Inflation, Employment and Various Interpretations of What is Happening In Japan

Well, promises are promises, but a birthday is a birthday, and since today it is my turn - and being a good Capricorn - what better way to spend it than in updating my excel files with all the new data coming out of Japan. And a veritable raft of data it has been, since there are releases about Consumer Prices, Family Income and Expenditure, the November Labour Force Survey, building starts, (covered separately here), and industrial output. But before we move on to the details, perhaps one "big-picture" detail is worth commenting on, and that is the very mixed reception which the perceived return of inflation to Japan is receiving (although please note I myself am not totally convinced that thing are as clear as some suggest, and that this months data may not be just another one of those "false calls", see below).

In this context I couldn't really help but be struck by the Bloomberg lead paragraph in their CPI coverage article:

Japan's inflation rose at the fastest pace in more than nine years in November and industrial production and household spending declined, signaling rising oil costs may derail the economy's longest postwar expansion.

So what is going on here. Isn't the return of inflation to Japan just what everyone was hoping for? I guess the response of Swedish blogger Setfan Karlsson in his "Wasn't Rising Prices Supposed to be Good For Japan?" post yesterday must be a reaction which is typical of what many are feeling. Namely, "huh"!

So where exactly are we right now? Is the momentary return of a positive reading on the core index to be welcomed or not? Is inflation a good thing or a bad thing? Obviously the answer is the ambiguous one of "it depends", and it depends especially on what you are looking for, but the problem of defining a consensus decision procedure in this case does give us a good illustration of what a hellishly complex business macroeconomics is. Not for the faint of heart this subject, I'm afraid.

Basically the problem is that economic systems are complex, and in them many variables are interconnnected in a way which may well produce important non-linearities. My feeling is that what you need in order to be a good macroeconomist is a feel for this complexity (and this is what sets the macro- off from the micro-economist, since the micro-economist is normally statisfied with some sort of partial analytic, you know, the good old ceteris paribus simulation, which may be very useful in terms of approaching certain very discrete and local phenomena, but turns out to be nearly useless when it come to real world, as it actually happens, macro). The macro-economist needs the ability to keep 3 or 4 (or more) variables in their head at the same time, and run sort of "what if" simulations mentally. Obviously it is hard to precisely assign an exact value to the number of parameters you need to keep spinning round simulataneously on any particular problem, or to give an explicit account of the system of virtual weights you implicitly assign to each of them, it is the scale of this that matters, and what counts if you want to do macro is the ability to carry out - on the fly - such large simultaneous mental simulations, since no computer model can possibly hope to handle the level of complexity involved, even if the parameters were well set up (ie included things like median age, fertility and life expectancy), which they aren't. This is basically analagous to the semantic interpretation argument in the Artificial Intelligence debate, and this kind of problem is one of the reasons why I feel machine translation is - at the very best - a long way off in the future, and the same really goes for "true to life" economic models. Try doing a machine translation from German into English, and reading through what you get. The print-out you get from running some version or other of MultiMod has just about the same degree of satisfactoryness.

So when we come to the inflation-in-Japan issue, the whole problem needs to be seen in the context of the undelying business cycle (and of course of why there is deflation there in the first place, which is a story for another day). What Japan needs to try to achieve is a positive reading on inflation as the economy expands (although this, please note, would not solve the economic difficulties which arise from Japan's oustanding demographically-related growth problems, but it would make them a damn sight easier to handle). Japan needs this kind of inflation for basically two reasons:

1) Firstly, simply because it is easier to maintain stability on a bicycle which is moving forward than it is on one which is stationary or moving backwards, so 1 to 2 percent inflation under normal conditions is possibly ideal for an economy in general terms. I think even modern monetarists like Jean Claude Trichet accept this, and this is why the ECB, for example, has its target on or around 2%, and not at zero.

