When Will Japan Intervene?

Well my dear JEW readers, as the global dollar sell-off continues in full swing against all major currencies we are moving into a territory which I just a few days implied to be wholly theoretical. You see, while indeed the USD has been trading at all time lows against Sterling and the Euro (to name but a few) the recent day's fall against the Yen has been particularly drastic. In time of writing and as such in real time the Yen is trading at a whopping 110.7 per USD. Now if that does not mean anything to you then have a look at the graphs I field in my recent large analytical post. As we can see the USD/YEN pair has moved from a little over 120 in May 2007 to about 110 today. So what does this mean? Well if you have a close look at my note linked above I emphasise the probability that Japan might actually intervene to keep the Yen down as we move closer to a USD/YEN of 100. But is that really probable? This is of course a pretty important question in itself but the mere fact that this is now being considered is sure to bring all kinds of spectres to the forefront of Japanese policy makers' mind.

(quote Bloomberg, and here)

The yen may rise to 100 per dollar by the end of 2008 as credit-market losses prompt investors to pare purchases of higher-yielding assets with loans from Japan, Lehman Brothers Holdings Inc. and Deutsche Bank AG said.Slowing global growth will also cause traders to pare purchases of riskier securities in so-called carry trades, Jim McCormick, head of currency research in London at the fourth- largest U.S. securities firm, said in an interview in Tokyo. He predicts the yen will climb to 100 by the end of 2008. Deutsche Bank forecasts 97.5 per dollar within 12 months.

Japan's currency gained 5.8 percent against the dollar this year as global stocks fell and U.S. investment banks reported losses linked to defaults on loans to homeowners with poor credit histories. The dollar slumped to a record low against the euro today on speculation widening credit-market losses will prompt the Federal Reserve to cut its benchmark interest rate for a third time this year. ``In our view, the yen is certainly undervalued,'' said Koji Fukaya, senior currency strategist at Deutsche Securities, the Tokyo unit of Deutsche Bank, the world's largest currency trader. ``The tightening credit market will weigh on the yen carry trade.''

Now, let me first address this idea of Yen 'undervaluation' and note two important issues. Firstly, what does it actually mean that a currency is over- and/or undervalued? I mean, in the concrete calculations; do we then incorporate the complex and essentially unique nature of Japan's demographic situation? Secondly and perhaps most importantly, an appreciation of the currency is associated with two things (all things equal); deflation and reduced competitiveness relative to the external environment. At this point many would be at pains to point out the lag with which these effects occur and as regards to exports many would even argue that this is exactly what the world needs; i.e. that Japan does its part in re-balancing the books. Alas, this is also part of the whole point since is this really realistic?

Finally, let me address the formal question with which this entry started. When will Japan intervene, if at all? This is a tricky question to answer and much will depend on the degree and abruptness of the current slide in the USD/YEN. But I will say this. The risk that Japan is now moving into a period of subpar growth is very high and this is only going to exacerbate the potential downside as global liquidity move in expectations of re-balancing. What the actual number is here is anybody's guess and by all means it is not even sure that Japan will intervene but take note. If the slide is as violent as it appears now the USD/YEN will see 105 in a couple of weeks and this won't go down well with the current economic environment at the moment. Personally I don't think (and certainly don't hope) that it will come to this but we are moving closer to what, only a few days ago, seemed a mere academic discussion.

Machinery Orders September 2007 and the Economy Watchers Index in October

Well, this week really has been a pretty gloomy and forlorn one in Japan, since following hard on the heels of the zero reading on the leading indicators index we now have the September machinery orders data, and the latest edition of the Economy Watchers index (Japanese only at present). First the machinery orders.

Machinery orders fell sharply in Japan in September, far more more than economists had forecast, and this may well be a sign that companies are reducing investment as demand wanes.



Machinery orders in fact declined a seasonally adjusted 7.6 percent to 958.7 billion yen ($8.5 billion) from August, which was the lowest level since May 2005, according to data from the Cabinet Office today. Machinery orders are often thought to indicate corporate investment in about three to six months. Total orders fell from 3.6% in the third quarter, and overseas orders fell 2.2%, but demand from domestic private customers was a plus and grew 3%. The big hit was in government orders, which drpoode a whopping 26.2%. In fact the volatility in government orders makes this data very hard to read, and anyone with any insight into just why this should exist in this way, please feel invited to drop a comment.



One explanation for the downturn is that the recent financial-market turmoil and the yen's 8 percent surge against the dollar since July may have deterred companies from ordering more machinery in September. Certainly the continuing slide in the value of the dollar will not be generating an overly enthusiastic and optimistic atmosphere among exporters.

