Update on QE in Japan

By Claus Vistesen: Copenhagen

Quantitative easing is certainly all the rage at the moment after this week saw the Bank of England move interest rates down 50 basis points to the level of 0.5% and, effectively, into QE. Over at Morgan Stanley, Manoj Pradhan talks about a new global QE scheme even if we are not quite there yet, and David K. Miles and Melanie Baker talk about the UK version. In the Eurozone, it appears that something fundamental has happened at the ECB with this week's decision to lower interest rates from 2% to 1.5%. At least, our good governor Trichet now seems to concur that the risks of inflation have receded (for now) and that a subsequent risk of deflation is present. This also means that me and Edward's stab at the ECB earlier might have been a bit unfair although I see the communications stream from the ECB is still quite volatile. Consequently, council members Jürgen Stark and Lorenzo Bini Smaghi were both quoted of saying that one should be weary of cutting interest rates too much since the impact of such measures would be limited. One wonders whether it is the blind leading the deaf or the other way around, and quite frankly I would, at this point, settle for a coherent message from the ECB, be it in favor of QE measures or not.

Meanwhile and on a brighter note, Cassandra approaches QE from a slightly more semantic and, as it were, historical perspective.

And in Japan ...

In Japan QE has arguably been in play since November 2008 or perhaps as some would smugly note; Japan never came off the tap having only been able to raise rates to 0.5% during this famed and so-called recovery which abruptly ended little less than a year ago. Whichever the version you prefer it appears that the BOJ will have to step up its efforts in the market for risky assets. The news is attached to Deputy Governor Hirohide Yamaguchi's comments that the BOJ have to increase its purchases of corporate bonds to alleviate the credit crunch.

Bank of Japan Deputy Governor Hirohide Yamaguchi said the central bank may need to expand its purchases of corporate debt to prevent a credit shortage from worsening the recession. “We can’t deny corporate financing will become even more difficult” toward the fiscal year end on March 31, Yamaguchi said in an interview in Tokyo yesterday, his first since joining the board in October. “If that happens, we’ll consider whether we can enhance operations already implemented and act if necessary.”

Yamaguchi is the first member of the board to hint at further policy actions since it unveiled the plan to purchase corporate bonds from banks last month. Having cut interest rates close to zero, the central bank is buying assets to channel funds to businesses whose profits are falling the most in more than 30 years as demand dries up at home and abroad.

The problem is of course a well known one; on the one side big companies are finding it difficult to raise capital (through equity as well as debt) and for small companies the credit crunch is ever present as their credit lines and facilities with banks are getting squeezed. In terms of the former, Bloomberg reports that three of Japan's biggest automakers Toyota, Mazda, and Honda publicly stated last week that they might need government funds as demand for their products have collapsed. Especially, the mounting problems for Toyota are preoccupying as it is bound to send ripple effects through its big network of suppliers As for the latter in the form of small businesses the current credit crunch marks a multi decade low point for financing condition.

SFCG Co., a bank focused on lending to small businesses, collapsed last month in Japan’s biggest bankruptcy by a publicly traded company in almost seven years. Chairman Kenshin Ohshima said getting funding had become “almost impossible.”

Small companies, which employ about 70 percent of the workforce, said access to finance is the harshest it’s been in at least 23 years, according to a survey published by Shoko Chukin Bank last month.

As I noted in my last entry on Japan and as Bloomberg elaborates one way in which the problem is being handled is for the BOJ to engage in direct purchases of corporate debt (A1 rating). At the time the BOJ committed itself to the purchase of 33 trillion Yen worth of corporate debt alone in Q1 2009. The immediate goal for the BOJ is however not narrated as re-capitalisation per se, but merely to narrow the widening spreads between government bonds and class A corporate paper. Apart from buying corporate paper the BOJ has naturally also been involved in the purchase of government paper to ease the funding requirements of the government in its effort to use fiscal stimulus as a tool to alleviate the crisis. The comments from Yamaguchi in this regard are interesting;

When asked whether the bank would increase the purchases to fund economic stimulus spending, Yamaguchi said buying bonds for that reason would spur concern that public debt will rise, driving yields higher and compounding Japan’s fiscal woes.

