Tuesday, February 19, 2008
Consumer prices rose 7.1 percent in January from a year earlier, the statistics bureau said today, after gaining 6.5 percent in December. January's consumer prices climbed 1.2 percent from December.
Widespread expectations of a significant jump in retail inflation had been reinforced yesterday when manufacturing producer prices hit a three-year monthly year-on-year high of 6.1 per cent, mainly as a result of winter transport bottlenecks and higher commodity prices.
There are signs that global inflationary pressures have been fuelling higher Chinese food prices. Global prices for top-quality spring wheat - for example - have jumped by 90 per cent in the past six weeks, as corporate consumers have scrambled to secure supplies and speculators have bought stocks. The rising cost of pig feed is another example, and pork prices climbed 59 percent, edible oil 37 percent and vegetables 14 percent. Even more preoccupying is the fact that this process might now endure well into the year – creating a further headache for Chinese policymakers.
The breakdown of the CPI is also interesting, food, with a weighting of about 25%, is obviously important, and the price of foodstuffs increased 18.2 percent. Of this total, the price of grain was up by 5.7 percent.
On the other hand clothing was down by 1.9 percent year-on-year. The price of household facilities, articles, and maintenance services rose by 2.1 percent year-on-year. Of which, the price of durables rose by 0.7 percent, but household services and upkeep surged by 10.7 percent.
The price of health care and personal articles increased 3.2 percent year-on-year. The price of western medicines increased by only 0.5 percent, while that of traditional Chinese medicinal materials and medicines was up by 11.4 percent.
The price of transportation and communication dropped 1.1 percent, with transport alone dropping 2.9 percent. Communication prices fell by 19.6 percent. The price of recreational, educational and cultural articles decreased 0.3 percent. Of which, price of tuition and child care increased 0.5 percent; that of teaching materials and reference books dropped 1.3 percent; that of expenditure of culture and recreation increased 2.1 percent; that of tourism and outgoing was up by 5.1 percent; and that of cultural and recreational articles dropped 0.7 percent.The price of articles related to residence expanded 6.1 percent over the same period of the previous year. Of which, price of water (5.5%), electricity (5.7%) and fuels (4.7%) all up strongly.
Inflation has soared since last year on food and fuel costs, but it is important to note that wages were rising by a very rapid 22% on a national basis in Q3 2007, and a surging money supply increasingly poses the risk that these price gains may become self-propelling.
The threat of enduring inflation will add significantly to the pressures on Beijing to allow an even faster appreciation of its tightly managed currency. Food prices soared 18 percent after blizzards paralyzed transport systems and destroyed crops. The government faces the challenge of curbing inflation without derailing the expansion of the world's fastest-growing major economy
The renminbi, which has risen by about 13 per cent against the US dollar since mid-2005, has been rising more rapidly recently, in-creasing at an annualised rate of about 19 per cent in January.
As a result, China’s central bank is, technically, losing billions of dollars a month on the foreign exchange reserves it invests in US dollar instruments because it is paying higher rates at home on renminbi bank bills than it is getting in the US. The key one-year lending rate is 7.47 percent.
With interest rates on the back burner, a higher renminbi has become an important weapon for the government to fight inflation, by lowering import costs of oil and other commodities as well as soyabeans. Eighty per cent of soyabean imports are used for pig feed.
Although higher Chinese costs and currency appreciation will inflate its export prices, China is still importing inflation rather than exporting it at the moment, say economists.
“If anything, what is happening in the US is affecting China rather than the other way around,” said one Beijing-based economist is quoted as saying.
Monday, February 18, 2008
Slowing inflation may be temporary because Prime Minister Manmohan Singh yesterday approved raising retail fuel prices for the first time in 20 months. India's central bank kept interest rates at a five-year high on Jan. 29, citing concern that fuel and food costs may fan inflation in Asia's third-largest economy.
Higher borrowing costs are putting a brake on demand for homes, motorbikes and other consumer durables, and this is significant since consumer spending has been a key driver of India's economic growth in recent times. Bajaj Auto - India's second- biggest motorcycle maker - reported recently that sales fell in January as local demand declined. Sales of motorcycles, three-wheeled auto rickshaws and scooters fell 16 percent to 192,193 in January from 229,583 a year earlier. That aggregate number included exports of 43,533 units, a gain of 9.3 percent.