2) This being said, the main reason you want some level of positive price movement in an economy is the technical one that without it you simply cannot run normal monetary policy. This is the argument - the technical liquidity trap one - that most people seem to have totally forgotten about recently (as I said, consensus discourse is normally only up to keeping one or two things in the head at a time). Back in February, when the BoJ finally decided to take the plunge and risk raising interest rates a further 0.25% to 0.5% I wrote a lengthy piece for Global Economy Matters - Japan in the Front View Mirror - where I basically argued that the whole "rate normalisation" policy being fomented by the G7 (a policy which had its origins in the central bankers and finance ministers meeting in Washinton in April 2006) and implemented by the BoJ was an error, and one which they might live to regret. Well, this is just where we are now, busy regretting all that "upswing exhuberance", and all the failure to really get down to the root of the problem. As I said at the time (and I think the whole article is still very much worth the read):

I cannot help having the unfortunate feeling that everyone is so busy eagerly looking forward (to the recovery, the end of the carry trade, or whatever) that they are making the glaring and rather irresponsible error of forgetting to check on what has been happening behind, and in the only all too recent past.......

The G7, as everyone by now probably knows, has just reasserted it's faith in the view that the Japanese economy is well on course to recovery. According to the official statement:

“Japan’s recovery is on track and is expected to continue. We are confident that the implications of these developments will be recognized by market participants”

Now this is a strange statement, since there are plenty of indications coming out of Japan that there are subtsantial doubts about this, and particular there are doubts about the resilience of domestic consumption in the current recovery, as Claus has already ably explained in two excellent posts (here and here). Since Claus will comment further on the details of the current decision, what I would like to do in this note is step back a bit, and reflect upon some aspects of the situation which should give us all cause for serious thought.

In particular there is the issue of deflation, and the danger that Japan may once
more fall back into the deflation trap. I say once more, since at the present
time I am already getting a strange feeling of deja vu, since few seem to
remember that the current approach was tried and found wanting once before, back
in 2000. Paul Krugman writing at the time had this to say:

So what if last Friday the Bank of Japan finally ended its "zero interest rate policy" (yes, ZIRP)? After all, it's only a quarter-point rise, in a faraway country that doesn't interest most Americans now that it no longer seems a dangerous competitor. And yet I would not be surprised if future economic historians look back at Friday's move as the beginning of the end for an era, and not just in Japan.

Really I strongly recommend reading Claus's No Signs of Inflation in Japan (1 Feb 2007), Japan's Economy Chasing Illusions? (19th January 2007) which give all the background on the whole debate, and will let you see had a glance who had been arguing sound-sense here, and who none-sense.

Now I did state that there are two potential grounds for feeling that a return of inflation in Japan - under the right business cycle conditions - would not be a bad thing, but I will rapidly correct myself, since I think there is a third argument, one which refers to global monetary policy. Basically Japan having interest rates so near the floor creates uncomfortable problems for the world monetary system (the presence of the carry trade being only the most visible and high profile of these) and it was as a result of some of this discomfort - a world being steadily flooded with liquidity - that the Central Bankers and G7 Finance Ministers took the decision to try to encourage the "normalisation" of rates. The decision was put into practice by the ECB in the first place, but the situation in Japan really was never far from the forefront of people's minds, and the BoJ soon followed suit.

The rub is that this "normalisation" process, far from being based on a decoupling phenomenon in some of the world's largest economies - obviously I am talking explicitly about Germany and Japan here - has only served to underline the ongoing weaknesses which exist in them. So I would argue that the G7 participants really do need do need to have some sort of a rethink at this point.

Basically the problem facing Japan is that the up-tick in inflation is taking place at precisely the same moment as there is a downtick in several other key economic indiactors. What this means basically is that Japan is getting squeezed on both fronts. As Bloomberg also note:

Core consumer prices rose faster than the 0.3 percent median estimate of 36 economists surveyed by Bloomberg News. Gasoline and kerosene contributed three-quarters of the gain, which was the quickest since March 1998, when an increase in the country's sales tax pushed the gauge to 1.8 percent.

The last time inflation showed signs of life in this way, Japan was pushed straight off into recession. History may well be about to repeat itself yet one more time here. But the real question is when will people actually start to learn some of the costly lessons experience is offering us?

Now for the data.

Consumer Price Inflation in November

The consumer price index for Japan in November 2007 was 100.7 (2005=100), down 0.2% from the previous month, and up 0.6% over the previous year. The consumer price index for Ku-area of Tokyo in December 2007 was 100.5(2005=100), up 0.2% from the previous month, and up 0.4% over the previous year.
Japan Statistics Bureau

So core consumer prices in Japan rose a faster-than-expected annual 0.4 per cent in November, with higher oil prices being the main driving force.

