Beware the Dreaded Mr Yen


It seems there are more deflation doubters, doubters that this is simply monetary. Welcome to the world of Mr Yen. In dismissing his views, we wouldn't be running the risk of ethno-centrism, now would we? Oh, never mind........

'Mr Yen' proclaims new era of deflation


Japan is the forerunner in a global shift from an era of structural inflation to one of structural deflation, according to Eisuke Sakakibara, the former vice-finance minister who is still referred to as "Mr Yen".Mr Sakakibara, now a professor at Keio University, said in an interview that Japan had been the first economy to fall into chronic deflation but that the US and Europe were likely to follow. Whether the consumer price index fell below zero depended on factors such as the price of oil, but was essentially beyond the power of monetary authorities to prevent, he said. "Even if we don't yet have [global] deflation, you have to concede that we have disinflation," he said, attributing falling prices to rapid productivity gains in manufacturing, particularly in China. "Deflation is a structural, not a monetary phenomenon."

"Alan Greenspan never used the word deflation," he said, referring to the chairman of the US Federal Reserve. "He called it an increase in productivity. But it's the same thing." On currencies, Mr Sakakibara said that calls for the weakening of all three currency blocks - the dollar, the yen and the euro - were dangerous. If governments started taking unilateral action to weaken their own currency, it could lead to competitive devaluations, protectionism and growing hostility. He foresaw a continued strengthening of the euro as funds flowed out of the dollar, but a stabilisation of the yen in the �116-Y121 range.


In calling deflation structural, Mr Sakakibara is part of an increasingly vociferous intellectual movement that thinks Japan has been unfairly blamed for failing to tackle deflation with conventional monetary policy. The Bank of Japan, he said, had vastly increased money supply but this had merely fuelled a bubble in the government bond market, in which interest rates on 10-year JGBs have dropped to 0.575 per cent. Credit had shrunk. Robert Feldman, chief economist at Morgan Stanley, has also argued that following classical monetary policy is inappropriate for Japan. "There's something new going on out here and I would hope the economic theorists would be able to think about it without being poisoned by what they're teaching their students," he said.

Mr Sakakabara said governments would have to learn to think of deflation differently. This new wave of price falls had more in common with that of the 1880s, associated with huge productivity gains, than with that of the recessionary 1930s, he said. "I think we must learn to co-exist with mild deflation," he said, adding that in Japan's case this would mean writing off much of the bad debt that had been built up over decades. This would require a big capital injection of funds either into the banks or into the companies themselves, he said. The existing pension system, unsustainable in a deflationary environment, would also have to be rewritten. Efforts led by Heizo Takenaka, economy and financial services minister, to force banks to accelerate the disposal of non-performing loans were suicidal, he said. They had already led to a dangerous credit crunch. "Squeezing banks and suggesting nationalisation is not the way to increase credit." Globally, governments would have to change their policy objectives, he said. "During the period of inflation, policy leaders had to avoid hyperinflation. During this period of structural deflation, we have to avoid spiralling deflation."
Source: Financial Times
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Japan the Next Big Success Story?


Joerg is asking awkward questions. What is happening in Japan? But not the normal, nice conventional questions. Joerg has the temerity to ask whether Japan is really so bad as everyone is saying. I'll let him explain:As you know, I disagree with your determined pessimism regarding Japan.

Recently, I came across an antiquarian economic history of Germany - more than a hundred years old. It contained a passage that compared Germany�s output statistics to, among others, the US and Russia. The author commented on the future prospects of those three countries and Britain. What really caught my attention: he claimed that the US had reached its zenith and that the next big success story would be Russia. Reason given: the extended deflation the US had gone through! Remember your "avalanching rice pile" post? I then checked US and Japanese data for the last few years: Since early 2000, Japanese real private-sector GNP has risen 3.5% overall. The per-capita gain amounted to 2.9%. The annual rate averaged to 0.9% - not exactly constituting overwhelming growth, but still qualifying as a substantial advance. On the other hand, U.S. real private-sector GNP increased by an almost identical 3.6% between 1999 and 2002. However, since the US population rose four to five times faster than in immigration-adverse Japan, income per head in the U.S. barely grew at all over the period.

