Crunchtime in Japan?

Here's another guest post from Danish Blogger Claus Vistesen:

Crunchtime in Japan?

Well I have pointed to this several times and most recently as the CPI index was revised bringing Japan dangerously close to the 0% inflation mark amidst talks of business cycles topping and whether the BOJ should indeed raise rates any further. This is of course very unlikely now and the future road for Japan might very well be another period of deflation or at least no-one can rule out this possibility at the current juncture I think.

Now, a revision of the statistics might not be important in itself but let us take a quote from and article in The Economist I used as a source in one of my posts linked above.

'This reshuffling of the statistician's shopping basket has rewritten recent history (see chart). Japan, it now seems, did not escape deflation definitively until July, when the core annual inflation rate reached 0.2% for only the second month in a row. As Richard Jerram, of Macquarie Research in Tokyo, puts it “price pressures today are where the BoJ thought they were six months ago.”'

So Japan is not quite out of the deflation spiral it seems or at least trying hard to get off the mark. On top of this the US is slowing which will be sure to dent Japanese exports. China will probably be able to do some heavy lifting here for a while but the main point here is that Japan lacks the domestic demand structure to carry through a sustainable recovery. Why? well a brief look at the country's demographics is of course quite illuminating here as I have argued several times. Another blogger worth mentioning here is Edward Hugh at Bonobo Land who actually was the one who initially steered me into seing Japan the way I do today ... more or less that is. His latest report on Japan is also very telling of things to come ...

Machine orders in Japan is falling rapidly ...

(quote Bloomberg)

'Japan's machine orders fell the most in almost 20 years, dashing expectations that the central bank will raise interest rates before the end of the year.

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. Orders from semiconductor, steel and mobile-phone businesses paced the drop.'

(Quote Edward)

This is what we could call a second stage event, and now has all the hallmarks of a classic domino chain, although it still isn't clear how far it will reach (all the way to Shanghai??). I am not at all convinced that investment in the US will take up the slack given what we know about fixed capital investment in China, and given the way capacity in things like machinery and equipment has just been ramped up so much in Germany and Japan. As we can see, in Japan it is fixed capital investment that is being hit first.

So watch out everyone, 2007 could be a very complicated year.

Update on Monday, September 11, 2006 at 10:25PM by CV

The Yen/Euro relationship also tells an important part of the story here ...

(quote Bloomberg - bold parts are my emphasis)

'The yen had its biggest drop against the euro since April on speculation the Bank of Japan will lag behind the European Central Bank in raising interest rates this year.

Japan's currency also slid from a one-month high after a government report showed machinery orders fell the most in almost 20 years in July. ECB Chief Economist Juergen Stark was reported today as saying inflation in the 12 nations sharing the euro will stay above target this year and next.

The drop in machinery orders `` confirmed the market's expectation that the Bank of Japan is likely to raise rates at a very slow pace this year,'' said Kamal Sharma, a currency strategist at Bank of America Corp. in London. ``The yen is likely to remain under pressure.''

(...)

``We'll see widening interest-rate differentials from here,'' said Benedikt Germanier, a currency strategist in Zurich at UBS AG. ``The key for euro-yen are the machinery order numbers which came in weaker.''

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. The median forecast of 30 economists surveyed by Bloomberg News was for a 5.4 percent decline.'

Japan Machinery Orders Slump

Wow, get this from Bloomberg today:

Japan's Machinery Orders Drop Most in Almost 20 Years

Japan's machine orders fell the most in almost 20 years, dashing expectations that the central bank will raise interest rates before the end of the year.

Non-government orders excluding shipping and utilities dropped a seasonally adjusted 16.7 percent in July from a month earlier, the largest slide since October 1986, the Cabinet Office said today. Orders from semiconductor, steel and mobile-phone businesses paced the drop.

``With risks over the U.S. economy looming large, we don't think the Bank of Japan can raise rates'' before March 31, said Yoshimasa Maruyama, an economist at BNP Paribas Securities in Tokyo. ``While part of the drop is a correction from several months of strong data, this was still a considerable decline.''

