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Tuesday, July 31, 2007

Japan - The Fundamentals Linger

By Claus Vistesen Copenhagen

As the result of Sunday's upper election is ticking in it is now clear that the ruling party LPD and its Prime Minister Shinzo Ape have suffered an expected trouncing by Japanese voters. However, the defeat apparently has not prompted Abe to resign his post which was also expected but the defeat does signal that the whim of the electorate does not support the current government's reform process which has also been riddled with scandals and mishaps. In this entry I shall not dwell with the political aspects of the very recent Japanese election, although I expect it to be difficult to disregard it entirely, but rather turn to Japan's economy in the remainder of 2007 and beyond. The most important economic issue at the moment and in the immediate horizon is whether the BOJ will raise to 0.75% come August's meeting? Until recently markets were basically certain that the BOJ would take it up a notch in August but now suddenly the sentiment seems to have changed somewhat.

In the following I will argue that it is not very likely that the BOJ raises in August but more importantly I will paint a picture of a Japanese economy which has not experienced a change in the fundamentals as many commentators have proclaimed. Japan is still stuck in a deflationary environment, domestic demand is still sluggish and a surplus on the external balance is still what drives the Japanese economy through its indirect effect of industrial production/corporate capex and through positive growth contribution from net-exports. Moreover, the recent election result indicate that the Japan is entering a period of reform fatigue right at a crucial time where bold reforms and changes are needed. Lastly, it seems as if markets are entering a fresh spout of risk aversion and fear over a credit crunch in the US on the back of the lingering subprime woes which recently stretched its fangs as far as to Germany.

All these factors will affect the Japanese economy and almost uniformly cloud the outlook on any expectation of a sustained process of interest tightening and essentially normalization in Japan and more generally the picture remains of an economy whose structural anatomy has very close ties to its demographic profile with a rapidly ageing population.

Firstly we might want to take a look at quarterly real GDP figures for Japan the past 1 1/2 year to see what we are in fact looking at. As such it seems evident that much of the flurry about Japan's coming sustainable recovery is vested in the rather dubious spike of growth observed in Q4 2006. In fact as can be readily seen growth already slowed somewhat in Q1 2007 and given the downward path of industrial production in the first half of 2007 as well as domestic which seems to be trending downwards (at least as we move into Q3) it remains unclear how 'sustainable' this end-of-2006 recovery really was.

Regarding the overall reasons for why the BOJ might run into difficulties raising in August and beyond there are many but in essence we know them very well. As such, it appears that while domestic demand has indeed been holding reasonably well in the first part of 2007 this may now change. The recent 0.4% decline in June's retail sales represent a valid indicator on this. And in general as we can see from the graph below, growth figures for domestic demand do not look perky by any means of the word. Especially we need to think about the big picture here and whether indeed domestic demand can pull Japan upwards towards meeting the challenge of a secular and severe decline in its working age population?

Another indicator which weighs heavily on the shoulders of the BOJ is the lingering trend of deflation as we move further into 2007. As such the general CPI index which excludes fresh food continued to stay in negative territory on a y-o-y basis and in fact as you can see in the graph below all measures of inflation in Japan are now stuck firmly in negative territory. Moreover, prices in Tokyo also fell 0.1% in July which points to how prices are not set to rise over the summer and into the Autumn.

This convergence of price measures may well be for cyclical as well as for structural reasons and regarding the former we should not get our hopes up on July and August either since, as mentioned by Takehiro Sato from Morgan Stanley, energy prices were very high in the summer of 2006. Turning to structural causes of deflation there are too many to deal with here but suffice to say that the lingering trend of wage decline (see appendix at the end) as well as the relative wobbles in domestic demand do not provide much hope as regards to a pick-up in inflation. On the other hand it seems as if food prices as well as indeed energy/commodity prices are now set to drift steadily upwards to a degree which have even prompted many economic commentators to hail the end of the great moderation which would again mean higher interest rates. This raises two crucial questions for the BOJ. First of all is the question of the general inflation index and what kind of inflation to actually target. And secondly is of course the whole Gordian knot of just how to reconcile the need to keep the costs of domestic sovereign debt low at the same as heeding the calls of financial markets and actors to normalize interest rates in order to help policing the excess global liquidity. Of course, at this point such a dilemma facing an ageing population is not mentioned in many textbooks but at this point it is very real in Japan.

In connection to the rather meager contribution of domestic demand to growth (except perhaps Q1 2007) which can be inferred from the graphs above other measures such as industrial capex suddenly becomes very important. On this account it seems as if the capex bonanza of Q4 2006 is drawing a longer shadow than could have been expected especially given the fact that the Japanese external surplus continues to thunder along (more about that below). As can be observed from the graph below industrial production is still situated on somewhat of a plateau given the impressive upward spurt over the course of 2006. Whether industrial production will stabilize at this level is difficult to say. The trend in the first of half of 2007 has been one of a modest but steady decline from the high levels of 2006 but then today we see that industrial production nudged back up significantly in June somewhat pairing the slide from the first part of 2007.

As long as the trade surplus continues to expand I would not expect any major correction in industrial production. For some general figures on the external balance I have some graphs in the appendix at the end which show how the trade and current account surplus is on a sustained positive path. Another important derivative aspect of the external balance is of course the perpetually low Yen which is causing much commotion in amongst financial market practitioners, institutional actors, and other central banks. The most important and often overlooked aspect here is the in-built propensity for BOJ to refrain from raising too much too fast as a result of Japan's dependence on exports to grow. I am sad to say that I have no hard data on the actual contribution of net exports to growth but at this point I would argue without much uncertainty that it is substantial on a yearly basis. This also means that Japan needs a low Yen in order to boost its exports which again means that any signal of normalization from the BOJ would have to be hinged on a pretty certain expectation that domestic demand would be able to take up the slack. Hence we are back into the same old dilemma.

