Japan Industrial Output January 2008

Japan's factory output fell in January at a much faster rate than most economists were expecting. Output was down 2 percent from December, when it rose 1.4 percent, the Trade Ministry said today in Tokyo.





The report also showed that companies plan to cut production further in February, with manufacturers antipitaing that output will slide 2.9 percent from January, before rebounding by 2.8% in March. It should be noted though, that despite the monthly drop, the year on year level was still up in January. However as far as Q1 2008 growth goes this number is far from being encouraging, and does not bode well at all for the coming months.




Two weeks ago, in a general Japan analysis, Claus had this to say:

In Morgan Stanley's GEF (edition 8th of February) Takehiro Sato points towards industrial production trends as well as US GDP readings and tantamount to the forecast that Japan is heading more meager times ...

"The risk of dual recession is mounting. Our US economics team is already calling for capex-induced negative GDP growth in successive quarters (Jan-Mar, Apr-Jun), for a technical minor recession in the first half of the year by definition. We are forecasting that Japan will cling on to a modicum of growth in the Oct-Dec 2007 quarter, boosted by external demand, but there is a possibility that, like the US, that quarter will mark the peak and the economy will retreat in Jan-Mar. Future data for industrial production will tell us if this is the case."

Well, if Takehiro Sato is right, then the industrial production data are now telling us just this.

Japan Trade Statistics January 2008

Bloomberg have a pretty misleading article today on the latest set of trade figures published by the Japanese finance ministry (let's say even more misleading than I have unfortunately become rather accustomed to in the Japanese context). Basically the Bloomberg story is:

Japan's export growth unexpectedly quickened in January, as rising demand for cars and steel from China and Russia made up for falling U.S. sales. Exports, the engine that drove almost half of the economy's expansion last quarter, rose 7.7 percent, from December's 6.9 percent gain, the Finance Ministry said today in Tokyo.

And all of this is, let it be said, absolutely true. The annual rate of growth in exports in January did accelerate when compared with December (slightly), but the rate of annual increase is way down from the double digit growth figures (see chart below) achieved in the May to August period, and this seems to be the significant detail. Also since November last imports have been increasing at a faster annual rate than exports, which means that the trade balance is not increasing as rapidly as it was (indeed there was a deficit of 3.5 billion yen in January, although January is an unusual month, since ports are closed for the New Year holiday, so I wouldn't make a great deal of this at this stage), and since it is the trade balance that matters for headline GDP growth, it would seem that the net contribution from external trade is SLOWING at this point, and not as the Bloomberg slant on the story would have it, holding up well.



All the data Bloomber present, apart from this rather unhelpful slant is, of course, very much to the point. Shipments to Asia and Europe were at a record level for the month of January - up by 4.6% y-o-y to China (which the astute reader will note is below the average rate of increase in exports, so this is not a China story by any means at this point, and indeed Japan's trade deficit with China deteriorated by 5.8% y-o-y). Exports to Europe, OTOH, were up by 10% (and with Russia and Central and Estern Europe by about 40%) on a January to January basis, while shipments to the US were down 3.2%. Latin America is also starting to figure - although from a very low base, with Chile up 61% and Brazil 33%. Vietnam was up 67%, and India 44%. Indonesia was up by 26%, but Philippines is definitely not a Japanese export story, with January shipments being down nearly 10% y-o-y.

Shipments to the U.S. accounted for only about 20 percent of total exports in 2007, compared with about 30 percent in 2000. Over the same time period, China's share jumped from 7 percent to 15 percent. Sales to Russia have doubled in the last two years.

Really this sort of country-level data breakdown is going to be very interesting to follow going forward now, since it will give us some concrete reference points in that great "de-coupling re-coupling" debate. As Bloomberg point out the International Monetary Fund last month forecast emerging economies will expand 6.9 percent in 2008, compared with 1.5 percent growth in the U.S. while they anticipate that China will expand 10 percent. I would say the points to watch here are the slowdown in Europe, and the inflation problem which is steadily extending its grip from the Baltic States - where the fire first broke out - across Central and Eastern Europe (via Ukraine and Russia) and now onto China. This whole issue raises real downside doubts on that 10% China number, and also raises the spectre of a major correction in Russia and Eastern Europe at some point.

