarily support any rapid re-stocking of inventories, but time will of course tell very soon.

Finally and specifically in relation to the analysis above, it is also interesting to ponder the discrepancy between the manufacturing and non-manufacturing sector in relation to the idea of Japan being dependent on exports to grow. Clearly, the manufacturing sector's higher sensivity with respect to the financial crisis and its top line makes sense since external conditions deteriorated very rapidly. Conversely, the domestic economy of Japan was not struck by a major, and relatively large, credit crunch. Hence, we see the top line of non-manufacturers relying more on domestic demand decline less. On the other hand, in relation to corporate capex the manufactures' slump in investment is very exclusively tied to the financial crisis while that of the non-manufacturers seem much more broad based. Once again can we rationalize this through the idea that the manufacturers remain tied to external conditions while that of the non-manufacturers is increasingly tied to the domestic market.

So, does this last niggle make sense? I am not sure, but it would be an interesting thing to check.