Japan: Bulls or Elephants?

Lex has a column on Japan in the FT today. Basically it reflects the growing attention which is likely to be focused on Japan's fiscal situation. One interesting point which can be seen in the graphic he provides is the fact that Japan seems to have peaked in early 2005. This may be the longest running expansion Japan has had in many a long year, but we definitely seem to be in the downswing at this stage. Which makes you wonder about all those 'recovery' arguments we had earlier in the year.

Lex is also right to draw attention to all the uncertainty which there is about the level of the debt. He suggests that it may be as low as 90% if you take into account accumulated assets in the social security fund, although some argue that if you take that into account then you also need to consider the acquired liabilites (all the pensions yet to be paid) and then you end up with something in the region of the 'official' 175% figure.

The numbers don't seem to be the important issue. The important issue is the sustainability of this moving forward.

And don't miss the fact that he gets the main point, namely that "nominal growth could slow as Japan’s workforce shrinks more quickly."


The news that Japan will soon enjoy its second golf course flotation since 2004 should warm the hearts of bulls. Whether Shinzo Abe’s ascent to prime minister this week should do so is less clear. During the tenure of Junichiro Koizumi, his predecessor, the scourges of bad debt, deflation and abysmal confidence were largely overcome. Unfortunately, in spite of slaying post-bubble Japan’s dragons, Mr Koizumi left behind an elephant in the room: the level of public debt.

This can be exaggerated. Gross public debt is a catastrophic 175 per cent of gross domestic product. But deducting substantial financial assets held by the state, but excluding central bank assets, leaves net debt at 90 per cent of GDP – lower than Italy, a fellow fiscal reprobate. And any government which can borrow 10-year money at a rate of 1.66 per cent cannot be said to face an imminent fiscal crisis. Mr Abe’s new cabinet confirms that he prioritises growth over lower debt. Koji Omi, finance minister, a proponent of higher consumption taxes, has said that this revenue-raising measure is off the agenda until after the July 2007 upper house elections.

And in the longer term? As cabinet secretary, Mr Abe signed up to Mr Koizumi’s July plan to eliminate the primary deficit (that is, before interest payments), currently 4 per cent of GDP, by 2011/12. Aside from the leisurely pace and, arguably, the lack of detail, there is one big objection: a primary balance may not be enough to lower net public debt relative to GDP. By 2011/12 the level of gearing will have reached about 100 per cent. For it to fall, the state’s effective net cost of borrowing must be lower than nominal GDP growth – today, at 1.5 per cent, it is at least 50 basis points below. But low real interest rates may well rise, while nominal growth could slow as Japan’s workforce shrinks more quickly.

Once More On The Yen ...

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


Once More On The Yen ... Talk Is In Fact Cheap

Some days ago I reported on how policy makers at the G8 summit in Skt Petersbourg were trying to talk up Yen in the midst of the recent weakening of the currency relative to the Dollar and Euro. The Japanese Finance Minister called the recent drop in the Yen a 'little rough' whereas others talked about how the value of the Yen simply did not reflect the fundamentals of the Japanese economy which after all is in the midst of a sustainable recovery. I obviously diagree here and I believe that the Yen's recent tumbling is very much aligned with the fundamentals of the Japanese economy; that is an economy which is having mighty difficulty escaping deflation, particularly after the CPI index was revised in August, and as such the BOJ is not going to embark on a hike any time soon.

Should we see what the markets have to say about the Yen then despite all the well thought comments from the G8 summit ...

(From Bloomberg - bold parts are my emphasis)

'The yen may fall to a 20-year low as individual investors in Japan join speculators on the Chicago Mercantile Exchange in selling the currency.

Measured against currencies of Japan's largest trading partners, the yen is approaching its lowest value since 1985, an index prepared by the nation's central bank shows. Japanese investors last month bought more overseas bonds than ever before. Traders on the Chicago futures exchange have a $9.74 billion wager the yen will decline.

The currency has fallen 4.3 percent against the dollar in the past four months as a rebound in the economy faltered, suggesting the Bank of Japan won't raise interest rates again this year from 0.25 percent. The prospect that rates will remain among the lowest in the world has prompted Japanese to invest more of their $6.55 trillion in currency and deposits outside of the country.

``We could see more massive outflows,'' said Lara Rhame, a senior currency strategist at Credit Suisse Group in New York. ``It's the yield story that's driving Japanese investors abroad.''