The change in core nationwide CPI, which includes energy costs, has now been positive for two straight months, after being at zero or in slightly negative territory for much of the year. The 0.4 per cent rise, excluding fresh food prices, came after a 0.1 per cent increase in October and was the fast rate of increase since March 1998, when a sales tax increase pushed the indicator up to 1.8 percent.

Nationwide, prices of oil-related products rose 9.2 per cent in November from the same period last year, against an increase of 2.2 per cent in October, showing the growing contribution of oil to the headline CPI reading.

Goldman Sachs - who described the phenomenon as “cost-push inflation” - cast doubt on the durability as well as its impact on consumer sentiment, which it said could be negative. As they say in their note, “The rise in CPI is largely a ripple effect from raw material prices rather than the result of domestic demand recovery.”

Even more to the point, so-called “core core” inflation - stripping out energy costs as well as fresh food in line with the general practice in many advanced economies - showed continued deflation of 0.1 per cent in November (see chart above). However, that was a slightly better performance than in October when prices, excluding energy and fresh food, fell 0.3 per cent. The question is, as Goldman Sachs argue, just how sustainable is this. Just how fast will oil prices continue to rise in 2008? Certainly the slowdown in demand inside Japan that we can now anticipate will tend to drag core prices downwards. So we are certainly not talking about any visible end to deflation in Japan at this point, and certainly not to a situation where a slight uptick inflation will lead the BoJ to consider a rate increase, which is really the reason - at the end of the day, and truth be told - that most people were hoping to see a return to inflation in Japan.


Employment and Unemployment

Next we have the monthly labour force survey. There is some evidence that the labour market is already becoming looser, raising the possibility that this economic cycle, which has already seen six years of growth, could run out of steam before deflation is in any way really over . Data out on Friday were positive on the surface, since they showed unemployment falling back to a seasonally adjusted 3.8 per cent after creeping up to 4.0 per cent during the two previous months, while the number of people in some form of employment or other was still up 230,000 year on year.

Summary of the November 2007 Survey Results
(1) Employment
The number of employed persons in November 2007 was 64.33 million, an increase of 230 thousand or 0.4% from the previous year.
(2) Unemployment
The number of unemployed persons in November 2007 was 2.46 million, a decrease of 130 thousand or 5.0% from the previous year.
The unemployment rate, seasonally adjusted, was 3.8%.
Japan Statistics Bureau



However, the jobs-to-job-seeker ratio, which many economists regard as a better guide to labour market conditions than the headline jobless number, weakened. In November, there were 99 jobs for every 100 jobseekers compared with 102 in October and 106 only a few months ago. This is the first time the ratio has dipped below 1 – at least 100 jobs for every 100 jobseekers – in the last two years.

Then we have the Family Income and Expenditure Survey. The deteriorating labour market, which has accompanied the economic slowdown since this summer, appears to be also damping consumer sentiment.

Expenditures for Two-or-more-person Households

The average amount of monthly consumption expenditures per household for November 2007 was 282,836 yen, same level in nominal terms but down 0.6% in real terms from the previous year.

Income and Expenditures for Workers' Households

The average amount of monthly income per household stood at 435,640 yen, down 1.5% in nominal terms and down 2.1% in real terms from the previous year. The amount of consumption expenditures was 302,879 yen, down 0.9% in nominal terms and down 1.5% in real terms from the previous year.
Japan Statistics Bureau

Real consumption down 0.6 per cent, which was more than expected, although the data are notoriously volatile and was affected to some extent by depressed car sales.






Industrial output

Industrial production, meanwhile, fell 1.6 percent in November from the previous month, the first drop in two months.Industrial output rose 1.7 percent in October after falling 1.4 percent in September, the Ministry of Economy, Trade and Industry said. The ministry also said manufacturers polled expect that their output will rise 4.0 percent on month in December, but will be unchanged in January.

Industrial Production in November decreased ▲1.6% from the previous month, showing a decrease for the first time in two months. It showed an increase of 2.9% from the previous year. The index in November was 110.4(seasonally adjusted).

Industries that mainly contributed to the decrease are as follows: 1. General machinery, 2. Electronic parts and devices, 3. Other industry, in that order.