But there seems to be something of a tussle going on between the Finance Ministry and the Central Bank over what to do about the situation. India's government announced on Feb 7 that India's economy may well only expand by 8.7 percent in the fiscal year ending March 31, which would be the slowest pace in three years, and the slowdown is in part the result of higher interest rates, and in part a consequence of the higher rupee, which makes India's exports more expensive.
On February 12 Finance Minister Palaniappan Chidambaram asked state-run banks to provide more loans for the purchase of homes and consumer goods after asking banks to cut interest rates last month. But it is not clear that they are of the same mind over at the Reserve Bank of India. Inflation is constantly being stressed, and needs to be brought down further, according to central bank Deputy Governor Rakesh Mohan yesterday in New Delhi, speaking just before the announcement of a fuel-price increase. ``The inflation rate is still high by global standards," he is quoted as saying. The Singh cabinet approved raising the retail gasoline price by 2 rupees (5 U.S. cents) a liter and the cost of diesel by 1 rupee a liter,yesterday.
Previously, the government had capped fuel prices and lowered import duties over the past year to curb inflation. It hadn't allowed any rise in fuel prices since June 2006, even as the cost of crude oil surged 57 percent last year and climbed to $100 a barrel in January.
“Fukui has often been portrayed as chomping at the bit to raise rates,” says Ben Eldred of Daiwa Securities “The truth is that Fukui’s BoJ has been fairly pragmatic – waiting until relatively late in the economic cycle before raising rates, doing so only very gradually and pausing as soon as it became clear that the global economic outlook had worsened in 2007.”
The pause to which Mr Eldred refers has lasted a year. As well as a response to international circumstances, the delay also reflects the failure of the domestic economy to click into gear as Mr Fukui has long predicted. The governor has continually stressed his belief that record corporate profits will feed through into higher wages and consumer demand – a “virtuous circle” that might have been a good justification for the bank’s forward-looking policy.
Unfortunately, it has not panned out. Wages have stalled or even fallen as global competition, coupled with labour market and demographic changes, has short-circuited the normal mechanism by which profits flow into remuneration.
This has left Japan’s economy running on only one, export-led engine and flying too close to the deflationary ground for comfort. What headline inflation there has been is due almost entirely to higher oil and commodity prices. If commodity-led inflation fades – as many predict if the global economy slows – Japan could yet crash-land back into deflation.
Markets are factoring in the possibility that the BoJ’s next rate move will be down – not up as the governor has long intimated. It would be a severe blow indeed for the bank to put hard-won interest rate rises into reverse. But if the day for such a decision arrives, at least it will not be Mr Fukui’s to make.
Basically I think Fukui's big bet was that domestic consumption would prove strong enough to provide a second leg (in tandem with exports) for the Japanese economy. As Claus details at great length here (and here) - and as Pilling also seems to accept -this view seems to be inadequate, and fails to get to grips with the malaise which is affecting the Japanese economy. And as if to give just one last kick to this now thoroughly wobbly perspective, todays index for December services has just been published by the Japanese Trade Ministry. The tertiary index, which is a measure of the money households and businesses spend on things like phone calls, power and transportation, declined 0.6 percent from November. The Ministry listed the following sectors as having declined:
1. Finance and Insurance, 2. Services, 3. Compound Services, 4. Wholesale and Retail Trade. Industries that contributed to the increase are as follows:1. Eating and Drinking Places, Accommodations, 2. Real Estate, 3. Learning Support, 4. Electricity, Gas, Heat Supply and Water, 5. Medical, Health Care and Welfare.
Although the index actually rose some 0.2 percent over the fourth quarter, this latest sign of weakening will certainly not come as good news for Fukui as he prepares to clear up his desk.
Saturday, February 16, 2008
In the context of Francois Guillaume's pertinent comments and questions to my review and preview note and in the light of today's much surprising Q4 GDP release I have chosen to present my comments and answers to Francois' questions/comments above the fold à la Q&A.
1) GDP much higher than expected...how do you explain that ??
I want to focus on two issues here. First of all, the current figures are preliminary and in this light I expect to see a downward revision in March. In this light, we need to realize I think that given the incoming stream of data we have seen from the three months of Q4 2007 this figure of 3.7% (Q4 YoY) is pretty hard to justify. For a reasonable take on the whole situation Graham Davis from the Economist Intelligence Unit had a good overview I think in his interview with Bloomberg (can’t hyperlink to the clip I am afraid). Also, we should note I think a comment made recently by Takehiro Sato over at Morgan Stanley’s GEF …
Incidentally, in Japan’s case, quarterly GDP data are too volatile to be a suitable criterion for calling the economic cycle. This is clear from the GDP trend in past recessions. Yet while GDP has at times been positive when the economy is in retreat, industrial production has consistently mirrored the downward path of the economy. It seems reasonable to say that the critical factor for assessing the economic cycle is simply the direction of industrial production.