At this point, you could perhaps be tempted to point out that while this might be true the Yen and thus the current interest rate level held by the BOJ were far too low to justify such 'traditional' arguments. I somewhat agree with this line of reasoning but it comes with an important question. What is a 'normal' interest rate in Japan given its underlying economic and demographic fundamentals? And, would this level of interest rate suffice to stem the tide of the carry trade and global liquidity flow? I have my doubts here and even at this point we also need to factor in Japan debt-to-GDP ratio at about 160-170% and what kind of interest rate level Japan can hold to anchor a long term value of the Yen in order to simultaneously be able to service its debt? These are not trivial questions I think and before we demand that the BOJ normalizes we need to understand the fundamentals of the Japanese economy which revolve around these very questions.

As we can see above the economic fundamentals in Japan remain the same. This does not mean that the BOJ cannot and will not raise come August but it suggests that the it will have a hard time justifying its course based on economic data. Of course we need to remember here the in-built change in the BOJ discourse where governor Fukui has made it well clear that the BOJ indeed could raise in a context of lingering deflation based on future expectations of inflation pressures. In the immediate horizon of 2007 this statement seems to come under considerable stress as prices are set to decline even further in July and August on the back of a negative adjustment from very high energy prices during the same period in 2006. Yet, beyond this short term perspective it is of course very likely that structural headline inflation will give the BOJ some justification to raise but this comes at an expense since it demands that the BOJ take a somewhat myopic view on price gauges relative to what seems to be a certain relative deterioration of economic fundamentals in the latter part of 2007 and perhaps beyond. This is also excellent noted by Takehiro Sato in a recent note over at MS GEF. Note in particular one of Sato's 'inconvenient truths' in the form of the observation that capital demand is receding, even at current interest rate levels.

Recently, bank lending figures have been fairly weak, despite 18 straight months of YoY positive growth. In the July ‘Senior Loan Officer Opinion Survey on Bank Lending Practices at Large Japanese Banks’, results indicated that capital demand is receding further, mainly at SMEs and for home mortgages. Results like this call into question the effectiveness of monetary policies in boosting the economy.

Whether or not the recent tightening of monetary policy has hit harder on corporate spending and private capital demand is indeed a worthy question to ask. However, more pertinent is perhaps to look at the recent legislative initiative which links up to this issue. As such we learned from the FT a month back how legislation to lower the maximum of potential loans to private as well as lowering the maximum interest rate on consumer loans. As the article quotes reveal this kind of legislation will especially make its presence felt in the context of small start-ups and SMEs.

Another ever recurring topic is of course the future course of the fiscal balance in Japan. In short, Japan badly needs to get the public books in order especially given the demographic profile which is set to worsen in the years and decades to come. In this way, the fall is set to be centered around a debate on whether to instigate a consumption tax hike. It will be most interesting to follow the further course of this consumption tax hike in the light of the recent trouncing of the LPD where you might expect Shinzo Abe to be rather weary of pushing forward such fiscal measures faced with a grumpy electorate. Of course, Abe left all options open just before yesterday's election but cabinet secretary Yasuhisa Shiozaki's corresponding qualifier puts the future course of the consumption hike in perspective, particularly given the rather strong message sent by the electorate this weekend.

(...) Shiozaki, who serves as the top government spokesman, said the issue should be brought up during the next House of Representatives election. "If we decide to raise the consumption tax as part of the drastic reform of the tax system, we must ask the public whether they will support it. If the next House of Representatives election is held after that, then we'll of course ask voters.

Finally, there is of course the recent credit and risk flurry in global financial markets which were felt the past week as Treasury yield plummeted to reflect a flight to safety among investors. This recent spree of market turmoil was interesting in so far as it was not driven by economic data from the US. In fact, the recent data releases on real economic indicators in the US point to somewhat of a recovery already in Q2 2007 although it does indeed seems as if consumer spending is finally coming down which raises the question of whether business investment can take up the slack entirely. For a complete overview of the recent wobbles in the US credit markets and economy Ted Wieseman over at Morgan Stanley has the necessary calm and cool oversight to provide a nice round-up. As a very final note on global financial markets I would also keep a weary eye on Eastern Europe and the CEE economies where the latter part of 2007 also will see the test of many countries' economic resilience as well as their credit/asset markets' liking amongst investors.

In Summary

The most important immediate point regarding the Japanese economy is whether the BOJ is going to raise to 0.75% come the much expected August meeting. Just a week a ago the implied probability of a hike which could be derived from various market derivatives and indices stood firmly above 70% towards predicting a 0.75% refi rate in Japan by the end of August. However, with the recent disappointing data on wages and consumption expenditures in June out today the overall sentiment towards a hike has cooled significantly in line with expectations as they have been laid out recently on Japan Economy Watch. This does not of course mean that the BOJ could not press on regardless but as I have also argued above the coming August decision will be a test on the acclaimed willingness by the BOJ to raise in the midst of deflation and down trending consumption spending on the back of solidified expectations of future sunshine. I maintain my view that it will be a hold but there is considerable risk attached to this call in the form of how the BOJ could act on future inflation expectations as well as to maintain its image in financial markets of a central bank devoted to the normalization of interest rates.

