Where next for the Japanese Yen and the Bank of Japan?

As the third most traded currency the Japanese Yen is one of the bedrocks of the world economy. In spite of the size and strength of the Japanese economy the currency tail can wag the economy dog as we saw on the period of the “Carry Trade” and its consequences. For newer readers I looked at the initial impact back on the 19th of September 2016.

 Ironically if done on a large-scale as happened back in the day with the Swiss Franc and the Japanese Yen it lowers the currency and so not only is the interest cheaper but you have a capital gain. What could go wrong? Well we will come to that. But this same effect turned out to make things uncomfortable for both Japan and Switzerland as their currencies were pushed lower and lower.

At that point borrowers were having a party as the got a cheaper borrowing rate and a currency gain but the Japanese ( and Swiss) saw their currency being depressed. However the credit crunch ended that party as currency traders saw the risk and that people might buy Yen to cover the risk. Thus there was a combination of speculative and actual buying which saw the Yen strengthen from over 120 Yen to the US Dollar to below 80.

There were various impacts from this and starting in Japan life became difficult for its exporters and some sent production abroad as the mulled an exchange rate of around 78 to the US Dollar. For example some shifted production to Thailand. Looking wider the investors who remained in the carry trade shifted from profit to loss. On this road in generic terms the typical Japanese investor often described as Mrs. Watanabe was having a rough patch as in Yen terms their investments went being hit. Actually that is something of a generic over my career for Mrs Watanabe as timing of investments in say UK Gilts or Australian property has often been poor. Of course as it turns out property in Oz did work but you would have needed plenty of patience.

Enter the Bank of Japan

The next phase was a type of enter the dragon as the Bank of Japan in 2013 embarked on an extraordinary monetary stimulus programme. Under the banner of Abenomics that was designed to weaken the Yen although it was not officially one of the 3 arrows it was supposed to fire. For a while this worked as the Yen fell towards 125 to the US Dollar. But just as economics 101 felt it could celebrate a rare triumph the Yen then strengthened again and actually rallied to 101 in spite of negative interest-rates being deployed  leading to yet another new effort called QQE and Yield Curve Control in September 2016.

So we see that Japan had some success in weakening the Yen but that then ended and even with negative interest-rates and the purchases by the Bank of Japan below there was a fizzling out of any impact.

The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen.

But you see these things have unintended consequences as Brad Setser points out below.

Japanese investors have been big buyers of foreign bonds—and U.S. bonds in particular. The lifers, the Japanese government through the government pension fund (GPIF), the Japanese government through Post Bank (which takes in deposits and cannot make loans so it buys foreign bonds since it cannot make money buying JGBs), and Norinchukin*

So a policy to weaken the Yen has a side-effect of strengthening it and even worse makes the global financial system more risky. Back to Brad.

In broad terms, a number of Japanese financial institutions have become, in part, dollar based intermediaries. They borrow dollars from U.S. money market funds, U.S. banks, and increasingly the world’s large reserve managers (all of whom want to hold short-term dollar claims for liquidity reasons) and invest in longer dated U.S. bonds.

What about now?

Things are rather different to this time last year when we were trying to figure out what had caused this?

The Japanese yen soared in early Asian trading on Thursday as the break of key technical levels triggered massive stop-loss sales of the U.S. and Australian dollars in very thin markets. The dollar collapsed to as low as 105.25 yen on Reuters dealing JPY=D3, a drop of 3.2 percent from the opening 108.76 and the lowest reading since March 2018. It was last trading around 107.50 yen………. ( Reuters )

That was from January 3rd whereas overnight we see this.

The major was trading 0.1 percent up at 110.09, having hit a high of 110.21 earlier, its highest since May 23.  ( EconoTimes )

On its own this may seen the Governor of the Bank of Japan have a quiet smile and a celebratory glass of sake. But falls in the Yen are associated with something else which will please the head of The Tokyo Whale.

TOKYO (Kyodo) — Tokyo stocks rose Tuesday, with the benchmark Nikkei index ending above 24,000 for the first time since mid-December, as investor sentiment improved on expectations for further easing of U.S.-China trade tensions. ( The Mainichi)

The Mainichi seems to have missed the currency connection with this but no doubt Governor Kuroda   will be pointing out both thresholds to Prime Minister Shinzo Abe.

Has something changed?

On Monday JP Morgan thought so. Via Forex Flow.

But because in recent years the yen is no longer being sold off in the first place, it is not acting as much like a safe-haven currency as in the past.

Okay so why?

if interest rates increase in other countries (opening a wider gap with rates in Japan)

Well good luck with that one! Maybe some day but the credit crunch era has seen 733 interest-rate cuts. However the Financial Times has joined in.

First, Japan is running trade deficits, which would imply a weaker currency. Second, domestic asset managers are busy buying higher-yielding foreign assets. Third, Japanese companies, confronting a chronic shortage of decent ways to deploy their capital at home, are increasingly spending it on deals overseas.

The last point is a really rather devastating critique of the six years of Abenomics as one of the stated Arrows was for exactly the opposite. Also there us more trouble for economics 101 as a lower Yen has seen a trade surplus switch to a deficit. Actually I think that responses to exchange rate moves can be very slow and measured in years so with all the ch-ch-changes it is hard to know what move is in play.

Comment

There is much to reflect on here. For example today may be one to raise a smile at the Bank of Japan as it calculates the value of its large equity holdings and sees the Yen weaken across a threshold. But it is also true that exactly the same policies saw the “flash rally” of over a year ago. In addition we see that the enormous effort in play to weaken the Yen has seen compensating side-effects which raise the risk level in the international finance system. Really rather like the Carry Trade did.

A warning is required because in the short-term crossing a threshold like 110 Yen sees a reversal but we could see the Yen weaken for a while. This is problematic with so many others wanting to devalue their currency as well with the Bank of England currently in the van. From a Japanese perspective this will be see as a gain against a nation they have all sorts of issues with.

“China has made enforceable commitments to refrain from competitive devaluation, while promoting transparency and accountability,” US Treasury Secretary, Steven Mnuchin, said.

President Donald Trump has repeatedly accused China of allowing the value of the yuan to fall, making Chinese goods cheaper.

But, on Monday, the US said that the value of the yuan had appreciated since August, at the height of the trade war. ( BBC )

How will that play out?

 

 

 

The mad world of negative interest-rates is on the march

Yesterday as is his want the President of the United States Donald Trump focused attention on one of our credit crunch themes.

Just finished a very good & cordial meeting at the White House with Jay Powell of the Federal Reserve. Everything was discussed including interest rates, negative interest, low inflation, easing, Dollar strength & its effect on manufacturing, trade with China, E.U. & others, etc.

I guess he was at the 280 character limit so replaced negative interest-rates with just negative interest. In a way this is quite extraordinary as I recall debates in the earlier part of the credit crunch where people argued that it would be illegal for the US Federal Reserve to impose negative interest-rates. But the Donald does not seem bothered as we see him increasingly warm to a theme he established at the Economic Club of New York late last week.

“Remember we are actively competing with nations that openly cut interest rates so that many are now actually getting paid when they pay off their loan, known as negative interest. Who ever heard of such a thing?” He said. “Give me some of that. Give me some of that money. I want some of that money. Our Federal Reserve doesn’t let us do it.” ( Reuters )

That day the Chair of the US Federal Reserve Jerome Powell rejected the concept according to CNBC.

He also rejected the idea that the Fed might one day consider negative interest rates like those in place across Europe.

The problem is that over the past year the 3 interest-rate cuts look much more driven by Trump than Powell.

Of course, there are contradictions.Why does the “best economy ever” need negative interest-rates for example? Or why a stock market which keeps hitting all-time highs needs them? But the subject keeps returning as we note yesterday’s words from the President of the Cleveland Fed.

Asked her view on negative interest rates, Mester told the audience that Europe’s use of them “is perhaps working better than I might have anticipated” but added she is not supportive of such an approach in the United States should there be a downturn.

