Deflation Grabs Hold of Japan

By Claus Vistesen: Copenhagen

I really don't want to beat a dead horse here and although I already gave it a kick in the context of the release of the May consumer price data I do think that this is pretty significant [quote from Bloomberg with my emphasis].

Japan’s producer prices fell at a record pace in June as oil costs declined and companies required fewer materials amid a global recession. The costs companies pay for commodities and unfinished goods tumbled 6.6 percent from a year earlier after sliding a revised 5.5 percent in May, the Bank of Japan said today in Tokyo. The median estimate of 22 economists surveyed by Bloomberg News was for a 6.4 percent drop.

Today’s report may stoke concern that deflation will take hold and hamper a rebound from the nation’s worst postwar recession. Bank of Japan Governor Masaaki Shirakawa said this week that his policy board will watch out for the risk that the economy and prices will slip below its forecasts.

“Viewing the broader price trend in the domestic economy, we would have to stress that homemade deflationary pressures are strengthening,” said Kyohei Morita, chief economist at Barclays Capital in Tokyo.

As I pointed out in the context of the consumer price release and as a general rule of thumb we can expect all y-o-y inflation figures coming in over the summer to be biased downwards due to the low base effect from very high headline inflation during the summer of 2008. Yet, I also showed that with respect to the consumer price data it was not entirely a question of headline disinflation since also the core-of-core index slid substantially on an annual basis. This analysis is backed up by a closer look at the data from Ken Worsley which clearly indicates that when it comes to policy makers and analysts, "on the ground" as well as of course the message from the raw data, Japan's domestic economy is providing a clear deflationary bias at the current juncture.

Today's release of the corporate goods price index for June can probably be given the same analytical treatment in the sense that although the disinflationary bias from lower headline inflation will be there there appears to be a strong underlying gravitional pull from the deflationary pressure from the lack of domestic demand. One interesting point here is in particular the tepid change in discourse away from the stubborn anticipation of the feedback from higher energy prices to core inflation and thus, in relation to producer prices, that companies would push on higher input prices on to consumers. Clearly, this scenario did not materialize and one has to wonder whether counting on it to happen might not constitute a parallel to that famous play by Samuel Beckett.

Rather, it is noteworthy to see that many analysts and policy makers are now beginning to focus on the fact that the squeeze in prices is also a result of the fact that there are no pull inflation but rather the opposite; Kyohei Morita being one example here. Apart from being deflationary in and of itself it also means that whatever the amount of input inflation it is likely to be clogged up in the value chain eroding the profit margins of those companies who rely on domestic demand to sell their products. It is interesting in this regard to point out that if we look at the evolution in the monthly figure (3 period moving average), the trend is still distinctly deflationary and in this specific case petroleum and coal products actually contributed positively but was weighed down by other goods and commodities. The monthly figure has been negative on a three month moving average basis since January 2009. In the context of the annual figure the low base effect is substantial with petroleum and coal products decline 41%, but it is important to point out that the decline in corporate goods prices is broad based which indicates that the only thing we need to consider in terms of the low base effect is the level of the decline and not the sign. Finally, it is worth pointing out that in terms of export and import prices the decline in bigger in the former than in the latter on an annual basis which suggest that Japanese exporters might be scoring some points on this account (and here I am not accounting for the currency effect which may tip the load in any direction).

In conclusion, deflationary pressures are intensifying in Japan and it is important for a whole host of reasons. Most prominently, there is an expectational element here and one which may be particularly sinister in Japan. In fact, and if we have learned anything from this crisis it is that managing expectations and especially avoiding lingering expectations of deflation is a key policy parameter. In this sense it is worrying to see that the BOJ's effort, albeit valiant, may be falling short.

Long term outlook for the yen

Yen: Safe Haven, But for How Much Longer?

"The Yen carry trade is long gone. Now that everybody else has the same "zero interest rate policies" the trade has been unwound. The Japanese economy is absolutely imploding as the fatal flaw in the great export experiment is revealed. No amount of so called "stimulus" at home will make up for evaporating foreign demand, especially after fifteen years of bridges to no where has satiated local demand. Japanese debt to GDP ratio is well over 100% and rising."

"Investors typically buy the yen as a haven for their cash because Japan’s current-account surplus reduces the country’s dependence on borrowing abroad."

