December Tankan Index

Well the latest edition of the Bank of Japan’s Tankan survey is now public property, and it does register a marginal increase to 25 from 24 last time. Perhaps just as significantly though the companies surveyed expect the index to decline to 22 next time round, which means that the forward looking component is not overly strong.

Perhaps the most noteworthy point in the FT article was this one:


"One of the mysteries of the present recovery, now in its fifth year, is the slow pace at which record corporate profits and a tight labour market have transferred to wages and consumption. Mr Ogawa said companies would have to start increasing the share of profits given to labour over the next year or so, but he didn’t expect any dramatic rise in wages."

Well I hope that by now this feature of the Japanese situation should no longer be a mystery for regular readers of Bonobo Land or Demography Matters, or for that matter for readers of Claus Vistesen's blog. Basically a rising median age is affecting the savings component relative to consumption, while at the same time the tightening labour market is more a reflection of a reducing potential labour force than anything else. Thus:

The diffusion index for employment conditions at big companies in all industries registered minus 11, compared with minus 8 in September. A negative number reflects a labour shortage, a situation that is expected to deteriorate over the next three months when the index is projected to reach minus 13.

Given Japan's demographic not only should we expect this situation to deteriorate, it is hard to see how it can do other than deteriorate, and deteriorate.

Incidentally we have another version of the every cloud has a silver lining story running in Japan at the present time:

"Capital Economics, a London-based research company, said a rate rise next week would be “more Santa than Scrooge” since it could actually improve consumer sentiment by boosting the interest paid on savings. Economists regard domestic an improvement in consumption as vital to keep the recovery going and to consolidate the defeat of deflation."

Well the last time I thought about it, rising interest rates were thought to encourage saving, not discourage it. So although there may be some sort of wealth effect somewhere, the NET impact is sure to be negative for spending, not to mention what rising interest rates would do to the servicing problem for Japan's enormous mountain of public debt.

In(de)flation in Japan?

(Cross post from Alpha.Sources)

I actually have a link to this in the post below but I still believe it deserves attention above the fold. On the back of this I would really like to hear anybody arguing the BOJ to raise any time soon.

(From Bloomberg)

Japanese inflation unexpectedly slowed in October as oil prices dropped, dashing expectations that the central bank will raise the lowest interest rates among major economies later this month.

Core consumer prices, which exclude fresh food, rose 0.1 percent from a year earlier, the statistics bureau said today in Tokyo, slower than the 0.2 percent median forecast of 36 economists surveyed by Bloomberg News. The unemployment rate dropped to 4.1 percent, close to an eight-year low of 4 percent, a separate government report showed.

Governor Toshihiko Fukui has said the Bank of Japan needs to gradually raise the lowest interest rates among major economies to sustain economic growth and avoid excessive business investment and asset-price bubbles. A slowdown in core prices won't impede the bank's attempt to raise interest rates early next year, said economist Eishi Yokoyama.

``It's clear that energy prices are really weighing on consumer prices and are one reason inflation isn't picking up,'' said Yokoyama, an economist at AIG Global Investment Corp. in Tokyo and one of seven surveyed who correctly predicted the number. ``Recently BOJ policy makers have been very upbeat so this number alone won't deter them from raising rates in January.''

The yield on the 10-year government bond fell 4 basis points to 1.605 percent as of the lunch break in Tokyo, the lowest in more than two months.

Household Spending

Household spending slipped 2.4 percent, less than a 4 percent median estimate of economists, the statistics bureau said in a separate report. The yen traded at 115.57 per dollar at 11:10 a.m. in Tokyo from 115.70 before the reports.

Consumer price gains slowed because of declining oil prices and the inflation trend is unchanged, Economic and Fiscal Policy Minister Hiroko Ota said in Tokyo today. The timing for an interest-rate increase is up to the Bank of Japan, she added.

Japan is Getting Interesting

(Cross post from Alpha.Sources)

As regular readers of Alpha.Sources will know I have become quite fond of 'Japan-watching' as a discipline and as the pundits' commentaries and general economic data keep coming in I must say that it is getting exceedingly more interesting. Clearly, I have an impetus here and in essence I feel that I am on to something and I will keep poking and scratching accordingly; so should look at the next round then? Let us by all means begin with some recent data ...

First of all the picture of consumer spending is shining bright as ever, this time as a derivative of dropping retail sales figures in November. (From Bloomberg)

Japan's retail sales unexpectedly fell for a second month, reducing the likelihood that consumer spending will accelerate and lead to an increase in the lowest interest rates among the world's seven biggest economies.

Receipts at retailers fell a seasonally adjusted 0.2 percent in October from a month earlier amid warmer-than-usual weather, the trade ministry said today. Sales of winter clothes and electronics led the decline.

The retail ``report does make it somewhat more difficult for the bank to move because things aren't exactly adding up,'' said Jan Lambregts, head of Asian research at Rabobank International in Hong Kong. ``The Bank of Japan is taking an optimistic view on the economy.''

