Japan Machinery Orders, Leading Indicator, Economy Watchers April 2008

Japanese machine orders rose in April after falling for two consecutive months, however Economic and Fiscal Policy Minister Hiroko Ota stressed that demand for machinery still remains weak. Machinery orders, which give an indication of likely capital spending in the coming three to six months, were up by 5.5 percent in April after declining 8.3 percent in March and 12.3 percent in February, according Japan's Cabinet Office.





Still, business investment continues to hold up even while declining, and the rate of decline in the first quarter was less than half the rate seen during the Japan's three most recent recessions. While capital spending fell for a fourth consecutive quarter in the three months ended March, the average rate of decrease in each quarter was less than 5 percent, compared with more than 10 percent in the three downturns since 1990.

The flipside of this, evidently, is that exports have continued to perform better than expected in the face of the US downturn and are even doing so now when confronted by an additional slowdown in Europe. The reason for this is relatively straightforward: continuing demand driven by vigorous growth in some emerging economies.

In addition, inside Japan itself companies remain under pressure to upgrade equipment after postponing purchases, in some cases for many years. More than half of Japanese businesses said the main reason for capital investment during the last fiscal year was to replace equipment, according to a government survey released in March.


Q1 2008 GDP Revision

At the same time Japan's first-quarter economic growth was faster than initially estimated according to figures released today which show that businesses spent more on capital equipment than previously estimated, while government spending fell rather less than initially estimated. Japan's gross domestic product expanded year on year by 4 percent in the three months which ended March 31, up from the 3.3 percent estimated last month according to revised data from the Cabinet Office.

Japan expanded 1 percent from the fourth quarter, today's figures showed, more than the 0.8 percent reported last month. Business spending increased 0.2 percent, compared with a 0.9 percent decline initially estimated, reflecting figures published by the Finance Ministry last week that showed companies increased capital spending by 1.3 percent in the quarter, and this data alone accounts for about 60 percent of the business investment component of revised GDP.

The rate of expansion of both exports and imports was also revised down, exports from a quarter on quarter growth of 4.5% to 4% and imports from 2% to 1.4%.







Leading Index

Japan's leading index tends to confirm the recent capex and machinery orders data, and suggests that the Japanese economy may continue to avoid recession during the next three months. The leading index, which is a composite of 12 indiactors including housing starts and stock prices, rose to 92.8 percent in April from a revised 90.8 percent the March, according to the latest release from the Cabinet Office. The increase suggests that far from slowing down growth may even accelerate slightly in the coming quarter.

The index is partly helped by the fact that Japan's housing starts have been recovering after plunging to a four-decade low last year because of a permit logjam which was produced by new government regulations introduced to stop building fraud. The government relaxed the rules in November and housing investment rose for the first time since 2006 in the first quarter of 2008.

Real wages also rose in April for a fourth month, the longest positive sequence in almost two years. Also the hiring of full-time workers has been accelerating since October as companies added permanent staff to comply with new labor regulations. Employers hired full-time staff at twice the pace of part-time workers in April. So basically consumer demand has been more positive of late in Japan, and while we are a far cry from seeing a consumption driven expansion, the year on year increase of 3.3% which was achieved in the first quarter is hardly to be sniffed at.




So Japan may well extend its longest postwar expansion for yet another quarter as a rebound in housing following a bureacratic driven crunch on new starts supports headline growth and rising wages give some relief to ever struggling consumer demand. However, the increase in the leading index doesn'tnecessarily mean conditions will improve substantially since the index has been on a declining trend since it peaked in 2006, and what we have been seeing is to some extent a rebound from the very low levels registered last autumn.

Doubts about sustainability certainly linger however, and Japan's longest postwar expansion may well be coming to an end, as record crude oil and raw material costs discourage companies from hiring and spending another government report showed. The Japanese economy may be reaching a "turning point,'' the Cabinet Office said earlier this week after releasing figures that showed the coincident index, a measure of current economic activity, fell to 101.7 in April from a revised 102.4 in March.