In a more long term and structural perspective I have also emphasised above how little has changed in the Japanese economy despite many an economic commentator's claim to the contrary. In this way I argue, through my data presentation above, that Japan is not set on the path of a sustainable recovery driven by domestic demand but rather still 'stuck' with the reliance on export and export driven capex to grow. This growth path which in my opinion is a fundamental result of Japan's demographic profile raises important questions and essentially puts Japan in a dilemma which is not, as far as I know, treated in any economic textbook. This dilemma centers around three inter-connected challenges of how to deal with lingering deflation, how to keep the public finances on a sustainable path as well as how to maintain external credibility as regards to monetary governance. In this note this dilemma was conceptualized on the venue of monetary policy where the BOJ needs to factor in much more than external pressure to unwind the carry trade in an orderly fashion. This is not to say that the current global liquidity situation is not creating distortions which might abruptly unwind but it is to say that it is more complex than just laying the blame at Japan's door.


In the appendix I present some further data on Japan which serves to substantiate the general general argument I am fielding above. First off, I have two graphs which attempts to capture the trend of wage decline. However as I finalized them and put them into this post I realize that they are perhaps not well suited. At least we need to remember that the y-axis is denominated in nominal Yen which of course tend to muddy the waters in a context of deflation. Moreover, we need to remember that the income data fielded below is for household heads as well as bonus and one-time payments are factored out. In this way I feel that the general picture of wage decline in Japan which is also due to the labour force's changing age composition and the growing prevalence of part time jobs is not well captured but still, as it were, hinted in the graphs below.

The second topic here in the appendix relates to the external balance and also here I have been struggling to find suitable data. As such the monthly figures fielded below are not very representative I think in the sense that I would have preferred data expressed in percentages. However, note in particular that I have included the income balance which is set to become important as Japanese retail and institutional investors alike look outside the borders of Japan in their search for yield.

The final graph in this appendix makes up, I think, for the shortfalls of its peers noted above. The graph plots monthly domestic consumption expenditures as Index 100 = 2005 since January 2000. As we can see and whatever we might want to claim about a sustainable recovery in Japan the trend in domestic demand seems to be one of secular decline. Furthermore, we should note that each cycle peak seems to be lower relative to the previous which lends evidence to the hypothesis of a secular decline in domestic consumption, all things equal, as a country enters the demographic state of Japan.

Friday, July 27, 2007

Japan's 2007 House of Councillors election

by Manuel Alvarez-Rivera, Puerto Rico

Voters in Japan go to the polls this Sunday to choose half the members of the Sangiin or House of Councillors - the upper chamber of the Japanese Parliament, the National Diet. A total of seventy-three seats will be filled in forty-seven constituencies by the semi-proportional Single Non-Transferable Vote (SNTV) system, while forty-eight seats will be allocated on a nationwide basis by proportional representation: Parliamentary Elections in Japan has further information on the House of Councillors' electoral system. In addition, GEM's Edward Hugh follows the election and its impact on the country's economy at Japan Economy Watch.

Under Japan's 1947 constitution, bills rejected by the House of Councillors can't become law unless the Shugiin or House of Representatives - the lower chamber of the Diet - overrides the upper chamber's veto by a majority of at least two-thirds. Thus, an opposition-controlled upper house can block the government's legislative agenda, although the lower chamber retains the final word on a number of important matters such as the designation of a prime minister.

Constitutional provisions notwithstanding, the 2007 upper house election has become for all intents and purposes a referendum on the ten month-old Liberal Democratic Party (LDP) government of Prime Minister Shinzo Abe, whose approval rating has fallen sharply following last May's suicide of Agriculture Minister Toshikatsu Matsuoka (who had become embroiled in a political funding scandal involving office expenses and bid-rigging of public contracts) and the disclosure of serious problems at the Social Insurance Agency, which has lost track of fifty million pension records; to add insult upon injury, an additional fourteen million records were never entered into the agency's computer system, and the municipalities previously responsible for the information have destroyed their records.

Meanwhile, the opposition Democratic Party of Japan (DPJ) has been riding on a wave of discontent in the aftermath of the pensions fiasco - a salient issue in a country whose population is both rapidly aging and gradually declining - and recent opinion polls have the DPJ ahead of the LDP by an increasingly large margin, with New Komeito - the LDP's coalition partner - in a distant third place, and the Communist and Social Democratic parties further behind.

Since 1955, the LDP - a conservative party with close ties to the business community - has been Japan's dominant political force. Until 1989, the party presided over a period of remarkable economic growth, in which Japan emerged as one of the world's major industrial powers. However, since 1990 the Japanese economy has been in and out of recession, alternating with periods of weak growth. Nonetheless, the LDP has been out of power only once during the last fifty-two years (from 1993 to 1994), although in 1989 and 1998 it suffered major defeats in elections to the House of Councillors: in both cases, the results were viewed as a popular rejection of incumbent LDP governments, and the sitting prime ministers were forced to step down. However, on both occassions the party went on to prevail in subsequent elections to the House of Representatives and remained in office.

In the last House of Councillors election, held in July 2004, the DPJ won more votes and seats than the LDP (although the latter retained control of the upper house in alliance with New Komeito - an offshoot of the lay Buddhist organization Soka Gakkai), but in an early House of Representatives election held in September 2005, the LDP government of then-Prime Minister Junichiro Koizumi won a landslide victory, trouncing the DPJ. Nonetheless, Koizumi had promised not to run for re-election as president of the LDP and stepped down from office in September 2006; Abe succeeded him as party leader and head of government.

