Last week saw much more action that what you might expect from a week in the middle of summer holidays and hence summer lulls in the Northern Hemisphere. At the end of it we had lower equity markets and higher government bond markets at least in the major ones and we waited to see if US retail sales and Consumer Price Index figures would add much information as to where the US economy is heading. In the event US Consumer Prices rose by a little more than expected at 0.3% on the month and 1.2% on an annual basis with energy prices rising on the month but did not really give us a vast amount of insight into the inflation/deflation argument. US retail sales rose by 0.4% on a month on month basis which whilst slightly worse than forecast did not again offer any great insight. The CRB spot index did go a little higher to 447.27 with all component indices rising and with fats and oils being the strongest.
I understand the concept of core inflation in that economists use it as a signal of whether inflation is settling into a system and also as a guide to likely future trends. Usually a core inflation index excludes certain items whose prices are more volatile and hence may not always represent a true picture of the inflation trends in an economy. However the words “excluding food and energy” in its definition trouble me each time I think of it. You see from the point of view of a human being the only things more core than food and energy are oxygen and water. So whilst core inflation has its uses as a guide to my mind it is a guide and is not as important as sometimes it is presented. For example if you exclude energy prices on the basis that they are volatile then you give yourself the problem of dealing with energy price moves which turn out to be more permanent in nature.
The Japanese Economy
On Tuesday the 10th August I discussed the recent policy meeting of the Bank of Japan and pointed out the following.
Part of the reason for not acting was probably that it had only a month ago raised its forecast for Japan’s economic growth for the year through March 2011 to 2.6% from 1.8%. At the time it said that the main reasons for this were improved demand for exports from the U.S. and developing nations like China.
So the economic news this morning from Japan must have left the BoJ shuffling a little uncomfortably in its seat. The Japanese economy grew by only 0.1% in the second quarter of 2010 or if we calculate the numbers in the American format by 0.4% on an annualised basis. So perhaps it was not the best time to raise your growth forecasts. Just to make a difficult situation worse economic growth in the first quarter of 2010 was revised down as well to 1.1% or 4.4% on an annualised basis and data further back was also revised downwards.
If we look at the breakdown of these figures we find some familiar themes are present. The Japanese economy grew more slowly in the second quarter than expected because of a lack of growth in consumer spending combined with falling public investment and slower export growth than expected. However export growth was still the main contributor to growth on the quarter it simply was slower than expected or hoped for. So yet again we see a Japanese economy that can only grow through exporting with domestic consumption yet again stalling and disappointing. Accordingly we have a set of figures that return us to groundhog day for the Japanese economy. There is of course hope for upward revisions as more data is added to the initial estimate but with the usual caveats on first estimates of economic growth this is a worrying number. After all the US economy is troubled by numbers which appeared initially to be much stronger than these.
Is China or Japan the second biggest economy in the world?
This debate has circled over the past few years, partly because the calculations are not as simple as you might think and partly because to put it politely there is some confusion over Chinese economic statistics and how much of reality they actually encompass. However in the release of data from Japan an official added the following.
The nominal size of the Japanese economy in the second quarter was $1,288 billion, compared with $1,337 billion for China.
So on this basis China overtook Japan and in a country like Japan where “face” is important this does matter.Just to make it clear face is a type of measure of reputation but also means more than that. The fact that one can to and fro about the data is less important than the symbolism of a Japanese official stating this. Actually these sort of calculations depend on what currency you use because you need an exchange rate and these are by no means stable or consistent. According to the IMF if you use purchasing power parity China overtook Japan some time ago.
Exchange Rate Policy
There has been some debate recently as to whether the Bank of Japan should intervene in currency markets. This is because the Yen has been on an appreciating trend against both the Euro and the US dollar. Today’s figures will reinforce such trends as they come with the suggestion that the currency appreciation has affected exports. This gives me two thoughts the first is that it appears from the evidence that the Japanese economy’s responsiveness to exchange rate movements is stronger in the short-term than my own the UK which has not responded as much as hoped to the 2007/08 depreciation. The second concerns Japan itself as her response appears one-sided as whilst her exports respond domestic consumption does not appear to respond in the same manner to cheaper import prices.
There will be some debate as to what Japan’s Finance Minister meant by “appropriate action” on Thursday. Some will expect intervention in foreign exchange markets although to my mind this ignores the reality that foreign exchange intervention very rarely works and if it does then it is likely to be associated with short-term issues. If you look at Japan it looks to me that we are going through a period where Yen based assets are not only in demand but are likely to remain so and accordingly intervention is unlikely to help much if at all. Japan tried an enormous amount of intervention in 2003/04 when some Yen 35,000 billion was spent only to end up with an exchange rate which was considerably higher at the end than the beginning. Also we have seen the Swiss National Bank in effect be overrun at the pass when it has tried to control the value of the Swiss Franc in recent times. Now the BoJ is more powerful than the SNB but currency markets are much more powerful than either.
In short whilst currency intervention is an option I think that Japan would be better off concentrating on improving domestic demand with whatever firepower her authorities can muster. We are looking at another consequence of the world-wide “carry trade” which took place. Here investors borrowed in currencies which had low-interest rates such as the Yen and Swiss Franc. However one of the consequences of the credit crunch is that now many countries have low-interest rates and so some investors have unwound the trade and others may do so in future. As the amounts available for such investments are very large they swamp even the resources of the BoJ. For the moment the prospect of possible intervention has led to a retracement of the Yen from its fifteen year high against the US dollar of 84.72 that it reached on Thursday but I suspect that this issue may not go away for long.
Reviewing the data that has emerged from Japan today leaves me with some very familiar themes and thoughts on her economic outlook. Export growth combined with weak domestic demand and deflation/disinflation are somewhat familiar concepts to say the least! One needs to be slightly careful as there was a quarter not so long ago when Japan got her economic growth figures rather badly wrong and had to make an embarrassing about turn. However the system has been modified and these figures do tally with other economic statistics emerging recently from Japan.
These numbers also contrast somewhat with her fellow net exporter Germany. However if one raises ones eyes to the world level it looks as if we will see downwards revisions to the recent US economic growth data so one is left looking for growth from somewhere to emerge just as a likely candidate China is possibly over-heating.
As to Japan the outlook does not look particularly optimistic for the rest of this year or the early part of 2011 for that matter. If we look at another theme her extraordinary national debt to Gross Domestic Product ratio that is on its way to 250% then slower growth will only put this ratio under more pressure. Even with the Japanese populations propensity to save one day this will have to be reflected in her government bond yields but for now such thoughts are far from players minds as the yield on her ten-year government bonds fell to 0.96% on the growth news.
For domestic players there is however a top up to the yield from the fact that prices are falling and overseas investors will recently have had a nice bonus from the appreciation of the Yen so as ever things remain rather complex. Indeed with falling governemtn bond yields in many places around the globe then hopes for currency appreciation will become an even bigger factor in overseas investors plans and calculations.