Japan Emerges From Recession, But The Slump Continues

Amidst a huge fanfare of euphoria from the press, Japan's GDP expanded by 0.9% quarter on quarter between April and June, or at a 3.7% annualized rate. In doing so it clocked up the first positive growth in five quarters. Many now claim the worst is over is over for Japan, and in terms of the depth of contraction it may well be, but I fear that recovery may be a much more distant prospect than some imagine, and even when it does come may be far more tepid than is being factored in by the consensus. I am not alone in having there doubts. The Financial Times this morning has already begun to qualify its initial response:

"Japan returned to growth in the second quarter after a year of contraction, but economists warned that the recovery remained vulnerable to any faltering in export demand or tightening of the government’s fiscal stimulus spigot........Yet with unemployment still rising and deflationary pressures growing, Japanese Prime Minister Taro Aso acknowledged the world’s second-largest economy was still far from a return to real health. “We are only halfway there,” the prime minister said during a pre-election debate with rival party leaders."

As has Bloomberg:

Japan’s 3.7 percent economic expansion last quarter ended the country’s worst postwar recession. The bounce may be as good as it gets. Growth will slow to an annual 2.9 percent pace in the three months ending Sept. 30, according to the median forecast of 10 economists surveyed after yesterday’s gross domestic product report. Falling business investment and rising unemployment may hamper a recovery that has been fueled by $2.2 trillion in emergency spending by governments worldwide.

Morgan Stanley analyst Robert Feldman was equally forthright and to the point:

“We have our doubts about the durability of this......There’s isn’t enough demand to get us back on a very strong recovery path. We don’t see a huge downside, but nevertheless the upside is pretty limited.”

Exports, and public investment were the main growth drivers in Japan this quarter, while private consumption remained notably weak. The principal impetus came from exports that jumped 6.6 percent (quarter on quarter), led by demand from China. At home, Taro Aso’s 25 trillion yen ($264 billion) in stimulus helped consumer spending rise 0.8 percent on the quarter and lead government investment to climb 8.1 percent. The figures evidently show hallmark of a worldwide rebound in factory demand (after inventories have been run down) and large-scale economic stimulus measures in Japan. The expansion in exports, benefits from economic stimulus measures, and inventory building are unlikely to continue, and growth will most likely slow again, especially after the last quarter of this year, as their impact fades. Deflation will remain a feature of the Japanese economy and I thus expect the BOJ to maintain its policy of monetary easing into the indefinite future.

Personally I do not expect to see anything resembling a full-fledged recovery in Japan until the second half of 2010, although the present slight expansion phase may well continue through the July to September quarter, and certainly the July PMI suggested this.

Thereafter, however, economic growth is likely to slow through to the end of the fiscal year, and we may well see further quarters of negative growth. The principal reasons for this expectation are:

(1) fading support from economic stimulus measures, especially after the elections, when the deteriorating fiscal situation will need to be addressed.

(2) prospects of a slowdown in economic activity overseas, especially in China, which has become a key customer, and

(3) downward pressure from household spending as employment adjustments have an effect.

Industrial Output Improves

Japanese industrial output rose for the fourth month in a row in June and is expected to keep climbing as manufacturers restart production lines halted during the highpoint of the slump. June industrial production was up 2.4 per cent month-on-month, a rate of increase lower than the revised 5.7 per cent growth recorded for May but still an increase.

It is now obvious that the drastic output cuts of the last quarter of 2008 and first quarter of this year have successfully cleared the excess inventory backlog despite the extraordinary speed at which demand declined. The Industry and Trade Ministry (Meti) reported that inventories were down 1.0 per cent month-on-month in June, while the inventory ratio - which compares inventory to actual shipments and is seen as a leading indicator - was down 9.8 per cent. This the sharp fall in the inventory ratio suggests that the driveing force behind the current production growth has shifted from excessive inventory reduction to responding to overseas and domestic demand fuelled by government stimulus policies across the globe.





July PMI survey data provided further evidence that Japan’s manufacturing sector may continue to sustain the economy into the next quarter. The seasonally adjusted headline Nomura/JMMA Purchasing Managers’ Index (PMI) rose to 50.4 in July, from 48.2 in the previous month, pointing to the first improvement in operating conditions for seventeen months. Although only marginal, growth of the sector was slightly faster than the survey’s historical average.