However, Abe is widely perceived as having moved away from the reforms initiated by his popular predecessor, pursuing instead a nationalist agenda centered around a revision of the pacifist "MacArthur" constitution (imposed on Japan by the U.S. after World War II) and the establishment of an education reform intended to foster patriotism. Although Abe's seeming indifference to bread-and-butter economic issues had dented his public standing (and a number of verbal blunders by some members of his cabinet haven't helped matters either), the government appeared to have suffered no lasting damage until the suicide of cabinet minister Matsuoka and the subsequent pensions debacle, which appear to have turned public opinion strongly against Abe and the LDP.

Should voters hand the government a major setback in Sunday's vote, it is widely believed that Prime Minister Abe would have no choice but to resign, triggering a leadership battle among the LDP's various factions, and perhaps an early election for the House of Representatives - although the latter is generally regarded as unlikely to take place unless the ruling party suffers a truly catastrophic defeat at the polls.


The Liberal Democratic Party (LDP) was comprehensively defeated in Sunday's upper house vote in Japan. With all votes counted, the ruling parties lost their absolute majority in the House of Councillors, where the opposition Democratic Party of Japan (DPJ) has displaced the LDP as the largest party for the first time in more than fifty years.

According to definitive figures published by Japan's Ministry of Internal Affairs and Communications, the results of the prefectural district vote were as follows:

Democratic Party of Japan (DPJ) - 24,006,818 votes (40.5%), 40 seats
Liberal Democratic Party (LDP) - 18,606,193 votes (31.4%), 23 seats
New Komeito (NK) - 3,534,672 votes (6.0%), 2 seats
People's New Party (PNP) - 1,111,005 votes (1.9%), 1 seat
Japanese Communist Party (JCP) - 5,164,572 votes (8.7%), no seats
Social Democratic Party (SDP) - 1,352,018 votes (2.3%), no seats
Independents - 5,095,168 votes (8.6%), 7 seats
Others - 477,182 votes (0.8%), no seats

Meanwhile, the results of the party list vote were the following:

Democratic Party of Japan (DPJ) - 23,256,247 votes (39.5%), 20 seats
Liberal Democratic Party (LDP) - 16,544,761 votes (28.1%), 14 seats
New Komeito (NK) - 7,765,329 votes (13.2%), 7 seats
Japanese Communist Party (JCP) - 4,407,933 votes (7.5%), 3 seats
Social Democratic Party (SDP) - 2,634,714 votes (4.5%), 2 seats
New Party Nippon (NPN) - 1,770,707 votes (3.0%), 1 seat
People's New Party (PNP) - 1,269,209 votes (2.2%), 1 seat
Others - 1,264,800 votes (2.1%), no seats

Consequently, DPJ won 60 seats; LDP, 37; NK, 9; JCP, 3; SDP, 2; PNP, 2; NPN, 1; and Independents, 7. In all, the distribution of seats in the House of Councillors after the 2007 election will be as follows: DPJ, 109; LDP, 83; NK, 20; JCP, 7; SDP, 5; PNP, 4; NPN, 1; and Independents, 13.

In terms of both seats and vote percentages, the LDP had slightly better results than in 1989, when the party was defeated in a House of Councillors election for the first time. However, the 1989 defeat came after a landslide LDP victory in the preceding 1986 upper house election, and the LDP remained by far the largest party in the legislative body, whereas this time around the defeat followed an earlier setback in 2004, and the result was a DPJ seat plurality. Meanwhile, the LDP's junior partner, New Komeito sustained comparatively minor losses, remaining by far the country's third-largest party.

Japan's election was closely followed in Peru, as former President Alberto Fujimori - who holds dual Japanese-Peruvian nationality - ran unsuccessfully on the nationwide list of the small People's New Party. Fujimori is currently under house arrest in Chile, awaiting possible extradition to Peru, where he faces corruption and human rights violations charges.

Although Prime Minister Shinzo Abe has acknowledged his party's defeat in the election, he insists he will remain in office, and leaders of the LDP and New Komeito agreed on Monday to continue ruling in coalition with Abe as head of government. Meanwhile, the opposition DPJ is expected to continue pressing for an early House of Representatives election, which Abe has rejected so far. However, with the opposition parties set to take control of the upper house, and potentially derail the government's legislative agenda, Abe is taking his party and his country into uncharted political waters, and it remains to be seen if he will be able to weather the storm.

Abe does an about-face, and resigns after a year in power

Six weeks after his ruling Liberal Democratic Party (LDP) suffered a crushing defeat in elections to Japan's upper house of Parliament, the House of Councillors, Prime Minister Shinzo Abe announced on September 12, 2007 he will resign as head of government, after just under one year in office. However, the LDP still holds a comfortable majority in the House of Representatives - which has the last word on the appointment of a prime minister - and an early lower house election is regarded as unlikely, all the more so given the ruling party's poor showing in the recent House of Councillors poll.

Abe, who had previously insisted he would remain in office irrespective of the upper house election outcome, asked the LDP to find a replacement, and in an internal election held on Sunday, September 23, 2007, the party chose Yasuo Fukuda as its new leader. Fukuda, who was chief cabinet secretary from 2000 to 2004 under former prime ministers Yoshiro Mori and Junichiro Koizumi, easily defeated LDP secretary-general Taro Aso, who served as foreign minister under Abe and who had been initially regarded as the front runner in the ruling party's leadership race.