Why say “working better” then reject the idea?  We have seen that path before.

The Euro area

As to working better then a deposit-rate of -0.5% and of course many bond yields in negative territory has seen the annual rate of economic growth fall to 1.1%. Also with the last two quarterly growth readings being only 0.2% it looks set to fall further.

So the idea of an economic boost being provided by them is struggling and relying on the counterfactual. But the catch is that such arguments are mostly made by those who think that the last interest-rate cut of 0.1% made any material difference. After all the previous interest-rate cuts that is simply amazing. Actually the moves will have different impacts across the Euro area as this from an ECB working paper points out.

A striking feature of the credit market in the euro area is the very large heterogeneity across countries in the granting of fixed versus adjustable rate mortgages.
FRMs are dominant in Belgium, France, Germany and the Netherlands, while ARMs are prevailing in Austria, Greece, Italy, Portugal and Spain (ECB, 2009; Campbell,
2012)

Actually I would be looking for data from 2019 rather than 2009 but we do get some sort of idea.

Businesses and Savers in Germany are being affected

We have got another signal of the spread of the impact of negative interest-rates .From the Irish Times.

The Bundesbank surveyed 220 lenders at the end of September – two weeks after the ECB’s cut its deposit rate from minus 0.4 to a record low of minus 0.5 per cent. In response 58 per cent of the banks said they were levying negative rates on some corporate deposits, and 23 per cent said they were doing the same for retail depositors.

There was also a strong hint that legality is an issue in this area.

“This is more difficult in the private bank business than in corporate or institutional deposits, and we don’t see an ability to adjust legal terms and conditions of our accounts on a broad-based basis,” said Mr von Moltke, adding that Deutsche was instead approaching retail clients with large deposits on an individual basis.

So perhaps more than a few accounts have legal barriers to the imposition of negative interest-rates. That idea gets some more support here.

Stephan Engels, Commerzbank’s chief financial officer, said this month that Germany’s second largest listed lender had started to approach wealthy retail customers holding deposits of more than €1 million.

Japan

The Bank of Japan has dipped its toe in the water but has always seemed nervous about doing anymore. This has been illustrated overnight.

“There is plenty of scope to deepen negative rates from the current -0.1%,” Kuroda told a semi-annual parliament testimony on monetary policy. “But I’ve never said there are no limits to how much we can deepen negative rates, or that we have unlimited means to ease policy,” he said. ( Reuters )

This is really odd because Japan took its time imposing negative interest-rates as we had seen 2 lost decades by January 2016 but it has then remained at -0.1% or the minimum amount. Mind you there is much that is crazy about Bank of Japan policy as this next bit highlights.

Kuroda also said there was still enough Japanese government bonds (JGB) left in the market for the BOJ to buy, playing down concerns its huge purchases have drained market liquidity.

After years of heavy purchases to flood markets with cash, the BOJ now owns nearly half of the JGB market.

In some ways that fact that a monetary policy activist like Governor Kuroda has not cut below -0.1% is the most revealing thing of all about negative interest-rates.

Switzerland

The Swiss found themselves players in this game when the Swiss Franc soared and they tried to control it. Now they find themselves with a central bank that combines the role of being a hedge fund due to its large overseas equity investments and has a negative interest-rate of -0.75%.

Nearly five years after the fateful day when the SNB stopped capping the Swiss Franc we get ever more deja vu from its assessments.

The situation on the foreign exchange market is still fragile, and the Swiss franc has appreciated in trade-weighted terms. It remains highly valued.

Comment

I have consistently argued that the situation regarding negative interest-rates has two factors. The first is how deep they go? The second is how long they last? I have pointed out that the latter seems to be getting ever longer and may be heading along the lines of “Too Infinity! And Beyond!”. It seems that the Swiss National Bank now agrees with me. The emphasis is mine.

This adjustment to the calculation basis takes account of the fact that the low interest rate environment around the world has recently become more entrenched and could persist for some time yet.

We have seen another signal of that recently because the main priority of the central banks is of course the precious and we see move after move to exempt the banks as far as possible from negative interest-rates. The ECB for example has introduced tiering to bring it into line with the Swiss and the Japanese although the Swiss moved again in September.

The SNB is adjusting the basis for calculating negative interest as follows. Negative interest will continue to be charged on the portion of banks’ sight deposits which exceeds a certain exemption threshold. However, this exemption threshold will now be updated monthly and
thereby reflect developments in banks’ balance sheets over time.

If only the real economy got the same consideration and courtesy. That is the crux of the matter here because so far no-one has actually exited the black hole which is negative interest-rates. The Riksbank of Sweden says that it will next month but this would be a really odd time to raise interest-rates. Also I note that the Danish central bank has its worries about pension funds if interest-rates rise.

A scenario in which interest rates go up
by 1 percentage point over a couple of days is not
implausible. Therefore, pension companies should
be prepared to manage margin requirements at
all times. If the sector is unable to obtain adequate
access to liquidity, it may be necessary to reduce the
use of derivatives.

Personally I am more bothered about the pension funds which have invested in bonds with negative yields.After all, what could go wrong?

 

 

Japan and Korea have chosen a bad time to fire up their own trade war

This is a story influenced by a brewing trade war but not the one that you might think. It is between Japan and Korea and the latest phase started in July when Japan imposed restrictions on trade with Korea for 3 chemicals. This gets more significant when you realise that they are crucial for smartphones ( displays on particular) and that according to CNBC Japan is responsible for 90% of the world’s supply of them. This affects quite of bit of Korean industry with Samsung being the headliner. Them Japan dropped Korea from its whitelist of trusted trading partners making trade more difficult before Korea did the same.

According to Bloomberg Citigroup have tried to downplay this today but I note these bits of it.

Meanwhile, boycotts in South Korea have led to a plunge in sales of Japanese consumer goods and a decrease in tourists to Japan, who may have decided to travel domestically instead, according to Citi………Last month, South Korean exports to Japan fell 14 percent, while imports from Japan slid 23 percent. South Korea’s trade ministry attributed the declines to industrial factors rather than trade actions.

Ah an official denial! We know what that means.

The issue has deep roots in the past and the Japanese occupation of the Korean peninsula a century ago as well as its later use of Korean “comfort women.” That explains the Korean issue with Japan and on the other side the Japanese consider themselves superior to Koreans and in my time there were quite open about it. Whilst he initially made moves to calm the situation there was always going to be an issue with a nationalistic politician like  Shinzo Abe running Japan.But let us move on noting that both countries will be experiencing an economic brake.

Japan Economic Growth

Let me hand you over to The Japan Times which gives us the position and some perspective.

In the third quarter the world’s third-largest economy grew an annualized 0.2 percent, slowing sharply from a revised 1.8 percent expansion in April to June, according to preliminary gross domestic product data released by the government Thursday.

It fell well short of a median market forecast for a 0.8 percent gain, and marked the weakest growth since a 2.0 percent contraction in the July-September period last year.

So over the past six months Japan has grown by 0.5% and we also get an idea of the erratic nature of economic growth there.This is partly due to the way that Japan does not conform to stereotype as it has struggled more than elsewhere to measure GDP. Partly due to last year’s third quarter drop. annual growth has picked up to 1.3% but that looks like being the peak.

Why? Well the 0.2% growth was driven by a 0.9% rise in domestic demand ( both numbers are annualised) just in time for the consumption tax to be raised. Actually private consumption was up 1.4% in the quarter suggesting that purchases were being made ahead of the rise.

At the end of last month this was reinforced by this.

The Consumer Confidence Index (seasonally adjusted series) in October 2019 was 36.2, up 0.6 points from the previous month.

Yes it was up but you see the number had fallen from around 44 at the opening of 2018 and these are the lowest readings since 2011.

Korea Economic Growth

Real gross domestic product (chained volume measure of GDP) grew by 0.4 percent in the third quarter of 2019 compared to the previous quarter……Real GDP (chained volume measure of GDP) increased by 2.0 percent year on
year in the third quarter of 2019.