Toshihiko Fukui's Term At The BoJ

Toshihiko Fukui will retire as governor, after five years at the helm of the Bank of Japan, on the 19th March. His successor may well be announced this week. This morning in the Financial Times David Pilling has a long, and very "fair and balanced" asseessment of Fukui's time at the BoJ, which is more than worthwhile reading for those of you who would like to understand the workings of this venerable institution just a little better. As Pilling's concluding paragraphs make clear, what would seem to matter most in this case isn't so much what just happened, as what gets to happen next:

“Fukui has often been portrayed as chomping at the bit to raise rates,” says Ben Eldred of Daiwa Securities “The truth is that Fukui’s BoJ has been fairly pragmatic – waiting until relatively late in the economic cycle before raising rates, doing so only very gradually and pausing as soon as it became clear that the global economic outlook had worsened in 2007.”

The pause to which Mr Eldred refers has lasted a year. As well as a response to international circumstances, the delay also reflects the failure of the domestic economy to click into gear as Mr Fukui has long predicted. The governor has continually stressed his belief that record corporate profits will feed through into higher wages and consumer demand – a “virtuous circle” that might have been a good justification for the bank’s forward-looking policy.

Unfortunately, it has not panned out. Wages have stalled or even fallen as global competition, coupled with labour market and demographic changes, has short-circuited the normal mechanism by which profits flow into remuneration.

This has left Japan’s economy running on only one, export-led engine and flying too close to the deflationary ground for comfort. What headline inflation there has been is due almost entirely to higher oil and commodity prices. If commodity-led inflation fades – as many predict if the global economy slows – Japan could yet crash-land back into deflation.

Markets are factoring in the possibility that the BoJ’s next rate move will be down – not up as the governor has long intimated. It would be a severe blow indeed for the bank to put hard-won interest rate rises into reverse. But if the day for such a decision arrives, at least it will not be Mr Fukui’s to make.

Basically I think Fukui's big bet was that domestic consumption would prove strong enough to provide a second leg (in tandem with exports) for the Japanese economy. As Claus details at great length here (and here) - and as Pilling also seems to accept -this view seems to be inadequate, and fails to get to grips with the malaise which is affecting the Japanese economy. And as if to give just one last kick to this now thoroughly wobbly perspective, todays index for December services has just been published by the Japanese Trade Ministry. The tertiary index, which is a measure of the money households and businesses spend on things like phone calls, power and transportation, declined 0.6 percent from November. The Ministry listed the following sectors as having declined:

1. Finance and Insurance, 2. Services, 3. Compound Services, 4. Wholesale and Retail Trade. Industries that contributed to the increase are as follows:1. Eating and Drinking Places, Accommodations, 2. Real Estate, 3. Learning Support, 4. Electricity, Gas, Heat Supply and Water, 5. Medical, Health Care and Welfare.

Although the index actually rose some 0.2 percent over the fourth quarter, this latest sign of weakening will certainly not come as good news for Fukui as he prepares to clear up his desk.

Q&A on Japan

In the context of Francois Guillaume's pertinent comments and questions to my review and preview note and in the light of today's much surprising Q4 GDP release I have chosen to present my comments and answers to Francois' questions/comments above the fold à la Q&A.

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1) GDP much higher than expected...how do you explain that ??

I want to focus on two issues here. First of all, the current figures are preliminary and in this light I expect to see a downward revision in March. In this light, we need to realize I think that given the incoming stream of data we have seen from the three months of Q4 2007 this figure of 3.7% (Q4 YoY) is pretty hard to justify. For a reasonable take on the whole situation Graham Davis from the Economist Intelligence Unit had a good overview I think in his interview with Bloomberg (can’t hyperlink to the clip I am afraid). Also, we should note I think a comment made recently by Takehiro Sato over at Morgan Stanley’s GEF …

Incidentally, in Japan’s case, quarterly GDP data are too volatile to be a suitable criterion for calling the economic cycle. This is clear from the GDP trend in past recessions. Yet while GDP has at times been positive when the economy is in retreat, industrial production has consistently mirrored the downward path of the economy. It seems reasonable to say that the critical factor for assessing the economic cycle is simply the direction of industrial production.