However, if we accept the figure as it is I still don’t think that the underlying path of the Japanese economy has changed even if the level seems somewhat too high. Let me consequently highlight some of the snippets from Bloomberg’s report on the break-up of the GDP components as well as the much more detailed break-up provided by Edward vis-à-vis the official estimate provided by the Cabinet office. What thus seems clear to me is that although consumption rose in the last half of 2007 net exports and by derivative capex continues to drive forward Japan on the margin. Remember that we need to talk about levels here too since private consumption commands a much larger share in the Japanese economy than does both investment and net exports.
Let us try to annualize the quarterly growth rates in both real and nominal terms which yields a quite different picture. In real terms Japan thus grew 1.8% through 2007 and in nominal terms we are down to a rather un-impressing 0.6%. Particularly for Q4 the figures are 0.9% and 0.3% for real and nominal growth rates respectively. In this way, the GDP deflator is a welcome alternative to the CPI index in that it accounts for the change in prices relative to what consumers actually buy in the measurement period. Thus note in passing the following from Bloomberg …
Rising oil prices may have boosted growth in real terms. The GDP deflator, a broad measure of prices used to calculate real growth from nominal, fell 1.3 percent from a year earlier, the biggest drop since the first quarter of 2006. The deflator is adjusted downwards when oil prices rise. In nominal terms the economy grew an annual 1.2 percent in the fourth quarter.
I am going to discuss this more below since inflation measurement is clearly one of those areas where data mining and basket building can be used to construct just about any kind of number you would like. In this way, all these kinds of inflation adjusted growth rates etc need to be taken with a pinch of salt. In conclusion on the GDP figures I think the following is important to note. First of all, this is good news since it indicates, all things equal, that Japan has defied at least some of the claims that a recession/slowdown is imminent. However, I am not sure how much valuable information we can reasonably derive from the figures at this point. First of all, I think these figures are in for a haircut once they are subject to revision. Yet, even if we rely on them such as they are I think that it is reasonably clear how for example the value component of energy prices might have pushed up the real GDP to unrealistically high levels if we consider the underlying trend.
2) Inflation: see my previous posts: CPI is just a price index. Its definition is very different from a country to another. Change in the index & methodology would give a total different picture. Most important is the trend of the index itself, and the recent trend is up. It’s ridiculous to speak of deflation any more. CPI has been ranging from -2% to 1% in last years. It doesnt make a lot of difference. Asset-prices are more important: Nikkei is still nearly more than 80% off 2003 lows, real estate in central Tokyo as well despite being off its highs probably by 20% at least.
Unfortunately I am not sure about which posts Francois is referring to here but nevertheless he fires off a lot of reasonable questions here. First of all, I completely agree with the point on methodology. Since the CPI is based on a basket which can be changed and re-weighted and since the CPI may or may not include headline inflation what we end up with is a veritable mind field of potential ‘best practices’. This also means that whatever the picture you want you can rig the data so that your specific view of the world emerges. I don’t think however that this is what I have falling victim to in my analysis of Japan. In my opinion, the price movements in Japan both in the most recent period as well as in 4-5 year perspective show two things.
First of all, there is the overall level of inflation which has been very low and essentially negative. This, coupled with the very aggressive monetary regime put in place to normalize conditions indicates I think that there is indeed ‘something funny’ about consumption and domestic demand in Japan and this is what has led me to conclude that the whole price edifice in Japan has something to do with the population structure of the country. Secondly and in the more immediate context the recent divergence between input and output prices further support my claim that price dynamics in Japan do not follow the theories we can discern from macroeconomic textbooks and traditional empirical studies. Moreover, it obviously suggests that the equality often exclaimed in the financial press between the return to inflation and economic recovery is wrong.
Now, all this leads me to disagree with Francoise when he says It doesnt make a lot of difference. I think it does although I do agree that asset price deflation/inflation is extremely important too. In this respect the Nikkei is mentioned being considerably off its low levels of 2003 as well as those much debated Tokyo real estates have seen hefty increases in price. Both these points are very important to take aboard I think and merits, at least a bit, that Japan has moved on. Of course, the most recent developments in the Japanese housing sector suggest that the construction/residential sector in Japan might very well be in for a more difficult future but let us leave this point here.