Tuesday, July 17, 2007

Turkey's early parliamentary election of 2007

by Manuel Alvarez-Rivera, Puerto Rico

Turkey will be holding an early parliamentary election this Sunday - three months ahead of schedule - in the wake of an impasse over the election of a new president between the Islamist-oriented Justice and Development Party (AKP) government of Prime Minister Recep Tayyip Erdogan and the country's staunchly secular elite.

Turkey's head of state is presently chosen by the country's unicameral Parliament, the Grand National Assembly, and the ruling party wanted to elect Foreign Minister Abdullah Gul as president. Despite the fact that Erdogan's government has pursued Turkey's membership in the European Union (EU) and introduced a number of liberal reforms in order to bring Turkish law in line with EU standards, the opposition parties accuse Gul and AKP of having a hidden Islamist agenda that constitutes a threat to the country's strict separation of religion and state - the legacy of Kemal Atatürk, the founder of modern Turkey - and boycotted the presidential election. As a result, the required two-thirds quorum was not attained, and the Constitutional Court subsequently annulled the election. Meanwhile, Turkey's army - which regards itself as the "defender of secularism" - expressed its "concern" regarding the presidential vote. In 1960 and 1980 the military overthrew civilian administrations, and in 1971 and 1997 it pressured democratically elected governments out of office.

However, Prime Minister Erdogan - who has sought to portray his Justice and Development Party as a moderate Islamic political force, similar in outlook to the Christian Democratic parties of Western Europe - secured parliamentary approval for a package of constitutional amendments that would provide for the election of the president by popular vote for up to two five-year terms (instead of a single seven-year mandate), and for the Grand National Assembly to be chosen every four years, instead of every five. The amendments will be submitted to voters in a referendum expected to be held next October, following a ruling by the Constitutional Court which rejected challenges brought forward by outgoing President Ahmet Necdet Sezer and the country's main opposition party, the left-wing, secularist Republican People's Party (CHP).

Members of the Grand National Assembly are chosen in multi-member constituencies by a proportional representation (PR) electoral system that has gained notoriety due to an unusually high - and highly controversial - electoral threshold, set at ten percent of the nationwide vote since 1983. Earlier this year, the European Court of Human Rights ruled that Turkey's 10% threshold was not in violation of the European Convention on Human Rights, but at the same time noted that "it would be desirable for the threshold complained of to be lowered and/or for corrective counterbalances to be introduced to ensure optimal representation of the various political tendencies."

Elections to the Turkish Grand National Assembly has further information on Turkey's electoral system.

The ten percent threshold - introduced by the 1980-83 military government to prevent a recurrence of the excessive parliamentary fragmentation and resulting governmental instability that characterized Turkish politics for much of the 1970s - has had a mixed record over the years. Following eight years of single-party governments headed by the free market-oriented Motherland Party (ANAP), no party secured an overall majority in the 1991, 1995 and 1999 general elections, and for eleven years the country was ruled by a succession of largely weak, unstable coalition cabinets.

However, the 2002 parliamentary election brought an unprecedented political upheaval: four of Turkey's major parties at the time - the Democratic Left Party (DSP), the far-right Nationalist Action Party (MHP), ANAP and the right-of-center True Path Party (DYP) - were wiped out when they fell below the threshold, while the recently established AKP, a successor of the Virtue Party and the Welfare Party - previous Islamist parties disbanded by Turkey's Constitutional Court - won a large parliamentary majority with 34.3% of the vote. Besides AKP, only CHP overcame the ten percent barrier and secured parliamentary representation (having previously failed to do so in the 1999 general election); over forty-five percent of the votes were cast in favor of parties which failed to cross the threshold and obtained no seats in the National Assembly, including the Democratic People's Party (DEHAP) - the legal vehicle of Kurdish nationalism - which won the largest number of votes in thirteen provinces in south-eastern Turkey.

The ongoing exclusion of pro-Kurdish parties from the Grand National Assembly has been yet another sore point for Turkey's sizable Kurdish population, which is not officially recognized as an ethnic minority. For most of the 20th century, successive Turkish governments sought to forcibly assimilate the Kurds, which were officially designated as "Mountain Turks" or "Eastern Turks", and use of the Kurdish language was strictly prohibited. These restrictions were relaxed in 1991, and under pressure from the EU, broadcasts and education in the Kurdish language were legalized in 2002.

Successive pro-Kurdish parties have had to deal with intense hostility from the authorities, which have repeatedly sought to identify the former with the outlawed Kurdistan Workers' Party (PKK) and its successors, which wage a violent campaign to establish an independent Kurdish state. However, this situation is just one manifestation of a widespread perception that equates (or is unable to distinguish between) legitimate dissent and subversion. Despite the adoption of major reforms in recent times, organizations such as Amnesty International remain critical of Turkey's human rights record, and Freedom House continues to classify Turkey as a partly free country.

Under Erdogan's tenure, the Turkish economy has enjoyed several consecutive years of strong growth, and opinion polls show AKP well ahead of its opponents; among the latter, only CHP and MHP appear to be above the minimum ten percent of the vote required to secure parliamentary representation. However, the nationwide threshold does not apply to independents, which are running in record numbers in the election; in fact, the Democratic Society Party (DTP) - the successor of DEHAP - has fielded independent candidates in what could prove to be a successful attempt to circumvent the electoral barrier. Thus, while AKP appears likely to prevail in the election, it is less clear that it will retain an absolute majority in the Grand National Assembly, and Prime Minister Erdogan has announced he will retire from politics if the ruling party is not returned to office as a single-party government.