Today's drop ``is payback for strong orders in recent months,'' said Itsushi Tachi, director of business statistics at the Cabinet Office. ``The trend is for growth.''

The government forecasts machinery orders will increase 4.9 percent in the quarter ending Sept. 31.

``To reach this target, we need growth of 16 percent in August and September,'' Tachi said.

I will write and post more on this as and when I have some time. For now I would just point out that on both this and the German front I have long forseen what was going to happen and in a certain sense the data is now 'coming home to Daddy', although I can't say that this makes me especially happy: I would prefer to have been wrong.

More fuel on the fire will definitely comes from this news last Friday in the US:

"The Federal Reserve reported Friday that consumer borrowing rose at an annual rate of 2.8 percent in July, down from an increase of 7.3 percent in June."

"The slowdown was led by a sharp deceleration in credit card debt, which rose by just 3.4 percent in July after gains of 13.2 percent in June and 13 percent in May."
Associated Press

This is what we could call a second stage event, and now has all the hallmarks of a classic domino chain, although it still isn't clear how far it will reach (all the way to Shanghai??). I am not at all convinced that investment in the US will take up the slack given what we know about fixed capital investment in China, and given the way capacity in things like machinery and equipment has just been ramped up so much in Germany and Japan. As we can see, in Japan it is fixed capital investment that is being hit first.

So watch out everyone, 2007 could be a very complicated year.

Basically the whole Greenspan/Bernanke hand-over was bungled, they should have had one token pause back in November, then Bernanke wouldn't have had to prove his inflation fighting prowess so, and advance over what seems to have been a bridge too far. (I was in fact arguing this back then on this blog).

Also the central bankers collectively should carry some of the can, if what looks like it might happen actually does, since all this 'inflation fighting' jargon has really been quite stupid. As Rogoff has been arguing, what we really have is a change in the terms of trade.

Yen Up, Yen Down

This one in Bloomberg brought a smile to my face:

Yen Jumps After Mirow Says IMF to Discuss Currency's Weakness

The yen jumped after German Deputy Finance Minister Thomas Mirow said the currency's weakness will be discussed when finance ministers and central bank governors meet in Singapore next week.

``The yen has clearly weakened against the dollar but also against the euro, and in so far this will surely be discussed,'' Mirow told reporters in Berlin today.

``There's growing unease outside Japan about the yen's weakness and government officials will have something to say about it,'' said Carsten Fritsch, a currency strategist at Commerzbank AG in Frankfurt.

The yen advanced to 116.26 against the dollar at 7:15 a.m. in New York, compared with 116.65 late yesterday. It also had its biggest gain against the euro since May, climbing to 148.17 from 149.39. The euro fell to $1.2727 from $1.2806.

Japan's currency has slid 6 percent since reaching 109 per dollar on May 17, the highest since September 2005. It also dropped to a record 150.73 versus the euro on Aug. 31.

Now the 24 hour change isn't that great, but the timing IS impeccable. So you can put two readings on this, either markets reacted anticipating changes, or someone somewhere threw a switch to try and ward-off criticism.

There are sort of wheels-within-wheels here, because of course it was a little strange that the yen should be so low against the euro if the Japanese economy was in the process of powering back into the growth arena.

So again you could read the low yen in a number of ways. It could be a sign that many in Japan don't believe the recovery story, and are hedging just in case, or it could be that the disappearance of deflation is in part produced by a policy of steering the yen downward. Choices to suit all appetites, so take your pick. Mind you, if it was the latter, then that *would* explain it if there had been a little hand reaching out discretely to throw a symbolic switch :).

Dooming and Glooming about Japan

And now for something completely different, a guest post from Danish Blogger Claus Vistesen:

Dooming and Glooming about Japan ... Is it too much?