However, what about another kind of asset in the form of human capital? How does the value of this asset stand? Well, as we have observed one of the recent trademarks of the Japanese labour market has been a consistent decline in wages and the transition from a labour market of full time workers to part time workers (on the margin of course). Since aggregate national wages essentially can be seen as a measure/reflection of the national labour productivity (either absolute or per/hour) what does this imply for the general price level in Japan? As can be seen, this readily becomes rather complicated. Another reason as to why inflation matters has to do with the workings of a modern economy is monetary policy. Quite simply, deflation or next to no inflation has implications for the workings of monetary policy as well as it has implications for the consumption dynamics of the society. More importantly, we have seen the condition of deflation in Japan and subsequent low interest rates have had notable externalities on the global economy. So, I would say that it does indeed matter.
3) Monetary policy. I fear there could be a big misconception on USD buying interventions. MOF as you know is running a hell lot of debt. It is short Yen cash. But it seems to me that most of the FX intervention is executed by BOJ, but on behalf of the MOF. So when MOF buys USD, it needs to borrow even more JPY. But with the end of Quantitative easing, they can’t issue as many Financial Bills to back them as they would like to (because BOJ would basically buy an unlimited amount of them @ 0% before.) I think that with the deterioration of public finances, it becomes harder to do such intervention. So I see just a lot of talk, not much more.
Here I stand corrected. Consequently, I had not, in my analysis of the JPY and subsequent potential for intervention, thought about the perspective Francois presents here. It is very interesting I think. Now, for some of our readers this may seem a bit complicated but what Francois is saying is simply that absent quantitative easing/ZIRP it becomes more ‘expensive’ for the MOF to intervene since they cannot be sure that they are able to offload the subsequent debt. Of course, this also paves the way for a rather perverse scenario. Consider thus that the JPY is driven largely by risk sentiment at the moment. If the BOJ sees it fit to lower rates during the course of 2008 and perhaps even returns to ZIRP we could expect the JPY to shoot up given we accept the current market dynamics. Note in passing here that this morning’s GDP release has been followed by a depreciation of the JPY which shows the disconnect between the fundamentals and the JPY. In this way, a return to ZIRP or just a drop to 0.25% could in this context be followed by an increased in the pressure to intervene. Of course, this is not a plausible scenario at this point but still goes to show the potential dynamics as we move forward.
4) JPY everybody I talk to is bullish on the JPY... maybe that is why it is so sticky now...but its way off its lows against many crosses.
As I have said above and also in my recent review and preview the JPY remains wholly disconnected from the fundamentals of the Japanese economy. I concur with Francois that the sentiment on the JPY at the moment seems to be bullish given the general risk sentiment in the markets. At time of writing it is sniffing at 108+ which is outside the recent weeks’ range of 106-107. It is difficult to see where it goes from here. I am expecting this ‘stickiness’ theme to dominate since it is unclear I think whether market conditions would favor a move below 105 or upwards to 110.
5) Long term interest rates... the credit markets have imploded in less than a year. My prediction is for a failure of a big govt bond market in 5 to 10y time. Japan would be an obvious candidate. In that scenario, long term interest rates are heading HIGHER. Just people will be tired to be stuck with low interest rates when there is inflation everywhere. But in the short term, as the asset-bubble is deflating, and this process is not over, global govt bonds will remain for some time the asset of choice, by default.
Now, this is very interesting in my opinion. Whether or not we will see a failure in a government bond market is an open question subject to one of those rather long term falsification clauses. I have argued before that in the context of countries such as Japan and Italy it will, at some point, cease to make sense in ‘rating’ the sovereign debt market based on the same criteria as you treat e.g. India, the US etc. Quite simply, this will become unfeasible as we move forward since this would push these countries into a technical default. As Francois alludes this may of course come to pass some way or another not because of the rating agencies themselves but rather because with inflation the nominal yield may become too unattractive.
Note also that once we enter this discussion we also enter a whole gamut of issues in the context of Japan in the sense that the BOJ and the MOF is in a double bind. On the one hand the BOJ faces external pressure (those externalities again) to raise or more aptly to normalize rates but it finds this difficult because deflation still dominates the general price level. Moreover, a transition towards whatever the interest level we assert to be normal would most likely drive up the value of the JPY and thus further lead to deflationary pressures. We should also consider the simple points that as interest go up the debt becomes more expensive to service and in this way the MOF has a distinct interest in keeping interest rates down. Within this framework headline inflation pressures are of course simply a further pinch it seems not least because of the reasons mentioned by Francois.This topic on sovereign debt and long term interest rates is very important I think but for now I think that I will lower my guns. Thanks for Francois for the comments. Needless to say, here at JEW (and at Alpha.Sources) we always appreciate to be challenged on our views and opinions.