The ruling Justice and Development Party (AKP) of Turkish Prime Minister Recep Tayyip Erdogan will remain in office after having scored a second landslide victory in the elections to the Grand National Assembly held last July 22.

Definitive results of the election, released by Turkey's Supreme Election Council on Monday, July 30 were as follows:

Justice and Development Party (AKP) - 16,327,291 votes (46.6%), 341 seats
Republican People's Party (CHP) - 7,317,808 votes (20.9%), 112 seats
Nationalist Action Party (MHP) - 5,001,869 votes (14.3%), 70 seats
Independents - 1,835,486 votes (5.2%), 26 seats
Democrat Party (DP) - 1,898,873 votes (5.4%), no seats
Young Party (GP) - 1,064,871 votes (3.0%), no seats
Felicity Party (SP) - 820,289 votes (2.3%), no seats
Others - 783,204 votes (2.2%), no seats

84.2% of the electorate turned out to vote, up from 79.1% in 2002.

The major election winners were AKP, whose share of the vote increased substantially with respect to the 2002 legislative election, and the Nationalist Action Party, which staged a comeback and returned to Parliament after having lost all its seats in the 2002 debacle. Meanwhile, the Republican People's Party - which ran in alliance with the Democratic Left Party (DSP) - barely improved over the combined 20.6% share of the vote won by CHP and DSP in 2002. (Turkey's electoral law forbids electoral coalitions, but political parties get around this restriction by having their candidates stand under the banner of an allied party.)

Despite polling a larger percentage of the vote, both AKP and CHP lost seats to MHP and to twenty-six successful independent candidates. AKP's losses were largely offset by its sizable vote increase and the party retained a reduced but nonetheless substantial parliamentary majority, but CHP suffered heavy seat losses. Twenty of the newly-elected independent deputies are affiliated with the pro-Kurdish Democratic Society Party (DTP) - which successfully circumvented the electoral threshold - and the remaining six independents include notable personalities such as former Motherland Party (ANAP) leader and ex-Prime Minister Mesut Yilmaz, who won a seat in Rize province (ANAP did not contest the 2007 parliamentary election).

Although the percentage of votes cast for parties that failed to cross the ten percent barrier required to obtain parliamentary representation fell from forty-five percent in 2002 to thirteen percent in 2007, the figure remains high by Western European (but not Eastern European) standards. The main casualty of the electoral threshold was the Democrat Party (DP; formerly the True Path Party), which had fallen just below the threshold in 2002 but lost further ground in the 2007 election.

While AKP won a decisive victory at the polls, the issue that brought about the early election - the designation of a new president - remains unsettled. The Supreme Election Council has scheduled the referendum on constitutional amendments (which among other things would provide for the direct election of the president) for next October 21, but in the meantime Turkey's head of state will have to be chosen by the Grand National Assembly. It is anticipated that the ruling party will renominate Abdullah Gul as its presidential candidate, but the military has made it clear that regardless of the election outcome, they still hold the view that Turkey's next president must be a committed secularist: as General Yasar Buyukanit, Turkey’s Chief of the General Staff bluntly put it, "the views of the Turkish Armed Forces do not vary from day to day."

Perhaps more importantly, following the election AKP is further behind the two-thirds majority required to elect a new president, which means the ruling party is in no position to impose its candidate of choice. Prime Minister Erdogan has indicated his willingness to compromise on the issue, but insists the candidate must come from his party. Although Erdogan has proven to be a very skillful politician, it remains to be seen if he can reach an agreement with the opposition parties and prevent a showdown with the armed forces.

Turkey elects an Islamist president covers the election of Abdullah Gul as President of Turkey.

Wednesday, July 4, 2007

The Global Economy ... The Topics Which Matter

by Claus Vistesen Copenhagen

I have treated this topic on several occasions both at Alpha.Sources as well as at Global.Economy.Matters(GEM). In many ways, the lingering discourse on the global economy is vested in the separate discourses on five closely interrelated topics. As I demonstrate below, I believe these topics to be; macroeconomic imbalances, excess liquidity, the risk of an impending credit crunch, de-coupling, and demographics. My main tenet is that in order to understand the global economy you not only need to analyse each of these topics individually but crucially you need to look at how and where these topics interact. In the following I try to do just that while simultaneous giving a sort of on to go impression of where the global economy is now and where it is headed.