The quote of the day, tucked away in the Bloomberg coverage, is certainly this one:

``My advice to investors is to fasten your seatbelts,'' said Hiromichi Shirakawa, chief economist at Credit Suisse Group in Tokyo. ``Orders peaked in July, and we're not expecting a rebound until the second half of next year.''

And meanwhile domestic demand remains as weak as it ever was. More confirmation of this is available today with the issuing of latest edition of the Economy Watchers index. Japanese workers, consumers and small businessmenhave become increasingly pessimistic about the current and future economic conditions in Japan according to a survey released today by the Cabinet Office.

The main index of the Economy Watchers Survey fell 1.4 points to 41.5 in October, the lowest reading since March 2003 and the seventh straight month of decline. The index, which gauges the mood among ordinary Japanese workers who can observe economic developments firsthand such as taxi drivers and shop keepers, has now been below the boom-or-bust line of 50.0 for seven straight months.



Three subindexes that dropped in the month were the household spending index, which fell 0.4 points to 41.3, the corporate index, which declined 2.5 points to 41.0 and the employment index, which dropped by 5.0 points to 43.8.



In addition the housing outlook is turning increasingly - and almost alarmingly - negative. In September Japan's housing starts fell by 44% (y-o-y) and this followed falls of 43.3% in August and 23.4% in July. The main cause of the rout was a new building standards law introduced in June. The law was aimed at ensuring building safety measures, but the apparent lack of adequate warning before the law was enforced caused a sudden, drastic increase in paperwork to get a building permit, and a sharp delay in initiating new buildings. But this kick-stop on the permits front now seems to have initiated a more general problem, since it coincided with the global tightening in bank lending conditions.

The watchers survey showed 41.7% of survey respondents said housing-related spending was worse than three months ago.

Is Japan Recession Bound?

Well as Scott said yesterday it is "hard to see how Japan can avoid a recessionary 4th quarter". This is also the gist of Claus's much longer analytical post, and I cannot but agree.

So at this point I think we need to bear a number of issues in mind. The principal one of these is that recent Japanese recessions have tended to be messy long-drawn-out affairs. In fact Japan has had three recessions since the bursting of the stock and property bubbles in the late 1980s early 1990s. The first lasted 32 months from March 1991 to October 1993, and the second dragged on for 20 months from June 1997 to January 1999. The most recent recession ran for a full 14 months from December 2000, following the bursting of the information-technology boom and the impact this had on exports and capital investment. This is perhaps why all those Japanese investors and businessmen are looking with something more than a simple wary eye on the sub-prime turbulence which is coming out of the United States at the present time.

But if Japanese recessions have grown longer, and more intractable, and deflation has proved to be persistent and equally intractable, and if interest rates, even in the longest boom since the end of the 1980s bubble, still have not been able to get raised above the 0.5% threshold, then isn't really time that more people started to ask themselves more questions about just what is (and has been) going on in Japan. Is it just a coincidence that Japan now has the highest median age on the planet? Is it really the case that 30 years of below replacement fertility is so harmless as almost everyone seems to believe? Isn't it worth just allowing ourselves to ask the question whether all this might not be somehow interconnected, because one thing is sure, until we get the right diagnosis there is very little chance we are going to be able to apply the adequate medicine and cure. Now what was it you said that patient had doc? Appendicitis, or simply indigestion. Somehow I think the answers we let ourselves give to the question we allow ourselves to ask might turn out to be pretty important when it comes to the outcome we may lead ourselves to expect.

Japanese Leading Indicators-all negative

Just to follow up on Edward's chart, I had assumed on seeing the news item about this index that the result of zero was due to an equal number of positive versus negative components. That is not the case...if you follow the link in Edward's post you will see that every single available component was negative. So the headline number is a bit misleading if you are not familiar with the details of how the index is calculated. It's hard to see how Japan can avoid a recessionary 4th quarter.

Japan Leading Index Falls To Zero

Japan's broadest indicator of what the outlook for the economy may be fell to the lowest level in a decade today, signaling growth may be in the process of grinding to a halt. The leading index was zero percent in September, according to the Cabinet Office in Tokyo today. A reading of below 50 is normally considered to indicate that the economy may slow in the coming three to six months. Since the Japanese economy already was at stall speed in Q2 2007 this is not good news.




I will leave this as a brief note at this point, since Claus really said it all in his very extensive post yesterday.