In a broad sweep this means that economic growth has been slowing as it was 3.2% in 2017 and 2.7% in 2018. Rather unusually Korea saw strong export growth especially of we look at what was exported.

Exports increased by 4.1 percent, as exports of goods such as motor vehicles and semiconductors expanded. Imports were up by 0.9 percent, owing to increased imports of transportation equipment.

Also manufacturing grew.

Manufacturing rose by 2.1 percent, mainly due to an increase in computer, electronic and optical products.

However the economy has been slowing and if either of those reverse will slow even more quickly. Back on the 18th of October we noted this response.

The Monetary Policy Board of the Bank of Korea decided today to lower the Base Rate by 25 basis points, from 1.50% to 1.25%.

This was more of an external rather than an internal move as last week we learnt this.

During September 2019 Narrow Money (M1, seasonally adjusted, period-average) increased by 0.6% compared to the previous month.

So whilst it had been weak as annual growth was 3.3% in June it has risen since to 5% which is slightly above the average for 2018.

However they could cut on inflation grounds as this from Korea Statistics shows.

The Consumer Price Index was 105.46(2015=100) in October 2019. The index increased 0.2 percent from the preceding  month and was unchanged from the same month of the previous year.

According to the Bank of Korea the outlook is for more of the same.

 The Producer Price Index increased by 0.1% month-on-month in September 2019 – in year-on-year terms it decreased by 0.7%.

Exchange Rate

This is at 10.68 Won to the Yen as I type this and is up over 7% over the past year. So an additional factor in the situation will be that the Korean’s have been winning the currency war. This of course, will be annoying for Shinzo Abe who’s Abenomics programme set out to weaker the Japanese Yen. As we stand Korea has an official interest-rate some 1.35% higher so there is not a lot the Bank of Japan can do about this.

Comment

As we stand it initially looks as if Korea will be the relative winner here.

“Domestic demand had made up for some of the weakness in external demand, but we can’t count on this to continue,” said Taro Saito, executive research fellow at NLI Research Institute.

“A contraction in October-December GDP is a done deal. The economy may rebound early next year, but will lack momentum.” ( Japan Times)

But the argument it is in a stronger position weakens somewhat if we switch to its Gross National Income.

Real gross domestic income (GDI) increased by 0.1 percent compared to the previous quarter.

Over the past year it has gone on a quarterly basis -0.3%,0.2%,-0.7% and now 0.1%.

Korea is looking to use fiscal policy to stimulate its economy which sets it in the opposite direction to the consumption tax rise in Japan. But as they use a time of trouble to posture and scrap let us look at something that they share.

Korea’s potential output growth is expected to fall further in the long term, as the productive population declines in line with population aging and the low fertility rate……In addition, it is necessary to slow down the decline in labor supply resulting from population aging and the low birth rate, through policy efforts including encouraging women and young people to participate in economic activities and coping actively with the low birth rate. ( Bank of Korea Working Paper )

I wonder what the latter bit really means?

Meanwhile this is the last thing Japan needs right now.

(Reuters) – Japan’s Nissan Motor Co Ltd (7201.T) has said it is recalling 394,025 cars in the United States over a braking system defect, causing concerns that a brake fluid leak could potentially lead to a fire.

Podcast

 

 

Japan gets paid to issue debt and yet it has just tightened its fiscal policy!

Today I am looking east to the country which is hosting the rugby world cup and let me congratulate them on their victory over Ireland. But there is another area where Japan is currently standing out and that is the arena of fiscal policy. The current establishment view is that it is time that fiscal policy took up the slack after years and indeed in Japan’s case decades of easy monetary policy. One feature of that type of thought is seen by the cheapness of public borrowing in Japan where the ten-year yield is -0.22% and the thirty-year is a mere 0.35%. So Japan is either paying very little or being paid to borrow right now.

Consumption Tax

Last week it did this.

After twice being postponed by the administration of Prime Minister Shinzo Abe, the consumption tax on Tuesday will rise to 10 percent from 8 percent, with the government maintaining that the increased burden on consumers is essential to boost social welfare programs and reduce the swelling national debt. ( The Japan Times )

This is an odd move when we note the current malaise in the world economy which just gets worse as we note the fact that the Pacific region in particular is suffering. We looked at one facet of this last week as Australia cut interest-rates for the third time since the beginning of the summer.

Things get complex as we note that there are offsetting measures.

The 2 percentage point boost is estimated to inflict about a ¥5.7 trillion burden on households. However, making preschool education free of charge, keeping the 8 percent rate for food and nonalcoholic beverages and beefing up social welfare are expected to lessen that burden to around ¥2 trillion — about a quarter of the ¥8 trillion cost of the 2014 hike, according to the government and the Bank of Japan. ( The Japan Times )

As you can see this takes away a lot of the point of making the change in the first place! According to the government the net effect will be a bit more than a third of the gross. Also it means the government interfering in more areas leafing to transfers of cash from one group to another. Now whilst free preschool education is welcome we have seen extraordinary transfers in the credit crunch era via policies such as negative interest-rates and QE bond buying.

As ever the numbers seem in doubt as NHK News thinks the impact will be larger.

Half the revenue will be spent on making preschool education and childcare free of charge, easing the financial burden of higher education, among other things. The rest will go to restoring the country’s fiscal health.

The economic impact

The very next day Japan’s Cabinet Office released this bombshell.

The Consumer Confidence Index (seasonally adjusted series) in September 2019 was 35.6, down 1.5 points from the previous month.

The Japan Times covered it like this.

A Cabinet Office survey showed earlier this week that consumer sentiment in Japan weakened for the 12th straight month in September, hitting its lowest since the survey started in April 2013……….The index was lower than the 37.1 marked during the first stage of the hike in April 2014.

The last sentence is especially ominous if we consider the impact of the 2014 Consumption Tax rise. If we return to the survey we see from the series that it has been falling since some readings above 44 in late 2017 and the fall has been accelerating. In terms of detail there is this.

Overall livelihood: 33.9 (down 0.9 from the previous month)
Income growth: 38.7 (down 0.8 from the previous month)
Employment: 41.5 (down 0.7 from the previous month)
Willingness to buy durable goods: 28.1 (down 3.6 from the previous month)

So all elements fell and the employment one is particularly significant when we note this.

 The number of unemployed persons in August 2019 was 1.57 million, a decrease of 130 thousand or 7.6% from the previous year…..  The unemployment rate, seasonally adjusted, was 2.2%. ( Japan Statistics Bureau )

As an aside this makes the various natural and equilibrium levels of unemployment look laughable. For newer readers that is demonstrated by the Bank of England thinking it is 4.25% when Japan has an unemployment rate around half that.

This morning has brought news that things have gone from bad to worse.

TOKYO (Reuters) – A key Japanese economic index fell in August and the government on Monday downgraded its view to “worsening”, indicating the export-reliant economy might face slipping into recession.

The outlook was mostly driven by this.

The separate index for leading economic indicators, a gauge of the economy a few months ahead that’s compiled using data such as job offers and consumer sentiment, dropped 2.0 points from July, the Cabinet Office said.

Fiscal Policy

The other side of this particular coin was illustrated by the response of Fitch Ratings to the Consumption Tax hike.

Japan’s consumption tax hike supports medium-term fiscal consolidation efforts, and the country’s sovereign credit profile, Fitch Ratings says. We estimate it will lower Japan’s debt ratio by about 8pp of GDP by 2028; however, very high public debt will remain a key credit weakness.

They further crunched the fiscal numbers here.

Total annual revenue from the tax hike is estimated by the government at about 1% of GDP, half of which is earmarked to reduce debt (the remainder will be used to permanently increase spending for education and long-term care). This would result in Japan’s gross general government debt-to-GDP ratio falling to just over 220% by 2028, from 232% at present.