This is of course the eternal headache faced by Japanese policy makers in their attempt to use the fiscal weapon since the simple point is that they don't have the money or the future revenues to mount anything remotely resembling a credible fiscal jolt. As an alternative the Finance Minsitry has been working with the idea to capitalise (well, cover the potential losses) and subsequently allow the Development Bank of Japan to enter the market for equities and preferred shares in order to prevent a wave of corporate bankruptcies.

Of course, the problem for the MOF lingers if anything simply because they will have to issue a considerably amount of IOUs in the coming months and quarters. As one could imagine, markets have not been oblivious to this trend.

Japanese 10-year bonds completed the biggest weekly decline in a month on speculation that governments in the U.S., Japan and Europe will increase spending to help counter a deepening recession. Benchmark yields held near the highest level in four weeks after Chief Cabinet Secretary Takeo Kawamura said the government needs to make the “utmost effort” to manage policies to prevent stocks from collapsing, spurring concerns that the nation’s debt burden will worsen. Sales of government bonds will rise to 113.3 trillion yen ($1.2 trillion) in the year starting April 1 from 106.3 trillion yen this financial year, the Ministry of Finance said in December.

“Given the severe state of the Japanese economy, the government may need to boost budget spending by an additional 15 to 20 trillion yen,” said Hirokata Kusaba, a senior economist in Tokyo at Mizuho Research Institute Ltd., a unit of Japan’s second-largest bank. “The issuance of new bonds may increase by 30 trillion yen, boding ill for the debt market.”

It is interesting to note the opposing trends here. One the one hand yields should be coming down to reflect the fact that interest rates are about to go lower, but since interest rates are virtually zero it is not at all unimaginable that yields will go up to reflect the increased supply of bonds in the market (and the general public debt situation in Japan). It is of course because of this that the MOF needs the BOJ and one would be tempted to argue other domestic cash rich investors to buy the debt. At this point I would not point to a heightened concern for the government's financing possibilities if anything because the game of issuing IOUs is turning global. Yet, it should be watched as we move forward.

Japan's Industrial Slump Deepens In January

Japanese manufacturing output fell in January by a record 10 per cent month-on-month while new job offers declined 18 per cent, reflecting the deepening recession in the world’s second biggest economy. Industrial production was down a whopping 30.8 per cent year-on-year, as manufacturers of vehicles, electronics parts and devices and general machinery slashed output to adjust to the rapid fall in global demand.

According to the Ministry of Economy Trade and Industry, which unveiled the figures, production is expected to decrease again in February, by 8.3 per cent, which seems pretty reasonable if you look at the PMI (see below). If production matches forecasts for February and March, we could see a 22.5 per cent decline in output for the first three months of the year, well above the 12 per cent fall in the last quarter of 2008, amd potentially the largest ever quarterly fall in Japanese output. If this is the case Q1 GDP will be a real shocker.


The fall in industrial output is being driven by a fall in Japanese exports, which slumped by a record 45.7 per cent in January.

The February manufacting PMI showed manufacturing activity contracted for a 12th straight month in February, underscoring the fact that the depressed state of Japanese industry is likely to continue. Although the Nomura/JMMA Japan PMI edged up to a seasonally adjusted 31.6 from a record low of 29.6 in January, it remained well below the 50 threshold that separates contraction from expansion.

And if we look at the comparison between PMI and GDP to be seen in the chart below, we can see that Japan may be looking at something like a 5% quarter on quarter contraction at this point, or a 20% annualised rate of contraction.


This is much worse than the Q4 2008 contraction since gross domestic product declined at an annualised rate of 12.7 per cent.

Japan's Exports Collapse In January

Japan’s exports plunged by 45.7 percent year on year in January, producing a record trade deficit, as recessions in the U.S. and Europe, and a sharp downturn in China crushed demand for the country’s machinery, cars and electronics. A drop of this size is truly staggering.

“People are coming to realize that Japan is in deep trouble,” said Hiroshi Shiraishi, an economist at BNP Paribas Securities Japan Ltd. in Tokyo. “Considering what’s happening on the export side, and the implications that has for the domestic economy, the yen is clearly not a buy.”

Japan's trade balance was sent deep into red territory driven, of course, by the 45.7% fall in overall exports to 3.48 trillion yen. As can be seen in the chart below, the yen value of Japanese exports has simply collapsed in recent months.