Here's how it could work: Japan stays in deflationary mode until the yen drops, but that will take quite a while for demand for JGB's to be overwhelmed by supply. After all, all that money that is being repatriated into yen at a rapid pace gets *parked*, esentially, until a run for the exits happens. Think of the massive amount of JGB's out there, and all of the quantitative easing that the BoJ has done attempting to reflate. It would be a long term process due to Japan's trade surplus and the country's high savings rate, but eventually domestic savers will have to use their savings. The inflationary results of Japan's monetary and fiscal policy show up, and the currency loses value rapidly.

Consumer Sentiment Rises As Exports Slump - But Where, Oh Where Is The Recovery?

Japan put in a pretty negative export performance in May. Even shipments to China show little sign of improvement, and the general impression is that hopes for a quick recovery in global demand are looking very premature.



On the other hand a 42 per cent year-on-year fall in imports in May left Japan with a trade surplus of Y299.8bn for the month - something that will help push gross domestic product back toward growth this quarter, but a trade surplus where imports fall faster than exports is not the same as a surplus where exports grow faster than imports, and certainly for the global economy it isn't.


The Details

Shipments fell 41 per cent by value year-on-year amid a rising yen and continuing weakness in sales in key markets for electronics and automobiles. May’s year-on-year drop was greater that the 39 per cent one recorded in April, while seasonally adjusted exports slid 0.3 per cent from the previous month, after having risen in both March and April.

Nonetheless Bank of Japan data showthat when inflation and currency changes are stripped out, exports were up 5.1 per cent in May. And - depending on what the June numbers look like - exports in the second quarter of the year will certainly be up on exports in the first quarter by somewhere between 7% and 10%. Shipments to the U.S. fell 45.4 percent in May after dropping 46.3 percent in April.

Exports to Europe were down 45.4 percent following a 45.3 percent year on year drop in April.

Shipments to China, Japan’s biggest trading partner, fell 29.7 percent, more than April’s 25.9 percent. Exports to Asia slid 35.5 percent from 33.4 percent a month earlier. Japan’s exports to the rest of Asia were also well up, over 5% month on month, marking the third straight month of increases. Going by what we have seen so far, it looks like exports to the region will rebound strongly in the second quarter, and we may see growth of 15%+ over the previous quarter, following a drop of more than 20% in the first quarter over the last three months of 2008.




But even while exports to countries like Vietnam and Indonesia are rebounding (see chart below) those to India are still falling, and the situation in other a number of other key emerging markets is hardly improving.

If China’s exports fall faster than global demand, that opens up space that allows others to cut back less. The alternative — fast Chinese export growth amid a shrinking global economy — would be a sure source of trouble. But China still isn’t really acting as a locomotive for overall global demand growth.
Brad Setser

Confidence On The Rise

The Export aituation stands in fairly strong contrast with the mood of consumers and small businessmen inside Japan. Japan’s household sentiment rose to a 14-month high in May, leading many to conclude that Japan's deepest postwar recession may be easing. The confidence index climbed to 35.7 from 32.4 in April, according to the Cabinet Office in Tokyo. The index has now improved every month since it hit a record low of 26.2 in December.


At the same time confidence among Japanese merchants and small traders rose to a 14-month high in May The Economy Watchers index, a survey of barbers, taxi drivers and others who deal directly with consumers, climbed to 36.7 from 34.2 in April, the highest level since March 2008.

OECD Revises Down Forecast

While the Bank of Japan appears increasingly hopeful that the worst of the slump is or will soon be over, there are plenty of doubts about how robust and enduring any coming recovery is likely to be. As I am trying to stress it is one thing bringing a halt to the decline in exports, and quite another to ramp them back up again. Many companies are now operating well below output capacity, and there is a limit to how long they can do this without laying off part of their workforce. So unemployment, which has been rising, looks set to rise further.

In its world economic forecast, the OECD said Japan’s huge fiscal stimulus packages would begin to support growth from the second half of 2009, but that the economy was nevertheless on course to contract 6.8 per cent in the year as a whole. With the effect of fiscal stimulus set to ”begin to fade” in 2010 and only a ”relatively modest upturn” in world trade expected, the OECD is now forecasting Japanese GDP growth of only 0.7 per cent in 2010. To put this in perspective, if these forecasts are fulfilled Japan GDP will be back at the 2004 level at the end of 2009, and will not reach the 2005 level until 2011, at the earliest. Since these are key years for Japan in preparing to bear the weight of all those extra dependent elderly the output loss is deeply significant. And remember, prior to 2005 we had all those lost years, so another little data point, in 2009 GDP will be only something like 4% up on 1997 - 12 years later!