However, if we accept the figure as it is I still don’t think that the underlying path of the Japanese economy has changed even if the level seems somewhat too high. Let me consequently highlight some of the snippets from Bloomberg’s report on the break-up of the GDP components as well as the much more detailed break-up provided by Edward vis-à-vis the official estimate provided by the Cabinet office. What thus seems clear to me is that although consumption rose in the last half of 2007 net exports and by derivative capex continues to drive forward Japan on the margin. Remember that we need to talk about levels here too since private consumption commands a much larger share in the Japanese economy than does both investment and net exports. Let us try to annualize the quarterly growth rates in both real and nominal terms which yields a quite different picture. In real terms Japan thus grew 1.8% through 2007 and in nominal terms we are down to a rather un-impressing 0.6%. Particularly for Q4 the figures are 0.9% and 0.3% for real and nominal growth rates respectively. In this way, the GDP deflator is a welcome alternative to the CPI index in that it accounts for the change in prices relative to what consumers actually buy in the measurement period. Thus note in passing the following from Bloomberg …

Rising oil prices may have boosted growth in real terms. The GDP deflator, a broad measure of prices used to calculate real growth from nominal, fell 1.3 percent from a year earlier, the biggest drop since the first quarter of 2006. The deflator is adjusted downwards when oil prices rise. In nominal terms the economy grew an annual 1.2 percent in the fourth quarter.

I am going to discuss this more below since inflation measurement is clearly one of those areas where data mining and basket building can be used to construct just about any kind of number you would like. In this way, all these kinds of inflation adjusted growth rates etc need to be taken with a pinch of salt. In conclusion on the GDP figures I think the following is important to note. First of all, this is good news since it indicates, all things equal, that Japan has defied at least some of the claims that a recession/slowdown is imminent. However, I am not sure how much valuable information we can reasonably derive from the figures at this point. First of all, I think these figures are in for a haircut once they are subject to revision. Yet, even if we rely on them such as they are I think that it is reasonably clear how for example the value component of energy prices might have pushed up the real GDP to unrealistically high levels if we consider the underlying trend.

2) Inflation: see my previous posts: CPI is just a price index. Its definition is very different from a country to another. Change in the index & methodology would give a total different picture. Most important is the trend of the index itself, and the recent trend is up. It’s ridiculous to speak of deflation any more. CPI has been ranging from -2% to 1% in last years. It doesnt make a lot of difference. Asset-prices are more important: Nikkei is still nearly more than 80% off 2003 lows, real estate in central Tokyo as well despite being off its highs probably by 20% at least.

Unfortunately I am not sure about which posts Francois is referring to here but nevertheless he fires off a lot of reasonable questions here. First of all, I completely agree with the point on methodology. Since the CPI is based on a basket which can be changed and re-weighted and since the CPI may or may not include headline inflation what we end up with is a veritable mind field of potential ‘best practices’. This also means that whatever the picture you want you can rig the data so that your specific view of the world emerges. I don’t think however that this is what I have falling victim to in my analysis of Japan. In my opinion, the price movements in Japan both in the most recent period as well as in 4-5 year perspective show two things. First of all, there is the overall level of inflation which has been very low and essentially negative. This, coupled with the very aggressive monetary regime put in place to normalize conditions indicates I think that there is indeed ‘something funny’ about consumption and domestic demand in Japan and this is what has led me to conclude that the whole price edifice in Japan has something to do with the population structure of the country. Secondly and in the more immediate context the recent divergence between input and output prices further support my claim that price dynamics in Japan do not follow the theories we can discern from macroeconomic textbooks and traditional empirical studies. Moreover, it obviously suggests that the equality often exclaimed in the financial press between the return to inflation and economic recovery is wrong.

Now, all this leads me to disagree with Francoise when he says It doesnt make a lot of difference. I think it does although I do agree that asset price deflation/inflation is extremely important too. In this respect the Nikkei is mentioned being considerably off its low levels of 2003 as well as those much debated Tokyo real estates have seen hefty increases in price. Both these points are very important to take aboard I think and merits, at least a bit, that Japan has moved on. Of course, the most recent developments in the Japanese housing sector suggest that the construction/residential sector in Japan might very well be in for a more difficult future but let us leave this point here. However, what about another kind of asset in the form of human capital? How does the value of this asset stand? Well, as we have observed one of the recent trademarks of the Japanese labour market has been a consistent decline in wages and the transition from a labour market of full time workers to part time workers (on the margin of course). Since aggregate national wages essentially can be seen as a measure/reflection of the national labour productivity (either absolute or per/hour) what does this imply for the general price level in Japan? As can be seen, this readily becomes rather complicated. Another reason as to why inflation matters has to do with the workings of a modern economy is monetary policy. Quite simply, deflation or next to no inflation has implications for the workings of monetary policy as well as it has implications for the consumption dynamics of the society. More importantly, we have seen the condition of deflation in Japan and subsequent low interest rates have had notable externalities on the global economy. So, I would say that it does indeed matter.