It has been a while since I have reported on the excellent writings of the Economist's weekly column Buttonwood about economic and financial markets. And before we get into the actual topic I would like to offer my humble advice to the editors of the Economist's website and Buttonwood herself. Consequently, it is beyond me why The Buttonwood Column has not, a long time ago, been structured as a blog with permalinks to entries, entries archived chronologically, trackback features, categories, a blogroll, a decent commentary option (the one now is useless) and a unique RSS feed (does it have that?). I mean you could make these changes in an afternoon (or perhaps two :)) and the attention towards Buttonwood would increase more than ten-fold. The column would instantly get a prominent place on Alpha.Sources' blogroll as well as a welcome post although I am quite sure that its entry into the econ-sphere would be appreciated by all of us. End of rant ...

Now let us move on to the actual content of the Buttonwood column as it was updated last (8th of August) (Walled for non-subscribers). In this column Buttonwood takes on the Japanese economy and gives a vivid and precise description of two discourses; optimists and pessimists concerning the recovery of the previously deflation crippled economy. Regular readers of Alpha.Sources will know that I am (still) amongst the latter and since Buttonwood, at least reluctantly, places herself in the optimist camp there should be ground for an interesting exchange here.

'Quite a few such people [pessimists narrated as Western Money managers by Buttonwood] have been populating the lobbies of Tokyo's lusher hotels this summer, venting their spleen about Japan's economic prospects in a way that strikes local boosters, such as this columnist, as the grossest of ill-manners in a country where these things matter.'

And the bottom line of the pessimists;

'The naysayers point out that the blistering (for Japan) pace of economic growth has probably slowed sharply from its rate of more than 3% earlier this year, thanks to a slowdown in export growth, a destocking of inventories and cuts in public spending. Japan's economic fundamentals, they argue, are weakening, notably in business investment, the area that has until now generated the most excitement about Japan's recovery.'

Moving on the optimists;

'The boosters affect not to be too concerned about that. After all, the outlook for capital expenditure is bright, as reflected in the Bank of Japan's latest Tankan survey of business conditions, published last month. It shows growing optimism among companies, particularly large ones, which plan to boost capital expenditure by 12% in the fiscal year that began in April. What is more, non-manufacturing companies also feel confident enough now to invest.'

Now before we move on it is clear that what we need to really talk about here is the nature of Japan's recent growing growth rates. The quotes above implie that the growth has, to a large degree, been driven by exports which again means that in order for the recovery to be sustainable domestic demand has to pick up to at least some degree in order to carry the positive spiral on. And this is exactly where we need to be cautios I think ... Following Buttonwood further we find that this is also what distinguishes the optimists from the pessimists ...

Besides, boosters expect consumption to take up the running from investment as the main driver of domestic demand—just as business investment earlier in the four-year-old recovery took over from exports. Here, the naysayers, in their pinched fashion, point out that little sign of this recovery in consumption is apparent yet. Data collected by government surveys of households show that both consumption and disposable income were falling in recent quarters. Shops report sluggish or negative growth. Car sales are falling.

Buttonwood stands firm though ...

'This columnist attempts to gather his composure. Yes, consumption is patchy, but that's not the whole picture. As far as jobs are concerned, the outlook is bright. Labour markets in many parts of the island chain are tight and companies expect to do more hiring. As Mr Feldman points out, the number actually in work has been stable since mid-2003, despite a fall in the working-age population. This suggests that workers who dropped out of the labour force during the long slump have been keen to rejoin it'

So where is the Japanese consumtion patterns going and more importantly, will there enough and sustainable domestic demand to support the recovery and future growth? This seems to be the question does it not and although I cannot by no means give the answer it seems prudent to at least exhibit caution when we, after all, are talking about the world's oldest population with a TFR well below replacement level. In short; there might other reasons why labour markets are tightening. It definitely seems as if Japan has escaped deflation (for now) and this is good because this means a growing economy. In the end I do not want to be the wiser here because my argument drawn from the demographics of Japan has long term implications none of us can predict. Japan is certainly now in a much more virtuos circle than before where it was held back by the claws and fangs of deflation and this is good but I do not think we should expect a Tiger's roar from Japan; more like a faint miauww perhaps?