Manufacturing production increased for the second month running in July, rising at the most marked pace since September 2006. Where an expansion of output was signalled, PMI survey panellists frequently linked this to renewed growth of new orders. It was the first improvement in firms’ order books for seventeen months. Those respondents that reported a rise in new order levels widely attributed this to firmer demand from home and overseas, with export sales rising for the second month in a row. The survey organisers stated that anecdotal evidence suggested improved demand from China was providing the main boost to workloads at manufacturers.



Deflation A Done Deal, And Digging In For A Long Winter

The shortfall in demand is already weighing on prices, making it likely that deflation will once again become entrenched in the economy. Consumer prices plunged a record 1.7 percent in June and yesterday's GDP report showed wages fell a record 4.7 percent from a year earlier. Capital spending, which accounts for about 15 percent of the economy, fell 4.3 percent last quarter. A survey published this month by the Development Bank of Japan showed companies expect to cut fixed investment 9.2 percent this fiscal year. Reductions by manufacturers will be the steepest since 1993.



While the falling energy prices that have been the main driver behind the decline in the consumer price index to date, deepening deflation fuelled by job insecurity and massive manufacturing over-capacity could become a major feature of the Japanese economic environment and effectively undermine the economic recovery process. The fall in "core-core" consumer prices, which exclude both food and energy, accelerated to 0.7 per cent in June, while more recent July price data for urban areas of Tokyo showed a fall of 1.1 per cent.

Unemployment On The Way Up

Japan’s unemployment rate rose to a six-year high in June and consumer prices fell at a record pace, adding to evidence the domestic economy is struggling to recover even as exports start to improve. The jobless rate advanced to 5.4 percent from 5.2 percent in May, the statistics bureau said today in Tokyo, higher than the 5.3 percent median forecast of economists surveyed.
Economists expect the jobless rate to rise to a record 5.8 percent as companies cut costs. Deflation may erode profits even as factory output rebounds, further hampering Japan’s recovery from its deepest postwar recession.



In addition there is the so called "hidden unemployment" problem - employees retained by Japanese companies who are effectively surplus to current needs. A recent study by analysts at Nomura found that when indexing the number of those employed and real GDP to the output peak of Q4 2007 the result showed a considerable gap. Based on a simple calculation and assuming this gap to represent the amount of “hidden underemployment”, they arrive at a figure for “hidden jobless” in Q1 2009 of 4.7m. This is far higher than the June unemployment figure of 3.48m. If the hidden jobless are included together with the registered “unemployed”, they calculate that the unemployment rate would leap from 5.4% to 12.2%.

Consumer Confidence Rises

Japan’s household sentiment rose for a seventh month in July, adding to signs the world’s second- largest economy is edging closer to a recovery. The confidence index climbed to 39.4 from 37.6 in June, the Cabinet Office said today in Tokyo. It has improved every month since tumbling to a record low of 26.2 in December. A number below 50 means pessimists outnumber optimists.




The Economy Watchers index, a survey of barbers, taxi drivers and other small businesses who deal directly with consumers, climbed to 42.4 from 42.2 in June, making for a seventh monthly increase.




Storm Clouds Ahead

So despite the sigh of relief that everyone must have gasped on seeing the growth number for the second quarter, it is obvious that Japan's problems are far from over. Unemployment - with or without the hidden variety - is going to remain a problem, and the consensus view among economists expects the unemployment rate to climb to an unprecedented 5.9 percent by next year. On the other hand real wages continue to fall, sliding by 5.2 percent in June from a year earlier, the fastest decline on record.



And while the Bank of Japan this month announced that economic conditions had “stopped worsening”, it also highlighted doubts about the robustness of recovery by predicting the contraction in the fiscal year would be greater than previously forecast. The BoJ now expects gross domestic product to contract 3.4 per cent in the year to March 2010. Bank of Japan Governor Masaaki Shirakawa stresssed that demand for the country’s products and services may well not gain momentum.

