Japanese Third Quarter GDP

Well Japanese GDP maintained its momentum in the third quarter according to the initial data released today:

Japan grew more strongly than expected in the third quarter with strong exports more than offsetting weak domestic consumption to produce annualized growth of 2 per cent......The economy, which grew a revised 1.5 per cent in the second-quarter on an annualized basis, has been expanding for seven straight quarters. Next week, the recovery will enter the record books as the longest - though far from the fastest - period of sustained growth since the war."

"Third-quarter numbers showed that consumption shrank 0.7 per cent from the previous quarter. But exports climbed 2.7 per cent and capital investment, in spite of weak recent numbers, jumped 2.9 per cent, marking the 10th quarterly rise in a row."

and Bloomberg:

Consumer spending, which accounts for more than half of the economy, fell 0.7 percent, twice as much as the 0.3 percent drop expected, amid a spell of bad weather that kept shoppers at home and as wages growth stalled.

So the picture remains pretty much the same, strong export lead growth sustained by capital investment, with shrinking domestic consumer demand. A big part of the burden was carried by growing investment demand:

"Capital spending in the quarter surged 2.9 percent, more than three times the 0.9 percent gain expected. Mizuho Financial Group Inc., Japan's second-largest bank by market value, and Tokyo Electric Power Co., the nation's biggest power company, announced plans this month to invest as the economy grows."

But the big question mark still remains as to whether this is anticipating internal demand which may not arrive, and whether or not this investment is justified if export demand weakens. In other words we may have excess capacity building up again, which obviously would be deflationary in its impact. This is presumably not being lost on the BoJ who are using the growth in such investment spending as an argument for raising rates, but here, as I have been arguing, they are trapped between a rock and a hard place, and indeed it is hard to assess how many of these investment projects are being financed now precisely to avoid having to pay the higher interest rates which the BoJ is threatening to introduce later.

One thing which is striking here is the way in which, despite the inevitable labour market tightening as the population shrinks, wage drift and inflation remain incredibly tame. This is an indicator of just how far the reform process has actually gone in Japan, since there seems to be absolutely no room whatever for wage-push inflation. This is also something of a warning for those who simply argue that more structural reforms will cure the problem, since in the case of Japan at least they seem to have been tried and found partially wanting. Still, there are those who live in hope:

Koji Omi, finance minister, told the Financial Times last week that the recovery remained solid in spite of signs of slowing US demand. It was true, he said, that higher profits had not fed quickly into better wages and stronger consumer demand. However, he said that, with the labour market tighter than at any time in 15 years, he expected wages and consumption to pick up soon.

Right and Wrong on Japan?

This is a cross-post from my own blog Alpha.Sources in which I argue that any economic analysis of Japan must begin with the demographics. I am no fundamentalist but it seems very clear to me that any economic analyses on Japan which do not take the time to look at the structural effect of the demographics on the economy are not worth much I am sad to say.

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We are now ready to another trip around the economic commentaries dealing with the Japanese economy and its sustainable/ongoing recovery. For a list of my recent post on Japan go here.

Let us begin with the those who are getting it right. First off, the FT's Lex column seems to be on the right track concerning Japan. Back in September Lex ran a column asking about what in fact was happening to the Japanese recovery based on disappointing data coming out from June. This week Lex also takes on Japan in one of her columns pointing once again to weak data especially on lending and subsequent consumer spending.

(bold parts are my emphasis in terms of all excerpts presented below)

What recovery? Japanese economic data continue to disappoint. The latest, published on Thursday, show bank lending growth decelerated on an annualised basis in October, for the third month in a row. City banks actually lent less than a year ago.

Borrowers are clearly in short supply. Companies are less willing to invest. Even if they were willing, most have plenty of cash on their balance sheets. Nor is it just borrowers who are thin on the ground. Shoppers too are holding back, as the government knows to its cost: consumption tax revenues fell 3 per cent year-on-year in the six months to September. Private sector economists are slashing estimates for third-quarter growth, due out on Tuesday. Since consumption alone fell 0.9 per cent, it is possible the economy contracted.

Also the FT's David Pilling is scratching the right places in an article discussing how the BOJ might act pre-emptively against inflation and raise rates come next meeting (that is, some time before the end of the year). Yet as Pilling so rightly points to (at least implicitly); what inflation? If we discount the headline Japan is still running deflation and even including energy Japan is flirting with a potential backlash into a vicious deflationary circle.