It hardly seems worth it when it is put like that. Also perhaps unwittingly they let the cat out of the bag as to why Abenomics is so keen on raising the level of inflation.

We estimate that Japan’s public debt dynamics have stabilised due to the resumption of nominal GDP growth in recent years.

Nominal GDP growth includes inflation.

Comment

This is a story with several facets so let us open with the driving force of this which was the IMF or International Monetary Fund and the case it made in the earlier part of this decade for Japan to improve its national debt to GDP ratio. Here is the IMF Blog after the 2014 Consumption Tax rise.

Japan’s GDP declined by almost 7 percent in the second quarter, more than many had forecast including us here at the IMF.  Many cite the increase in the sales tax this April for this decline.  But that is not the full story.

That opening suggests there were other reasons for the fall but fails to state them as it then discusses general rather than specific issues. Oh and it does not day but it means annualised fall in GDP. The impact was so great that the 2015 rise was delayed to now rather ironically because of the recession risk. What it means is that Japan ends up doing this at a very risky time if we look at the world economic outlook.

We now find also that IMF fiscal conservatism is being applied just as it has switched to expansionism. That is quite a mess! No wonder Christine Lagarde shot out of the door. After all Japan can borrow quite cheaply mostly due to the fact that The Tokyo Whale ( Bank of Japan for newer readers ) owns so much of it. The IMF has just published a Working Paper on this so let me give you some numbers from 2017.

As shown in the Fiscal Monitor, Japan’s PSBS stands out as one of the largest PSBS in the world, with assets and liabilities of 533 percent of GDP in 2017. Japan’s
PSBS also includes cross-holdings of assets and liabilities within the public sector, exceeding 210 percent of GDP in 2017—the largest in the IMF’s PSBS database. Much of these come from public corporations’ financing of central government liabilities. ( PSBS = Public Sector Balance Sheet)

Next let me help the author out as the situation below is explained by world wide trends accompanied thsi decade by the enormous purchases of The Tokyo Whale.

Several previous studies considered it puzzling that the stock of Japanese Government Bonds (JGBs) has been increasing but their yields have been declining
for the last three decades.

Next we get a higher estimate for the national debt.

However, these may not fully explain why Japan has been able to build up 288 percent of GDP in public sector borrowing.

Also it is not only The Tokyo Whale that has bought this.

In 2017, the public sector finances 150 percent of GDP of public sector borrowing,

In some ways it has been buying off other parts of the public-sector.

For example, the Post Bank
reduced allocations to public sector financing from 95 percent of its total assets at its peak in
1998 to 33 percent in 2017. The social security funds also reduced asset allocations to public
sector financing from 77 percent at its peak in 1998 to 34 percent in 2017.

Oh what a tangled web we weave……

Meanwhile it would appear that even extraordinary fiscal expansionism has not done much good.

Borrowing of general government ballooned in the 1990s and 2000s. It was 60 percent of GDP in 1990 and
increased to 226 percent of GDP in 2017.

The ordinary Japanese may have a job but real wages are falling again and fell at an annual rate of 1.7% in August.

Podcast

 

 

What is the economic impact of an oil price shock?

The economic news event of the weekend was the attack on the Saudi oil production facilities. It looks as though Houthi rebels and Iran were involved but forgive me if I am careful about such things along the lines of this from the Who.

Then I’ll get on my knees and pray
We don’t get fooled again

As you can imagine there was a lot of attention on the London oil price opening last night and no doubt fear amongst those who were short the oil price. Their fears were confirmed as we saw an initial flurry of stop loss trading which can the price of a barrel of Brent Crude Oil go above US $71 which was some US $11 higher. It then fell back to more like US $68 quite quickly. For those unaware this is a familiar pattern in such circumstances as some will have lost so much money they have to close their position and everybody knows that. It is a cruel and harsh world although of course you need to know the nature of the beast before you play.

Thus the first impact was some severe punishment for sections of the oil trading market. The rumour was that a lot of quant funds were short of oil and we will have to wait and see if there is a blow-up here. If we move on we see that the oil price has been falling this morning leaving the price of a barrel of Brent Crude at US $65.50 or up over 8%.So let us start by looking at the winners from a higher oil price.

Winners

A clear group of winners and presumably the group who have taken the edge off the higher oil price are the shale oil wildcatters in the United States and elsewhere.

“Since the last in-depth review five years ago, the United States has reshaped energy markets both domestically and around the world,” the IEA’s Executive Director, Fatih Birol, said at the presentation of the report on Friday, accompanied by U.S. Secretary of Energy Rick Perry. ( oilprice.com )

If we continue with this analysis here is some more detail.

U.S. crude oil exports have soared since the ban was lifted at the end of 2015, to reach 3.159 million bpd on average in June 2019, according to the latest available EIA crude export detail.

As you can see the impact of the shale oil era had one underlying effect last night and this morning via the way that Saudi production is not as important as it was. But also there is the economic model of the shale oil industry which I have pointed out before is more of a cash flow model than a profit one. So I would have expected them to rush to hedge their production last night and this morning. As it happens these levels are ones which would be profitable for them as their costs are often around US $50 per barrel. However they will not be making as much as you might think as they would have impacted more on the WTI ( West Texas Intermediate ) benchmark which is about US $5 lower than the Brent benchmark.

Other companies in the production business will also be winners and we see an example of that as the British Petroleum share price is up 4% at 523 pence today.

Next comes the countries who are net oil producers. We have looked at the US already and the position for Saudi Arabia is mixed as it is getting a higher price but has lower production. Russia is a clear winner as its economy depends so much on its oil production.

Exports of mineral products (consisting mainly of oil and natural gas) accounted for 59.2% of total Russian exports in 2016 (Rosstat, 2017).

There is quite a list of winners in the Middle East including ironically Iran assuming it will be allowed to sell its oil. Then places like Kazahkstan as well as Canada and to some extent Australia. There is also Norway where according to Norskpetroleum it represents some 16% of GDP and 40% of exports as well as this.

The government’s total net cash flow from the petroleum industry is estimated to NOK 251 billion in 2018 and NOK 263 billion in 2019

Thus I am a little unclear how Oxford Economics are reporting that Norway would lose from a higher oil price.

There are quite a few African countries which produce oil and Libya comes to mind as do Ghana and Nigeria ( assuming the output of the latter can avoid the problems there).

Another group of winners would be world central banks especially the ECB after its moves on Thursday. The reason for this is that they have been trying to raise the inflation rate for some time now and either mostly or entirely failing as Mario Draghi pointed out on Friday..

The reference to levels sufficiently close to but below 2% signals that we want to see projected inflation to significantly increase from the current realised and projected inflation figures which are well below the levels that we consider to be in line with our aim.

Should this transpire then we will no doubt see a shift away from core and the new “super core” measures of inflation which for newer readers basically ignore what are really important.

Losers

These are the net oil importers which are most of us. In terms of economic effect the standard view has been this from FXCM.

Data analysed by the Federal Reserve shows that a 10 percent increase in the price of oil is associated with about a 1.4 percent drop in the level of U.S. real GDP.

The 10% depends on the actual price but that has been a standard with the Euro area thinking there would be the same effect on it from a US $5 move. Of course these days the US would see more offset from the shale industry and I think worldwide the advance of renewable energy would help at the margins. But a higher oil price leads to a net loss overall as the importers are assumed to fall by more than the exporters rise. Geographically one thinks of China, Japan and India.

The effect on inflation is unambiguously bad and let me offer a critique of the central banking view above. The impact of inflation on real wages will make workers and consumers worse and not better off reminding us that central bankers have long since decoupled from reality.

Comment

There are a couple of perspectives here. The first is that in any warlike situation the truth is the first casualty. This leads to a situation where we do not know how long Saudi oil output will be reduced for, which means that we do not know how long there will be an upwards push on the oil price. Next comes a situation where looking ahead there will be fears that attacks like this could happen again. That is in some way illogical as defences will no doubt be improved but is part of human nature especially as we now know how concentrated the production facilities are in Saudi Arabia.