It is now highly likely that the next central bank inflation forecast will predict that deflation will extend into 2011, which will force them to prolong their policy of keeping rates near zero for some considerable time. Shirakawa himself has admitted that prices are falling worldwide because of a dearth of demand and excess supply in the wake of the global economic crisis, adding that it will take “considerable time” before price drops moderate.

On top of this there is continuing political uncertainty. Opinion polls show the ruling Liberal Democratic Party is likely to lose the lower house election to the opposition Democratic Party of Japan, which has never held power before. The DPJ has made considerable promises to the Japanese electorate for spending increases, but it is unclear how they will, in fact react give the very strong constraints on public spending which actually now exist. On thing. however, is certain: if they do win the coming elections they will inherit an economy which even after last quarter’s expansion is still at its 2004 level.

Japan still a major factor in US Treasury market

as reported in the US Treasury's TIC report. It's interesting that China did not surpass Japan until September of 2008; and that those two countries dwarf all the other holders. How long can Japan avoid having to redeem some of these assets to fund domestic social programs?

June Exports Sustain Upward Momentum But Surplus Employment Rockets

Japan’s June exports fell at the slowest annual pace this year, helping the trade surplus widen for the first time in 20 months. Shipments abroad were down 35.7 percent from a year earlier, following a 40.9 percent in May, according to the Finance Ministry. The surplus widened to 508 billion yen ($5.4 billion).

Real exports (adjusted for price change impacts) rose an estimated 8.0% over May (according to Nomura calculations), the fourth straight monthly increase. Q2 real exports were up 12.2% over the previous quarter, demonstrating a strong rebound from the 28.7% decline in Q1. Exports are clearly stronger. Nomura estimate that external demand made a +1.1ppt contribution to real GDP growth in Q2, a complete tirnaround on the –1.4ppt contribution in Q1. The export orders index in the manufacturing PMI, which many see as a leading indicator of Japanese exports, was also up 1.4ppt month on month in June, marking the sixth straight monthly of increase.



Nomura's seasonally adjusted regional export volume indices show improvement across all regions, but exports to Asia improved the most. Apr–Jun exports to Asia rose 18.9% q-q (versus –21.3% q-q in Jan–Mar), those to the US rose 7.4% q-q (–33.3%), while those to the EU rose a very weak 3.8% (–30.7%).


Faster growth (and faster lending) in China is evidently propping up sales for Japanese manufacturers. China, which grew an annual 7.9 percent last quarter, has now surpassed the U.S. as Japan’s biggest export customer. Chinese government subsidies to encourage consumer spending and investment in building projects have benefited Japanese manufacturers. In fact June exports to China fell 23.7 percent from a year earlier, the smallest drop since October.




Shipments to the U.S. declined an annual 37.6 percent, the least since December.



Sales to Europe slid 41.4 percent, the best this year, but still steep on the back of very weak quarterly growth



The largest contribution to higher exports came from electrical equipment, chemicals and transport equipment. Real exports of electrical equipment rose 23.9% q-q in Q2, following a decline of 26.9% in Q1, chemicals rose 23.2% (–10.6% Q1), and transportation equipment 7.7% (–42.0% Q1). The large increase in electrical equipment exports is generally thought to be related to higher exports of semiconductors and electronic materials, which are heavily weighted towards Asia. Exports of general machinery remained weak, falling 8.0% q-q in Q2 (–31.8% in Q1). Machinert exports have failed to recover since falling sharply at the end of 2008, and this is evidently a reflection of persistent weakness in capex generally, something which should serve to question a little the overall robsutness of recovery.

Japanese machinery orders dropped in May to a record low (see table below) with firms limiting their spending as the economy remained weak. Core private sector machine orders, viewed as a key indicator of capital spending, fell 3% from April to 668.2bn yen ($7.1bn). May's drop is less than the 5.8% fall seen in April, but still in sharp contrast to the 2% rise analysts had forecast.




Deflation Getting Entrenched

Japan is under continuing deflationary pressure, and consumer prices fell at a record pace in May, adding to the risk that deflation will become entrenched. Prices excluding fresh food slid 1.1 percent from a year earlier after dropping 0.1 percent in the preceding two months, the statistics bureau said today in Tokyo. This was the sharpest decrease since comparable figures were first compiled in 1971.

