Japan is Getting Interesting
As regular readers of Alpha.Sources will know I have become quite fond of 'Japan-watching' as a discipline and as the pundits' commentaries and general economic data keep coming in I must say that it is getting exceedingly more interesting. Clearly, I have an impetus here and in essence I feel that I am on to something and I will keep poking and scratching accordingly; so should look at the next round then? Let us by all means begin with some recent data ...
First of all the picture of consumer spending is shining bright as ever, this time as a derivative of dropping retail sales figures in November. (From Bloomberg)
Japan's retail sales unexpectedly fell for a second month, reducing the likelihood that consumer spending will accelerate and lead to an increase in the lowest interest rates among the world's seven biggest economies.
Receipts at retailers fell a seasonally adjusted 0.2 percent in October from a month earlier amid warmer-than-usual weather, the trade ministry said today. Sales of winter clothes and electronics led the decline.
The retail ``report does make it somewhat more difficult for the bank to move because things aren't exactly adding up,'' said Jan Lambregts, head of Asian research at Rabobank International in Hong Kong. ``The Bank of Japan is taking an optimistic view on the economy.''
In terms of coherency of arguments we might want to hold on to the one made by Jan Lambregts as he points out that things, in terms of the BOJ's ability to raise, not exactly are adding up. Meanwhile, we also have the recent numbers on industrial output and wouldn't you know it; here Japan shows a quite impressive progress, (from Bloomberg).
Japan's industrial production unexpectedly rose to a record, backing the central bank's assessment that the world's second-largest economy is strong enough to withstand higher interest rates. The yen rose.
Factory output in October climbed a seasonally adjusted 1.6 percent from a month earlier, the Ministry of Economy, Trade and Industry said in Tokyo today. Gains were led by autos and semiconductors as production rose 7.4 percent from a year earlier, the biggest jump in more than two years.
Toyota Motor Corp., Japan's biggest company, said this week it increased output in October by 16 percent because it expects overseas demand to climb. Central bank Governor Toshihiko Fukui said yesterday the lowest interest rates among major economies will have to rise to ensure the economy keeps expanding.
Notice especially the central bank governor Fukui's discourse about how the economy surely is on its way to become resilient enough to sustain an increase in the interest rates which for the record is still running at a staggering 0.25%. Now dear reader I can certainly understand if something in your mind is not adding up but I can assure you that by applying the right tools we can break this nut. Let me first get one point across the board here which has to do with the nature of economic growth in Japan. In short, how would we explain growth in an economy where total output is going up while domestic output is down driven by declining domestic consumption? Yep, you got it; export driven. This is of course not very complex but we need to ask ourselves why Japan's growth is export driven and more importantly why/whether it will continue to be so as we move along. As such there are two rivalving analyses here ...
1. The first explanation is roughly based on the ideas of business cycles in the economy and seems to be the mainstream way to see this. Following this it is by defintion only a matter of time before the upbeat trend in the corporate sector spills over into the private sector and thus pulls up private consumption in order to achieve a balanced growth path. As such a recent commentary from Morgan Stanley's Global Economics Forum argued the following;
As shown in preliminary Jul-Sep GDP numbers, the contrast between the corporate sector and the household sector has intensified, and this gap is not likely to close for some time. We assume that it will take a year or more for a positive growth cycle to develop, as momentum on the corporate front gradually spreads to the consumer and household level.
Notice particularly the idea of the 'gap' closing here as it is precisely this kind of dynamic I for one do not see in Japan as we move along. This is also from where we get all the mixed messages from monetary policy watchers since it is presumed that monetary policy should act counter cyclically as the economy gains momentum in order to keep the economy not to spiral out of control and thus make the bust on the other side even more severe*. However, it is of course increasingly getting difficult to defend a raise since domestic consumption stays persistently low. In essence this kind of analysis ends up as one big waiting game in which the prediction of the transition towards a 'sustainable/balanced' growth path (i.e. one based on domestic consumption too) amounts to circular reasoning based on arguments about how domestic consumption is bound to go up at some point.