“The economy already seems to be falling apart,” said Masahiro Eguchi, who manages economic research at Shoko Chukin. Companies are likely to cut production more steeply, he said, and even if they continue to reduce output at the current pace, “many small companies won’t be able to survive.”

Imports, at 4.44 trillion yen, were down 31.7 percent from a year earlier.The declines in both importas and exports widened the trade deficit to 952.6 billion yen ($9.9 billion), the biggest since 1980, the earliest year for which comparable data is available. The drop in export shipments abroad eclipsed the previous record of 35 percent decline set only last month.




Exports to the U.S. fell an unprecedented 52.9 percent from a year earlier, and shipments to Asia and Europe also clocked in their largest-ever declines as the global recession deepened. Shipments to Europe slid 47.4 percent in January from a year earlier, while exports to China fell 45.1 percent and those to Asia dropped 46.7 percent.

Even emerging economy sales in countries like India, Brazil, Vietnam and Russia, which had buoyed up the numbers in the middle of 2008 have fallen rapidly. Exports to India were down by 34.9% year on year, Brazil exports fell 38%, Vietnam 48.4% and Russia 65.5%.

Japan's economy shrank at an annualised rate of 12.7 percent pace in the last quarter, the most since the 1974 oil shock, and it is clear that the worst is yet to come. The consensus forecast at this point is that Japan's economy may shrink by a record 4 percent in the year starting April 1, but even this may now be optimistic. The worst contraction Japan has seen to date was in fiscal 1998, when the economy contracted by 1.5 percent.

And while talk from the Bank of Japan of possible share purchases saw Japanese stocks rebound from quarter-century lows and the yen was trading at its weakest level since last November the Japanese government has still been unable to pass the stimulus package that could help encourage domestic spending in the absence of export demand. Prime Minister Taro Aso is struggling to get approval from the opposition-controlled upper house to spend 10 trillion yen to aid companies and households. But while the politicians dither, Tokyo burns, or almost.

Japan's "Unimaginable" Contraction

Well, it isn't only in Europe that we are having a hard time of things. Last week Kazuo Momma, head of the Bank of Japan’s research and statistics department, warned that Japan’s economy now faced an “unimaginable” contraction, and today we can begin to see just what the unimaginable might look like, since the preliminary data for fourth quarter GDP are now out. And what we find when we come to stare the unimaginable in the face is that Japan’s economy contracted by 3.3 per cent in the three months to December (compared with the previous quarter), effectively the country's worst economic performance in 35 years.

On an annualised basis, gross domestic product declined at a rate of 12.7 per cent, a number which perhaps better than any other highlights the depth and severity of a slump that has surely now dispelled all those early hopes that the global economy might be able to shrug off the effects of the financial crisis just like that. To puts things in a comparative setting, the contraction was three times as bad as that of the US in the same quarter. Year on year GDP was down by 4.6%.



This quarter's big slide in GDP was in fact the second-worst the country has experienced in modern times, lying just a thin hair's breadth away from the record 3.4 per cent quarterly contraction clocked up in 1974, in the wake of the first Middle East oil shock, and well beyond anything Japan's economy has experienced in what is now the "lost decade and a half".



The slowdown was pretty generalised, but lead most decisively by exports which plunged an unprecedented 13.9 percent from the third quarter (see chart below). In fact Japan has become systematically more dependent on sales abroad for growth over the past decade, and overseas shipments make up 16 percent of the economy today compared with about 10 percent in 1999.




Domestic demand, which includes spending by households and companies, made up 0.3 of a percentage point of the contraction, while capital investment fell 5.3 percent. Manufacturers cut investment spending by a record 11.3 percent in the quarter, indicating they have little need to buy equipment as factories lie increasingly idle. Consumer spending, which accounts for more than half of the economy, dropped 0.4 percent on the quater, as exporters began firing workers.

“There’s no doubt that the economy is in its worst state in the postwar period,” Economic and Fiscal Policy Minister Kaoru Yosano said in Tokyo. “The Japanese economy, which is heavily dependent on exports of autos, electronics and capital goods, has been severely hit by the global slowdown.”