Now all of this is going to open a nice can of worms, so let's do it. Firstly Joerg is raising some important points. One of them is about the Japanese use and misuse of statistics. Now Joerg is quite right to note that economics is, in one sense, the pursuit of war by other means. It is important to remember that following Pearl Harbour, and all its consequneces, there has been a tacit understanding that has governed all US-Japan relations: Japan will never risk a frontal confrontation. So things have to be done another way. This is Joerg's point about the Japanese data, whereas data in many countries has a tendency to downwards revisions, the Japanese data tends to be revised up. So as not to offend, you understand.

Now I would make two points. I am sure Joerg has a point, Japan is 'enjoying' its ill health. It is a lot easier to explain an excessively bad economic performance to the US than it is to explain an excessively good one. But I am equally sure that 'measurement problems' are more acute in Japan than they are in the US or Europe. Japan is not only 'risk averse', it is also 'information averse' (everyone really should read Karel van Wolferen ). So the tricky stats argument cuts both ways, and it is difficult to draw any decisive conclusions here.

Now for the middle argument. One of the points about deflation is, of course, that nominal prices fall. This is something of a curse, since we are all accustomed to deflating inflated nominal prices, and it really is a switch of mindset. The point is you need to add the rate of deflation to the nominal GDP numbers to see what is really happening. Indeed (leaving aside deflation as a problem) shrinking nominal GDP in Japan and a rising yen are pretty much compatible as a way of maintaining relative global GDP shares. I said leaving aside deflation as a problem, since of course the rising currency means there is no change in the deflation process. Having said this Joerg is absolutley right in pointing out that the Japanese performance is not half as bad as is sometimes suggested. A glance at the statistics will show this. The bad years were 97/98 and 2001, and of course 2001 was a problem everywhere. So Japan, is not quite as bad as it seems? Well, not really, because the Titanic has a big hole in it, and is taking in water. I think that is the essence of the two types of deflation argument, some of us can see that nothing good can come of this. Quite another thing would be a generalised drop in prices and sustained economic expansion. My analysis (Mr Yen notwithstanding) is that this is not what we have in Japan.

Now this raises yet another question. Are we facing a global deflation scenario? The IMF thinks we are not, and I think we may be. If this is the case then continuing deflation in Japan is inevitable, and we, and they, will have to learn to live with it. This will be a 'phase transition'. You see this is the meaning of a dynamic system, things change. Solutions which were available yesterday, are not available today. I am sure the G7 are not listening to me, obviously had they been we would still have had the same problems, but maybe we would have had some palliatives, and maybe more options would be open. They are not, and the gardens are now closing, and not only in the west. Time is running out. This is not a 'funny' game. I, reluctantly, think that the most sensible thing now is to accept the inevitable. The 'liquidity-viscosity trap is a real problem, but there is no 'push this button' solution. Maybe, maybe if we were to do a big 'helicopter money' drop on the third world, but this, realistically, is not on the agenda.

So the questions, and here Joerg may be right, may become: how to learn to live with it? Many may wish to take issue with those luminaries of economic theory who said it would never happen. My pragmatism pulls against this, it is better to get on with the job, and look up river. Now Japan seems to be adapting. The question then is:can this last?

This is where I really take my difference from Joerg. Athena will not rise from the head of Zeus. All we are likely to find is a lot of rubble. You see, Joerg mentions the per capita growth question, what he does not mention is the dependency ratio: this must surely be the key productivity measure. And it is an assymetric one, since looking to the future, under 15 is better than over 65. So the first move should be to check out the population pyramid. In the table above the pyramid it can be clearly seen that population over 65 is growing (absolutely and as a percentage), while the other two groups are both declining. Now if we look at the labour force survey we can see that the labour force and the participation rate is declining, while the unemploymenbt rate is rising. This tendency seems unlikely to be reversed, ever (well maybe the unemployment rate may stabilise, but the participation rate will not. Conclusion, inevtiably we will have secular decline in both nominal and real GDP.