Bretton Woods 2 and the Global Imbalances ... Regarding first the global macroeconomic proxied by Bretton Woods II there is little sign of change albeit the fact that dim signs are perhaps emerging that the peggers will loosen the band to a higher degree in the future. The US is still getting plenty of financing though from the usual suspects and as such the system lingers. If we take BW2 in a larger perspective some commentators have been talking lately about how China has transisted from a traditionally fixed peg to a crawling peg which essentially also signifies the difficulties facing China with sterilising the inflows. Also regarding the actual remedy of the imbalances has there been much flurry recently about whether in fact the RMB is undervalued or not? Personally, I take the view that we need to look at this in the immediate light of the Dollar peggers as well as in a more structural perspective. As such, it would make little sense in my opinion to apply the same reasoning to Japan's and Brazil's surpluses where the former's, I think, is related to demographics whereas the latter's clearly, to some extent, is related to its policy of pegging to the Dollar. I would also put China and the Petroexporters in this box which means (surprise, surprise) that I actually agree with a lot coming from Brad Setser. I have two main qualifiers though. Firstly, and while I accept the point about RMB undervaluation I do think that there is much more to a rebalancing of the Chinese growth path than aligning the RMB with equilibrium fundamentals. Secondly, and related to the point before I see very little chance of a Dollar crash except in the case where the Dollar pegger themselves took on the task of absorbing the adjustment. In this way, some commentators' notes about how China might diversify into Euros which could crash the Dollar is way off in my opinion. Not even if the Fed lowered interest rate would this happen I think since it would immediately I think prompt the ECB to hold or perhaps even follow the Fed down and if it did not ... well, brace yourselves for the slide of Italy and Portugal out of the Eurozone then. Consequently, as I also noted in the inaugural post at GEM there are some divergence in terms of what drives these imbalances and consequently also whether they can and will unwind with a great crash. As a result, the imbalance discourse also mirrors discussion on what seems to be the main concern in the global economy at the moment. Is it reserve accumulation by major emerging markets in Asia and the Middle East (Bretton Woods II), is it the excess liquidity and complexity of financial markets which has deprived central banks the control of the supply of credit, or is the ongoing global demographic transition which is presenting the global economy with a new and historically unique challenge? Or perhaps, it is even something else? At the end of the day we need all the explanations I think in order to get it right. However, amongst these differing perspectives I tend to play, as many others, the role of a 'one-trick pony' in my continuous emphasis on demographics as an important explanatory variable in terms of explaining the structural nature of the imbalances.

(Excess) Liquidity ... The sources of liquidity in the global economy represent a topic a bit too large to go into in detail with here. Also, As Brad Setser shows us on a daily basis there is a lingering data issue in terms of tracking reserve growth and thus financing of the US but the story remains intact. In this way, also the story of global liquidity remains much intact. Interestingly, there are many ways to approach this but ultimately we end of up with the same thing I think. As such, there is little difference I think between arguing that the world suffers from asset-shortage to argue that there is a 'wedge' betwee the return and cost of capital. The latter point is often also operationalized in the global K/L (capital labour ratio) which has been skewed towards labour as Asia's massive workforce has been integrated into the global economy. This has indeed boosted the relative return on capital but also further allowed central banks to keep the cost of capital low. In this light it should readily be seen that this potentially could lead to a situation of asset shortage as too much capital chases too little yield implied by the relative lack and thus high price of assets. In a note over at GEM on ageing and financial markets I try to give a bird's eye view of the structural drivers of the asset supply in the future from the point of view of equities and sovereign debt. This is also where I feel that demographics are very important in order to see the big picture since demographics most likely will act further to push up asset prices in the future through three main mechanisms. Firstly, by contributing to the dwindling supply of sovereign debt. The unwind of BW2 could help here in the short to medium term but further afield the ageing of especially China will present an enormous challenge for the global economy. Secondly, by pushing up demand for the structurally depressed shortage of assets proxied by pension funds, retail investors, mutual funds etc in search for yield. And thirdly, by keeping the relative cost of capital down through low real interest rates in domestic economies where ageing is prevalent. In my opinion, we are already seeing this at the moment with the Yen carry trade and as long as globalization in financial markets keeps capital extremely mobile across borders it is difficult to see how this can stop despite warnings from institutional actors such as the BIS and IMF. Of course, if financial markets suddenly took a hit and if risky leveraged positions abruptly unwound (e.g. as a result of the US subprime mortgage mess) it could, I think, lead to some kind of global institutional and behavioral backlash which would dwindle the plays on the highly leveraged 'certain-to-win' liquidity casino.

Yet, the fundamental question regarding liquidity in the global economy still centers on whether there is too much of it? This question, I think, masks another dirty little secret or question as it were; have central banks lost control over liquidity? This is an enticing question I think and I am sure that if you consult the CBs themselves as well as the large global institutional organizations (e.g. the IMF, the BIS, etc) they would to some extent flag this worry. This, I think, is epitomized in the recurring worry about the complexity and depth of financial markets where risk is like dark matter, you know that it is there but where? In this light, we should remember why the current tightening process by global CBs began in the first place, namely to mop up up excess global liquidity. To this date the process (amongst the big three) has been halted in the US on the back of a slumping housing market, in Japan, monetary 'gradualism' has gotten a whole new meaning and only in the Eurozone does Trichet continue, like Don Quixote, to fight the proverbial wind mills epitomized by the illusive M3 gauge. I say this with a bit of tongue in cheek since it is of course a dilemma. Liquidity has scarcely abated and amongst central bankers where the predominant concern is and should be solid anchoring of inflation expectations the alarm bells are still ringing especially given the recent signs that inflation might be picking up due to capacity strains and structural headline inflation. The paradox in all this is however that the very wide global interest rate differential with the BOJ at 0.5% coupled with ample liquidity through deep capital markets actually serves to work like a reinforcing mechanism increasing liquidity in the very economies (i.e. the external deficit countries) who are trying to stem the tide of brisk economic growth. New Zealand and the UK would perhaps be adequate examples here.

Add to this just a couple of the main structural sources of liquidity in global economy and it is clear that if the target is liquidity and the subsequent worry of upward inflation pressure raising rates might not be the best remedy in the current environment. These sources would then divide the external surplus nations into the demographic agers on the one hand (e.g. Japan and Germany) and the Dollar peggers, and their SWFs on the other (e.g. China, the Petroexporters, Brazil etc). More generally, pension funds and other institutional investors where pensions are pooled should also be noted as well as of course those famed Japanese housewives and businessmen who have figured out how to short the Yen and buy, among other things, Kiwis.