Thursday, February 14, 2008
On a quarter-on-quarter basis, growth in Q4 was at 0.9%, up from 0.3% in Q3, and the -0.4% contraction in the second quarter.So it is clear that, despite all the negative sentiment we have been faithfully recording here, the Japanese economy actually accelerated in the second half of 2007 and this despite the dramatic slowdown in residential housing. The big question - as Francois reasonably asks in comments to Claus's last post - why?
I freely admit these results have surprised me, as I was expecting something significantly worse. But I suppose we should to some extent have seen this coming. Growth in Q2 was very bad, and the rebound in Q3 was relatively weak, yet all those export numbers we have also been recording over the months - and the surprise upside in consumption in December - should have been some sort of indication. Plus government spending in the last quarter seems to have been pretty strong. Lets take a look at some of the details.
I have made the following charts on a simple cut-and-paste basis from the PDF summary file provided by the cabinet office, but I think they may help people to see what is happening at a glance, since they show either the percentage contributions of the more important components to growth or the quarterly percentage growth rates (depending), and hence may make what are otherwise pretty dry numbers a bit more real. Firstly the evolution in real quarterly GDP growth (all the charts are based on real, not nominal, data).
If we now come to look at the comparative role of exports and domestic demand, we can see that while the role of exports continues to be strong (and is much better in both Q3 and Q4 when compared with Q2) the share was actually down slightly on Q3, so exports aren't the whole story here by any means, since domestic demand moved from being a negative 0.4% drag in Q3 to a positive 0.5% boost in Q4.
Household consumption was up slightly, contributing 0.2 percentage points to growth:
The decline in residential construction continued and even accelerated across Q4 (residential construction declined by 9.1% over the previous quarter when it declined by 8.3% from Q2, although the rate of decline may well have been slowing off in November and December).
Private non-residential investment (or fixed capital formation) grew strongly in Q4. Could we interpret this as a response to the stronger than expected performance in exports in the face of the US slowdown?
But perhaps the biggest surprise of all comes from government consumption, which grew 0.8% over the previous quarter, contributing 0.1 percentage points to quarterly growth.
So to go back to Francois original question, about how to account for the Q4 performance, could we say some small improvement in household consumption, sustained export growth, an increase in government consumption (perhaps undertaken to offset the impact of the housing contraction), and a large rise in investment, as I say possibly the outcome of the strong performance in exports and the reasonable domestic consumption outcome leading people to be a wee bit more optimistic about the immediate future.
And here's a bit of news I just saw in Bloomberg that may help explain some of what is happening on the exports front:
Japan's shipments of construction machinery may rise 9 percent to a third straight annual record next fiscal year as building and mining booms in Asia drive demand for earthmovers built by Komatsu Ltd. and its rivals.
Shipments of excavators, tractors, cranes and other construction machinery may climb to 2.6 trillion yen ($24 billion) in the year starting April 1, according to estimates released by the Tokyo-based Japan Construction Equipment Manufacturers Association today. Shipments in the year ending March 31 may reach 2.4 trillion yen, 15 percent more than the previous year.
China's effort to develop its hinterland, oil-funded construction booms in Russia and the Gulf nations, and mining projects in Southeast Asia have countered the housing recession in the U.S., the world's biggest market for earthmoving equipment. The demand has prompted Komatsu and Hitachi Construction Machinery Co., Japan's biggest makers of earthmoving machinery, to expand factories and boost production.
Wednesday, February 13, 2008
I realize that I am moving in a bit late with this but the data I use to input in my analysis only recently came out for December 2007. More generally, this post is going to be quite big since I have a lot of things I want to get off my chest this time around. I have two main areas of focus I want to cover.
- Firstly I want to finalise my analysis of Japan in 2007 with the December data for consumption expenditures and prices.
- Secondly, I want to continue with a general assessment of two of the main market points in Japan at the moment. The Yen and the BOJ rate policy faced with an incoming slowdown and potential recession.
As for the general situation in Japan I am sure it has not escaped your attention that Japan now seems set to enter a recession. The only question will be the extent and more importantly the length of the slump. In Morgan Stanley's GEF (edition 8th of February) Takehiro Sato points towards industrial production trends as well as US GDP readings and tantamount to the forecast that Japan is heading more meager times ...