Even excluding food and energy, consumer prices fell 0.5 percent in May, the fastest pace in 22 months. Core prices in Tokyo, a harbinger of national inflation trends, fell 0.7 percent in June from a year earlier, making for the biggest drop in six years. The Bank of Japan now forecast that core prices, the central bank’s key gauge of inflation, will slide 1.5 percent this fiscal year and 1 percent in the next.



And wholesale prices seem to suggest worse to come. Japan's domestic corporate goods price index, the nation's benchmark measure of wholesale prices, fell a record 6.6% in June from June 2008. The result was marginally stronger than the 6.3% fall forecast in a survey of economist by Kyodo News and the 6.4% projected in a Reuters poll. It was also the largest on-year tumble on record. From May, the index was down 0.3%. Export prices were down 12.8% on year in June, while import prices were 32.2% lower.



Falling wages and unemployment rate at a five-year high are forcing households to reduce spending. Japan's jobless rate rose to 5 percent in April, the highest since 2003, and there are about two people looking for work for every job vacancy, the most severe job shortage on record. The Organization for Economic Cooperation and Development have forecast Japan’s jobless rate will rise to an unprecedented 5.8 percent in 2010. Real wages have now fallen for 11 consecutive months, the worst performance in six years.

And there may well be much worse to come. The government now estimates the number of surplus to requirements workers in Japanese companies jumped to 6.07 million in the first quarter of the year. This was the highest level ever recorded, according to the fiscal 2009 Annual Report on the Japanese Economy and Public Finance.The number of excess workers is calculated by subtracting the number of what the Cabinet Office deems to be the optimum number of employees from the actual number of employees. According to the white paper, the number of surplus workers had been on a declining trend after hitting a peak of 3.59 million in the first quarter of 1999, now, as can be seen in the chart below it is surging once more, and will be a harbinger of huge layoffs if global demand for Japanese products doesn't really pick up soon.



Unsurprisingly Japan’s retail sales dropped for a ninth month in May. Sales slid 2.8 percent from a year earlier. Department-store sales fell 12.3 percent in May, the 15th monthly decline, and supermarket sales also slumped. From a month earlier, retail sales were unchanged after rising for the first time in eight months in April.And declines in consumption may accelerate in coming months once the effect of Prime Minister Taro Aso’s stimulus measures wears off. The Japanese government has given cash handouts to residents, as well as tax breaks for fuel-efficient cars and incentives for buying eco-friendly televisions, refrigerators and air conditioners, and still sales fall.

Given the extent of the stimulus programme it is perhaps not surprising that Japan's overall household spending rose 0.3 percent in May from a year earlier in price-adjusted real terms. This follows more than twelve months where Japanese households had been continuously pruning spending as companies cut jobs and bonuses. Compared with April on a seasonally adjusted basis, spending rose 2.2 percent. Spending by wage earners' households rose 1.8 percent in May from the same month a year earlier.


Basically, the future of the Japanese economy hangs on the future of the global one. It is hard to see the economy advancing on the momentum of domestic consumer demand alone, and we should expect the positive push the economy has received this year from the various stimulus packages to diminish in 2010 as the incoming government (of whichever party) finds itself increasingly constrained by the burden of the growing volume of government indebtedness.

Daniel Gross on Mellowing Japan

By Claus Vistesen: Copenhagen


In a recent article published in Slate, Daniel Gross gets to the heart of the matter. Essentially, he argues that one of the principal reasons that Japan is not rising is that it has failed to do the homework in the human capital department or as Gross phrases it; while Japan is still leading in engineering, this is not the case with respect to social engineering.

Japan still retains its lead in engineering. A showroom at Panasonic's headquarters displayed a heated, multifunction toilet seat that conserves energy. (Wouldn't leaving the seat cold conserve even more?) The sleek Shinkansen bullet trains roll up to their appointed spots on time. TKX, an 87-year-old Osaka-based company that makes abrasives, has adapted its expertise to cutting silicon ingots into wafers for solar panels.

