This Seems To Be Important

The Japanese finance ministry seems set to unveil plans to cut new government bond issuance by more than 10 per cent - to below Y30,000bn ($258bn) - in the year to April 2007. The Financial Times has the story. They had better hope they are reading the situation aright, since if they aren't they are heading straight back into recession. This is what all the battle with the BOJ is about. 2007 is rapidly getting pencilled into my diary as an economic annus horribilis.

Mr Koizumi considers that the economic recovery, about to enter its fifth year, is robust enough to withstand a mild fiscal contraction, although he on Monday came out against a consumption tax increase for at least two years.

Sadakazu Tanigaki, the finance minister, said: “I think we can break down the barrier of Y30,000bn.”

Japan has been running a budget deficit of about 6 per cent of gross domestic product, including interest payments on public debt of about 150 per cent of GDP. Mr Tanigaki is keen to accelerate the process of regaining primary fiscal balance, before interest payments, by the first years of the next decade.

The finance ministry will make cuts by, among other things, trimming payments made to doctors and further bearing down on public works spending, which has fallen by a quarter since Mr Koizumi took office in 2001.

Right Royal Row Over the BOJ

Things down at the Bank of Japan are hardly calm these days. On one version of events (see yesterdays Tankan) Japan is about - finally - to emerge from deflation, and the BoJ naturally enough wants to 'normalise' monetary policy. The politicians however are non-too clear about this:

"Japan’s ruling Liberal Democratic party will on Thursday urge the Bank of Japan to tie its monetary policy to nominal gross domestic product in an effort to lock in the central bank’s ultra-loose monetary stance for as long as possible."

"The proposal, which marks an escalation in tension between Japan’s politicians and the independent central bank, aims to stimulate above-trend economic growth for up to five years."

Japanese Third Quarter Growth

Well here it is, all coming home to daddy. The Japanese data I mean. Third quarter annual growth in Japan has just been revised down from 1.7 to 1%. This is coming home to daddy, since I continue to believe that - for demographic reasons - we will not see a self-sustaining Japanese recovery. Japan will continue to be dependent for growth on China, the US and Europe. Hence weaker than expected data should hardly be surprising.



Gross domestic product was up only 0.2 per cent on the quarter in real terms, with an annualised rate of 1 per cent. The new figures show that growth has been slower than expected, and significantly lags behind the pace in the first half of the year. The government had previously estimated quarterly growth of 0.4 per cent in the three months to September and 1.7 per cent growth on an annualised basis.

Japan and the US Yield Curve

Understand why the US yield curve may be about to invert and you've understood a lot IMHO.

Brad Setser picks up on the FTs Steve Johnson, and earlier here.

Johnson makes one extremely revealing point:

"The chief problem for the yen is that the flattening of the US yield curve has made it uneconomical for Japanese investors to hedge their ongoing purchases of US Treasuries, but a falling yen encourages overseas investors to hedge their purchases of Japanese equities - negating the value of these latter flows in currency terms."

Obviously what we have is asymmetric hedging. This begins to solve what had long been a mystery for me: who was really buying into the sustained Japanese recovery argument. Obviously many of the Japanese themselves aren't (sensible them). But OPEC members are. Really they should sack all their financial consultants :). The big issue, of course, is the US yield curve. The chain normally cracks at its weakest point, so this is a must to watch. Also, I wonder how much asymmetric hedging is taking place in Germany?

Basically the growth imbalance between the US, Germany and Japan, and the inability of these latter two economies to 'normalise' interest rates is producing a significant distortion in the global financial system. The US can have interest rates in the 4 to 5% range and still grow faster than either of the other two.

Co-indidentally cross this with a petro-dollar surplus arising from the changing terms of trade, and you have all the ingredients for some kind of problem. Now let's wait and see what happens next. I'm fascinated.