The Japanese government hasn't described the economy in these terms since the recession of 2001. Factory output has been falling and corporate profits are deteriorating, indicating that there may well be an underlying loos of Japan momentum since growth the first quarter. The issue I think very much depends on what happens to growth in those emerging markets where Japan has been sustaining its export expansion, and the future of this growth depends in large part, I think, on what happens to inflation.

To add somewhat to the confusion produced by this plethora of reports it is also worth noting that the Japanese government recently changed the methodology behind the leading, coincident and lagging indexes. All of these are now composite indexes, which means they reflect the magnitude of the ongoing improvement or deterioration in economic indicators, whereas previously they were diffusion indexes whose results depended on whether indicators had improved or worsened from three months earlier. So a certain amount of caution is advised in reaching any strong conclusions here.

In other recent reports we get further evidence of how rising energy and commodity prices may be hurting businesses and consumers. Bank lending rose at the fastest pace in 16 months in May as companies borrowed more to pay for costlier raw materials, according to the Bank of Japan.



Economy Watchers Index


In addition Japan's economy watchers' index, which measures workers' perception of economic trends, fell for the second straight month in May as the cost of living increased with the rise in petrol prices. The major index for current conditions fell to 32.1 last month from 35.5 in April, the Cabinet Office said. The index hit 31.8 in January, the lowest since December 2001.




The data showed that workers' perception of Japan's economic recovery has been 'extremely weak,' the Cabinet Office said. The index measures whether respondents with jobs most sensitive to economic conditions, such as taxi and truck drivers, department stores sales staff, as well as restaurant and shop owners, believe economic conditions are better or worse than they were three months before.

A reading above 50 indicates that most respondents believe conditions are improving while a reading below 50 suggests that most respondents think conditions are worsening.

The forward-looking index, which measures expectations about economic conditions in subsequent months, slipped to 35.1 in May, the lowest since December 2001 when the index hit 33.2. The index stood at 36.1 in April.


Consumer Confidence


Japan's consumer confidence also fell in May to the second-lowest level on record. The index dropped to 33.9 from 35.2 in April according to the Cabinet Office. May's reading was the lowest since December 2001, when the index touched a record low of 33.0.

Japan Capital Spending Q1 2008

Japanese businesses investment fell less than previously anticipated during the last quarter according to the latest data from the Ministry of Finance. Capital spending (excluding software) fell 5.3 percent in the three months ended March 31 from a year earlier.

While business investment has now fallen in each of the last four quarters, the pace of decline is less than half that recorded during Japan's three most recent recessions. If today's numbers are anything to go by it is quite possible that the Japanese government will raise its first-quarter economic growth estimate on June 11.

So at the present time the Japanese economy is showing much more resilience than in 1998 or 2001. The reason for this resilience is not hard to find. It is certainly not the result of a resurgence in domestic consumption, but rather continuing strength in exports, even as demand for Japanese products from the US declines, and from the Asian tigers and the EU slows. Te source of the extra demand is evidently China, and now other emerging economies like Indonesia, Vietnam, India, Brazil and Russia. As long as these emerging economies keep expanding rapidly, Japan can sustain. But for how long will this be? Inflation is becoming a real bugbear, and the situation in some of these economies (especially Vietnam and Russia) is in danger of turning critical. There is a certain irony in the fact that inflation may indeed be the undoing of the present Japanese expansion, but not domestic inflation but rather inflation among the emerging economies (the Economist had a useful summary of the current position here).

Japan Wages and Employment April 2008

Average total cash earnings rose in Japan rose in April for the fourth consecutive month as companies added full-time workers to comply with new labor regulations. However the arrival of inflation has meant that in real terms (ie allowing for inflation) contractual wages actually fell year on year. Monthly wages, including overtime and bonuses, were up 0.6 percent from a year earlier to 281,246 yen ($2,670), following a revised 1.5 percent increase in March according to data from the Labor Ministry in Tokyo this morning. When corrected for inflation, however, basic wages (without bonuses, overtime etc) were down 0.4% year on year, marking the first such decline since December.





