Raising Consumption Taxes To Finance Pensions?

According to reuters today:

Japan may finance its basic pension scheme through a rise in its consumption tax, a senior official from the ruling party said on Thursday.

"We are not going to resort to using the sales tax from the beginning, but in the end I think we will conclude that it's best to finance the pension scheme with the sales tax," said Sadakazu Tanigaki, the Liberal Democratic Party's policy chief.

Tanigaki has said in the past that Japan will need to raise its consumption tax from the current 5 percent to address the problem of its huge public debt.

Japan is an ageing society with an already congenitally weak domestic consumption situation. Raising consumer taxes has one very well known impact on demand (as in elementary economics well known): it reduces it. Japan needs to think very carefully indeed before going down this road. Claus wrote a good analysis of what the likely consequences would be of raising Germany's VAT consumption tax by three percentage points last January to pay for the health system. At the time such arguments were dismissed, but as we can now see, the chickens are coming home to roost. The German comparison is important since, due to rapid population ageing, the German economy is dependent on exports in just the same way the Japanese one is.

Japan Trade Surplus August 2007

Well as Claus forecast in his last post, I have indeed been preparing something on the last trade figures. First off, the headline numbers.

Japan's August trade surplus widened to 743.2 billion yen ($6.5 billion). On an annual basis exports rose at more than twice the pace of imports, according to the latest data released by the Finance Ministry today. The surplus has nearly quadrupled - and increase of 287% - from this time last year.

At the same time shipments to both Europe and Asia rose to monthly records. The overall picture is however, a complex one. In the first place exports in July and August were both down on the June peak, as can be seen in the chart:



The big difference between July and August is that imports held up in June, while they dropped back in July. This is undoubtedly the impact of two factors, slowing domestic demand in Japan itself and fluctuations in energy costs. In fact petroleum imports did drop back from 1,137,199 million yen in July to 1,081,920 million yen in August, a drop of 55 million yen or so, or some 50% of the change in the balance.

In fact the monthly fluctuation in the trade surplus is not a very interesting or reliable data point at all (since it in part depends on fluctuations in earlier data), as the following charts will show. Firstly the chart for the monthly trade suplus since January 2006:



So as we can see, the August trade surplus was not particularly large at all, but experienced a fairly large annual increase due to the fact that the August 2006 surplus was very small. Economic data are full of anomalies like this.

The situation becomes even clearer if we look at the monthly year on year changes in the surplus since January this year. The anomalous nature of the August reading becomes even clearer, and we shouldn't take it as a reading on anything very special.



Now for some more interesting data. Exports to the EU, the US and China.



What we should note from this chart is that while exports to the EU have held up reasonably well since the start of 2007, and while they have been strong to China, exports to the US have been wobbling notably, which is understandable once you take into account the relative decline in the dollar (although not especially against the yen) and the fact that the US economy has itself started to wobble.

Another detail which is worth noting before I wind up, and that is that even while exports to China form a vital part of the Japan "recovery" panorama (they are now not that far short of direct exports to the US, and Japan will feel any slowdown in China ) Japan in fact runs a DEFICIT in goods trade with China. Here's the chart:

(please click on image to see more clearly)



In this context it is interesting to ponder what might possibly happen if the yen were ever to appreciate notably against the Chinese yuan. At the present moment however this eventuality seems rather unlikely and the yen was trading at 114.91 per dollar at 12:34 p.m. in Tokyo up from 114.57 before the report was published, but still within an acceptable range from the Japanese export point of view.

At the end of the day, and given what we know about the Japanese economies dependence on exports the future evolution of the export data will be crucial for determining just how well the Japanese economy is able to weather the storm caused by cooling global economic growth following the financial turmoil associated with the crisis in the U.S. subprime mortgage market.

So going back to our charts, rather than simply reading Chinese tea leaves, my feeling is that we need to keep a close eye on the evolution of Japanese exports to those three big customers - the EU, the US and China - if we want to get an early indicator of whither the Japanese economy is headed at this point.

On We Go?

Well, I know that Edward is already preparing something on today's reading on the Japanese surplus which seems to be muddling along just fine even in the midst of ever more uncertain global economic conditions. The question is of course whether this will continue?

Meanwhile, Bloomberg also looks forward this morning to a slew of data due at the end of the week. And the predictions?

On inflation the consensus remains sure that Japan remains in deflation and so do I especially since if we look at the core-of-core index.

Core consumer prices, which exclude fresh food, dropped 0.1 percent from a year earlier, the same pace as the preceding four months, according to the median estimate of 44 economists surveyed by Bloomberg News.

On industrial production however the analysts are rather bullish ...