Foreign Investors Buy Into the Japanese Recovery

Foreign investors buy into the Japanese recovery, but the Japanese themselves apparently don't, or at least if they do its's on nothing like the same scale. More to add to the puzzle I was getting at in my last post about how people seem to find all this so hard to understand or accept. Denial, what denial!

Foreign buying of Japanese stocks has reached a record level as global investors buy into the country’s economic recovery. Overseas investors bought Y9,441bn ($78.9bn) more in Japanese shares than they sold in the year to November 18, according to the Tokyo Stock Exchange. The figure includes trading on the Osaka and Nagoya exchanges and beats the previous record of Y9,127bn in 1999.

Feverish overseas interest has been the biggest reason behind Japanese stocks’ sharp rise. The Tokyo Stock Price index climbed 33 per cent to 1,529.67 by last Friday – though the rise is still dwarfed by the near 60 per cent increase in 1999.....

But the strong interest shown by foreigners contrasts with the scepticism of Japanese institutional investors, who are still net sellers. For this reason, Japan bears regard this year’s share price rally as very fragile.

Here We Go Again!

Well yet another consumption driven recovery seems to be grinding to a halt in Japan. The only thing which puzzles me is why people continue to be surprised, and why people fail to see the similarieties between Japan and Germany in this regard. It's an up-hill (rather than a flat) world obviously:

Japan’s “Warm Biz” campaign, which should have boosted the sale of warm winter clothes, has failed to catch the imagination of consumers. Retail sales in October were down 0.3 per cent on the year – the first annual fall in eight months. The news prompted the Ministry of Economy, Trade and Industry, which published the figures on Monday, to downgrade its view on retail spending. An official was quoted by Reuters as saying on Monday that retail sales were flattening, toning down the Ministry’s view in the second quarter that sales were recovering moderately.

There is some discussion of the German comparison in this post and comments.

Meantime, with the fiscal deficit issues looming in both countries, central bank independence (or reducing it I should say)is one more creeping onto the agenda. I noted this last week vis-a-vis Japan:

Heizo Takenaka, the powerful internal affairs minister, told the central bank it should set monetary policy in conjunction with the government. In a repeat of stern remarks made by another senior politician this month, he warned the BoJ that its independence could be stripped away if it tightened policy prematurely.


Meantime, vis-a-vis Germany, Wolfgang Munchau reminds us that:

"It is still not too late to propose ECB reform as part of the next treaty revision. For as long as EU leaders maintain the status quo, they have the central bank they deserve."

"The pre-announced interest rate rise that the European Central Bank is due to agree this Thursday must rank as one of the most bizarre monetary policy decisions of recent times. The economic recovery in the eurozone remains fragile, as last week’s German confidence indicators have shown. Even the ECB’s own forecast for headline inflation is relatively optimistic, while core inflation remained unchanged at 1.5 per cent in October."

I couldn't agree more with Munchau about one thing though: the recent decision announced by Trichet to raise eurozone rates "must rank as one of the most bizarre monetary policy decisions of recent times"!

Good News, Now Let Battle Commence!

Most commentators are getting excited about the recent reading on the Japanese core consumer prices index which stopped falling in October. There is just one small snag, the core CPI in Japan - until next August - still includes oil and energy costs. Stripped of these it is estimated that the underlying CPI was still down by about 0.3 per cent. The reading does however mark the first 'near miss' of the Japanese index with positive prices in some years, so it is hardly a 'non-event'. Meantime, as the FT notes:

Instead of celebrating, politicians lined up to remind the Bank of Japan that it was too early to declare deflation dead or to ditch its super-loose monetary policy.

Heizo Takenaka, the powerful internal affairs minister, told the central bank it should set monetary policy in conjunction with the government. In a repeat of stern remarks made by another senior politician this month, he warned the BoJ that its independence could be stripped away if it tightened policy prematurely.

