All the excitement and action that has surrounded both events in the UK and in Europe has meant that I have not been publishing many updates on Japan recently. However she is important for many reasons not least the size of her economy in world terms and as some new data has been released overnight I thought that it was time to consider her position again. She is in some respects a symbol and forerunner of policies which are now being tried elsewhere but she is also a country with quite a different situation. You see Japan is mired in disinflation where her consumer price indices are negative and her “lost decade” has now stretched into two decades. Also at a time when as I discussed yesterday that even the European Central Bank is in effect indulging in Quantitative Easing (QE) via its sterilisation programme which is something of a charade and a smoke screen one can look at Japan for the signs of the long-term effects of QE as she was the first country to employ this tactic back in the 1990s.
Where is Japan different to say Greece?
If we compare these two countries and look at some of the issues that have impacted on Greece over the past 6 months or so it is easy to take the wrong direction. For example Greece is vilified for having a gross national debt of 115.1% of her Gross Domestic Product (GDP) as of the end of 2009 (figures quoted in this paragraph are from the latest IMF Fiscal Monitor) whereas Japan had one of 217.7%. Greece has had a difficult year because she has had a lot of debt to refinance so adding her expected fiscal deficit of 8.1% to her refinancing needs of 12.4% means that in 2010 she will have to issue debt of 21.5% of her GDP. However and you might wish to sit down before reading this Japan has debt to refinance this year of 54.2% of her GDP and an expected fiscal deficit of 9.8% making a grand total of 64% of her GDP in debt issuance. So not only does she have a flood of bonds to issue Japan has an expected fiscal deficit which is expected to be larger than that of Greece now that she is on her IMF approved austerity programme.
One of the measures of Greece’s problems has been the yield level of her government bonds and the ten-year bond is used as a benchmark. This has been into double figures recently but last night closed at 8.19% somewhat up on the previous day making me wonder what games the ECB is playing with its Quantitative Easing programme. However back to Japan you might be expecting some horrendous yield level for a country with a higher national debt than Greece,worse fiscal deficit than Greece and a veritable flood of bonds to refinance. Well you would be wrong as her equivalent bond yield closed at 1.29% last night. I have got used to having positive yield comparisons with Germany but here is a country with a negative one and it is -1.46%. Of the worlds major economies no-one else even comes close to this and even Switzerland is left trailing in her wake in this respect.
So we have a clear difference with Greece as Japan manages to have a government bond yield nearly 7 percentage points below that of Greece whilst on many fashionable economic measures she is in fact in a worse position. Welcome to the enigma wrapped in a puzzle which is Japan.
Japanese GDP Figures
Last night saw economic growth figures for the first quarter of 2010 published and they do help to shed a light on the reasons for the situation I have discussed above. On an annualised basis Japanese economic growth was 4.9%, slightly slower than the expected 5.5% but still rather respectable in world terms at 1.2% for the quarter. However her GDP deflator (a measure of inflation) actually fell by 3% and here you are getting one of the clues as to where she is different Japan has falling prices or disinflation. There is another clue to where she is different in the composition of these figures, you see only 17% of this growth came from domestic consumption with the rest being provided by exports. She is in effect riding the economic growth of the Pacific region but is struggling to add to this growth domestically. It is good that she is a net exporter and many countries would envy her,after all how many currently are crying out for export-led growth? But for Japan it always comes with poor domestic consumption and this is another problem for her going forwards.
Poor domestic consumption and disinflation are the features of Japan’s “lost decade” and it would appear that she cannot escape them.
Themes of Japan’s problems
In my article on Japan on the 12th January 2010 I produced some themes which illustrate Japan’s economic situation and problems.
1. Reducing the National Debt
2.Shoring up the National Pension System
3.Raising economic productivity
4.Increasing the birthrate so Japan has future income earners to support an ageing population
5.Ending the spectre of deflation and disinflation
6.Boosting domestic consumption
7.Getting economic growth to be at least twice long-term interest rates.