Randall Jones, head of the OECD’s Japan and Korea desk, argues that such anaemic growth will be far from enough to stem the huge output gap, with the liklihood that Japan is set for ”persistent deflation” - an outcome that will only add to the difficulty of addressing the rapidly growing fiscal debt burden.



The Cabinet Office’s Consumer Confidence Survey price forecasts are a key indicator of Japanese household inflation expectations. The price forecast index for May, published in June, confirmed that individual inflation expectations have fallen further. 38.6% of survey respondents said that they expected prices to be higher in one year’s time, down from 42.3% in the April survey. This is the 10th consecutive month of decline. At the same time, 22.3% of survey respondents said that they expected prices to be lower in one year’s time, up from 21.6% in the April survey, the eighth consecutive month the percentage has increased.

Japan's government went back on 220 billion yen ($2.3 billion) of planned welfare spending cuts this week and effectively put fiscal reform on hold for a decade as it adopted a new long-term reform target to allow it to issue a record amount of bonds to combat recession. The economic policy outline for 2009, which serves as the basis for compiling next fiscal year's budget, will only add to unease at Japan's ability to manage its colossal public debt.

Doubts also abound as the government led by Prime Minister Taro Aso's Liberal Democratic Party could lose power after more than half a century of almost unbroken rule in elections that must be held by October, according to media polls. The economic policy outline points to a fatal flaw common to both the LDP and the main opposition Democratic Party of Japan, which has its best shot ever at taking control: Neither have a credible plan to lower Japan's debt burden and provide a high level of social services to a rapidly ageing population. "Fiscal discipline is a common issue for Japan, the United States and Europe," said Yuuki Sakurai, chief executive and president of Fukoku Capital Management.

Senior members of the LDP twice rejected draft versions of the 2009 economic outline, which is drawn up by the top advisory Council on Economic and Fiscal Policy, as they sought to delete a pledge to cut annual increases in welfare spending.Giving up on that pledge and the old fiscal reform target marks a rollback of former Prime Minister Junichiro Koizumi's reform drive to limit spending and reduce the size of government.

Japan now aims to stabilise its ratio of debt to gross domestic product by the mid-2010s and to lower it steadily by the beginning of the 2020s, according to the outline. The government also plans to halve the ratio of the primary budget deficit to GDP in at least five years after the economy recovers. The primary budget deficit excludes debt issuance and servicing costs.

Japan's fiscal condition is the worst among major economies, and the government expects the ratio of its long-term debt to gross domestic product to hit 170 percent by the end of 2009/10. The country's primary budget deficit is expected to rise to 8.1 percent of GDP this fiscal year, up from 3.9 percent in 2008/09. Japan’s debt burden will probably spiral to 197 percent of gross domestic product next year, according to the Organisation for Economic Cooperation and Development.

Japanese Prime Minister Taro Aso looks set to abandon a government pledge to curb social welfare spending following a decision of the ruling Liberal Democratic Party this week. Japan is about to drop its goal of trimming growth in the welfare budget by 220 billion yen ($2.3 billion) in each of the five years through 2011 in what is only the latest sign that the country is losing its battle to contain what is currently the world’s largest public debt.

Japan's initial goal of a achieving a primary balance by 2011/12 has thus been pushed back 10 years following the government decision to sell a record 44 trillion yen of new debt in the fiscal year to next March to finance both regular spending and stimulus packages. Tax revenue for the year which ended last March came in 5 percent short of government estimates, and the government could issue even more bonds to make up for the shortfall, according to an unsourced report in the Nikkei financial daily.

The Cabinet also reiterated earlier promises to raise the ratio of the public contribution to basic pensions to 50 percent after 2010, to recycle laid-off workers into the caregiver industry and to consider tax exemptions with one-time payouts for the poor. The country’s ageing population is driving up spending for medical care and pension payments, and welfare costs are already eating up more than a quarter of this year’s budget. Indeed these costs rose 14 percent from the year earlier even after the government applied the 220 billion-yen spending cap restriction.

"We have to allow for a natural increase in welfare spending," Finance Minister
Kaoru Yosano told reporters after the Cabinet approved the outline. "The message
we've heard on social services is to stop making cuts that are impossible to
make. Past government policy allows us some flexibility to respond as the
situation changes."

The deep underlying problem is that this situation is no longer a temporary one. Japan has now been stuggling with such difficulties since the mid 1990s at least, and has become increasingly dependent on exports to live. So the flexibility they are looking for may now simply not be there.