The government of Junichiro Koizumi, prime minister, is worried that the BoJ could choke off the lengthy, but fragile, recovery by exiting too early from the ultra-loose quantitative easing monetary policy adopted in 2001.

Curiously enough all of this has a striking parrallel with what is happening in Germany right now, where politicians, who want to address the fiscal deficit by raising taxes are worried that the ECB could choke off the fragile German recovery by exiting too early from the ultra-loose monetary policy operating for some months now in the eurozone.

An Orderly Withdrawal?

On one version of events the Bank of Japan is simply dotting the 'i's and crossing the 't's on it road map to exit the massive monetary easing process sometime during the next six months. On another the road itself is fraught with difficulty, and an overly 'inflation wary' central bank might risk upsetting the whole apple cart if it proceeds to rapidly. It is this tension which seems to be reflected in today's FT article from David Pilling about a shouting match which seems to have broken out between the Ministry of Finance and the BoJ. According to Pilling:

Japan’s government on Monday tried to calm a potentially explosive row with the central bank over the timing of monetary tightening, saying there was no “wavering of trust” in its relationship with the Bank of Japan.

The MoF is concerned that any premature monetary tightening could threaten fragile economic growth and limit its ability to conduct what it considers essential fiscal tightening.

MoF officials are also concerned that the central bank may cut its purchases of government bonds, currently at Y1,200bn a month, as part of monetary tightening, a move that could push up long-term rates and damage efforts to roll over huge quantities of public debt.

Hidenao Nakagawa, policy chief of the ruling Liberal Democratic party, is quoted as saying:

“The BoJ has no independence when it comes to policy targets.If it does not understand this, we need to consider amending the BoJ Law”

Former BoJ board member Nobuyuki Nakahara is also cited as saying that the central bank was “crazy” if it thought the government would let it reduce JGB purchases, since it was a move which “would immediately invite long-term rates to rise.”

Coincidentally or otherwise the FT also has a story today about how Sadakazu Tanigaki, Japan's finance minister, said on television on Sunday that spending cuts and a reduction in debt issuance were not sufficient to restore government finances to sound health, and that an increase in consumption tax was required to tackle the country’s heavy debt burden.

And if anyone is really interested in following where the coincidences end here and the patterns begin, the FT has another piece, about Germany this time, where it notes that the new coalition partners "are poised to preside over one of the most fiscally conservative governments in nearly two decades". Value-added tax is about to rise by three percentage points from 2007, with two-thirds of the proceeds going towards plugging the budget hole. The top tax rate for high earners will rise by three percentage points, and many tax incentives that had allowed Germans to minimise their tax bills will be scrapped. A corporate tax reform intended for 2007 will also be postponed by one year.

Of course both Japan and Germany are countries with export driven economies, running balance of payments surpluses, and where domestic consumption has been running notoriously weakly, so the ecopnomic rational here is peculiar, except for the fact that both have the fical holes due to the presence of rapidly ageing popultaions.

Still, if you want to follow the coincidence through to the end, what's the betting that government representatives in Germany (but this time perhaps diplomatically), are making it known over at the ECB that moving later rather than sooner with any rate rises would be greatly appreciated.

Japan Continues To Grow

I think there is a pretty fair and balanced assessment of the current Japan situation by David Turner in today's FT. He makes the following points:

1/. Japan’s economy continued to grow slowly but surely in the third quarter, supported by heavy investment by companies and moderate growth in consumer spending.

2/. The world’s second largest economy was expanding despite a negative contribution from trade. The country’s trade surplus in the period had narrowed on high crude oil prices, reducing overall GDP by 0.1 per cent.

3/. Corporate investment remained one of the high points of the economy, as companies took advantage of continuing high profits. Capital spending rose 0.7 per cent.

4/. The real-term rise in third-quarter GDP was also the slowest this year, compared with the 0.8 per cent growth in the June quarter. Recent data on household spending, such as retail sales, have disappointed economists. Although Japanese consumers are spending more, the country is still far from a consumption boom.

