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Saturday, November 22, 2008

Exports Drop Sharply As Japan Officially Enters Recession

by Edward Hugh: Barcelona

The Japanese cabinet officially recognised this week that Japan's economy has entered its first recession since 2001, following a second quarterly contraction in Q3 2008. Claus Vistesen has already analysed (in this post) the key issues which lie behind the present recession data, and has also, in this post today, attempted to place Japan's renewed deflation alert in a somewhat broader context. Thus I will limit myself here to looking at the basic GDP data, and the export developments which accompany it.

The Recession Becomes Official

Japan's gross domestic product shrank by an annualised 0.4 per cent in the three months to the end of September, following a revised decline of an annualised 3.7 per cent in the second quarter, according to data released by the cabinet office on Monday. It is quite possible that we will now see a third consecutive quarter of contraction in the October - December period, especially if October's export performance (see below) is anything to go by.

Quarter-on-quarter, Japan's economy shrank 0.1 percent, lead by a 1.7 percent drop in capital spending. In fact, as can be seen in the chart below, Japanese investment has now been dropping back steadily since the third quarter of 2007.

Net exports also weighed on growth - subtracting 0.2 percentage point from growth after imports outweighed an increase in shipments abroad. Exports were up 0.7 percent, while imports climbed 1.9 percent as oil surged to a record in July. Consumer spending, on the other hand, increased by 0.3 percent, a much better showing than the one achieved in the second quarter, when consumption declined a quarterly 0.6%. Year on year, household consumption dropped back from 1.7% growth in the first quarter to 0.4% in the second quarter and 0.3% in the third one.

The rapid decline in the Japanese economy’s fortunes has pushed the government of prime minister Taro Aso into introducing a Y5,000bn ($51bn, €40bn) stimulus package, despite the mounting debt of the Japanese government, while the Bank of Japan has been forced to desist for the time being from its monetary "normalisation" programme, and has but the monetary vehicle in reverse gear by once more cutting interest rates -on this occassion for the first time in seven years. The cut - which was by 20 basis points - took BoJ interest rates to 0.30 per cent, meaning that during the longest economic expansion in recent Japanese history the bank was only able to raise rates by 0.5% during the upswing, and we now eagerly await to see what it will be capable of during the downcycle.

In any event neither the fiscal stimulus nor the monetary easing are likely to be of great impact since Japan's economy is export driven and it is the downturn in demand in the US , Europe, China, Russia and elsewhere, and the consequent battering of Japanese exports, which has lead to the recent strong decline in investment and consumption.

Meanwhile the unwinding of the carry trade has pushed the yen up, and the currency has gained some 9.4 per cent vis a vis the dollar since the end of September (see six month chart below), only adding to the difficulties faced by Japanese exporters as their goods become more expensive for overseas buyers.

The Tokyo stock market has also fallen 44 per cent fall this year, depressing consumer sentiment, while bankruptcies in October hit a 2008 peak of 1,429, according to credit reference agency Tokyo Shoko Research.

And we should not imagine that the current recession is likely to be short lived one, since we are going to have to learn to live with the current problems for most of 2009 at least, an outlook which has also been endorsed by Japan's economy minister Kaoru Yosano, who warned last week that the next fiscal year (starting in April 2009) was likely to continue to register negative growth for the economy. "I can hardly be confident that it would be positive," he told a news conference.

Export Pressure Grinding Japan's Economy Down

And the present contraction only looks set to deteriorate in the fourth quarter with Japan posting a Y63.9bn trade deficit in October, reinforcing concerns that falling exports will push the country even deeper into recession. In fact Japan's exports declined at the fastest pace in almost seven years in October as sales of cars and electronics slumped. Exports fell by 7.7 percent from a year earlier, which was the biggest drop since December 2001, according to the Finance Ministry.

The monthly report showed just how the global financial crisis is hurting demand from emerging markets, which up to now have helped prop-up Japan's export growth as shipments to the U.S. and Europe have waned. Not surprisingly - since Europe is in recession - shipments there plunged an annual 17.2 percent, the largest drop since December 2001, while demand from the U.S. dropped 19 percent. But even exports to Asia were down (byan annual 4 percent) while shipments to China fell for the first time in three years.

We should, however, bear in mind, that these figures are to some extent influenced by the yen value of the export shipments, since euro and dollar denominated prices will have registered lower readings when converted back into yen, due to the sharp and sudden rise in the yen in mid October, which could hardly have been anticipated at the time of planning shipments. So yen fluctuations may make the October numbers look worse than they actually are in volume terms.

Imports, on the other hand, were up 7.4 percent on the year, and this produced the trade deficit of 63.9 billion yen ($666 million), the third shortfall so far this year.

Deflation A Large Problem That Once More Looms

Both the U.S. Federal Reserve and Bank of Japan officials now openly admit to being on active alert for the early signs of deflation, and both are actively grappling with the thorny problem of just how to continue to keep it at bay as interest rates steadily approach zero (well, truth be said, in the Japanese case they never moved too far away from it). There are growing signs that the Federal Reserve may have already resorted resorted to some form of quantitative easing - a procedure that relies more on massive liquidity injections into the banking system than it does on the more conventional key policy-rate-driven monetary tools.

But while Bank of Japan Governor Masaaki Shirakawa accepted that just such injections had helped stabilise (but not cure) Japan's decade long deflation problems, he declined to comment on whether or not it would currently be the best response to the economic downturn in Japan.

As Claus indicates in his accompanying post, central bankers who only few months ago were struggling to contain an inflation flare-up stoked by soaring commodity prices are now desperately trying to prevent the global market rout from degenerating into a cycle of falling prices and economic output. Consumer demand is falling sharply across most of the industrialized world and U.S. while consumer prices fell at a record pace in October.

The Fed and other central banks are already flooding the banking system with cash in an attempt to prod banks into lending to each other, but the funds supplied are still lent at a some sort of notional cost (however low). In Japan, during the period of quantitative easing from 2001 to 2006, banks received cash free (although during deflation since prices drop, the value of money paradoxically rises) in the hope that it would spur credit growth and consumption. But the Bank of Japan is being much more cautious at the moment about what the best policy to tackle deflation actually is, and for the moment are relying on interest rates being held at 0.3 percent.

Bank governor Shirakawa said on Friday that in his mind further rate cuts might do more harm than good by further disrupting markets. He was also pretty non-committal about a return to quantitative easing.

"The BOJ decided to implement quantitative easing in the past because it was appropriate to do so in light of economic developments at the time," he said. "As for what would be the best policy in the future, we will decide by examining economic and financial developments."
When asked about the risk of falling prices, Shirakawa said: "Now that raw material costs are falling, a key factor to watch is whether that would cause a knock-on effect and push down overall prices." "We will closely watch the balance of domestic supply and demand and how people's price expectations develop".

However, with Japan's economy already in a recession and oil and commodity prices in sharp retreat, it looks very probable that core core consumer prices will start falling again either in December or early next year, at which point the Bank of Japan will have some serious thinking to do. In the meantime, as always, we watch and wait.