In short, liquidity remains the flavor of the day in the global economy powered by strong structural forces and in my opinion only a backlash from financial markets through a credit crunch major risk adjustment can change this.

An impending credit crunch ... This one is more dubious I think but in the context of the global economy I definitely think it is something which has to be entertained. We all know the potential suspect of this in the form of the US subprime market as well as the potential wreckers of havoc of CDOs and CLOs, if ,of course, they are ever downgraded :). The signs are definitely there with widening spreads as well as a declining home equity index in the US. The main question is indeed as put by MS' Richard Berner in a recent note (see previous link) over the GEF ...

While this renormalization of risk spreads represents a tightening of financial conditions, it is so far proceeding in an orderly way. But in my view, it is far from over; indeed, the events of the past two weeks probably mark the beginning of a significant widening of spreads. Both history and fundamentals suggest than when risk spreads begin to widen after a long period of stability — especially when that stability has encouraged investors to take on more risk — they can overshoot or even turn into a rout. The question now: Could this so-far orderly renormalization now morph into an ugly credit crunch that would slam the brakes on the economy and corporate leverage?

So far then the normalization of risk and spreads are muddling along in an orderly fashion but it remains to be seen whether there is a flare out there waiting to ignite the markets and force a major and abrupt correction. For more on this I can recommend two articles from the Economist which treat this subject in more detail. On balance I don't see a credit crunch on the horizon mainly because I don't see the global economic fundamentals changing. But I also think that it is very difficult these days to glance through what are essentially very opaque financial markets and as such it is difficult to say whether there is indeed imminent danger for an abrupt reversal. If it were to happen however the main venue would most likely be the US economy something which would then seriously put the 'de-coupling' thesis, noted below, on trial.

De-coupling ... In many ways I have also dealt extensively with my view on this in a lengthy note over at GEM. As I argued, it is difficult to speak of de-coupling without also talking about global imbalances. As such, it would not be unreasonable to claim I think that the extent to which the world really de-couples from the US economy also hinges on the potential unwind of the global imbalances themselves. Basically, I believe that we need to look at de-coupling in a short-term (the current global economic upswing) as well as more long term. Regarding the imminent synopsis on de-coupling there is indeed evidence that such a process is occurring albeit the fact that US economy has not exactly crashed (yet?). However, I must say that I am duly surprised over the amount of momentum we are seeing at the moment in the Eurozone as well as to some extent in Japan. This reflects two things I think. Firstly, as I noted above, the US economy is still muddling along despite at deeply depressed housing market and secondly the world has already 'decoupled' from the US as it were or at least to some extent with big emerging markets growing very quickly. So even though e.g. China and Brazil might be pegging to the Dollar they are still pulling along their part of the wagons although of course you could reasonably argue that they should be pulling even more. However, this also strikes at the very core of the de-coupling thesis in my opinion because there is a very big difference between de-coupling from the US economy in particular (i.e. the short term perspective) and de-coupling from export driven growth in general (i.e. the long term perspective). In fact, a rudimentary head-count at this point suggests that the deficit nations and surplus nations are very much the same and my guess is that as ageing and BW2 thunders along this will only exacerbate the lock-in mechanism of the imbalances which will pose great challenges for the global economy.

In conclusion, the proponents of de-coupling might feel vindicated at this point but in my opinion we need to go beyond the idea of decoupling from the US to see the complete picture.

Demographics ... Well, it can hardly come as a surprise that I believe this is important. In fact, based on the notes above it should pretty clear that I believe demographics to be a very important component of the global economy at this stage. The first thing which needs to be emphasized relates to the scope of demographic change and its effects. Clearly, as is often the standard answer amongst many economic commentators demographics tend to exerts its influence over the very long run which subsequently makes the magnitude of the effects rather small in the short term. Or does it? After all, as Keynes aptly put it, in the long run we are all dead so perhaps it is time to say the obvious truth. Regarding demographics the long run is very much here today, alive and kicking. Another point which needs to be realized is that contrary to popular belief it is not population growth but rather ageing (measured by median age, dependency ratios, etc) which represents the salient variable.

Regarding the concrete effect of demographics on the global economic environment I have already outlined them in some detail above. First and foremost I believe ageing already represents a strong structural driver for the 'excess' of global liquidity through on the one hand pushing rapidly ageing economies into external surplus and on the other hand increasing the portfolios of institutional investors eager to place their money to earn yield (SWFs is a case in point). From this also follows that the global macroeconomic imbalances cannot entirely be conceptualized without factoring in the fact that ageing acts as one of the important variables. Finally, ageing also relates to the notion of de-coupling in the long run where the real question becomes, as with the global imbalances, who are in fact going to run the deficits in the future? Especially, if you believe that the US at some point will face an abrupt correction it would be interesting to hear your suggestion as to where Chinese, Japanese, and German (Eurozone?) savings are going to flow? India or Brazil perhaps?

There is really not much to summarize and as such it is all noted above. This is basically the global economy as I see it at the moment. One thing which I feel should be included as an addendum before I leave you is the recent talk about capacity strains in key economies around the globe and how this might lead to increased inflation. This I feel is also set to become a somewhat global phenomenon at some point especially if global growth continues to power along as we are currently seeing. I will not go into this in detail here but save it for another day but I do think it is important keep in the back your mind.