It is a bit difficult to know what is actually going on here, certainly bonuses must be part of the picture. Employees at manufacturers worked less overtime in April as production slowed, limiting wage growth for the month, according to Shunichi Ando, head of the Labor Ministry's statistics division. Working hours at manufacturers fell 4.1 percent, the biggest drop in six years. In construction, however, overtime was up 11% y-o-y.

The number of people employed on a full-time basis rose 2 percent year on year, exceeding the 0.8 percent increase in part-time staff, as new labor rules lead companies to treat more temporary workers as permanent employees.



Hiring of full-time workers has been accelerating since October as companies anticipated the new labor regulations, which came into effect on April 1. The 0.8 percent increase in part-time staff last month was the slowest rate of increase for part time workers since December 2005.

Japan's Savings - Going for Yield

The idea of having a large pool of funds to place on the world's asset markets in order to livf off of the derived income seems alluring to most I think. In fact, you could argue that it is precisely this allure and many an economy's pursuit of it that is causing much of the current debacle in the global economy. In Japan's case we are arguing as a part of our ongoing observations that Japan is now dependent on exports. In reality Japan has been dependent on external demand to grow for some time now. More specifically we have, here at JEW, argued why we should look at Japan's age structure to find the principal reason as to why Japan has the growth profile it has. The point is simply that when the labouring cohorts of the economy are declining in number with such a pace as we are seeing in Japan domestic production and productivity will have to be channeled towards external demand. I see no coincidence in all this but a quite natural consequence of the fact that domestic capacity in Japan is now declining and will continue to do so for the immediate future. As such, if Japan is ever to keep the ratings agencies at bay and if Japan is ever going to have hope, even a fool's hope, of servicing the pension demands of her citizens it is necessary for the economy to be biased the way it is. Of course, and this I have been pointing out extensively, the problem is that Japan is not the only ageing economy and in fact if we extrapolate the demographic developments a bit we are going to end up with a lot of exporters and no one willing to run a respectable external deficit. This global bias towards one end of the intertemporal spectrum of the current account is a very interesting theoretical theme which I intend on investigating further as I go along. In a recent post I elaborate further on this topic and especially the following rather lenghty quote is important to take away in terms of my main argument.

"This 'crowding' of countries in one end of the intertemporal spectrum of savings/investment and consumption is not coincidental and perhaps most importantly it will result in important global externalities. The drivers of this tendency (to the extent that it exists) need to be found in terms of life cycle dynamics aggregated to population levels. At this point I feel that we are far away from really pinning this one down. However, one part of it is related to three potential hypotheses that I am working with in terms of consumers life cycle pattern. 1) people do not dissave to 0 since they do not know when they will end their existence. 2) Rising life expectancy will induce consumers to save more and longer during their life cycle. 3) Ageing societies are likely to, one way or the other, promote forced savings in order to ease the societal burden of the intergenerational skewness as the dependency ration rises. If we add this together with the decline in home bias currently observed in Japan (the oldest society on earth) we consequently run smack into the externalities I was talking about before. Consequently, if we go back to the point on intergenerational preference for spending we need to understand that ageing economies will indeed attempt to invest their accumulated savings. They have to in order to earn income but they cannot invest it in their domestic economies. Thus we have the externality in the sense that as the world ages we are likely to see a process by which more and more countries will develop a propensity to 'export' in order to sustain growth."

So, what does it mean to be dependant on external demand? Traditionally we think of Japan as being dependent on exports of tangibles but this does not represent the complete picture. To be sure Japan is extremely dependent on exports in the form of a trade surplus but on the margin another factor is important too; the income balance.