3) Monetary policy. I fear there could be a big misconception on USD buying interventions. MOF as you know is running a hell lot of debt. It is short Yen cash. But it seems to me that most of the FX intervention is executed by BOJ, but on behalf of the MOF. So when MOF buys USD, it needs to borrow even more JPY. But with the end of Quantitative easing, they can’t issue as many Financial Bills to back them as they would like to (because BOJ would basically buy an unlimited amount of them @ 0% before.) I think that with the deterioration of public finances, it becomes harder to do such intervention. So I see just a lot of talk, not much more.

Here I stand corrected. Consequently, I had not, in my analysis of the JPY and subsequent potential for intervention, thought about the perspective Francois presents here. It is very interesting I think. Now, for some of our readers this may seem a bit complicated but what Francois is saying is simply that absent quantitative easing/ZIRP it becomes more ‘expensive’ for the MOF to intervene since they cannot be sure that they are able to offload the subsequent debt. Of course, this also paves the way for a rather perverse scenario. Consider thus that the JPY is driven largely by risk sentiment at the moment. If the BOJ sees it fit to lower rates during the course of 2008 and perhaps even returns to ZIRP we could expect the JPY to shoot up given we accept the current market dynamics. Note in passing here that this morning’s GDP release has been followed by a depreciation of the JPY which shows the disconnect between the fundamentals and the JPY. In this way, a return to ZIRP or just a drop to 0.25% could in this context be followed by an increased in the pressure to intervene. Of course, this is not a plausible scenario at this point but still goes to show the potential dynamics as we move forward.

4) JPY everybody I talk to is bullish on the JPY... maybe that is why it is so sticky now...but its way off its lows against many crosses.

As I have said above and also in my recent review and preview the JPY remains wholly disconnected from the fundamentals of the Japanese economy. I concur with Francois that the sentiment on the JPY at the moment seems to be bullish given the general risk sentiment in the markets. At time of writing it is sniffing at 108+ which is outside the recent weeks’ range of 106-107. It is difficult to see where it goes from here. I am expecting this ‘stickiness’ theme to dominate since it is unclear I think whether market conditions would favor a move below 105 or upwards to 110.

5) Long term interest rates... the credit markets have imploded in less than a year. My prediction is for a failure of a big govt bond market in 5 to 10y time. Japan would be an obvious candidate. In that scenario, long term interest rates are heading HIGHER. Just people will be tired to be stuck with low interest rates when there is inflation everywhere. But in the short term, as the asset-bubble is deflating, and this process is not over, global govt bonds will remain for some time the asset of choice, by default.

Now, this is very interesting in my opinion. Whether or not we will see a failure in a government bond market is an open question subject to one of those rather long term falsification clauses. I have argued before that in the context of countries such as Japan and Italy it will, at some point, cease to make sense in ‘rating’ the sovereign debt market based on the same criteria as you treat e.g. India, the US etc. Quite simply, this will become unfeasible as we move forward since this would push these countries into a technical default. As Francois alludes this may of course come to pass some way or another not because of the rating agencies themselves but rather because with inflation the nominal yield may become too unattractive. Note also that once we enter this discussion we also enter a whole gamut of issues in the context of Japan in the sense that the BOJ and the MOF is in a double bind. On the one hand the BOJ faces external pressure (those externalities again) to raise or more aptly to normalize rates but it finds this difficult because deflation still dominates the general price level. Moreover, a transition towards whatever the interest level we assert to be normal would most likely drive up the value of the JPY and thus further lead to deflationary pressures. We should also consider the simple points that as interest go up the debt becomes more expensive to service and in this way the MOF has a distinct interest in keeping interest rates down. Within this framework headline inflation pressures are of course simply a further pinch it seems not least because of the reasons mentioned by Francois.

This topic on sovereign debt and long term interest rates is very important I think but for now I think that I will lower my guns. Thanks for Francois for the comments. Needless to say, here at JEW (and at Alpha.Sources) we always appreciate to be challenged on our views and opinions.