2 . The second explanation is the one I have been forwarded in my observations on Japan and essentially I argue that the current environment in Japan is a result of the structure of the Japanese society with the world's oldest population. This is in fact all I am arguing at first hand which crucially means that we should not expect any hikes by the BOJ anytime soon and also that private consumption will continue to drift gradually downwards. So am I trying to re-write the economics textbooks here? Well not yet at least ... I am sure that at some point as the effects of the global demographic trends become clear there will be a theoretical showdown between growth and business cycle theory on the one side and another pardigme which is way more sensitive to the demographic changes which display a very real transmission mechanism with the macroeconomic environment.
On that note let us also take a look at a recent piece from, yep you guessed it, Morgan Stanley Economics Forum (Robert Alan Feldman) about the peculiar nature of private consumption in Japan. Now let me say initially here that Feldman's piece comes really close to an explanation of what we are seeing here and he is really getting a lot of things right in my opinion. The first important thing is that Feldman seems to want to address head-on the conundrum of why corporate investment (CAPEX) is increasing while private consumption remains low. Notice also in particular Feldman's recognition that business cycles are of little use here ...
What is “funny” at the moment? Consumption is decelerating while capex is accelerating and profits are still rising ― all this after what has already been the longest expansion in post-war history. There is a problem of consistency here. Corporations are predicting an outright decline of profits in the second half of the year. But if firms are so worried about profits, why are they investing so much?
Cycles are cycles, goes the mantra, and if things are good today, they have to turn bad tomorrow. If we have not seen the downturn yet, it must be coming soon. So, consumption swings wildly, and firms continuously undershoot profit estimates. So far, the number of people saying “That’s funny” is small. However, the longer the anomaly of strong capex and weak consumption continues, the more likely will emerge others (like myself) who will claim that high capex and low consumption is the correct structure for the economy.
Wow, that is certainly interesting is it not? Hands down, Feldman is the first semi-influential commentator I have seen who have argued this to be a structural phenomenon and consequently I feel we have already taken a huge step forward here. Now, for the sake of argument I will skip through to Feldman's conclusion in which he reveals his fundamental case for optimism;
The key reason for my optimism is simple: The combination of aging demographics and structural reform has created a new dynamic in Japan. This new dynamic will keep capex and productivity rising, and obviate the need for as much consumption growth as would have been necessary at an earlier stage of Japan’s economic history.
This is of course where I disagree a bit with Feldman but let us still scrutinize this a bit. A new economic dynamic in Japan driven by changing demographics which influence the use of input variables to production (i.e. high CAPEX) thus maintaining high productivity growth and indeed economic growth detatched from the need to rely on domestic consumption. Or as I put it above in fewer words above; export driven ... and this time it should seem pretty clear that the export nature of growth is a structural and indeed inevitable result primarily caused by the ageing of the domestic population.
So why do I disagree with Feldman? Well, in order for Japan to run on exports others need to run deficits, this should be fairly clear for even non-economists. This is of course all migthy fine but the problem is that Japan is not the only country in the world with a rapidly ageing population and the need to run a surplus in order to grow. In fact, this is beginning to look alarmingly much like an explanation of what we like to call global marcroeconomic imbalances; or as Edward Hugh neatly puts it;
In other words Feldman has, inadvertently walked right into the current global imbalances minefield by suggesting that Japan, as an aged economy (and the first of many more to come) will have to be high capex, low consumption, and logically, to sell the product, dependent on exports. What happens if this ever sinks in somewhere?
Food for thought I should say?
*I am nimbly avoiding to open the can of worms here about whether we should adhere to the view of 'real business cycles' which argues that fluctuations in fact are expressed directly through fluctuations in potential output or whether the sluggish adjustment of macroeconomic indicators themselves are what cause business cycles. The expectation of a correction in domestic consumption (I guess (?)) would then be based on the latter view.
Post scriptum ...
In fact Edward Hugh from Bonobo Land has also recently done some very interesting posts on the sources above. Clearly, he and I are grinding the same ore here. Of particular notice is this post in which he scrutinizes the fiscal situation in Japan. See also the post on the recent consumption data and also the post discussing Feldman's piece in much detail. More generally Edward and I are also putting up all our Japan post on the blog Japan Economy Watch, basically in order to collect all our sources at one place.