Japan, Hong Kong, Taiwan: Indefinite Deflation


Obviously things look pretty different in Hong Kong to the way they seem in New York, Washington, Brussels and Frankfurt. Andy Xie again:

Excess supplies of labor and capital continue to exert powerful deflationary pressure on East Asia. Export performance or the credit cycle may give the appearance for short periods that inflation is returning. When cycles peak, inflation tends to disappear quickly and deflation either gets under way or resumes. Korea�s inflation in 2002 was largely due to its rapid credit growth. The high oil price nudged inflation higher in the first quarter of 2003. It is now trending down and is likely to reach new lows. China is experiencing some inflation because of the increase in its raw material costs. The surge in investment demand is the main cause. As we have observed previously, deflation usually follows investment driven-inflation. A high savings rate, surplus labor, and lack of entry barriers always allow the benefits from productivity gains to be passed on to consumers in China. Japan, Hong Kong, and Taiwan seem to be in deflation almost indefinitely. Their interest rates are already near zero. They do not appear to have income drivers to solve their demand problems. It is difficult to visualize any scenario under which deflation in these economies would end. East Asia must resist currency revaluation. There are no obvious policy tools for combating its contractionary effect. Interest rates are close to zero except in Korea. Fiscal deficits are quite large already. A major revaluation would just crush the economies in the region, in our view.
Source: Morgan Stanley Global Economic Forum
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Japanese Bank Bailout


The decision to inject an estimated $17.7 billion into Japans fifth largest bank has set-off all manner of questions about the future of the 'reform' process, including questions about the survival of key economics minister Heizo Takenaka whose attempts to accurately reclassify the book value of bad debts are thought to have provoked the capital adequacy problem. On the back of the latest GDP deflation figures, the pressure certainly seems to be building up.

Anxiety about the state of Japan's banks, rekindled by the government's weekend decision to bail out the nation's fifth-biggest banking group, has turned up pressure on the administration to kill profit-destroying deflation. The rescue of Resona Holdings also reignited calls to oust Financial Services Minister Heizo Takenaka, an academic closely identified with Prime Minister Junichiro Koizumi's reform agenda and a target of old guard discontent. "Prime Minister Junichiro Koizumi...must do his utmost to prevent the crisis from spreading," the Yomiuri Shimbun newspaper, Japan's biggest, said in an editorial on Sunday. "At the same time, we should not forget Resona's case has been influenced by the hard-line financial reconstruction policy championed by Heizo Takenaka...which has gone astray," the conservative newspaper added. The government said on Saturday it would rescue Resona with a huge injection of funds after tougher accounting rules pushed its capital adequacy ratio below limits needed to do business. Media reports said the infusion of public funds could be as much as two trillion yen ($17.17 billion). Ruling politicians on Sunday generally endorsed the decision. But Taro Aso, policy chief of the ruling Liberal Democratic Party, and others called on the government to address the persistent decline in prices that is likely to get worse as the nation's banks struggle to dispose of an estimated 40 trillion yen ($345 billion) of problem loans now on their books. Aso attributed Japanese banks' dismal situation to declines in the value of real estate, which was used as collateral for many loans in during the late 1980s "bubble economy" and is now a major cause for soured loans, as well as falling stock prices."Asset deflation is the biggest problem," he said.

Aso sidestepped the issue of whether Koizumi -- whose central policy pillar is fiscal reform -- should adopt an extra budget to fund public works as suggested by some LDP heavyweights and their partners in the three-way ruling bloc. "When you are suffering from both diabetes and consumption, you have to treat the consumption first," was all he would say. Koizumi, who meets President Bush later this week for a bilateral summit, also faces international pressure to tackle a four-year slide in core consumer prices. Japan pledged at a weekend meeting of Group of Seven finance ministers in France to step up efforts to fight deflation. But Finance Minister Masajuro Shiokawa offered few clues as to how Japan, burdened by massive public debt, could do so.

Shiokawa said Japan would ensure ample liquidity in financial markets and diversify the way it provided liquidity, although the Bank of Japan (BOJ) already pins interest rates at near zero and floods the money market with far more liquidity than it needs. The central bank is set to hold a policy-setting meeting on Monday and Tuesday. The maverick Koizumi sprang to power in April 2001 on a wave of public support for his agenda of painful reform, including reining in the nation's ballooning fiscal deficit and lifting the heavy hand of government from Japan's long-stagnant economy. Criticism of his policies from within the LDP has been harsh, but some on Sunday urged him not to cave in. Calling for a "comprehensive policy" focusing on deregulation and tax reforms to nurture new business and create fresh demand, the liberal Asahi Shimbun newspaper said the massive stimulus policy adopted after a 1997 financial crisis had inflated government debt without fixing the financial system. "We cannot walk that same path again," the newspaper said. Still backed by about half the nation's voters despite plummeting stock prices and a stagnant economy, Koizumi vowed on Saturday to carry on with his reform agenda. "There is absolutely no change in our reform stance," he said after the government held its first emergency financial crisis council meeting to approve public funds for Resona. "We took measures so that a financial crisis will not occur."