Another perspective is provided by the fact that the oil price is back to where it was in May and some of July.

Oh and central bankers used to respond to this sort of thing with interest-rate increases whereas later this week we are expecting an interest-rate cut from the US Federal Reserve. How times change…..

Podcast

Thank you to those of you who have supported this as the listener numbers on Soundcloud on Saturday alone exceeded any previous week..

 

What to do with a problem like Japan?

Next week on Thursday we will get the latest policy announcement from the Bank of Japan and it may well be a live meeting. With other central banks acting – and by this I mean easing policy again – there will be pressure on the Bank of Japan to maintain its relative position. But yesterday provided a catch which at the time of writing is in fact a version of Catch-22. This is because financial markets did the opposite of what Mario Draghi and the ECB wanted. At first markets went the right way and let me highlight bond markets as they digested these words from Mario Draghi at the press conference.

First of all let me start from one thing about which there was unanimous consensus, unanimity, namely that fiscal policy should become the main instrument.

This curious statement which is way beyond any central banking mandate even came with an official denial of its purpose.

they are packages not meant to finance Government deficits,

But my point is that the market move then U-Turned and bond yields rose. So for example the German bond market future fell by over 2 points from its peak. The ten-year yield rose and is now -0.51%. Next the Euro fell but then rose strongly and is now 1.108 versus the US Dollar.

Such developments will be watched closely in Tokyo with the concept of more easing leading to a stronger currency being something that would make Governor Kuroda want something a bit stronger than his morning espresso. Actually even something which is good news may have him chuntering as it reminds him of the demographics issue that Japan faces. From NHK news this morning.

Japan now has more than 70,000 centenarians, according to the health ministry. A new high has been reached every year for 49 years in a row.

The ministry says 71,238 people will be 100 or older as of September 15. That’s 1,453 more than last year………

There were only 153 centenarians when the ministry conducted its first survey in 1963. The figure surpassed 10,000 in 1998 and 50,000 in 2012.

Officials attribute the rapid rise to medical advances and campaigns to stay fit.

The ministry says it will provide support to enable elderly people to maintain their well being.

In this area economics lives up or rather down to its reputation as the dismal science as the good news above reminds us of Japan’s shrinking and ageing population.

The Banks

We rarely here these mentioned as of course the Japanese banks passed into the zombie zone some years and indeed decades ago. But The Japan Times is on the case today.

Since negative rates were introduced in 2016, Japanese bank shares have languished as their lending profitability dwindles. Nishihara estimates another rate reduction could wipe out as much as ¥500 billion ($4.6 billion) of bank profits, though lenders could make up ¥300 billion if they charge ¥1,000 per account annually.

They do not specify but they seem to be assuming Japan will match the ECB ( and its last move) and cut interest-rates from -0.1% to -0.2%. As to the making money from fees this would be especially awkward in Japan for this reason.

Such levies could help to address Japan’s unusually high number of accounts, easing costs for banks, then-central bank Deputy Gov. Hiroshi Nakaso said in 2017. There are about seven accounts per adult in Japan, the most in the world, according to International Monetary Fund figures.

I mean who cares about the people when The Precious is a factor?

Smaller Banks

These are a case of “trouble,trouble,trouble” as Taylor Swift would say.

Troubled regional banks are plunging into riskier corners of the credit markets, in a battle to survive ultralow interest rates and an industry shakeout.

A clear backfire from the QE or as we are in Japan QQE era. If you are wondering why QE became QQE in Japan think of how the leaky Windscale nuclear reprocessing plant became the leak-free Sellafield. I am just trying to remember if it was 13 or 19 versions of QE before the name change but I imagine you get the idea either way.

As to the smaller banks.

The latest case came last week. Local lenders were among the buyers of samurai bonds — those denominated in yen and issued by non-Japanese companies — sold by Export-Import Bank of India with a BBB+ rating, just three steps away from junk, that may have dissuaded the financial firms in the past. In another unconventional move last month, a few regional banks also put their money in the first negative-yielding note issued by a Japanese agency.

The title of “samurai bonds” is worrying enough in itself. Then moving into negative yielding bonds, what could go wrong?

I do enjoy the description of Japan’s face culture as “taking a more lenient view”.

Even Japan’s two major rating firms, which have tended to take a more lenient view, are sounding alarms. Downgrades and outlook cuts of regional lenders have increased to 13 so far this year at Japan Credit Rating Agency and Rating & Investment Information, the most for similar periods in data compiled by Bloomberg going back to 2010.

Oh and please remember when you read the quote below that the third arrow of Abenomics was supposed to be economic reform.

The government also said earlier this year that legislation will be submitted to the Diet in 2020 that will exempt regional banks from the anti-monopoly law for 10 years to facilitate mergers.

Banks are banks

It would seem that banking behaviour is the same wherever we look.

Japan Post Bank improperly sold investment trust products to elderly customers in violation of its rules in a total of some 20,000 cases, according to informed sources.

An investigation by the Japan Post Holdings Co. unit newly discovered some 2,000 cases of improper investment trust sales at 200 post offices, the sources said. Most contracts were conducted in fiscal 2018, which ended March 31.

Bank of Japan

There is often a lot of hot air about private ownership of central banks but as today’s Bank of Japan Annual Review points out, well you can see for yourself.

The Bank is capitalized at 100 million yen in accordance
with Article 8, paragraph 1 of the Act. As of the end of
March 2019, 55,008,000 yen is subscribed by the
government, and the rest by the private sector.

Some food for thought is provided by the word gearing. Why? Well the Bank of Japan has 486,523,186,968,000 Yen of Japanese Government Securities alone on its books.

Life Insurers

A problem for Japan’s life insurers is that they cannot get any interest or yield in Japan without rocketing up the risk scale. So according to Brad Setser they have been doing this.

But that changes when insurers cannot get the returns they want (or need) at home, and they start investing abroad in a quest for yield. Japanese life insurers (and for that matter Post Bank and Nochu) have looked abroad because yields at home are zero, and Japanese firms (in aggregate) don’t need to borrow.

Ah Post Bank again. How much?

For Japan, the data above shows a broader set of institutions—but the life insurers hold around $1.6 trillion, a sum that is around a third of GDP.

Comment

As you can see there are lots of questions about the financial system in Japan. That may move the Bank of Japan to copy the ECB as it notes that shares in The Precious have risen ( Deutsche Bank if up 0.25 Euros at 7.59).

Moving to the real economy it has not had such a bad 2019 so far. Whilst economic growth was revised down from 1.8% to 1.3% in annualised terms in the second quarter that is still better than I though it would be. For Japan these days an annual GDP growth rate of 1% is about par for the course and is better in individual terms due to the shrinking population. But as we look ahead we see a Pacific Region which is in trouble economically and of course a Consumption Tax rise ( which impacted so heavily in 2014) is due soon. So over to you Governor Kuroda.

Oh and something I have not mentioned so far which is that the Yen is at 108.

 

 

 

The Bank of Japan fears no longer being the “leader of the pack”

The next two weeks look set to bring a situation you might not expect. After all Japan has built a reputation as the “leader of the pack” as the Shangri-Las would put it in terms of monetary policy easing. Except that it is now facing a situation where it looks set to be left behind. On Thursday the European Central Bank will announce its latest moves and its President Mario Draghi has been warming us up for some action. Either he will announce an interest-rate cut or he will signal one for September. So there are two perspectives here for Japan. The first is that the Euro area looks set to cut by the total amount that Japan has below zero as 0.1% is the minimum and of course 0.2% would be double it. Next is the issue that the new rate of -0.5% or -0.6% would be a considerable amount lower than in Japan.

If we now shift to the United States the US Federal Reserve looks set to cut interest-rates as well when it meets at the end of the month. There was a spell last week when financial markets switched to expecting a 0.5% cut which would put the new rate at 1.75% to 2%. Personally I am far from convinced by that and a 0.25% cut seems much more likely but nonetheless it puts the Bank of Japan under pressure.

