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Friday, October 31, 2008

As The BOJ Cuts Rates Japan Grits Its Teeth For Another Bout Of Deflation

by Edward Hugh: Barcelona

Well, suddenly Japan's economy seems to be back in the news. The BOJ today lowered interest rates, inflation seems to have peaked (and deflation may be once more looming on the horizon), householding spending is in decline, employment is falling, exports are languishing as the yen hits one high after another against both the dollar and the euro, Prime Minister Taro Aso is (despite the perilously large size of Japan's debt to GDP ratio) preparing yet another counter-recession spending package (this time of some $275 billion dollars, with $50 billion in additional spending), and yes, above all, Japan already seems to be mired deeply in recession.

The Economist said the following:
WITH luck rather than skill, Japan escaped the bubbles in housing, credit and commodities. As Western banks suffered, Japanese ones even went on a small acquisition spree. But the (fairly) good times are over. The unwinding of the yen carry trade, in which investors borrowed low-interest yen to place in higher-yielding assets abroad, has helped to send the yen soaring (see chart). Exotic foreign-currency products sold to retail investors reinforce the currency's upward trajectory.

The stronger currency threatens the profits of Japan's big exporters, contributing to a stockmarket rout, which in turn is winnowing Japanese banks' capital. To alleviate the woe, the Bank of Japan was expected to cut interest rates from 0.50% to 0.25% on October 31st. But the economy will still get walloped.
Personally I would say - and despite the venerable opinions of the Economist - that there was nothing either especially "lucky" or even "exotic" here - if you look carefully you will find that the similarities with what is happening in Germany are absolutely striking. Both countries have a very high populationmedian age (43), both have congenitally weak internal demand (no credit expansion driven housing booms here), both are thus completely dependent on exports (with GDP growth folding in rapidly as world trade growth comes to a halt), and both escaped the domestic lending driven banking problems being faced in the US, the UK or Spain, bygenerating an external lending driven ones - since they lent out in large quantities the precious fruits garnered from many hard years working to create very large current account surpluses. Now put that in your pipe, and go smoke it.

The BOJ Drops Rates

The Bank of Japan cut its benchmark interest rate today to 0.3 percent - in a split decision with Governor Masaaki Shirakawa casting the deciding vote. The key overnight lending rate was thus lowered from 0.5 percent - the first rate reduction in seven years - after four of the eight board members voted "no", according to a statement from the central bank in Tokyo this morning (Friday).

Shirakawa had been under considerable pressure to lower borrowing costs after the Nikkei 225 Stock Average slumped to the lowest level since 1982, with widespread concern that the global financial crisis will only serve to deepen Japan's current recession (the economy declined at a 3% annual rate in Q2, and a further contraction in Q3 is more or less guaranteed. Until today, the bank had held rates steady even while other central banks across the globe cut, arguing that Japanese rates were already "very low". Now, with the US Federal Reserve Rate at only 1% (and Ben Bernanke rumoured to be making contingency plans for a Japan style ZIRP for the US) they do not seem to be that high.

Board members Miyako Suda, Atsushi Mizuno, Seiji Nakamura and Hidetoshi Kamezaki, all of whom have private sector backgrounds, voted against the decision. The central bank also cut back its growth forecast for the financial year ending March to 0.1 percent - from the 1.2 percent which was still being predicted as recently as July.

The bank also altered its inflation forcast, arguing that inflation will continue to fall next during the next fiscal year. The bank forecast assumes that core consumer prices will rise 1.6 percent in the current fiscal year and remain stationary in the following 12 months. This looks very optimistic to me, and I think we are soon headed back to deflation territory (see argument below) - prices month on month were already more or less stationary between August and September, and the so called core-core index has only been positive on an annual basis during the last 4 months out of the 32 since January 2006 (when my records stop).

The central bank also decided to begin paying interest on reserves commercial lenders hold at the bank to provide liquidity to the financial system and trimmed the Lombard rate - the cost it charges for loans made directly to member banks - to 0.5 percent from 0.75 percent.

Before today, Shirakawa and his board had given no indication they planned to cut borrowing costs, other than to say that policy was "flexible". Even following today's decision policy makers do not seem comfortable with the situation they find themselves in, and warned that `"from a longer-term perspective" keeping borrowing costs low for too long "may lead to larger swings in economic and financial activity as well as in prices". Well, as Keynes also warned in the longer term perspective the only thing we know for sure is that we are all dead, and in the meantime I suggest it will be many a long day before we see the risk of that excessive asset bubble the BoJ seem to live in such fear of. Downside risks, recession, deflation and sustainability of the government debt dynamics seem to be much more to the point at the moment.