The risk of dual recession is mounting. Our US economics team is already calling for capex-induced negative GDP growth in successive quarters (Jan-Mar, Apr-Jun), for a technical minor recession in the first half of the year by definition. We are forecasting that Japan will cling on to a modicum of growth in the Oct-Dec 2007 quarter, boosted by external demand, but there is a possibility that, like the US, that quarter will mark the peak and the economy will retreat in Jan-Mar. Future data for industrial production will tell us if this is the case.
This note will not focus on figures for industrial production or US GDP stats but rather I will initially move in with my traditional focus on the internal demand dynamics in Japan. As ever, the Japan Economy Watch contains the latest cyclical indicators fresh in off the wire in order to bring you up to speed. Here at Alpha.Sources I made a note recently which also sums up the most recent trends and pieces of data. For now, let us turn to the updated charts which usually form the main edifice of my analysis of Japan ...
If we begin with prices we see that inflation, at a first glance, seems to have returned to the shores of Japan even to such an extent that I will soon need to adjust the y-axis of my graph (and yes, this is an apology for a sloppy excel graph). Yet, the most important point to take away from this is, as I have been at pains to hammer home before, the disconnect between the inflation indices. Core inflation as measured by inflation ex food and energy prices is still in negative territory whereas the general index is shooting up thanks to headline inflation. This disconnect suggests that the inflation we are seeing in Japan is not driven by demand factors (demand pull) but rather by supply factors (cost push) and thus this does not signal an impending Japanese recovery.
Quite the contrary in fact as the spurt of inflation at this particular point in time will only further pinch an already troubled Japanese consumer. Edward also moves in with a much worth while analysis of the inflation issues in Japan. A key point here will be the extent to which future inflation readings will have a bearing on the BOJ's decision to actually move in with a cut in the already low interest rate of 0.5% in order to accommodate a slumping economy. I don't think Fukui will cut rates before his term ends this spring and given the debacle which may arise in the context of finding a new governor it seems that economic fundamentals should not be the only thing to watch in order to make a call. What seems obvious however is that if inflation pressures suddenly show signs on abating the door will be open for a cut.
If we turn to the indicators for domestic demand proxied by various measures of consumption expenditures we can also close the book on my forecasts for 2007. As such, I dared to venture that growth in consumption expenditures would not increase by more than 1% on a y-o-y basis. Let us look at what we have.
Let us start by the forecast first. As can be observed the Japanese consumers put in a strong showing in December on a y-o-y basis with a 2.2% increase. I have to say that this figure represents something of a fluke for me since if you look at the underlying indicators such as income, retail sales and department store sales they all clocked in with declines. Ken Worsley also ponders the 2.2% increase and provides a detailed break-down which shows how spending on culture and recreation as well as furniture and household utensils accounted for a substantial part of the increase.
I have to agree with Worsley though when it comes to January and beyond where the rise in energy prices, declining income, and a general slumping confidence will be sure to slow spending considerably. As for the forecast, the December reading almost had my forecast shattered or, if you will, assured that I was very close to the mark. Consequently, the mean value of the increase in consumption expenditures was a 0.95% monthly y-o-y growth rate. The two remaining charts are merely there for differentiation. The average value for the m-o-m chart was 0.217% in 2007 and together with the y-o-y figure it shows the momentum and level of growth rates we can expect from Japanese internal demand in a given economic environment.
The long term index anchors my analysis in the sense that it supports the general hypothesis that domestic demand is on a structural decline in Japan and that this might very well be due to the demographic profile of Japan, this last point of course being a hypothesis of mine. In terms of forecasts for 2008 I have no trouble extending my forecast of an increase of <1%>
Before I finish I want to make a leap up towards current events and assess a couple of mounting issues in the context of Japan. Firstly, I think that the Yen demands some attention. Recently, I noted how the Yen was driven by anything but macroeconomic fundamentals. This clearly still seems to be the case. However, the main question is when this will end? At the moment and if you look at the FX price action in the beginning of 2008 almost all Yen crosses have been correlated with the stock market and thus by derivative the general sentiment of risk aversion in the market. This is nothing new in the sense that since the subprime market hit the global economy in the middle of August 2007 the Yen has been the main canary in the coalmine when it comes to the risk sentiment in the market.