The most likely prognosis is that a lot of what we are hearing is election talk, and that the long proposed onsumption tax hike looks more and more probable and imminent. Evening taking the new targets for fiscal consolidation involving a return in the primary balance to surplus within 10 years we may be looking at a 7% rise in consumption tax (from 5%to 12%) as early as 2011. The rhetoric may lead markets to not expect a rise in the consumption tax at any early date, but the reality may be that this is the only option left and that the ground is steadily being prepared for just such a move.

Looking For The Door

Despite the fact that the recession has been extraordinarily deep, and that recovery is bound to be a long, hard and protracted affair, the debate among market participants has now shifted towards possible BOJ exit strategies. In fact a full exit from the monetary easing process is not at all either likely or contemplateable in the short term. However, it is not impossible that the BoJ decide not to renew the temporary measures that are scheduled to come to end in September, like the outright purchases of Commercial Paper and corporate bonds, the Special Fund-Supplying Operations to Facilitate Corporate Financing.

Despite all the speculation the reality is that the BOJ’s view on the economy is still very cautious. Governor Masaaki Sirakawa limited himself this week to saying that the central bank will decide how to deal with the temporary measures “by the end of September in a predictable manner to market participants.” The Bank of Japan also said that the recession is easing as fiscal stimulus measures worldwide spur demand and companies increase production. But Governor Shirakawa has also cited the reduction in inventories both in Japan and overseas as one of the reasons for the bottoming out of the economy, and stressed that it is what happens to final demand - domestically and overseas - after this reduction in inventories comes to an end which holds the key to any long term improvement in the economic situation.


In its Monthly Report of Recent Economic and Financial Developments the BOJ revised its basic view of the economy upwards for the second consecutive month. In April, the Bank were saying that “Japan’s economic conditions have deteriorated significantly”, but this was revised in May to the view that “Japan’s economic conditions have been deteriorating, but exports and production are beginning to level out”, and in June to the view that "Japan’s economic conditions, after deteriorating significantly, have begun to stop worsening".

This has been widely seen as an indication that the BOJ has revised its view on the economy upward, but the BOJ itself has been trying to discourage this interpretation. At the press conference, Governor Shirakawa said that the BOJ's view on the current state of the economy was in line with the forecast made in the Outlook for Economic Activity and Prices report published on 30 April, namely that “the pace of deterioration in economic conditions will likely moderate gradually and start to level out”, thus emphasizing that the BOJ has not changed its view. To reinforce this point, using the analogy of a weather forecast, he said that if the weather forecast for the following day turns out to have been right, this does not mean that the forecast has been revised.

Facebook Links

Quietly clicking my way through Bloomberg last Sunday afternoon, I came across this:

Facebook Members Register Names at 550 a Second

Facebook Inc., the world’s largest social-networking site, said members registered new user names at a rate of more than 550 a second after the company offered people the chance to claim a personalized Web address.

Facebook started accepted registrations at midnight New York time on a first-come, first-served basis. Within the first seven minutes, 345,000 people had claimed user names, said Larry Yu, a spokesman for Palo Alto, California-based Facebook. Within 15 minutes, 500,000 users had grabbed a name.

Mein Gott, I thought to myself, if 550 people a second are doing something, they can't all be wrong. So I immediately signed up. Actually, this isn't my first experience with social networking since I did try Orkut out some years back, but somehow I didn't quite get the point. Either I was missing something, or Orkut was. Now I think I've finally got it. Perhaps the technology has improved, or perhaps I have. As I said in one of my first postings:

Ok. This is just what I've always wanted really. A quick'n dirty personal blog. Here we go. Boy am I going to enjoy this.

Daniel Dresner once broke bloggers down into two groups, the "thinkers" and the "linkers". I probably would be immodest enough to suggest that most of my material falls into the first category (my postings are lo-o-o-ng, horribly long), but since I don't really fit any mould, and I am hard to typecast, I also have that hidden "linker" part, struggling within and desperate to come out. Which is why Facebook is just great.

In addition, on blogs like this I can probably only manage to post something worthwhile perhaps once or twice a month, and there is news everyday.

So, if you want some of that up to the minute "breaking" stuff, and are willing to submit yourself to a good dose of link spam, why not come on in and subscribe to my new state-of-the-art blog? You can either send me a friend request via FB, or mail me direct (you can find the mail on my Roubini Global page). Let's all go and take a long hard look at the future, you never know, it might just work.