Monday, December 24, 2007

Japan in 2008 ... ZIRP Coming Closer?

by Claus Vistesen

None of the writers here at Japan Economy Watch are professional forecasters and analysts per se. Yet, with what seems to be happening 'next' in Japan I can not help but think that you have been extraordinarily well served here at JEW during the past year. As such, let us have a look at what I said on Japan (and indeed the global economy) about a year ago as we stood on the brink of 2007.

(...) we have the Top 10 of economic predictions for 2007 by Global Insight where the chief economist Nariman Behavesh argues that the BOJ is likely to have raised to 1% by the end of 2007; this would then imply three 0.25% steps from the current level 0.25%. As you will see this is a part of a broad discourse concerning how global interest rates differentials will narrow as the Fed is going to cut while the BOJ and the ECB are going to raise; for the record I do not see this happening at all!

Now, the ever perceptive readers of this blog will immediately notice the apparent rather peculiar reason as to why I am feeling so smug in my introduction. In this way and apart, of course from the BOJ raising to 1%, isn't this thing of 'narrowing' of global interest rate differentials exactly what we have seen? It could indeed seem so as the Fed's aggressive easing have coincided with a fixed stance in Japan and increases moving over to holding operations at the ECB. However, this is also where I would like to start the whole 'what will happen in 2008' debate since how sustainable is this current state of affairs amongst the three G3 economies? Well, as for the US they have already bitten the bullit. The subprime mess is still pounding away with the recent victims being Morgan Stanley and Bear Sterns having to push the big delete button on a slew of internal balance sheets as it became clear that the subprime debacle had claimed yet another score of assets. But the US economy in general and while certainly still on the ropes is on its way to get to grips with its new situation and get on with the fight. I won't even begin to rant on the Eurozone here where I fear that 2008 will be a year of many a camel swallowing (or was that cold pouridge?) by those who have been pushing the Goldilocks narrative the hardest. Let me move swiftly over to Japan where as can readily be seen the BOJ has not managed to raise the short term interest rate to 1%, far from it actually. I should note in this context that I am not trying to pound excessively on Global Insight and its chief economist who I am sure is a very able and smart analyst. I am simply trying to hammer down that the consensus on Japan as it emerged from 2006 has not exactly materialised and what we now need to do is to understand why as well as we need to look forward as to what will happen next. I will begin with the latter question as Bloomberg today carries a piece on Japan where it is actually suggested that the BOJ will have to lower rates which effectively would take them back into ZIRP ...

Toshihiko Fukui's final act as governor of the Bank of Japan may be to cut borrowing costs for the first time in more than six years. Economists began predicting Fukui, 72, will have to lower rates after the Bank of Japan yesterday downgraded its assessment of the economy for the first time in three years. The bank has raised rates twice since July 2006, when it ended a policy of keeping borrowing costs near zero to beat a decade of deflation. ``They may have to cut,'' said Robert Feldman, head of economic research at Morgan Stanley in Tokyo. ``As Fukui said yesterday, the economy is getting worse.''

This is of course far from being a done deal but it is interesting to see how the discourse kicked off in 2006 with sustainable recovery stories flying all over the place to now where it seems as if we have come full circle. What I particularly want to emphasise here is that this Felman talking and when he says something on Japan people all over the place are bound to listen carefully. Whether the BOJ will actually go ahead with a return into ZIRP is difficult to say indeed. The point is that while economic factors will indeed be importants determinants so will political. The BOJ stands before a change in leadership in Spring 2008 and given the current spout of political uncertainty lingering in Japan combined with fierce debate over potential future 'un-popular' political measures (e.g. a consumption tax perhaps?) any decision and especially one downwards in the interest rate is bound to be surrounded by much commotion not least from the external environment where the G7 is sure to be jumping and dancing all over the place in the event of a cut. This brings me to the other question raised above and one which is far more fundamental and important. As such, why is it that Japan did not see that sustainable recovery? The first thing to bear in mind is clearly the fact that the financial turmoil which was brewing in the beginning of 2007 reared its head with much more force than most had anticipated. There is no doubt that this has not exactly been accomodative to the Japanese economy. However, what I really want to home in on is the narrative which has emerged here in the twilight of 2007 as it has become clear that Japan will probably be flirting with a recession. In this way, it seems that whatever happens next in Japan with respect to the inevitable slowdown of economic momentum is bound to shore up exclusively at the politicians' door. Now, this is an extremely dangerous path to go by I think as I also noted recently (for good measure, Takehiro Sato's 'Buckle Up' analysis can be found here). Edward also treats this point in one of the post which immediately preceedes this one where the following point is worth pondering ...

For anything to work for you in life you need a certain amount of good luck, and when your luck is down, and the level of adversity you face mounts, then the problems only seem to pile up. This perfectly describes Japan present problem set I think (I mean don't forget the famous pensions-records scandal, which seems to have been all but forgotten at the moment, except by the people who had their records lost, of course). If you really could live without a spanner showing up in the works, then it never fails to show up. That's what we mean by being "down on your luck". As Jefferson said, when I find myself being lucky I am normally sitting here, hard at work at my desk. That is, we make our own luck, using foresight and sound policy.

In this way and to paraphrase one of pre-modern history's most vexing questions on whose altar many a head has been severed from its body we need to ask whether the sun revolves around the earth or whether in fact it is not the other way around? Of course, no heads will be severed this time around which serves to indicate the strides human intelligence and community have made after all. So, leaving you with these arcane matters I might risk coming off as a scrooge here just before Christmas. This was not my attention but I do think that we need to think long and hard about what cause and effect are in terms of analysing the Japanese economy.

I will have more later on the actual market implications of all this and do have a Merry Christmas come next week.

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