Whether the graphs above tell the story of an ageing economy is of course debatable. I clearly think it is and I believe that there are sound theoretical reasons back my thesis. This point notwithstanding we can clearly see how Japanese savers have stepped up their holdings of foreign assets and given the impressive growth of the global economy the income earned has certainly been quite respectable. However, why invest abroad when you can invest at home? Well, I have always answered that question above but two seperate headlines in Bloomberg very neatly sums up the situation. First, we learned from Bloomberg reporter Patrick Rial that Japanese companies lost investors a hefty $3.2 billion the fiscal year ending this April and secondly we got the news, referring to the charts above, that Japan was the largest holder of foreign assets in the world. I don't think it takes much of an economist to connect the dots here and if we accept the fact that Japan's deflation problem and its subsequent low interest rate are related to the country's demographic profile it should not be too difficult to see what is going on.

The graphs above will be familiar to many a financial trader as it shows the lingering negative trend in Japan's main stock index. Of course the second index could just as well have been made with 2003 as a starting point in which case we would be observing +100. In this light it will be interesting to see just how far the Nikkei will fall this time around as Japan enters yet another tough patch in terms of economic growth.

It is thus not so strange that Japanese savings are rather eager to go abroad and why we consequently have observed a very rapid decline of home bias amongst Japanese investors. However, this decline is not so much a story of equities but rather one of debt (0.5% interest rate remember) not least the samurai bonds; a topic which I have addressed on several occasions.

The graph above speaks a clear language I feel and even though the share of equities have nudged upwards recently the majority of Japanese portfolion investments still go into debt.
Lead by a suffering Citi Group in the wake of the credit turmoil the sale of yen denominated bonds is thus estimated to have tripled in 2007 from 2006. Part of this was no doubt due to the fact that spreads in Japan offered significantly more calm straits than the credit crunch ladden debt markets in Europe and the US but it is also a simple reflection of the fact that Japan has the spare capital. In this way and as a market mechanism Japan's role here is no different from when one of those much debated SWF dares to venture a stake in rebuilding the balance sheet of a tarnished knight from the US financial service sector. In the context of the credit turmoil Reuters also reported how market participants are well satisfied with the state of affairs;

Dealers in the Samurai market say investors remain keen to buy the bonds -- issued in Japan by foreign entities -- because of the higher yields they now offer and because they see little risk of big U.S. banks and investment banks defaulting.

We can always quibble about just how secure those US investment banks are (well, if Bear Stearns is anything to go by I would say very!) but from Japan's point of view and in the grand scheme of things with a debt/GDP ratio of 170% the income earned on these instruments are quite vital. In fact, notional evidence suggests that Japan may well be an asset managers wet dream in terms of securing funding. A Bloomberg piece fresh in off the wire consequently alerts us to the fact that hedge funds are also dotting down Japanese savings for a source of capital. Obviously, these money need to earn a return though and this is where it all gets very complicated since what happens when everybody wants to be Japan? Coupled with a reserves piling up in China and in the petroexporters' vaults hunt for yield and the subsequent low return and/or overheating are structural consequences for the growth path of the global economy.

A Tendency to Watch

I think that the points above represent important tendencies to watch for both theoretical economists and investors alike.

• For acamedic wonks (such as myself in spe) I think that the idea of the intertemporal current account is important in terms of describing what is going on. More specifically I believe that the tendency of ageing economies to exhibit the same savings/consumption profile in terms of the trade-off between the two is important. If we look at the intertemporality as a spectrum we can say that as the global economy ages economies will tend to crowd in one end of the spectrum and I think that important externalities will arise as a result.

• For investors and asset managers I don't think that the importance need much explanation. However, I do think it is important that investors think about narrating capacity and more importantly excess capacity in terms of demographic age structures. In the context of Japan it means that ageing economies can be a source of capital (hardly news at this point) but it also means that changing demographics in terms of age structure should be incorporated into the asset management framework.