The Yen

The factors we have looked at above will be putting some upwards pressure on the Yen as interest-rate expectations shift against it. This has been reinforced by an unintended consequence of the policy applied by the central planners at the Bank of Japan.

The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain more or less at the current level (around zero percent). With regard
to the amount of JGBs to be purchased, the Bank will conduct purchases more or less in line with the current pace — an annual pace of increase in the amount outstanding
of its JGB holdings at about 80 trillion yen — aiming to achieve the target level of a long-term interest rate specified by the guideline. JGBs with a wide range of maturities will continue to be eligible for purchase, while the guideline for average remaining maturity of the Bank’s JGB purchases will be abolished.

The problem here as I have pointed out before is that something which was supposed to have kept Japanese Government Bond ( JGB) yields down has ended up keeping them up. Ooops! As world bond markets have surged Japan has been left behind because its bond market is essentially run by the Bank of Japan ( 80 trillion yen a year buys you that) and it has been wrong footed completely. The recent surge began in early March and the German ten-year yield has fallen as much as by 0.6% and the US by 0.8% but Japan by only 0.16%.

So as you can see relative interest-rates and yields have moved to support the Yen since the early spring of this year. The policy of “yield curve control” aiming for bond yields of 0% to -0.1% no doubt seemed a good way of continuing the Abenomics policy of weakening the Yen at the time. However over the period that bond markets have surged the Yen has strengthened from 112 versus the US Dollar to 108 now. That is before we see any shift in the rhetoric of President Trump who as the tweet from the early part of this month below points out, wants a weaker US Dollar.

China and Europe playing big currency manipulation game and pumping money into their system in order to compete with USA. We should MATCH, or continue being the dummies who sit back and politely watch as other countries continue to play their games – as they have for many years!

That will have been viewed with horror in Tokyo because whilst The Donald is not currently putting Japan in his cross hairs they have looking to weaken the Yen since Abenomics began back in 2013. This would be quite a reverse for Japan as it would not want to get into a currency war with the United States.

Moving to other currencies we see that the Yen has been strengthening against the Euro and the UK Pound as well. Indeed we get another perspective I think from looking at Switzerland which regular readers will know I labelled as a “Currency Twin” with Japan due to the way both currencies were borrowed heavily in the pre credit crunch period. There are increasing rumours that the Swiss National Bank has been getting the equivalent of an itchy collar over the strength of the Swiss Franc and has been checking the markets as a hint that it may intervene again. It may well find itself having to match any ECB interest-rate cut and that will echo in Tokyo as well as giving us a new low for negative interest-rates.

The Pacific Trade Crisis

The stereotype of this area is of fast growing economies with the image of many of them being Pacific Tigers compared to the more sclerotic Western nations. Yet troubles are there too now so let us go to Seoul on Thursday.

The Monetary Policy Board of the Bank of Korea decided today to lower the Base Rate by 25 basis points, from 1.75% to 1.50%.

Okay why?

With respect to future domestic economic growth, the Board expects that the adjustment in construction investment will continue and exports and facilities investment will recover later than originally expected,
although consumption will continue to grow. GDP is forecast to grow at the lower-2% level this year, below the April forecast (2.5%).

This morning has brought more news on that front. From Bloomberg.

South Korea’s exports, a bellwether for global trade, appear set for an eighth straight monthly decline as trade disputes take a toll on global demand. Exports during the first 20 days of July fell 14 percent from a year earlier, data from the Korea Customs Service showed Monday. Semiconductor sales plunged 30 percent, while shipments to China, the biggest buyer of South Korean goods, fell 19 percent.

Korea is a bellwether as these numbers are released very promptly and many of its companies are integrated into global supply chains, so it gives a signal for world trade. Currently it is not good and there is a direct link to Japan.

Imports from the U.S. rose 3.7 percent, while those from Japan dropped 15 percent.

Also on Thursday Bank Indonesia decided to join the party.

The BI Board of Governors agreed on 17th and 18th July 2019 to lower the BI 7-day Reverse Repo Rate by 25 bps to 5,75%,

A day earlier say troubling news for the economy of Singapore.

SINGAPORE’S exports, already in double-digit decline for three straight months, fell again in June, according to Enterprise Singapore data released on Wednesday morning.

Non-oil domestic exports (NODX) were down by 17.3 per cent on the year before – a six-year low  ( Business Times )

Comment

The Bank of Japan finds itself between a rock and a hard place on quite a few fronts. The Yen has been strengthening and other central banks are on their way to matching its policies. That is before we get to the issue of the clear trade slow down in the Pacific region. This will add to the problem hidden in what looked on the surface as solid economic growth in the first part of the year.

In the three-month period, exports dropped 2.4 percent and imports sank 4.6 percent, as in the initial reading. As a result, net exports — exports minus imports — pushed up GDP by 0.4 percentage point. ( Japan Times).

In all other circumstances the Bank of Japan would cut interest-rates in a week. But they do not like negative interest-rates much and they are buying pretty much everything ( bonds, equities and commercial property) as it is! In October another Consumption Tax rise is due as well. Perhaps Bryan Ferry was right.

Say, when you’ve been around, what’s left to do?
Don’t know? Ask Tokyo Joe
So inscrutable her reply
“Ask no question and tell me no lie”

Podcast

 

 

The Bank of Japan begins to face its failures

The last couple of weeks have seen two of the world’s main central banks strongly hint that the path for interest-rates is now lower, or perhaps I should say even lower. So as we open this week my thoughts turn eastwards to what the Shangri-Las would call the leader of the pack in this respect, Nihon or Japan. If we look at the Nikkei newspaper we see that Governor Kuroda of the Bank of Japan has also been conducting some open mouth operations.

TOKYO — Bank of Japan Governor Haruko Kuroda said extra stimulus would be an option if prices refuse to keep rising toward the central bank’s 2% inflation target.

The BOJ “will consider extra easing measures without hesitation” if the economy runs into a situation where momentum toward reaching stable inflation is lost, Kuroda said at a news conference on Thursday in Tokyo after keeping monetary policy unchanged.

There are various problems with this which start with the issue of inflation which has simply not responded to all the stimulus that the Bank of Japan has provided.

  The consumer price index for Japan in May 2019 was 101.8 (2015=100), up 0.7% over the year before seasonal adjustment,   and the same level as the previous month on a seasonally adjusted basis. ( Statistics Bureau).

This has been pretty much a constant in his term ( the only real change was caused by the rise in the Consumption Tax rate in 2014) and as I have pointed out many times over the years challenges Abenomics at its most basic point. If we stick to the monthly report above the situation is even worse than the overall number implies. This is because utility bills are rising at an annual rate of 3.2% but this is offset by other lower influences such as housing where the annual rate of (rental) inflation is a mere 0.1%. Also the services sector basically has virtually no inflation as the annual rate of change is 0.3%. Even the Bank of Japan does not think there is much going on here.

On the price front, the year-on-year rate of change in the
consumer price index (CPI, all items less fresh food) is in the range of 0.5-1.0 percent. Inflation expectations have been more or less unchanged.

Wages

On Friday we got the latest wages data which showed that real wages fell at an annual rate of 1.4% in April, This meant that so far every month in Japan has seen real wages lower than the year before. If we look back we see that an index set at 100 in 2015 was at 100.8 in 2018 so now may well be back where it started.

This matters because this was the index that Abenomics was aimed at. Back in 2012/13 it was assumed by its advocates that pushing inflation higher would push wages even faster. Whereas that relationship was struggling before the credit crunch and it made it worse. Indeed so strong was the assumed relationship here that much of financial media has regularly reported this it has been happening in a version of fake news for economics. The truth is that there has been an occassional rally such as last summer’s bonus payments but no clear upwards trend and the numbers have trod water especially after Japan’s statisticians discovered mistakes in their calculations.