Now, to anticipate a little, I imagine Joerg will come back with the inevitable 'what if': what if the value added of the reduced workforce increases sufficiently to offset the decline in workforce. This is where the on the fly vs accumulated experience comes in. With things getting faster faster, the 'youth premium' goes up, and if you have lproportionately less young people, then you aren't in the high-end-value class. Ok that's it. Japan is sinking, we're all sinking, now what are we going to do?

Shooting Blanks in the Air

So the Bank of Japan has been caught in the act: intervening to no effect. Of course so long as the US authorities continue to be 'comfortable' with the fall, there is really little that the central banks can do. Mind you, these dollar denominated assets could be a real investment for the future. I mean printing yen and getting a peice of the US action, that has to be one of the best business deal on offer right now.

The Bank of Japan this week set two apparent records relating to the currency markets, but the impact on its main aim - to weaken the yen - appeared to leave currency strategists and investors less than impressed. On Thursday, weekly custody data released by the US Federal Reserve - seen as a proxy for overseas central bank holdings - showed a sharp increase in US Treasuries owned by overseas institutions to a record monthly total of $35.4bn. For holdings to have risen that much, strategists believe one or more central banks must have been actively intervening. Bank of Japan data released on Friday appeared to confirm suspicions that almost all of the Treasury buying came from Tokyo. The BoJ's figures implied a record Y3,983bn ($33.4bn) was spent by the bank in May to stem the yen's appreciation - a bigger sum than many in the market had estimated.

Some said the BoJ's spending underlined its commitment to stemming the yen's appreciation against the weaker dollar and would serve as a warning to any investor preparing to short the dollar against the yen. Most, however, noted the limited impact of the bank's action. "What this shows is how significant the pressure on the dollar is - spending $30bn plus only moved the yen less than 4 per cent," said Mitul Kotecha, head of FX strategy at Credit Agricole Indosuez. The dollar fell to a two-year low of Y115.1 on May 19 and by the end of this week, had climbed to a month-high of over Y119.
Source: Financial Times
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Tightening the Deflationary Screws

Long term interest rates are dropping across the planet. Japan 10 year bonds are now at 0.555 per cent. Looks like we're settling in for the season:

A leading Japanese business daily warned long-term interest rates were falling to historically low levels in Japan, the United States and Europe, amid fears of a deepening global deflationary trend. The yield on newly issued 10-year government bonds, a benchmark of Japanese long-term interest rates, has fallen about two-thirds in a year, the Nihon Keizai Shimbun said. The rate declined to 0.555 percent on Friday, down from the 1.400 percent return offered a year earlier. The daily noted that the yield on 20-year bonds sank to 0.860 percent and that on 30-year instruments dropped to 0.980 percent. This means that the yields on all key Japanese long-term bonds are now lower than one percent, Nihon Keizai said, adding that long-term interest rates are close to future nominal economic growth rates predicted by investors. Private-sector economists have predicted the Japanese economy will suffer negative growth of minus 1.3 percent in nominal terms in the year to March 2004. Japan's price index for consumer goods, excluding perishables, had steadily fallen from year-earlier levels for the past three and a half years, it said.


The deflationary trend is spilling over into the United States and Europe with China emerging as the world's largest manufacturing base with cheap labour and technological innovation, it quoted an analyst as saying. US and European interest rates were already declining rapidly, with the yield on the 10-year US treasury bond touching 3.28 percent on Friday, the lowest level since 1958. The yield on 10-year German federal government bonds slid to 3.6 percent, the lowest return since January 1999. The US consumer price index dropped 0.3 percent in April from the previous month. The US Federal Reserve Board has pointed to a disinflationary trend in which the pace of price growth declines.


The direct cause of recent drops in Japanese long-term interest rates has been the growing movement of funds from stocks to bonds by banks, life insurance companies and pension fund managers, who predict a fully-fledged economic recovery will not occur for some time, it said. Those investors are expecting deflation to adversely affect stock prices through falling corporate sales and income, and are rushing to shift their funds to bonds to protect themselves against that risk, it said. The concentration of investment in government bonds causes a serious distortion in the overall flow of funds, the daily warned. But even if financial authorities relax their grip on credit, most of the funds made available will make their way into government debt instruments, with lending to corporate borrowers continuing to drop and little money being funneled into stock purchases
Source: Yahoo News
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