Separate reports also on Sept. 28 are likely to provide better news on the world's second-largest economy. Industrial production grew 3 percent in August from July, when output dropped 0.4 percent because of an earthquake, according to the median estimate of 46 economists. That would be the biggest gain in almost four years.

Perhaps we will see some seasonal swings on the back of the earthquake in the months to come? Yet, if indeed IP were to grow at 3% it would go some way to falsify my hypothesis that industrial production could be heading for a sustained downward trend in the remainder of 2007. In this light also the recent readings on the trade surplus provides good reading since this is sure to keep those factories ticking. I am awaiting this one with some excitement then.

Finally we have the predictions on unemployment and consumer spending;

The jobless rate probably held at a nine-year low of 3.6 percent and household spending climbed 1.2 percent, the fastest pace since February, analysts predict.

On consumer spending a rise of this magnitude would indeed constitute something of a rebound relative to recent month's meager performance. Once again, there might be some seasonal rebound going on here which of course needs to be smoothed out but I won't be looking for a positive number of the kind we are seeing here. In any case, please do remember my general prediction here in the sense that whatever we attribute to m-o-m readings we are not likely to see Japanese domestic demand push the 1% threshold in 2007.

So, let us wait and see; it is difficult to see just how much importance which can be attributed to this week's readings in themselves since there are bound to be earthquake rebounds etc entrenched in the data but still interesting nonetheless. One thing seems certain which is that if we get an overall positive reading the de-couplers will come back out, the Yen will shoot up, and the BOJ will consequently be pitched to raise before year's end. Luckily, we don't have to believe everything which comes out on the war drums, especially not in these market conditions.

No Hike in Sight at the BOJ

(Cross-post from Alpha.Sources)

As Bernanke chooses to cut 50 basis points and as economic growth is visibly slowing in Europe and even contracting in Japan I don't think many of us expected the BOJ to raise rates. As such, Fukui and his colleagues duly chose to stand firm yet again yesterday as the economy contracted in Q2 2007 and remained mired in deflation. In this way it indeed seems as if Fukui is going to find it mighty difficult to end his term at the BOJ on a hawkish stance. The official decision by the BOJ can be found here (PDF!) as well as the accompanying statement from which I quote below.

Japan's economy is expanding moderately.

Public investment has been sluggish. Meanwhile, exports have continued to increase, and business fixed investment has also continued to trend upward against the background of high corporate profits. Housing investment has fallen lately. Private consumption, however, has been firm in a situation where household income has continued rising moderately. With the rise in demand both at home and abroad, production has continued to be on an increasing trend, although it has been flat most recently.

Japan's economy is expected to continue expanding moderately.

Exports are expected to continue rising against the background of the expansion of overseas economies as a whole. Domestic private demand is likely to continue increasing against the background of high corporate profits and the moderate rise in household income. In light of these increases in demand both at home and abroad, production is also expected to follow an increasing trend. Public investment, meanwhile, is projected to be on a downtrend.

Clearly the main narrative above is riddled with hedging and essentially a lot of word salad given the actual trend we are seeing but this I think is the normal nature of these kinds of statements. People should be clever enough to make up their own minds based on the present data. However, I do think that it would be a mistake to interpret the above as a sign that the BOJ will find space to raise rates anytime in the remainder of 2007. Of course, markets don't agree with me completely :) and thus seem to have a bit of difficulties finding their feet at the moment or at least this is the way I choose to interpret the fact that yields on Japanese notes actually rose on the back of 'bad-boy' Atsushi Mizuno's consecutive dissent in the BOJ's voting which is seen as a forward looking sign that the BOJ might just raise before the end of 2007. Clearly, the Fed decision in itself will have had something to do with this but as for the expectation of a BOJ hike in 2007; well, here is to hoping but I fear that this indeed constitutes a fools hope. For a general overview of the recent economic data and commentary on Japan you can check out the latest posts on Japan Economy Watch which almost constitutes a veritable tableau de noirceur over the recent slowdown in Japan.

If you want to get really up to date on Japan I reproduce the list of my most recent notes on Japan below ...

Japan - The Fundamentals Linger

Still Holding at the BOJ

Small Update on Japan

Is Japan Heading for a Recession? (GEM note)

Furthermore, I recommend you to stay in touch over at Japan Economy Watch where yours truly, Edward Hugh as well as Scott Peterson are always busy to keep you up to date on Japan. Lastly, I also want to endorse the excellent Japan Economy News Blog maintained by Ken Worsley which also presents a never ending stream of commentary and analysis on the Japanese economy and society. In fact, you could even say that between Worsley and the JEW team you don't even need Bloomberg, the FT etc. Ah well, that is of course for you to decide.