Problems for economics

Back when QE style policies began there was an assumption that they would automatically lead to inflation whereas the situation has turned out to be much more nuanced. As well as an interest-rate of -0.1% the Bank of Japan is doing this.

With regard to the amount of JGBs to be purchased, the Bank will conduct purchases in a flexible manner so that their amount outstanding will increase at an annual
pace of about 80 trillion yen……….The Bank will purchase exchange-traded funds (ETFs) and Japan real estate
investment trusts (J-REITs) so that their amounts outstanding will increase at annual
paces of about 6 trillion yen and about 90 billion yen, respectively…….As for CP and corporate bonds, the Bank will maintain their amounts outstanding at
about 2.2 trillion yen and about 3.2 trillion yen, respectively.

Yet we have neither price nor wage inflation. If we look for a sign of inflation then it comes from the equity market where the Nikkei 225 equity index was around 8000 when Abenomics was proposed as opposed to the 21,286 of this morning. Maybe it is also true of Japanese Government Bonds but you see selling those has been something of a financial widow maker since around 1990.

Misfire on bond yields

2019 has seen yet another phase of the bond bull market which if we look back has been in play since before the turn of the century. But Japan has not participated as much as you might think due to something of a central planning failure.

The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around zero percent. While doing so, the yields may move upward
and downward to some extent mainly depending on developments in economic activity and prices.

That was designed to keep JGB yields down but is currently keeping them up. Ooops! We see that bond yields in Germany and Switzerland have gone deeper into negative territory than in Japan. If we compared benchmark yields they go -0.31% and -0.51% respectively whereas in Japan the ten-year yield is -0.15%.

Economic Growth

On the face of it the first quarter of this year showed an improvement as it raised the annual rate of economic or GDP growth to 0.9%. That in itself showed an ongoing problem if 0.9% is better and that is before we get to the fact that the main feature was ominous. You see the quarterly growth rate of 0.6% was mostly ( two-thirds) driven by imports falling faster then exports, which is rather unauspicious for a trading nation.

If we look ahead Friday’s manufacturing PMI report from Markit posted a warning.

June survey data reveals a further loss of momentum
across the manufacturing sector, as signalled by the
headline PMI dropping to a three-month low. Softer
demand in both domestic and international markets
contributed to the sharpest fall in total new orders for
three years. A soft patch for automotive demand…..

The last few words are of course no great surprise but the main point here is the weaker order book. So Japan will be relying on its services sector for any growth. Also there is the issue of the proposed October Consumption Tax hike from 8% to 10% which would weaken the economy further. So we have to suspect it will be delayed yet again.

Comment

To my mind the Abenomics experiment never really addressed the main issue for Japan which is one of demographics. The population is both ageing and shrinking as this from the Yomiuri Shimbun earlier this month highlights.

The government on Friday released a rough calculation of vital statistics for 2018, revealing that the number of deaths minus births totaled 444,085, exceeding 400,000 for the first time.

The latest numbers on Thursday showed yet another fall in children (0-15) to 12.1% of the population and yet another rise in those over 85 to 4.7%. In many ways the latter is a good thing which is why economics gets called the dismal science. The demographics are weakening as Japan continues to borrow more with a national debt of 238% of GDP.

The size of the national debt is affordable at the moment for two reasons. The first is the low and at times negative level of bond yields. Next Japan has a large amount of private savings to offset the debt. The rub is that those savings are a buffer against the demographic issue and there is another problem with Abenomics which I have feared all along. Let me hand you over to a new research paper from the Bank of Japan.

The reversal interest rate is the rate at which accommodative monetary policy
reverses and becomes contractionary for lending. Its determinants are 1) banks’
fixed-income holdings, 2) the strictness of capital constraints, 3) the degree of passthrough to deposit rates, and 4) the initial capitalization of banks.

So it looks like they are beginning to agree with me that so-called stimulus can turn out to be contractionary and there is more.

The reversal interest rate creeps up over time, making steep but short rate cuts preferable to “low for long” interest rate environments.

Exactly the reverse of what Japan has employed and we seem set to copy.

Podcast

Japan adds sharply falling imports to its continuing real wages problem

Today gives an opportunity to head east and look at what is sometimes considered to be the engine room of the world economy looking forwards. We can do so via an old friend which is Nihon the land of the rising sun. It is facing a situation where central banks in Malaysia, New Zealand and the Philippines have cut interest-rates this month. The latter cut was a reminder of different perspectives as we note this from The Business Times.

Gross domestic product (GDP) expanded 5.6 per cent in the first three months of the year, dragged by a slowdown in government spending, farm output, exports and the country’s budget deadlock. The pace was slower than the previous quarter’s 6.3 per cent and also the 6.1 per cent forecast in a Reuters poll…….On a seasonally adjusted basis, the economy grew 1.0 per cent in the January-March period from the previous quarter, far slower than the upwardly revised 1.8 per cent in the fourth quarter of 2018.

Of course Japan would get out it’s party hats and best sake for anything like that rate of growth but for it today’s story started well with this. From Reuters.

Japan’s economic growth unexpectedly accelerated in January- March, driven by net contributions from exports and defying forecasts for a contraction in the world’s third-largest economy.

At this point things look really rather good as in a time of trade wars growth from net exports is especially welcome. Before I get to that we may note that the forecasts were wrong by quite a wide margin but as we have a wry smile I would just like to add that initial GDP data in Japan is particularly unreliable. I know that goes against the national stereotype but it is an ongoing problem. The Bank of Japan thinks that the numbers have been consistently too low but the catch is that it is hardly an impartial observer after all its extraordinary monetary policies. For the moment,however we have been told this.

Japan’s economy grew at an annualized 2.1% in the first quarter, gross domestic product (GDP) data showed on Monday, beating market expectations for a 0.2% contraction. It followed a revised 1.6% expansion in October-December.

The Rub

The problem with growth from net exports as Greece discovered is that it can be a sign of contraction as it is here. Fortunately someone at Reuters seems to have learnt from my style of analysis.

The headline GDP expansion was caused largely by a 4.6% slump in imports, the biggest drop in a decade and more than a 2.4% fall in exports.

As imports fell more than exports, net exports – or shipments minus imports – added 0.4 percentage point to GDP growth, the data showed.

If we look further into the detail we see that this quarter exports knocked some 0.5% off GDP with their fall, although not everyone seems to think that if this from @fastFT is any guide.

 the world’s third-largest economy was boosted by better-than-expected exports.

Let us be kind and assume they though they would be even worse.

Returning to the main point we are now left wondering why imports were so weak. We get a partial answer from this.

Private consumption slid 0.1% and capital expenditure dropped 0.3%, casting doubt on policymakers’ view that solid domestic demand will offset the pain from slowing exports.

Lower consumption will have been a factor although I am much less sure about investment because public investment rose by 1.5% and total investment added 0.1% to the GDP growth figure. So as Japan needs basic materials and is a large energy importer we face the likelihood that industry is nervous about the prospects for late spring and summer and has adjusted accordingly. This from Nippon.com will not help.

The slump in China, which is the center of production and consumption in Asia, has spread to other countries in the region. Trade statistics for March 2019 show that exports to Asian countries (including China) fell by 5.5% compared to the same month the previous year, marking the fifth straight monthly decline since November 2018.

 

If you want a scare story the Japanese way of annualising numbers creates one because on this basis exports fell by 9.4% and imports by 17.9%.

Industrial Production

There was some better news on this from earlier as the preliminary report of a monthly fall of 0.9% in March was revised up to a 0.6% fall. But even so this meant that production was 4.3% lower than a year before. Thus we see why imports have dropped as the official views has gone from “Industrial Production is pausing.” to “Industrial Production is in a weak tone recently.”

The index is at 102.2 where 2015 = 100 but as recently as last October it was 105.6.

Wages

Low wage growth and at times declining real wages has been a theme of the “lost decade” era in Japan and January produced bad news for confidence in this area for both the numbers and the official data series. From the Nikkei Asian Review in late January.