The IMF’s recent report on Japan suggested the following
the need for early and credible fiscal adjustment has become critical. The fiscal response to last year’s recession was necessary and effective, but has pushed public debt to unprecedented levels…………Stabilizing the public debt ratio and placing it on a downward path will also require measures to contain the growth in spending
You may have already spotted the flaw in this argument. Japan is already struggling for domestic consumption and this is a long-running problem for her since the mid-1990s,so a cut in government spending could lead to another downwards spiral for her, and yet she needs to cut her deficit. There are elements of a trap her as she is damned if she does and damned if she doesn’t. There is no easy answer to this and the main hope is of course external that world trade grows and Japan benefits from it . Whilst this is plainly a good outcome the truth remains that it only masks Japan’s domestic problem of a lack of consumption.
Here is another big factor in the Japanese economic experience. Her Consumer Price Index is currently at -1.1%. This figure went negative in February 2009 and has remained there since. It is a big problem as it forms a negative feedback loop with the lack of consumption problem. In Japanese minds the thought must be why buy now? After all it will soon be cheaper.
Japan’s aging population
I wrote on this subject back in December 2009.
With long-term solvency an increasing problem for Japan as a nation then its ageing population structure makes the potential problem worse. Its population is 130,000,000 but its birthrate per woman has dropped to around 1.3. Demographers estimate that a level of 2.07 is necessary to maintain a stable population.
So as we go forward Japan has a population structure that is likely to increase government expenditure as for example spending on health will plainly have to rise and also reduce taxation as less of the population is of working age. And yet remember her existing level of national debt (217.7% of GDP)? This is high enough.
The Bank of Japan
Having been the first central bank to actively pursue a policy of Quantitative Easing and with interest rates virtually zero the Bank of Japan does not have many options going forward. In essence Japanese economic policy is as follows. The Bank of Japan blames the governments fiscal policy for Japan’s economic problems and the government of Japan blames the Bank of Japan’s monetary policy. You could compare them with two schoolchildren squabbling in a playground.
The Bank of Japan is currently in a two-day meeting but I do not expect much. There is talk of a plan to expand lending to businesses but I expect some talk and symbolism but little real action. I rather suspect that the Bank of Japan has run out of ideas but in true Japanese style will not admit this due to the loss of face it would provide.
I compared Japan to Greece earlier and indicated that if you look at many currently fashionable economic statistics Japan is in fact in a worse position than Greece. However I have hinted at a clear difference and the truth is you can sum it up in external balances. As I have discussed above Japan is a net exporter and this gives her two strengths. Firstly she has economic growth ( 1.2% in the first quarter of 2010 compared with Greece’s -0.8%) derived from the exports and secondly she has no need for foreign finance. Indeed as domestically her nation is a nation of savers then if we use the stereotype of Mrs. Watanabe then she is a saver and she can finance Japan’s national debt. You could hang up a sign saying foreigners not required and this is why Japan has such low bond yields. Any positive yield when you have disinflation is a real gain.
However there are clear challenges as Japan’s national debt is ballooning and looking forward she has an aging population. This aging population may help with her lack of domestic demand but then she will save less and so the deficit will be less affordable. Each time you think of a way out of this conundrum you hit another problem. So whilst Japan is on a longer fuse than Greece she too is showing all the signs of long-term insolvency.
I believe that there is a potential answer to the problem and it lies in her banking sector. You see ever since I worked in Japan in the early 1990s there have been questions over the solvency of her banking system. Of course in the last couple of years many other countries have had similar problems, but Japan’s have been much longer lasting. Her banks are currently trying to raise capital and according to the Financial Times raised some US $38 billion last year and so far this have raised US $12 billion in equity finance. They are afraid of new capital requirements from any Basel accord. However I think the problem is deeper than this you see Japan has supplied liquidity and cut interest rates and fudged numbers ( banks can count losses as capital) but has never really reformed her banking system. Somewhere in that fact is why she has not recovered and it is a lesson for us all as so far we have not done so either.
We are in danger of making the same mistake as Japan in bailing our banks out, letting them fudge numbers but not reforming them. I believe that we should be reforming our banking system right now instead we have had two years of wasted time.
In a slightly curious move the New York Stock Exchange invoked Rule 48 today as the US markets opened.
Rule 48 provides the Exchange with the ability to suspend the requirement to disseminate price indications and obtain Floor Official approval prior to the opening when extremely high market-wide volatility could cause Floor-wide delays in opening of securities on the Exchange
In a market where there is fear and uncertainty regulators seem determined to add to it rather than reduce it….