After ten years of sacrifice and reform, it must be pretty shocking for most Japanese to discover that their economy is still in "terrible shape".

And The Worst Is Still To Come


Evidence of Japan’s slowdown can now be found right across the economy. On Monday the country’s electric utilities industry association said that power generation had fallen 6.4 per cent in January as the industrial sector rapidly winds down. This was the sixth straight monthly decline and the steepest fall since a 6.9 per cent drop recorded in July 2005. Even Japan's services sector is suffering, and the new Japan Services PMI, compiled by Markit Economics on behalf of Nomura and published for the first time on the 4th February, showed the country’s downturn deepening in January.

In addition the Nomura/JMMA Manufacturing PMI survey indicated that the goods producing sector contracted at a series record rate in January, in excess of the 22.5% annual decline indicated by official Trade and Industry Ministry (METI) data for December, with plummeting export sales leading the sector’s decline. With both manufacturing and service sectors reducing employment at sharp rates in January, consumer confidence – and therefore household forthcoming spending on both goods and services – looks set to deteriorate further moving into Q1, dragging Japan’s economy deeper into recession.

Japan’s consumers remained at their most pessimistic level in at least 26 years in January (see chart below), indicating households are likely to keep cutting back on spending as the recession deepens. The confidence index nudged up very slightly 26.4 from December's 26.2, according to the Cabinet Office last week. December's numbers had been the lowest since the government began compiling the figures in 1982.



Export Dependency Is The Heart Of The Problem

But why is Japan so export dependent? Well here you will find explanations to suit every palate, but if I can just add my 5 cents worth, I would say that the fact that Japan's population currently has the highest median age on the planet is not simply an incidental correlate (nor is the fact that Germany has the second highest median age and is currently struggling with the same problem simply another incidental detail). Basically years of ultra low fertility coupled with relatively unfriendly immigration attitudes means that the median ages of the Japanese and German population (at 43) are now the highest on the planet. Previously it was assumed that we wouldn't see much in the way of economic consequences from all this till much later in the century, but now, to me at least, it is obvious those consequences are already here.

The consequences are, basically, to be seen in very weak domestic consumption growth, which means that economic growth (which is needed to pay all those pensions and health care costs) is totally dependent on exports, and hence the economic well-being of others. And this growth roller-coaster (which can only get worse as the median age rises further) cannot be that much fun for the population at large. One minute you have the best growth in a decade, and the next you go crashing through the floor. Ouch!

So - in addition to the bank regulations fix - something also needs to be done to slow down the rapid ageing of the Japanese and German populations, and as far as I know there are only two ways to do that, get fertility up, and open the doors to immigration.

In this context it is interesting to note that an 80-strong group of economically liberal politicians in the ruling Liberal Democratic Party (LDP), led by Hidenao Nakagawa, a former LDP secretary-general, are pushing for a change in immigration policy (full story in the Economist here). These venerable gentlemen are calling for the number of foreigners living and working in Japan to rise to 10m over the next half century, and for many of these immigrants to become naturalised Japanese. In addition the Keidanren, the association of large manufacturers, is also shifting position, and last autumn called for a more active immigration policy to bring in more highly skilled foreign workers. The Keidanren estimates the present number to be a mere 180,000. The Economist refers to these moves as bold, I would rather term then "baby steps" in the right direction, although we must wait and see what material outcome such pressures lead to, for good intentions have often been expressed in this regard in the past.

As for fertility, again there is a lot of debate about how to encourage people to have more children, and I am sure there is no easy answer here, but I can think of one thing which would help, and that is a change in the national mindset. You see, maybe it isn't true to say that countries like France, the United States and Sweden will have no problems with population aging, but they will certainly have a lot less than many others, since their underlying pyramids are much more stable. And you know what? Few people in these three countries would question the fact that having enough children to maintain national economic stability is important, while in the worst affected countries - Japan, Germany, Italy, Russia, China etc - we find precisely the opposite situation, with few people thinking of the fertility topic as an important one. Indeed many people in very low fertility countries attempt - often vociferously - to deny that long term demography has any economic significance at all. No wonder then, that people in these countries have less children. So when you make your long list of all the lessons which need to be learnt from all the hurting we are just about to get, be sure to remember to add this one.