A data scandal at Japan’s labor ministry has created further headaches for the Abe government in its protracted attempts to spur inflation.

The ministry’s Monthly Labor Survey overstated nominal pay increases in the first eleven months of 2018. Corrected monthly results released on Wednesday saw year-on-year wage growth drop by between 0.1 and 0.7 percentage point. Officials revised data for every month.

The new series has seen real wage growth accelerate downwards in 2019 so far starting with an annual fall of 0.7% in January then 1% in February followed by 2.5% in March. If we switch to wage growth on its own we see that the real estate sector was ht hardest in March with an annual fall of 5.9% followed by the finance and insurance sector where it fell by 4.6%.

The highest paid sector ( 446,255 Yen) in March was the utility one (electricity, heat and water).

This weaker set of data also has worries for those on us following at least partly on the same road as Japan as The Vapors once again remind us.

I’m turning Japanese, I think I’m turning Japanese, I really think so
Turning Japanese, I think I’m turning Japanese, I really think so
I’m turning Japanese, I think I’m turning Japanese, I really think so
Turning Japanese, I think I’m turning Japanese, I really think so

Comment

So far I have avoided financial aspects and only briefly referred to the Bank of Japan. It of course has been pursuing the policy of Abenomics for some time now but some of the arrows have misfired. Actually the case of currency depreciation may boomerang in some areas as we see a falling Chinese Yuan. Indeed the Japanese Yen has been rallying against the UK Pound £ which has been pushed back to the 140 level. Signs of economic weakness and trouble give us a stronger Yen as markets adjust in case the Japanese decide to take some of their large foreign investments home.

It is unclear how the Bank of Japan can help much with the current series of problems. For example its role of being the Tokyo Whale and buying Japanese equities on down days for the market is unlikely to do much about the real wages problem or the aging and shrinking population. Although the rhetoric of “powerful monetary easing” continues.

In addition, the Bank decided to consider the introduction of a facility for lending exchange-traded funds (ETFs) that it holds to market participants.  ( Governor Kuroda)

In reality that seems to be forced because it is on its way to buying them all!

While I will not explain these measures in detail today, they all will provide support for continuing with powerful monetary easing through the Bank’s smooth fund-provisioning and securing of market functioning.

Also if fiddling at the margins like this worked Japan would have escaped its lost decade years and years ago.

 

 

 

Central bankers are warming us up for more inflation again

A feature of the credit crunch era is the repetition of various suggestions from governments and central banks. One example of this has been the issue of Eurobonds which invariably has a lifespan until the nearest German official spots it. Another has been the concept of central banks overshooting their inflation target for a while. It is something that is usually supported by those especially keen on ( even more) interest-rate cuts and monetary easing so let us take a look.

Last Wednesday European Central Bank President Mario Draghi appeared to join the fray and the emphasis is mine.

Well, on your second question I will answer saying exactly the same thing. We don’t tolerate too low inflation; we remain fully committed to using all necessary instruments to return inflation to 2% without undue delay. Likewise, our inflation aim doesn’t imply a ceiling of 2%. Inflation can deviate from our objective in both directions, so long as the path of inflation converges towards our medium-term objective. I believe I must have said something close to this, or something to this extent a few other times in the past few years.

Nice try Mario but not all pf us had our senses completely dulled by what was otherwise a going through the motions press conference. As what he said at the press conference last September was really rather different.

In relation to that: shouldn’t the ECB be aiming for an overshoot on inflation rather than an undershoot given that it’s been below target for so long?

Second point: our objective is an inflation rate which is below, but close to 2% over the medium term; we stay with that, that’s our objective.

As you can see back then he was clearly sign posting an inflation targeting system aiming for inflation below 2%. That was in line with the valedictory speech given by his predecessor Jean-Claude Trichet which gave us a pretty exact definition by the way he was so pleased with it averaging 1.97% per annum in his term. So we have seen a shift which leads to the question, why?

The actual situation

What makes the switch look rather odd is the actual inflation situation in the Euro area. Back to Mario at the ECB press conference on Wednesday.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in March 2019, after 1.5% in February, reflecting mainly a decline in food, services and non-energy industrial goods price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months.

So we find that inflation is below target and expected to fall further in 2019. This was a subject which was probed by one of the questions.

 It’s quite clear that the sliding of the five-year-to-five-year inflation expectations corresponds to a deterioration of the economic outlook. It’s also quite clear that as the economic outlook, especially the economic activity slows down, also markets expect less pressure in the labour market, but we haven’t seen that yet.

The issue of markets for inflation expectations is often misunderstood as the truth is we know so little about what inflation will be then. But such as it is again  the trend may well be lower so why have we been guided towards higher inflation being permitted.

It might have been a slip of the tongue but Mario Draghi is usually quite careful with his language. This leaves us with another thought, which is that if he is warming us up for an attitude change he is doing soon behalf of his successor as he departs to his retirement villa at the end of October.

The US

Minneapolis Fed President Neel Kashkari suggested this in his #AskNeel exercise on Twitter.

Well we officially have a symmetric target and actual inflation has averaged around 1.7%, below our 2% target, for the past several years. So if we were at 2.3% for several years that shouldn’t be concerning.

Also he reminded those observing the debate on Twitter that the US inflation target is symmetric and thus unlike the ECB.

Yes, i think we should really live the symmetric target and not tap the brakes prematurely. This is why I’ve been arguing for more accommodative monetary policy. But we are undertaking a year long review of various approaches so I am keeping an open mind.

As you can see with views like that the Donald is likely to be describing Neel Kashkari as “one of the best people”.  If we move to the detail there are various issues and my initial one is that inflation tends to feed on itself and be self-fulfilling so the idea that we can be just over the target at say 2.3% is far from telling the full picture. Usually iy would then go higher. Also if your wages were not growing or only growing at 1% you would be concerned about even that seemingly low-level of inflation.

If we consider the review the US Fed is undertaken we see from last week’s speech by Vice Chair Clarida a denial that it has any plans to change its 2% per annum target and we know what to do with those! Especially as he later points out this.

In part because of that concern, some economists have advocated “makeup” strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path.

As the credit crunch era has seen inflation generally be below target this would be quite a shift as it would allow for quite a catch-up. Which of course is exactly the point!

Comment

Central bankers fear that they are approaching something of a nexus point. They have deployed monetary policy on a scale that would not have been believed before the credit crunch hit us. Yet in spite of the negative interest-rates, QE style bond purchases and in some cases equity and property buys we see that there has been an economic slow down and inflation is generally below target. Also the country that has deployed monetary policy the most in terms of scale Japan has virtually no inflation at all ( 0.2% in February).

At each point in the crisis where central bankers face such issues they have found a way to ease policy again. We have seen various attempts at this and below is an example from Charles Evans the President of the Chicago Fed from back in March 2012.

My preferred inflation threshold is a forecast of 3 percent over the medium term.

We have seen others look for 4% per annum. What we are seeing now is another way of trying to get the same effect but this time looking backwards rather than forwards.

There are plenty of problems with this. Whilst a higher inflation target might make life easier for central bankers the ordinary worker and consumer faces what economists call “sticky” wages. Or in simple terms prices go up but wages may not and if the credit crunch is any guide will not. My country the UK suffered from that in 2010/11 when the Bank of England “looked through” consumer inflation which went above 5% with the consequence of real wages taking a sharp hit from which they have still to recover.

Next comes the issue that in the modern era 2% per annum may be too high as a target anyway. In spite of all the effort it has been mostly undershot and as 2% in itself has no reason for existence why not cut it? Then we might make progress in real wage terms or more realistically reduce the falls. That is before we get to the issue of inflation measures lacking credibility in the real world as things get more expensive but inflation is officially recorded as low.

Meanwhile central bankers sing along to Marvin Gaye.

‘Cause baby there ain’t no mountain high enough

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