Yet, the Yen is not only driven by cyclical factors. As such, the decline in home bias of Japanese investors as well as the general yield disadvantage of Japan suggests that all those talks about an undervalued Yen aren't clued in to what is really going on in the sense that what is really the fair Yen value at this point? We need to think about the fact that the whole global economy seems to be undergoing the initial phases of a much more structural correction (recoupling) and in this context it is difficult to see how the Yen can stand its ground. It might not happen today or tomorrow but I have difficulties seeing how the risk aversion dynamic can hold the ground for the more wider and structural trend.
Turning to more immediate drivers of the Yen the potential that Japan would intervene in currency markets to cushion the Yen's depreciation has reared its head with regular intervals. Back in early November I asked the question putting the limit at 105 for the USD/YEN which. Various other estimates have been around. Morgan Stanley's Stephen Jen puts it at 100 which is just the same as Macro Man. Recently, currency strategist at Dailyfx Boris Schlossberg kept the speculations alive suggesting, as me, that 105 just might be the threshold for Japan. Currently the Yen is hovering in the region of 106-107 and in this light Boris' conclusion seems to be a sound one, if a bit noncommittal, to take with you in the trenches of FX trading.
While there is certainly no guarantee that the BOJ will intervene at the 105-100 area, economic factors and positioning data suggest that Governor Fukui and company may indeed opt for that solution. Given that possibility the above mentioned strategies should hopefully minimize risk and optimize return for both momentum and carry traders. At the very least traders should pay particular attention to the price action if USDJPY slides down to the 105 level in the near future.
From a macroeconomic point of view this makes sense. Japan is largely dependant on exports to fuel growth as well as need to remember that an appreciating currency is deflationary and Japan has not escaped those fangs just yet. As for the Yen all evidence seems to point towards a continuation of current trends for the immediate future with the Yen acting as a global parameter of risk and investors' risk aversion. In this light, the risk of intervention needs to be weighed in as a potential market mover as we move forward.
The second topic I want to cover has already been mentioned above and essentially also cuts across the whole discussion on the Yen. In short, what will we see from the BOJ? Perhaps the most important thing to note here is that before we get to the discussion of what exactly the policy rate will be as we move forward into 2008 the BOJ will need a new governor. As I noted in my long end-of-2007 note this may well turn out to be quite a messy affair.
Whether the shift of guards at the BOJ will turn into the political gridlock many observers have indicated is difficult to see from my desk here in Europe. However, there are some clear risks. As I have argued before a situation of political stalemate in which the Democratic Party of Japan (DPJ) will use their majority in the upper house to stall the nomination of a new governor will, all things equal, bring the MOF closer to monetary policy making. Basic logic would, in such a situation, call for a freeze of the nominal interest rate until the new BOJ leadership is set to assume their seats. However, if this current slowdown turns for the worse it may provoke measures which at this point in time might seem unrealistic. One risk is thus that Japan re-enters ZIRP over the course of 2008 and that this happens sooner rather than later. Before this materializes however, I am quite happy moving in behind the Morgan Stanley team in forecasting a cut in the main refi rate for Q2 2008.
A lot of ground has already been covered in this piece and as such I think it is time to move in with some summarising remarks. I had two main objectives in this note. Firstly, I finalised my monthly analysis of consumption expenditures (domestic demand) and prices for 2007. Even though 2007 most likely will go down as a rather strong year in relative terms the failure of the overall consumption expenditure gauge to break the 1% threshold YoY tentatively suggests that domestic demand cannot become a driver of growth in Japan in any given sense. This point was underpinned by the monthly and long terms indicators of consumption. In connection to prices, we observed how inflation seems to be coming back to Japan. Yet, if we strip out energy and food Japan is still stuck in deflation and even though the core-of-core index might also nudge up towards positive territory the transmission mechanism from headline inflation to core inflation does not suggest that the inflation pressures we are seeing are driven by buoyant domestic demand. This does not warrant complacency against inflation but tells a story which needs to be told I feel if you really want to understand what is going on in Japan.
