Nikkei Back Down Below 8,000


In a sign of what may be in store for the post-war equity markets, the Nikkei fell below 8,000 today. With worries about Sars rising, Europe full of euro-related low groth problems, and the US job and profitability situation all focusing attention, it's hard to see a strong rally any time sooon. God, I can still remember that it was only March last year that we were all saying 10,000 would be a tipping point. Now it's down to 8,000 and heading South. Still, there will be a tipping point in there somewhere, the difficulty is only in identifying it.

The benchmark Nikkei average fell below the key 8,000-level in midday trade on Thursday, on continuing fears regarding the state of the global economy in the wake of the Iraq war.The benchmark Nikkei 225 fell 1.4 per cent to 7,941.96, while the broader Topix index was down 1.3 per cent to 790.76.Stocks were broadly lower, with Sony hitting a four-year low in intraday trade, on concern that Japan�s biggest exporters may feel the effects of a global economic slowdown following the Iraq war. Sony�s shares were down 3 per cent to Y3,900 in midday trade, a level last seen in January 1999. Downward pressures on blue chips. were exacerbated by corporate pension fund selling.
Source: Financial Times
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Reform at the Bank of Japan?


The BoJ has decided to proceed with its plan for buying asset-backed securities (ABS's) in particular by buying securities from small and medium-sized enterprises, and to conduct this activity as a routine part of its monetary operations - even if only on a temporary basis - over the next few years. This was decided at the 7, 9 April meeting by a majority vote of 8 to 1. This initiative aims to provide smoother financing to Small and Medium Enterprises (SME's) by purchasing securities based on sales receivables and other assets. According to the bank, the objective is to strengthen the effects of monetary easing by nurturing the development of tan assett backed security market, thereby making available investment funds to smaller enterprises. The big questions, of course, concern whether this will really have any impact, either in facilitating the growth of newer, more dynamic enterprises, or in the more general area of increasing liquidity to provoke inflation. Morgan Stanley's Takehiro Sato has plenty of doubts:

The bank�fs decision to purchase private-sector debt, rather than government debt, itself appears to be a major policy shift. Governor Toshihiko Fukui is pursuing involvement in corporate financing to enhance the quality of liquidity supply after seeing the limited effect of quantity expansion promoted by former Governor Masaru Hayami. A key premise for purchase operations of such risk assets to be effective, however, is a market with sufficient size and liquidity. Yet the ABS market is still in its infancy and lacks adequate outstanding value and liquidity, particularly for SME securities, and transaction price transparency. Furthermore, the bank intends to purchase ABS backed by the assets of SMEs with credit standing comparable to �gnormal�h in bank self-assessments. This requirement can be expected to limit the scope of ABS eligible for BoJ purchase operations and may make the policy initiative effectively meaningless.........

It is likely to be confirmed that these operations will not make a quick contribution to SME financing. However, the BoJ decision to move beyond the eligible collateral level and involve itself in corporate credit has created the possibility of more direct financing to corporations over the medium term. For example, the Bank is already considering purchase operations for not only senior securities but also the mezzanine segment. If this happens, credit standing for eligible collateral and purchased assets may be reversed in some cases, similar to the situation with bank equity holding standards. Future policy developments might therefore lead to a relaxation of eligible collateral criteria in order to maintain policy coherence. Easier eligible collateral criteria could enable banks to underwrite corporate CP and improve funding. Yet this is likely to reduce the chance of corporate liquidity failures in the same way as recent quantitative easing measures. In other words, reinforcement of the safety net for non-financial corporations, in addition to banks, could postpone the shakeout and reorganization process and allow financial socialism to make further inroads.
Source: Morgan Stanley Global Economic Forum
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Japan's Continuing Economic Crisis

One day or another Japan unfortunately is going to burst. Left on its present course, like the proverbial nineteenth century steamship with the boiler overheating, one day one too many of the bolts will sheer off, a boiler plate will give and then the devil take the hindmost. Of course one of the few debateable points remaining is whether or not there is really anything left to be done. Common sense says there is, and sheer humanity says that there ought to be. Recognising this is the easy part. The tricky bit is what to do. Ten years of sustained problems, various recessions, and the outbreak of what may be regarded as the developed world's first serious bout of sustained deflation have left little doubt about the depth and seriousness of what is taking place.................

In general terms, one of the problems with the whole Japan debate is that much of the available material fails to tackle the problem head-on. For instance the well-publicized Federal Reserve research report "Preventing Deflation: Lessons From Japan's Experience in the 1990s" rather surprisingly fails even to consider one of the most important factors which may be driving the Japanese deflation: DEMOGRAPHICS. This lacuna is not an isolated case. Even where the problem is mentioned, it is normally not explored.


So all of this is a bit like Hamlet without the prince. Little of the more fashionable analysis really helps us understand why Japan government debt is growing out of control - after all with deflation abounding, even government supplied services should get cheaper, and why raising interest rates at any point in the foreseeable future is going to be difficult. This is because many of the arguments rest on the assumption that eventually Japan will solve the slow growth problem and start to recover. Well, I'm afraid I wouldn't be too sureabout that. And if the problem is a faulty diagnosis, then how the hell do you expect the medicine to work............

As Robert Lucas among others has indicated, classical economists like Malthus and Ricardo saw the need to account for the dynamics of pre-modern societies, and in particular for the fact that in these societies per capita incomes normally did not increase, but rather tended to return to roughly constant levels despite technological improvement, as one of the central problems facing economic theory. Differences in ability to produce had the knock-on effect of leading to differences in population level, and not to differences in living standards. This static situation constituted what has become known as the Malthusian trap. With the coming of industrial society something new happened, we broke out of the trap. Population increased, but at the same time per capita incomes also continued to increase, systematically, and as never before in history. This 'modern era' has now lasted for around 200 years.


However, the signs are there that things are changing. We still continue to increase living standards in an unprecedented way, but planetary population is getting older, and soon, in some 33 developed countries according to the recent UN population revision, smaller. It seems we are once more in danger of falling into a population trap, one where population and economic growth again become ensnared, but this time in a downward spiral. Economic theory to date has notably and monumentally failed to come to terms with the implications of this change, and herein lies the significance of Japan.
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Japan a Lost Decade


A number of hypotheses have been presented to explain Japan's continuing economic failure since the beginning of the ninetees: inadequate fiscal policy, the liquidity trap, depressed investment due to over-investment during the "bubble" period of the late 1980s and early 1990s, a broken banking system due to a combination of the former, outdated labour market and work practices, growing competition from China, and (my own strong hypothesis, of course) demographic processes. While we have many hypotheses, we have, as yet, no coherent and compelling account. The Hayashi and Prescott paper examines the history of the "lost decade" using a standard neoclassical growth model. It identifies finds two developments which seem to be important for understanding the Japanese economy in the 1990s. First and most important: there was a fall in the growth rate of total factor productivity (TFP). This, argue the authors, had the consequence of reducing the slope of the steady-state growth path and increasing the steady-state capital-output ratio. Their most important finding: that the drop in the rate of productivity growth alone cannot account for the near-zero output growth in the 1990s.

Abstract
Japan a Lost Decade: Fumio Hayashi and Edward Prescott

This paper examines the Japanese economy in the 1990s, a decade of economic stagnation. We find that the problem is not a breakdown of the financial system, as corporations large and small were able to find financing for investments. There is no evidence of profitable investment opportunities not being exploited due to lack of access to capital markets. The problem then and still today, is a low productivity growth rate. Growth theory, treating TFP as exogenous, accounts well for the Japanese lost decade of growth. We think that research effort should be focused on what policy change will allow productivity to again grow rapidly.
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