The yen will weaken to 118 against the dollar in three months and 120 in a year, Credit Suisse predicts. Last week the yen gained 0.9 percent against the dollar to finish at 116.56 and declined compared with the euro to 149.

(...)

Back to the good-old yen carry trade ...

'U.S. and European money managers also are putting pressure on the yen by borrowing the currency at low rates and then investing in countries with higher yields, such as New Zealand and Iceland. The prospect the so-called carry trade will weaken the yen has encouraged others to bet against the currency.

Speculative short positions, or bets that the yen will fall, outnumbered long positions by 90,804 contracts on Sept. 19, up from 69,498 two weeks earlier, CME futures trading data show. Futures contracts are agreements to buy or sell a security at a specific date and price. Each contract is for 12.5 million yen.'

There is plenty more interesting points in the Bloomberg piece linked above and it is definitely worth, at least, a quick glance. As for my discourse on this it should come as little surprise for regular that this has a lot to do with the demographics of Japan. Actually demographics can explain much of what has happened in Japan the last decade. However, it seemed as if the end of ZIRP (Zero-Interest-Rate-Policy) a year ago by the BOJ, at least for a time, made people exactly forget about the fundamentals of the Japanese economy; that is that they did not change just because the BOJ shifted course. Let me be as clear as I can possibly be; Japan is not back amongst the leaders in the global economy in the sense that the country has finally escaped deflation (deflation is still a distinct possibillity here) and Japan is not going to experience any sustainable recovery based on a surge in domestic demand as many pundits predict. Given the current population dynamics of Japan the country's relative clout in the global economy will decline and obviously relative is important here since Japan still is one of the world's biggest economies but, I am sad to say, decline it will.

Japan's Trade Surplus

The recent drop in oil prices and the low value of the Yen seem to be sending Japan's trade balance once more spiralling into surplus:

Japan’s trade surplus rose nearly 100 per cent in August, showing that net exports were still contributing to overall economic growth and that the effects of high oil prices were slowly waning.

Although the leap was smaller than expected, economists said the numbers showed that exports to the US, China and Europe continued to expand. Because exporters tend to take a summer break in August, the trade surplus is generally small, making big changes in percentage terms quite common.

Japan, At Last Some Sense

This article about the extent to which the Japanese treasury is dependent on company profits for income is interesting, but beyond that I'm not sure how to interpret the fact since I am not sufficiently knowledgeable about the Japanese fiscal system.

However, a number of points do stand out. Corporate profits now fund the revenue:

Japanese corporate profit tax receipts are poised to overtake personal income tax contributions for the first time in 18 years, a shift that could influence debate among contenders vying to succeed prime minister Junichiro Koizumi.

Wages seem to be flat:

The figures highlight the strong return to profitability of Japanese companies, which have retained most of their gains without passing them on to workers in the form of higher wages. Although the labour market has become tight - with more jobs than job-seekers - wages have hardly risen, although bonuses have improved.

Consumption taxes are soon set to rise:

The finance ministry wants to rebalance the tax system largely by increasing consumption taxes. A central plank in the prime ministerial campaign platform of Sadakazu Tanigaki, finance minister, is a doubling of the sales tax to 10 per cent.

Although not everyone agrees:

Shinzo Abe, who is likely to win the leadership contest, is influenced by policymakers who argue that raising taxes could damage consumption and harm overall economic activity. His policy is to cut spending and try to increase the government’s tax take through promoting growth.

But funding through growth is just what has been tried and failed, that's why the debt is where it is. This view rings hollow.

Most Lopsided Economy in the G7

And then along comes Andrew Smithers:

Andrew Smithers, an economist at London-based Smithers & Co, has said in a recent report that the swing in corporate profits might need to be reversed in the interests of domestic consumption. He argues that Japan is the most lopsided of the G5 economies - the US, UK, Japan, France and Germany - with the lowest consumption and highest investment ratios; the largest current account surplus and budget deficit; the worst demographics and the lowest interest rates.

“These oddities are almost invariably ignored,” he says. “They illustrate how far the economy is from any likely equilibrium and this conflicts with the conventional wisdom which holds that Japan has corrected the past distortions of its economy and is now set on a path of balanced growth.”

Moreover the household savings rate has been falling steadily: from nearly 12 per cent of GDP in 1997 to just over 2 per cent last year. This is also perplexing, does this mean that, following the Life Cycle Theory people do finally get to dis-save in the end. I have long entertained doubts about this, but household saving in Japan is definitely something to watch. But what this seems to suggest is that after the reforms the Japanese are not only not spending, they aren't even managing to save like they used to.