Adjusting the Views on Japan?

(Cross-post from Alpha.Sources)

In my comments on Japan here at AS I have consistently advocated a rather pessimist discourse on the economy primarily driven by my belief that the economy is in a structural bind with a continuing downward trend in consumer spending regardless of the how well the corporate sector (i.e. the export sector) fairs. In short, I do not see Japan returning to a balanced growth path anytime soon (neo-classical growth proponents, take note!) and my analysis fundamentally hinges on the strong life-cycle component of the domestic consumption trend or put in another words; demography matters here!

Apart from my personal stubborn and persistently pessimistic position on Japan I also in all fairness have to point the data which has done nothing but support mine (and other's) narrative on Japan. Specifically, I am talking in a large (about 1 year) perspective. Consequently, it is sometimes nice to step back and look what has actually happened since Japan chose to end ZIRP back in the late spring this year. Back then, the move by the BOJ was widely seen as one of many steps in a long consistent process to mop up excess liquidity and normalize Japan interest rates, Japan was back amongst the leaders! Clearly, this has not been the case and one of the most striking features about Japan in the moment is how the BOJ just cant seem to find the economic justification to begin to turn off the money tap. Meanwhile, some of the most brilliant economic commentators still argue that it is only a matter of time before we see the much allured spill-over effect from the sparkly corporate sector to domestic consumption, that is the transition to a balanced growth path. We only need to wait. All this is of course being printed along side an inflation rate which is still flirting dangerously with the 0% mark and thus negative range and this has many thinking overtime because why is inflation so low in the light of a tightening labour market for example? Some indeed has come along way in seeing this correctly, and now also the big guns (i.e Morgan Stanley again) is also at least opening a backdoor as a hedge against the traditional positive stance ...

What we outline here is a risk scenario, not our main one. Nevertheless, we do not think it is a low-probability scenario, considering that the latest reading on price growth is very low, at just 0.1% YoY. In light of oil price trends, the Japan-style core CPI could contract again YoY in 2007 H1, contrary to our constructive economic outlook.

(...)

The recent, substantial, retroactive GDP revisions [see also here] confirm the weakness in the core of core CPI. For the F2006 national accounts, real GDP was revised downward by 0.9 ppt to 2.4%, which should have more than a negligible impact on estimates of the output gap since the economy’s potential growth rate is just shy of 2% at best. Based on the revised GDP data, the pace of the contraction in the output gap in F2006 declines by almost 1 ppt. If the improvement in the output gap is only modest, the spillover effect on prices would naturally be that much weaker.

Also please take note of this ... the return to ZIRP is not a fairytale but a distinct possibility.

If the Japan-style core turns negative several months after the next rate hike, it would be easy to imagine the BoJ being in a politically difficult situation in terms of putting a crimp in the Cabinet/ruling coalition’s pro-growth policies. Governor Fukui would not likely have to resign, but the choice of his successor after his term ends in March 2008 could be affected to some extent. To be more specific, Deputy Governor Toshiro Muto, who is currently widely expected to be the next governor, may be less likely to be promoted and the government and the ruling coalition may instead look for a candidate outside the BoJ

(...)

If someone with a strong monetarist bent is named to be the next governor, Japan could be stuck in an ultra-low rate environment for a long time, with price growth hovering very low. If policy is focused on an increase in money supply, the BoJ may increase the supply of reserve deposits and put the policy rate back to near 0%.

I think the key words for reading the Japanese economy at the moment is a bit of open mindedness in terms of what we could call the traditional/text book macroeconomic convictions. It should be quite clear for regular readers that I believe demography is a key determinant here. However, this does not mean that demography is the holy grail which can be applied universally to all macroeconomic issues. But in the case of Japan, the demographic economic analysis which is clearly an analytical field in development represents a very strong theoretical anchor for understanding what is going on; at least I believe this should be clear by now.

Japanese Growth Revisited

This article on the recent downward revision of Japanese growth is a bit old now, but it does contain a few useful points:

Japan's economy grew at a far weaker pace in the third quarter than previously reported due to downward revisions in consumer spending and capital investment, the government said Friday, raising concerns about the recovery's strength. Gross domestic product expanded at an annual rate of 0.8 percent, well below the preliminary 2.0 percent announced in November, but marked the seventh straight quarter of expansion, the government said.


Since exports remained relatively strong, the big changes were a revision downwards of consumption and investment:

Domestic demand — which includes consumer spending, government spending and private investment — had contracted 0.2 percent from the previous quarter instead of inching up 0.1 percent, as previously thought.

Separately government data viewed as a key indicator for corporate investment, released Friday, showed core machinery orders rose a weaker-than-expected 2.8 percent in October from the previous month. That reversed September's 7.4 percent plunge but missed the forecasts by economists surveyed by Dow Jones Newswires for 5.7 percent growth.

The key to the picture would seem to be consumption, since the weak investment most likely is a by-product of an equally weak estimate of the likely direction of internal consumption:



Economy Minister Hiroko Ota blamed the downward
GDP revision mostly on weak consumer spending, but assured the public that Japan's economic revival was on track.

"The lower GDP was mainly caused by weak consumption," she said. "I don't have any concerns that the economy will fall into a downward trend. Nor do I see any signs of its entering a lull."

Although Japan's economy has been emerging from decade-long slowdown that ran through much of the 1990s, recent signs have underlined the risk that growth may be overly reliant on exports. Some analysts say the revival is dependent on U.S. and other overseas economies holding up.

Analysts also say paychecks and other realities that trickle down to workers don't reflect upbeat GDP numbers, as companies cut costs to keep up with global competition and the Japanese population ages and increasingly shifts to lower-paying jobs.

This weak consumption in Japan meme now seems to be catching on, as this article on the world economic outlook from AP this weekend seems to have already internalised the idea that Japanese consumption is the current big enigma:

Japan, Asia's largest economy, is steadily recovering from a decade of stagnation. However, consumer spending appears to be weakening, leaving the economy vulnerable to slowing demand for exports, its traditional source of growth.

Anyone interested in a fuller theoretical explanation as to why consumption is holding so weak could do worse than this post of mine, or this post from Claus Vistesen.

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.