Koizumi, who must be re-elected as LDP president in September to keep his premier's job, stood by his controversial minister. "I have no intention of changing him," he said, when asked about calls for Takenaka's resignation. "He is doing a good job." Resona's call for help underscored longstanding suspicions that Japanese banks have overstated their capital by taking advantage of accounting loopholes. Auditors had declined to sign off on the group's earnings estimates, which were deemed to be far too optimistic. Stock market investors can expect a volatile day on Monday in reaction to the rescue deal if it's perceived that Resona's problems are just the tip of iceberg, analysts said. If bank shares get slugged, the Nikkei average could drop toward the 20-year lows it reached last month -- putting even more pressure on the banks, which have huge shareholdings.
Source: Reuters News
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Japan's Deflation Gathering Speed


David Pilling from Tokyo, on how the rate of deflation in Japan is accelerating. Not good news.And just as I was getting used to talking about the 'slow burn' deflation.The rise in the yen isn't going to help any, either.

Japanese deflation gathered pace in the first quarter with year-on-year prices falling 3.5 per cent - their fastest drop on record. The fall may fuel fears that Japan, which has managed to co-exist with relatively mild deflation since the mid-1990s, could be sliding into a deflationary spiral. Japanese prices - as measured by the gross domestic product deflator, considered a more accurate measure than the consumer price index - have been falling more or less continuously since 1995. Annual price falls have averaged between 1 and 2 per cent for most of that time. Friday's figures showed deflation accelerating in fiscal 2002, a year in which Japan was growing out of recession, to minus 2.2 per cent, a record for a full year.

The figures were released along with GDP data showing that growth in the first quarter fell to almost zero, leading some economists to conclude that the economy was on the brink of yet another recession. Nominal growth fell 0.6 per cent in the March quarter, or minus 2.5 per cent on an annualised basis. Paul Sheard, economist at Lehman Brothers, said: "If you look at the chart it looks horrible. It looks as though deflation is going through the floor." However, the headline figure exaggerated the picture, he said, because the GDP deflator in the first quarter of 2002, when Japan began to pull out of recession, was positive. "It's something of a statistical fluke, though deflation is deflation and it is not a good sign."Shuji Shirota, economist at Dresdner Kleinwort Wasserstein, said "unprecedented deflationary pressure" had been stoked by a big cut in the winter bonuses of government employees, as well as by a fall in the price of PCs and other electrical machinery.

The issue of deflation has split the government, with officials disputing its causes and disagreeing over its effects. Heizo Takenaka, economy and financial services minister, on Friday said falling prices posed a threat. "Deflation remains severe. While pursuing structural reform we must also press on with efforts to end deflation." This week, Eisuke Sakakibara, former vice-finance minister, said Japan could live with mild deflation so long as it prevented the economy tipping into a destructive spiral of falling prices. He said deflation was the structural result of global productivity gains and would likely spread from Japan to the US and Europe. Mr Takenaka drew some comfort from the fact that real growth for fiscal 2002 was 1.6 per cent, above the 0.9 per cent the government had predicted. Much of that was based on exports, which have begun to slow, and on surprisingly robust consumer spending. In the first quarter of this year, consumer spending, which accounts for 60 per cent of GDP, rose 0.3 per cent quarter on quarter. Mr Sheard said real growth of about 1 per cent a year over the past decade was welcome, but he pointed out that the economy was shrinking in nominal terms. Nominal GDP for fiscal 2002 fell to �499,000bn, the first time it has dipped below �500,000bn in eight years.
Source: Financial Times
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The Liquidity Trap: A Sticky Problem

Brad has a number of posts this week on the liquidity trap problem (and here and here . Two points occur to me: firstly, is it more than a merely semantic point whether we are 'fast approaching' or "already caught in the orbit" of one; and secondly whether (as Joerg asks me) the name is not a misnomer, wouldn't 'viscosity trap' be a better description? Meantime, John Irons recent post is as good a start for the 'unintitiated' (we still await the 'guide for the perplexed') as any you will find:

The recent FOMC statement by the Federal Reserve (Fed) included the line that "... the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level" (emphasis added.) It occurred to me that this statement might be a little confusing - isn't inflation supposed to be bad? Why would a fall in inflation be "unwelcome"? The answer has to do with what economists call a "liquidity trap." (Note: the full analysis of a liquidity trap is considerably more complicated than below, but this should convey the basic idea.)

The basic argument is that the interest elasticity of money demand increases, and monetary policy becomes less effective, when the nominal interest rate approaches zero. Ok, here's the English version...........
Source: ArgMax
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