Commodities that mainly contributed to the decrease are as follows: 1. Metal oxide semiconductor IC (Memory), 2. Semiconductor products machinery, 3. Printing machinery, in that order.

Japan METI

As we can see the recent performance of the Japanese industrial sector has been strong, November does represent a slowdown in the pace, but one month's data is clearly insufficient to be able to draw any substantial and robust conclusion from.

Japan Building Starts November 2007

Japan's housing starts fell for a fifth straight month in November, indicating that stricter rules for obtaining building permits, and the knock-on effects of the US sub-prime crisis may continue to act as a drag on economic growth in the first quarter of 2008. Ground broken on new homes and condominiums fell 27 percent from a year earlier after falling 35 percent in October and 44 percent in September, the Land Ministry said in Tokyo on Thursday.

According to Bloomberg:

Prime Minister Yasuo Fukuda said last week he regretted the slump in housing starts that resulted from building-code changes made in June after an architect fabricated earthquake-resistance data. The central bank lowered its evaluation of the economy for the first time in three years last week and the government slashed its growth forecast because of the building fiasco. Housing investment wiped more than 1 percentage point from Japan's 1.5 percent annual pace of economic expansion in the third quarter. The Cabinet Office last week cut its growth forecast for the year ending March to 1.3 percent from 2.1 percent. The Real Estate Economic Research Institute said last week that the condominium supply in Tokyo and the surrounding area will fall to the lowest since 1993 this year and may decline further in 2008.

The problem is affecting related industries. Demand for kitchenware, which represents about a quarter of the domestic stainless steel market, will decline from January, said Yoichi Saji, head of the Japan Stainless Steel Association. Nippon Steel & Sumikin Stainless Steel Corp., Japan's largest maker of the alloy, said yesterday it would cut output of nickel-based stainless steel by about 10 percent next month.

The 103-member Topix Construction Index has fallen 12 percent since having the biggest gain in more than eight years on Oct. 30 when the Land Ministry announced it would relax the building rules. Builders broke ground on 971,000 new homes and condominiums in November at an annual rate, the most since the regulations were introduced in June, today's report showed. The figure has risen from 720,000 in September, the lowest since the government began keeping records in 1965.

Merry Xmas and A Happy New Year

Well, a Merry Xmas and a Happy New Year to all our readers from me (Edward), Scott and Claus. Thank you for taking the time and trouble to pass-by. This blog will now - failing major and surprising new developments in the global economy - be offline till the end of the first week in January, or till after the festival of Los Reyes Magos in Spain (for those of you who know what this is all about). Come to think of it, maybe this is just what our ever hopeful central bankers are in need of even as I write - some surprise presents from the three wise men - but I fear that this year if these worthy gentlemen do somehow show at the next G7 meet, the star in the east which draws them will not be the one described in the traditional texts, but in all likelihood the rising star of India.



Credit crunch, did someone use the expression credit crunch?

Japan in 2008 ... ZIRP Coming Closer?

None of the writers here at Japan Economy Watch are professional forecasters and analysts per se. Yet, with what seems to be happening 'next' in Japan I can not help but think that you have been extraordinarily well served here at JEW during the past year. As such, let us have a look at what I said on Japan (and indeed the global economy) about a year ago as we stood on the brink of 2007.

(...) we have the Top 10 of economic predictions for 2007 by Global Insight where the chief economist Nariman Behavesh argues that the BOJ is likely to have raised to 1% by the end of 2007; this would then imply three 0.25% steps from the current level 0.25%. As you will see this is a part of a broad discourse concerning how global interest rates differentials will narrow as the Fed is going to cut while the BOJ and the ECB are going to raise; for the record I do not see this happening at all!