Speaking to a seminar in Tokyo, Mr Fukui said: “Waiting for inflation to build up in raising interest rates would cause a sharp swing in the economy. Our task is … to take careful action before these conditions appear in order to achieve price stability and keep future economic swings gradual.”

The governor’s comments come against a background of weak headline inflation and concern among some analysts that the economy, which is going through a weak patch, could actually slip back into deflation.

His remarks reinforce the bank’s insistence that it will not tie its policy to the headline rate of inflation, which has been sliding, partly due to technical factors.

Instead, the BoJ, which raised rates in July for the first time in six years to 0.25 per cent, wants room to be able to act against inflationary pressures before they are apparent. It has what some economists consider to be an overly conservative understanding that price stability equates to an inflation rate of between zero and 2 per cent.

This allows no buffer against slipping back into deflation, and the bank has resisted hitching its policy to a specific inflation target.

Jonathan Allum, Japan strategist at KBC Financial Products, said: “The nightmare scenario is that A: you begin to see evidence of economic contraction, B: you get a return to deflation, and C: the Bank of Japan ignores all this and tightens anyway.”

Mr Allum said the economy had been slowing for nearly a year and that it could even contract in the third quarter because of sluggish consumer spending. “Clearly there is a danger that the BoJ is too gung-ho in its view of the economy,” he said. “If energy prices are excluded, as they are in most economies, Japan is still in deflation.”

So these were the ones getting it right. Moving on I should say that I do not have an FT subscription but instead I have chosen some three years ago to go with The Economist. I stand by that decision but in no way because of the magazine's continuing la-la position on Japan. Consequently, The Economist runs a story this week about the 'vigorous' state of the Japanese economy.

The school of Japan-watchers that keeps an eye on the country's economy chiefly out of a morbid interest in terminal decline (ouch :)) has stopped dwindling . It has even taken on new adherents of late. For signs are mounting that the recovery that began in 2002 has slowed—or even, some say, gone into reverse.

The chief worry is that what started as a recovery driven by exports (chiefly to China), and then expanded to one led by business investment, has failed to spread to households, whose spending remains sluggish. Prices still flirt with deflation (see chart). And some economists predict that figures published on November 14th will show that the economy actually shrank in the third quarter.

Is this growing uneasiness justified? Mostly not. Take the economy first. Certainly, its anaemic performance marks this recovery as out of the ordinary, but then it follows long years of extraordinary distress. Habits are hard to change. So even though households now have more income—because companies are hiring more, and raising overtime and bonuses—this has not shown up in consumer spending. Alarm mounted last week when the main survey of household spending recorded a plunge in September of more than 6% compared with a year earlier. Yet this fall is too big to be credible; the survey (like early GDP numbers and other Japanese statistics) is notoriously unreliable.

Meanwhile, expectations are rising, even if habits have not yet caught up. Households' estimates of future inflation and property prices have climbed since the spring. People are not spending gaily, but they are starting to remove money from risk-free havens and invest it again. Deflation had killed the appetite for risk. There are other signs that the recovery is still broadly on track, even if it has, as in 2004, hit a soft patch. The latest bank lending figures seem to confirm this: though growth slowed in October, the year-old recovery in bank lending is still intact.

(...)

Moving forward in Japan? Well, certainly and good all the same! Addressing the Japanese 'dual-economy.'

A priority is to address Japan's so-called “dual” economy. The competitive exporting industries are not matched in agriculture and services, which are shielded from competition, lack economies of scale and are backward in their use of information technology. To boost investment, the government is mulling a cut in corporate income tax and other tax changes. Deep reforms to pensions and health care are also expected.

oh yes, and to use a classic proverb - it's the demographics stupid!

Japan's demography, says Genichiro Sata, the minister for regulatory reform, demands higher growth, and it is the Abe government's intention to impart deep structural change—including even a wholesale restructuring of government, by crunching Japan's 47 prefectures into a handful of American-style states. These are early days. Mr Abe has given little sense yet of his priorities, and many of the proposals are hardly vote-winners. Reformist achievements are yet to be seen. But the charge that Mr Abe has no reformist intentions is getting harder to make.