But social engineering is proving more challenging. Japan's population peaked in 2004 at about 127.8 million and is projected to fall to 89.9 million by 2055. The ratio of working-age to elderly Japanese fell from 8-to-1 in 1975 to 3.3-to-1 in 2005 and may shrivel to 1.3-to-1 in 2055. "In 2055, people will come to work when they have time off from long-term care," said Kiyoaki Fujiwara, director of economic policy at the Japan Business Federation.

Such a decline is cataclysmic for an indebted country that values infrastructure and personal service. (Who is going to maintain the trains, pay for social benefits, slice sushi at the Tsukiji fish market?) The obvious answers—encourage immigration and a higher birthrate—have proved difficult, even impossible, for this conservative society. In the United States, foreign-born workers make up 15 percent of the work force; in Japan, it's 1 percent. And, official protestations to the contrary, they're not particularly welcome. One columnist I met compared the standard Japanese attitude toward immigrants to that of French right-winger Jean-Marie Le Pen. In the 1990s, descendants of Japanese who had emigrated to South America early in the 20^th century returned to replace retiring factory workers. Now that unemployment is on the rise, Japan is offering to pay the airfare for those who wish to return home.

Japan doesn't particularly want to import new citizens, but it doesn't seem to want to manufacture them, either. It's become harder to support a family on a single income, and young people are living at home for longer. And Japan isn't particularly friendly to working mothers—pre-K day care is not widely available, and the phrase work-life balance doesn't seem to have a Japanese translation. (The directory of the Japanese Business Federation, a showcase of old guys in suits, makes the Republican Senate caucus look like a Benetton ad.) The upshot: a chronically low birthrate. Too often, demographic change was described to me as a zero-sum game—rather than being seen as potential job creators, women and immigrants are often seen as taking jobs from men.

As Gross goes on to argue, Japan seems awfully passive about this and while there is certainly merit in discussing whether the size of the Japanese population is moving in the right direction it is the composition which really matters here. You only need to move back one entry here at this space get some kind of indication of the outlook for Japan's population composition. There is really no need to get into the whole discussion about whether economic growth is a goal in itself or whether Japan shouldn't have the right to conduct the policies it wants. Evidently, it has. However, for all those who believe that aggressive population management is desirable either be it through deliberate policies (a la China) or by simply allowing the demographic transition to run its course (i.e. Germany, Japan etc) they should also provide an answer towards the question of what to do with the market economy defined, as it were, by a social contract between generations, some form of paygo pension system, as well as a wide batch of centrally provided goods.

Gross' analysis is not far from the view presented in a recent article by me and Edward published in the summer edition of JapanInc. In this article, we argue that Japan is dependent on exports and that this dependence is a function of its age structure.

We also emphasise that Japan, for all intent and purposes, may be stuck in so far as providing a strong response towards the challenge of ageing;

While it is certainly true that the Japanese economy is currently struggling, it is not entirely true that there is no line of defense. Japan still has both monetary policy and fiscal policy tools at its disposal. The problem is that having spent a decade and a half attempting to fight the twin problems of deficient internal demand and ongoing deflation, the force of these tools has been steadily ground down. Interest rate adjustments, after many years when Bank of Japan (BoJ) rates have been held near zero levels, have little additional push to offer, while less conventional tools (like simply printing even more money via quantitative easing) or strong fiscal stimulus face clear limits in a country where gross debt to GDP is forecast by the OECD to hit 193 percent in 2009. So what can Japan do? Well besides simply grinning and bearing it, the tragedy is that there is not a lot that can be done in the short term. Evidently the Japanese government should give what support it can through highly targeted spending programs. The Bank of Japan, meanwhile, should be moving ahead with an aggressive policy of quantitative easing to provide as much relief as possible to Japan’s struggling households and corporates. But the only real way forward here is to try to slow the rate of population aging, and that means a change in national discourse and priorities, giving more support to those Japanese women who want to have children and radically changing the mindset about the extent to which Japan needs to promote an active immigration policy.

However, if we can all agree that the situation is difficult, it is hardly an excuse for not moving forward on the issues which ultimately will need to be adressed. Japan will need to foster a more conductive policy for increasing fertility as well as a substantial changed is discourse is needed with respect to immigration.