In terms of coherency of arguments we might want to hold on to the one made by Jan Lambregts as he points out that things, in terms of the BOJ's ability to raise, not exactly are adding up. Meanwhile, we also have the recent numbers on industrial output and wouldn't you know it; here Japan shows a quite impressive progress, (from Bloomberg).

Japan's industrial production unexpectedly rose to a record, backing the central bank's assessment that the world's second-largest economy is strong enough to withstand higher interest rates. The yen rose.

Factory output in October climbed a seasonally adjusted 1.6 percent from a month earlier, the Ministry of Economy, Trade and Industry said in Tokyo today. Gains were led by autos and semiconductors as production rose 7.4 percent from a year earlier, the biggest jump in more than two years.

Toyota Motor Corp., Japan's biggest company, said this week it increased output in October by 16 percent because it expects overseas demand to climb. Central bank Governor Toshihiko Fukui said yesterday the lowest interest rates among major economies will have to rise to ensure the economy keeps expanding.

Notice especially the central bank governor Fukui's discourse about how the economy surely is on its way to become resilient enough to sustain an increase in the interest rates which for the record is still running at a staggering 0.25%. Now dear reader I can certainly understand if something in your mind is not adding up but I can assure you that by applying the right tools we can break this nut. Let me first get one point across the board here which has to do with the nature of economic growth in Japan. In short, how would we explain growth in an economy where total output is going up while domestic output is down driven by declining domestic consumption? Yep, you got it; export driven. This is of course not very complex but we need to ask ourselves why Japan's growth is export driven and more importantly why/whether it will continue to be so as we move along. As such there are two rivalving analyses here ...

1. The first explanation is roughly based on the ideas of business cycles in the economy and seems to be the mainstream way to see this. Following this it is by defintion only a matter of time before the upbeat trend in the corporate sector spills over into the private sector and thus pulls up private consumption in order to achieve a balanced growth path. As such a recent commentary from Morgan Stanley's Global Economics Forum argued the following;

As shown in preliminary Jul-Sep GDP numbers, the contrast between the corporate sector and the household sector has intensified, and this gap is not likely to close for some time. We assume that it will take a year or more for a positive growth cycle to develop, as momentum on the corporate front gradually spreads to the consumer and household level.

Notice particularly the idea of the 'gap' closing here as it is precisely this kind of dynamic I for one do not see in Japan as we move along. This is also from where we get all the mixed messages from monetary policy watchers since it is presumed that monetary policy should act counter cyclically as the economy gains momentum in order to keep the economy not to spiral out of control and thus make the bust on the other side even more severe. However, it is of course increasingly getting difficult to defend a raise since domestic consumption stays persistently low. In essence this kind of analysis ends up as one big waiting game in which the prediction of the transition towards a 'sustainable/balanced' growth path (i.e. one based on domestic consumption too) amounts to circular reasoning based on arguments about how domestic consumption is bound to go up at some point.

2 . The second explanation is the one I have been forwarded in my observations on Japan and essentially I argue that the current environment in Japan is a result of the structure of the Japanese society with the world's oldest population. This is in fact all I am arguing at first hand which crucially means that we should not expect any hikes by the BOJ anytime soon and also that private consumption will continue to drift gradually downwards. So am I trying to re-write the economics textbooks here? Well not yet at least ... I am sure that at some point as the effects of the global demographic trends become clear there will be a theoretical showdown between growth and business cycle theory on the one side and another pardigme which is way more sensitive to the demographic changes which display a very real transmission mechanism with the macroeconomic environment.

On that note let us also take a look at a recent piece from, yep you guessed it, Morgan Stanley Economics Forum (Robert Alan Feldman) about the peculiar nature of private consumption in Japan. Now let me say initially here that Feldman's piece comes really close to an explanation of what we are seeing here and he is really getting a lot of things right in my opinion. The first important thing is that Feldman seems to want to address head-on the conundrum of why corporate investment (CAPEX) is increasing while private consumption remains low. Notice also in particular Feldman's recognition that business cycles are of little use here ...

What is “funny” at the moment? Consumption is decelerating while capex is accelerating and profits are still rising ― all this after what has already been the longest expansion in post-war history. There is a problem of consistency here. Corporations are predicting an outright decline of profits in the second half of the year. But if firms are so worried about profits, why are they investing so much?

(...)

Cycles are cycles, goes the mantra, and if things are good today, they have to turn bad tomorrow. If we have not seen the downturn yet, it must be coming soon. So, consumption swings wildly, and firms continuously undershoot profit estimates. So far, the number of people saying “That’s funny” is small. However, the longer the anomaly of strong capex and weak consumption continues, the more likely will emerge others (like myself) who will claim that high capex and low consumption is the correct structure for the economy.

Wow, that is certainly interesting is it not? Hands down, Feldman is the first semi-influential commentator I have seen who have argued this to be a structural phenomenon and consequently I feel we have already taken a huge step forward here. Now, for the sake of argument I will skip through to Feldman's conclusion in which he reveals his fundamental case for optimism;

The key reason for my optimism is simple: The combination of aging demographics and structural reform has created a new dynamic in Japan. This new dynamic will keep capex and productivity rising, and obviate the need for as much consumption growth as would have been necessary at an earlier stage of Japan’s economic history.