Inflation Stationary, When Do We Officially Get To Declare Japan Back IN Deflation?

Consumer prices excluding fresh food climbed 2.3 percent from a year earlier, after rising 2.4 percent in August, the statistics bureau said today in Tokyo. But if we look at the core core index (which strips out both energy and fresh food) then we can see that it has been completely flatlining over the last twelve months, and with a very large capacity overhang now developing, this index will almost certainly get back into negative territory very soon.

Even the general index (which includes both food and energy) has now screeched to a halt (as energy prices plummet), and was stationary between August and September, as can be seen in the chart below). The index currently stands at 99.6 (on a 2005 base of 100) and only really need to fall about 0.2% (which is sure to happen over the next couple of months I think) for us to be safely tucked back once more under the beloved deflation safety blanket, an eventuality which seems not to preoccupy the BoJ in the least.

Household Spending In Decline

Household spending fell for a seventh month in September, with overall household spending falling 2.3 percent year on year in price-adjusted real terms. Compared with August (on a seasonally adjusted basis), spending was up 1.7 percent.

The average Japanese household spent 281,433 yen ($2,856) in September according to data from the Ministry of Internal Affairs and Communications. Spending by wage earners' households fell 3.4 percent in September from the same month a year ago.

Both Unemployment and Employment Fall

Unemployment in Japan decreased slightly in September, according to government data also out today (Friday).The seasonally adjusted jobless rate hit 4.0 percent, down from 4.2 percent in August. Many economists are confused by this - since they had forecast the jobless rate to stay at 4.2 percent - but they seem to be forgetting (yet one more time) to factor in Japan's ageing population ingredient, which means that the 15 to 75 population is now in slow decline, and that as employment conditions worsen normally see a withdrawal of people from the labour market rather than into unemployment. So unemployment may well rise in the months to come, but not necessarily by that much.

September's jobs-to-applicants ratio was 0.84, so there were only 84 available jobs for every 100 applicants. This was the lowest figure was since August 2004, and down on the 0.86 level reported in August.The government also said the number of new job offers decreased 13.4 percent from a year earlier - in fact there was a 21.3 percent year on year decline in August.

The number of people in the workforce shrank by 200,000 from August, and this drop was obviously the key factor behind the decline in the jobless rate. The number of people employed was also down - by 110,000 - and this was the fourth drop in five months.

So Onwards And Downwards We Go

Finally Prime Minister Taro Aso decided yestreday to postpone the national election that polls suggest could have seen him and his ruling LDP party being pushed out of power. He also announced an "economic revival" package, worth an estimated $275 billion, of which $50 billion would come from new spending (and the quantity of new money needed would undoubtedly have been higher if the BoJ had not "conveniently" cut interest rates today. The details we have so far on the package suggest it is set to give large tax breaks to home mortgage holders, extend tax cuts for capital gains, lower highway tolls and give loans to small businesses.

However, even with the stimulus package, Aso acknowledged that "It will take three years for the Japanese economy to fully cure itself." "The most important thing is to allay concerns about people's livelihoods," since the world economy is being pounded by a "once in a 100 years storm". Of course, more than any of the other major economic powers, export-dependent countries like Japan and Germany are the once who are receiving most of the pounding from that storm...

And before we talk about Japan's economy being finally "cured", it may well be that we need to get through to a once and for all thorough diagnosis of the problem. So I will juts leave you with two more charts. The first of these is the one showing Japan's long term low fertility problem.

And the other is the one showing the steadily rising population median age which this produces.

Now, with Japan government debt to GDP currently standing at 182% (according to OECD data), we might like to ask ourseleves just how many times Japan can spin round on this merry-go-round (remember we are now back effectively in 1998, but with a much higher debt to GDP) before the spinal axis finally snaps (or something worse happens). The latest package will only send debt to GDP even higher, and probably we will see more of the same in 2010. So is the sky really the limit here? Or will someone one day finally prove willing to take the bull by the horns, accept that what is happening actually is happening, and start to do something about it.

The Japanese government last week acknowledged Japan has probably entered its first recession in six years as exports, production and spending slow. And who am I to disagree with them. Now onwards and downwards we go to the coming Q3 GDP release.