Ok, am I being too much of a dooms-speaker here on Japan? Perhaps I am but only time will tell really. What I would like to do though is to make a point across the table here. Japan as a society and in this case as an economy is deeply affected by its demographics, subsequent low fertility and more importantly high median age. Demographics are not destiny but if we begin here I feel that much of Japan's current economic plight can be explained in its core. As such, I believe that the continuing lack of consumer spending is not subject to an automatic reversal as The Economist rather naively, I am sad to say, suggests. In fact, low consumer spending is a structural indicator of Japan’s population structure which is also why Japan is running a trade surplus and also why in the end Japanese economic growth is by and large export driven. I hardly think it is a problem of ‘habits which merely take time to adjust.’ This argument has wide consequences for the way we look at Japan and its problem with deflation which after all must also be considered a structural phenomenon in the economy. Even more obvious is the labour supply where many a commentator (although not any linked here!) have argued that the tightening labour market was a cyclical phenomenon pointing to supply having problem keeping up with demand as the recovery really got underway. I am sympathetic to this point since it is theoretically a good point, just not in Japan where the age composition of society is a proxy for tightening of the labour supply and as such is a structural effect of the changing pyramid more than a cyclical fluctuation.

So let us begin with a strong basis of analysis and move our way up from there, that is really all I am pointing to.

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And the Update 11 November based on the latest data on machine orders.

Sadly the data keeps on going the wrong way for Japan.

(From Bloomberg - bold parts are my emphasis)

Japanese machinery orders unexpectedly slumped, signaling economic growth may stall and prevent the central bank from raising interest rates, already the lowest among major economies. Stocks fell.

Non-government machinery orders, excluding shipping and utilities, dropped a seasonally adjusted 7.4 percent to 997.5 billion yen ($8.5 billion) in September from a month earlier, the Cabinet Office said in Tokyo today. Third-quarter orders sank 11.1 percent, the biggest decline ever.

Bonds rose on expectations that the report, an indicator of capital spending plans, will ease the Bank of Japan's concern its key overnight lending rate of 0.25 percent could fuel excessive investment. Next week's gross domestic product report is expected to show corporate spending growth slowed in the third quarter.

`The drop in machinery orders was a surprise,'' said Soichiro Kimura, an analyst at Mizuho Securities Co. in Tokyo. ``It's adding to speculation the report will weaken the central bank's case for raising rates.'' `

(...)

``The gap between the actual economy and the Bank of Japan's view might be widening,'' said Hiromichi Shirakawa, chief economist at Credit Suisse Group in Tokyo.

Sustained growth in exports, the only standout in the quarter, will be key in ensuring business investment keeps rising, Dai-Ichi's Iizuka said.

Japan: Good News or Bad?

The presentation of the latest set of industrial production figures from Japan is interesting. The consensus is basically upbeat (and here). But read between the lines and things aren't so clear. And if you look at my post here, Japan certainly seems to have been slowing for the best part of a year now.

As Bloomberg have it:

Japan's industrial output rose to a record last month and inflation accelerated, giving the central bank room to raise interest rates by the end of the fiscal year in March.

An index of production climbed 1.9 percent from July, led by autos and electronics output, the trade ministry said in Tokyo today. Core consumer prices, which exclude fresh food, gained 0.3 percent from a year earlier, the statistics bureau said. Both results were in line with economists' expectations.

But

Still, prices excluding food and energy, which haven't risen in eight years, continued falling last month, signaling recent gains in core consumer prices have been largely the result of rising oil costs. Prices excluding food and energy fell 0.4 percent from a year earlier, the statistics bureau said.

``August was the month when energy pressure peaked. We have already seen gasoline prices weaken,'' said Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo, predicting that core prices may resume declining by the year's end. ``That's a very tough situation for the central bank -- it's only energy pushing up the consumer price index.''

Core prices in Tokyo, home to one in 10 Japanese and a harbinger of Japan's nationwide consumer prices, were unchanged in September from a year earlier. Tokyo prices excluding food and energy fell 0.3 percent this month.

and

Today's factory output report showed that production, shipments and inventories of electronic parts and devices all rose to a record in August. A slowdown in global growth may pose a risk for production in the coming months.

``A potential risk is inventory accumulation in electronics parts and devices in anticipation of Christmas sales,'' said Morgan Stanley's Sato. ``This may result in unplanned inventory accumulation due to lower foreign demand.''

Japanese manufacturers cut output in 2004 when global demand for electronics and chips slowed, causing the economy to contract in the fourth quarter and almost pushing it into recession.

Interesting isn't it, the way you can 'spin' data.

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.