This is of course where I disagree a bit with Feldman but let us still scrutinize this a bit. A new economic dynamic in Japan driven by changing demographics which influence the use of input variables to production (i.e. high CAPEX) thus maintaining high productivity growth and indeed economic growth detatched from the need to rely on domestic consumption. Or as I put it above in fewer words above; export driven ... and this time it should seem pretty clear that the export nature of growth is a structural and indeed inevitable result primarily caused by the ageing of the domestic population.

So why do I disagree with Feldman? Well, in order for Japan to run on exports others need to run deficits, this should be fairly clear for even non-economists. This is of course all migthy fine but the problem is that Japan is not the only country in the world with a rapidly ageing population and the need to run a surplus in order to grow. In fact, this is beginning to look alarmingly much like an explanation of what we like to call global marcroeconomic imbalances; or as Edward Hugh neatly puts it;

In other words Feldman has, inadvertently walked right into the current global imbalances minefield by suggesting that Japan, as an aged economy (and the first of many more to come) will have to be high capex, low consumption, and logically, to sell the product, dependent on exports. What happens if this ever sinks in somewhere?

Food for thought I should say?

What's Funny About Consumption in Japan?

This question was being asked yesterday by Morgan Stanley GEF analyst Robert Alan Feldman (the post can be found towards the bottom of the page).

Now as Claus Vistesen will undoubtedly hammer home at some stage Feldman does get some important parts of the picture which I have referred to in my last posts (and here):

The data on consumption have certainly been a disappointment this year. Although the nearly 4%Y/Y rate reached at the end of 2005 was clearly not sustainable, the sharpness of the slowdown this year has been a surprise. In addition, the deceleration in compensation (whether measured by compensation per worker from the national accounts or by hourly earnings from labor data) has also been a surprise ― especially with record-high corporate profits. The weak growth of wages is all the more puzzling in light of tightening of labor markets shown by a number of indicators. Yes, the weather has been weird this year, but that cannot be the whole story. What is going on?

So far, the number of people saying "That's funny" is small. However, the longer the anomaly of strong capex and weak consumption continues, the more likely will emerge others (like myself) who will claim that high capex and low consumption is the correct structure for the economy.



Why? The idea is simple: As Japan ages, there will be a much faster shrinkage of the labor force than of the population. Hence, each remaining worker will need a lot more capital in order to keep productivity growth fast enough to maintain living standards. Economic growth theory ― in contrast to standard macroeconomic theory ― tells us that high capex and low consumption is just what an economy needs when aging. The implication for investors is equally simple: Stop worrying and love the high-capex economy.

Well really he is getting very near. But then note this:

"As a practical matter, however, consumers and investors will need more time before they accept that consumption need not become the engine of growth."

Well I would put a lot more names on this list other than consumers and investors, people like Brad Setser, Nouriel Roubini, the IMF, the BIS, US Treasury Secretary Paulson, Trichet and the gang at the ECB etc etc. In other words Feldman has, inadvertently walked right into the current global imbalances minefield by suggesting that Japan, as an aged economy (and the first of many more to come) will have to be high capex, low consumption, and logically, to sell the product, dependent on exports. What happens if this ever sinks in somewhere?

Basically he is not quite right about the contrast between macro theory and growth theory, since even though the Solow model is supply side oriented, it is normally situated in a general equilibrium model which includes demand side components and hence generates relative prices.

So you really do need a general equilibrium model running in your head somewhere to get to grips with the implications of what he is arguing. One of the factors he doesn't seem to think about - and why should he, he isn't a theoretical macroeconomist - is how the changed relative balance of consumption and saving affects interest rates, and thus the cost of all that capex, which with low interest rates is much less, and then of course you need to get onto relative prices, and especially if deflation persists.

Curiously he mentions Asimov, and Asimov was interested in robots (he could also have mentioned Zamyatin who wrote a novel called "I Robot"). Now the interesting thing is to think about VERY HIGH capex, at the levels we might see when robots get to build the machines, and then start thinking about whether this would be expensive (which is the story Feldman is trying to sell the investors, hence the possibility of good returns) or whether this would in fact be very cheap, being funded by virtually give-away money with very little of the really scarce and relatively expensive input (labour) being required and with the other constraint being the cost of the raw materials and power that the robots need in order to go to work. Of course, whoever develops the robots can make an initial short term 'rent' ( a la Schumpeter) while they still have a monopoly on the technology, but again there are winners and losers, since some will try and build the technology and fail.

Anyway, this point aside, Feldman is clearly in the right ballpark, and all people now need to do is take the relatively simple step (a small one for them, but a giant one for humanity, perhaps) of thinking this through to a much more general level, and contextualizing all this in what has come to be known as the demographic transition. Now just who the hell was that who ever said that demography isn't important to economists?