Now, the ever perceptive readers of this blog will immediately notice the apparent rather peculiar reason as to why I am feeling so smug in my introduction. In this way and apart, of course from the BOJ raising to 1%, isn't this thing of 'narrowing' of global interest rate differentials exactly what we have seen? It could indeed seem so as the Fed's aggressive easing have coincided with a fixed stance in Japan and increases moving over to holding operations at the ECB. However, this is also where I would like to start the whole 'what will happen in 2008' debate since how sustainable is this current state of affairs amongst the three G3 economies? Well, as for the US they have already bitten the bullit. The subprime mess is still pounding away with the recent victims being Morgan Stanley and Bear Sterns having to push the big delete button on a slew of internal balance sheets as it became clear that the subprime debacle had claimed yet another score of assets. But the US economy in general and while certainly still on the ropes is on its way to get to grips with its new situation and get on with the fight. I won't even begin to rant on the Eurozone here where I fear that 2008 will be a year of many a camel swallowing (or was that cold pouridge?) by those who have been pushing the Goldilocks narrative the hardest. Let me move swiftly over to Japan where as can readily be seen the BOJ has not managed to raise the short term interest rate to 1%, far from it actually. I should note in this context that I am not trying to pound excessively on Global Insight and its chief economist who I am sure is a very able and smart analyst. I am simply trying to hammer down that the consensus on Japan as it emerged from 2006 has not exactly materialised and what we now need to do is to understand why as well as we need to look forward as to what will happen next. I will begin with the latter question as Bloomberg today carries a piece on Japan where it is actually suggested that the BOJ will have to lower rates which effectively would take them back into ZIRP ...

Toshihiko Fukui's final act as governor of the Bank of Japan may be to cut borrowing costs for the first time in more than six years. Economists began predicting Fukui, 72, will have to lower rates after the Bank of Japan yesterday downgraded its assessment of the economy for the first time in three years. The bank has raised rates twice since July 2006, when it ended a policy of keeping borrowing costs near zero to beat a decade of deflation. ``They may have to cut,'' said Robert Feldman, head of economic research at Morgan Stanley in Tokyo. ``As Fukui said yesterday, the economy is getting worse.''

This is of course far from being a done deal but it is interesting to see how the discourse kicked off in 2006 with sustainable recovery stories flying all over the place to now where it seems as if we have come full circle. What I particularly want to emphasise here is that this Felman talking and when he says something on Japan people all over the place are bound to listen carefully. Whether the BOJ will actually go ahead with a return into ZIRP is difficult to say indeed. The point is that while economic factors will indeed be importants determinants so will political. The BOJ stands before a change in leadership in Spring 2008 and given the current spout of political uncertainty lingering in Japan combined with fierce debate over potential future 'un-popular' political measures (e.g. a consumption tax perhaps?) any decision and especially one downwards in the interest rate is bound to be surrounded by much commotion not least from the external environment where the G7 is sure to be jumping and dancing all over the place in the event of a cut. This brings me to the other question raised above and one which is far more fundamental and important. As such, why is it that Japan did not see that sustainable recovery? The first thing to bear in mind is clearly the fact that the financial turmoil which was brewing in the beginning of 2007 reared its head with much more force than most had anticipated. There is no doubt that this has not exactly been accomodative to the Japanese economy. However, what I really want to home in on is the narrative which has emerged here in the twilight of 2007 as it has become clear that Japan will probably be flirting with a recession. In this way, it seems that whatever happens next in Japan with respect to the inevitable slowdown of economic momentum is bound to shore up exclusively at the politicians' door. Now, this is an extremely dangerous path to go by I think as I also noted recently (for good measure, Takehiro Sato's 'Buckle Up' analysis can be found here). Edward also treats this point in one of the post which immediately preceedes this one where the following point is worth pondering ...

For anything to work for you in life you need a certain amount of good luck, and when your luck is down, and the level of adversity you face mounts, then the problems only seem to pile up. This perfectly describes Japan present problem set I think (I mean don't forget the famous pensions-records scandal, which seems to have been all but forgotten at the moment, except by the people who had their records lost, of course). If you really could live without a spanner showing up in the works, then it never fails to show up. That's what we mean by being "down on your luck". As Jefferson said, when I find myself being lucky I am normally sitting here, hard at work at my desk. That is, we make our own luck, using foresight and sound policy.

In this way and to paraphrase one of pre-modern history's most vexing questions on whose altar many a head has been severed from its body we need to ask whether the sun revolves around the earth or whether in fact it is not the other way around? Of course, no heads will be severed this time around which serves to indicate the strides human intelligence and community have made after all. So, leaving you with these arcane matters I might risk coming off as a scrooge here just before Christmas. This was not my attention but I do think that we need to think long and hard about what cause and effect are in terms of analysing the Japanese economy.

I will have more later on the actual market implications of all this and do have a Merry Christmas come next week.