5/. There have been encouraging signs which point to the end of deflation. Property prices are at last rising in Tokyo....At the same time, residential property prices continue to fall throughout most of Japan. Moreover, the Cabinet Office said on Friday that the GDP deflator – which some economists favour as a broad measure of inflation – was 1.1 per cent down on the year.

Don't Speak To Soon

Don't Speak To Soon

I have been arguing continuously for some months now that Japan might not escape the deflation trap so easily as some seem to imagine. Today there are two pieces of news which should at least give the 'optimists' some pause for thought.

Firstly the news that Japan's economy most likely slowed in the third quarter, with one of the principal explanations being the lack of dynamism in the consumer sector.

Secondly Morgan Stanley's Takehiro Sato suggests that negative influences on prices may mean that y-o-y positive prices may still be quite a time away.

Based on the above, it is clear that the scenario calling for the BoJ to eliminate quantitative easing owing to a slight recovery in the core CPI inflation rate is now on unexpectedly shaky ground. Even if the BoJ is compelled to keep its commitment and eliminate quantitative easing, the factors affecting whether it will be able to follow that move fairly soon with rate hikes as currently planned are becoming even less certain over the near term.

The BoJ is Convinced

The entire nine-member board of the Bank of Japan is convinced that deflation in Japan will be over by the end of this year: I only wish I was.

Minutes of the bank's board meeting earlier this month show board members expect year-on-year changes in consumer prices to be zero or to rise slightly at the end of the year.

In recent weeks, senior members of the BoJ, including governor Toshihiko Fukui, have been making statements saying the time is approaching when the bank can consider abandoning quantitative easing and considering raising interest rates.

Happy birthday Japan

Happy birthday Japan, welcome to year one of your new era. December 31st will mark the first anniversary of when your population actually started to fall, and from now on each year will see less and less Japanese citizens in the land of the setting sun. Another way of putting this would be that the proportion of robots to people is definitely set to rise there.

This turning point in human history is not necessarily a bad thing, it is, after all, partly a product of the fact that we get to live longer. The worrying thing is the blasé fashion in which we seem to be treating it. Typical of this are the statements by the Japanese Health, Labour and Welfare minister:


economy has emerged from seven years of deflation and reinforcing expectations of a change in monetary policy".

That certainly sounds like good news, but hang on a minute:

The yen fell the most against the euro in more than two months and dropped versus the dollar after reports showed a surprise drop in Japan's household spending and an increase in the jobless rate.

Japan's currency is down 12 percent against the dollar this year as the Bank of Japan held interest rates near zero to combat falling consumer prices. Finance Minister Sadakazu Tanigaki said today deflation ``still persists'' even after prices rose last month for the first time in two years.

``The weaker data confirms it's going to take quite a while for the BOJ to be able to act, even if consumer prices rise,'' said Niels From, a currency strategist at WestLB AG in Dusseldorf, Germany. ``The yen will continue to weaken for now.''

So we aren't out of the deflation woods yet, and consumer spending - whilst being markedly better than at some moments in the past - still isn't as solid as it might be. Hmmmm. Isn't it better to hedge our bets a bit more here. Especially when there are sound theoretical reasons for doubting internal consumption sustainability.


"Our country is now standing at a major turning point in terms of population," Health, Labor and Welfare Minister Jiro Kawasaki told a news conference. "We must take countermeasures against the falling birthrate along with measures to support and foster our future generations,"

This might have been a credible response a decade or so ago, but today it is almost laughable.

Meantime "hope eternal" struggles-on. Japan is still the best story in town we are cheerfully informed by Buttonwood in an article entitled Sweet Spot. Well if this is the best show, I'd certainly hate to see the worst one :).

Now, there are more conflicting signals in the press today:

Japan’s core consumer prices rose in November for the first time in two years, the FT tells us "sending the strongest signal yet that the world’s second-biggest