I also had a brief look at the Yen and more specifically the driver of the currency. I concluded that while risk sentiment seems to be the main trend explaining the current movements more general structural forces should not be neglected. The key issue here is timing and thus the dynamic relationship between the immediate environment and the more long term structural trends. Moreover, I also reviewed the latest speculation that we will observe intervention in the FX market by MOF and the BOJ. At this point, we have no clear indication that this will occur but I think the possbility should be entertained that the MOF will dip its toe at some point. In terms of the the BOJ and a subsequent call on the rate policy in Japan I moved in behind Morgan Stanley noting that Q2 2008 will see a cut to 0.25%. Another factor which I discussed was the extent to which the departure of governor Fukui will result in a policy gridlock. The risk is definitely there I would argue and it is a possibility which should be taken into account. I think that such a gridlock would (and should) result in a an effective standstill of rate movements but if the slump turns for the worse new dynamics may come into play where the MOF moves in to 'politically' steer down interest rates. Whether 2008 will see ZIRP is still an open question I think. I believe the probability is fairly high not least because I think that the recession we are now seeing on the horizon may very well be more severe than many expect. The main question however is not centered on the slowdown in Japan per se. This is the nature of economic cycles in the sense that they go up and down; yet, what remains the most compelling question in Japan's case is just how far and how long it will be this time.
Tuesday, February 12, 2008
Industrial production grew 9 percent in the nine months ended Dec. 31, less than the 11.2 percent gain in the same period in the previous year, the government said. Manufacturing in December rose 8.4 percent, led by a 16.6 percent increase in the output of capital goods such as plant and machinery.
Higher borrowing costs are prompting consumers to postpone purchases. Bajaj Auto Ltd., India's second-largest motorcycle maker, posted a 16 percent drop in sales in January, its 12th straight month of declines.
ABN Amro Bank NV's purchasing managers' index indicated manufacturing growth recovered in December from the previous month and fell again in January to the lowest level since September.
Prime Minister Manmohan Singh's government is spending 1.34 trillion rupees ($34 billion) in the year ending March 31, a 40 percent increase over the previous year, on roads, ports and power plants.
Economic expansion in India is still the second-fastest after China among the world's biggest economies. The economy has grown an average 8.8 percent since 2003, the fastest expansion since the country's independence in 1947.
India's middle class, defined as those with annual disposable incomes between $4,380 and $21,890, has more than doubled to 50 million in the past decade, according to McKinsey & Co., the New York-based consulting firm.
Sunday, February 10, 2008
Certainly both local Chinese and World Bank economists have significantly downgraded their forecasts for China’s 2008 growth in recent weeks – down from 11.4 per cent rate achieved in 2007 to around 9 to 9.5% this year. But more importantly, could the 11.4 per cent expansion in 2007 – the fifth consecutive year of double-digit increase – represent the peak point in headline growth for China's economic development process. That is, after falling back this year, will Chinese growth ever climb back to its previous heights, and even if it doesn't , should this fact be producing concern among us?
On the face of it, it is obvious that noone - not even China - can continue growing at double digit rates forever, and at some stage the cycle of growth will fall steadily back towards the much lower rates traditionally associated with a developed economy. The big question is really, has that point now been reached?
To get an idea of what we are talking about, and of what all this might this mean, perhaps it is interesting to take a quick look at the longer term growth patterns of some other economies who have been through the "accelerated greenhouse" catch-up growth that China is currently enjoying. Perhaps a good place to start would be with South Korea, since South Korea is arguably the South East Asian "tiger" which is most similar to what Chinese economic evolution might look like, since Singapore, Taiwan and Hink Kong are, each in their own way, very special cases.
Now as we can see from the above chart, South Korean was at one point very strong indeed, until growth "peaked" around 1987 (at 11.1%) and since that time growth has followed a more normal cyclical pattern, with the important detail that with each successive cycle Korean growth has slowly and inexorably slowed ("stripping out" the very exceptional sharp decline and rebound produced by the Asian crisis in 1998).
Economic growth for an emerging economy tends to show this kind of profile since in general terms there are both technological and demographic components in "catch up" economic growth - although there may actually be no such thing in reality as a constant steady state rate to catch up with as I try to argue here - and once most of the technological gap has been closed and the benefical momentum of arriving at maximum proportions of the population in the highly productive 25 to 50 age group begins to pass, economies then seem to eshibit a steady loss of momentum rather like air escaping from a pinprick in a gas balloon, as we can see in the cases of the two oldest societies on the planet, Japan and Italy, in the charts below.
Now I have singled out Italy and Japan (the profile for France, or the UK, or the US is really quite different) since they are both late economic developers, and also since their subsequent demographic transition to ultra low fertility has been very rapid, as it is about to be South Korea and China. Hence Japan and Italy have experienced very rapid ageing, and we already know China is about to follow them down this road, at what may well be an even more rapid pace. In fact China may well, thanks to the presence of a forced restriction of fertility, a reasonably high level of life expectancy and a virtually negligible impact from inward migration as we move forward, become the most rapidly ageing society the world has so far seen.
The comparative median age charts for China and South Korea give the general picture. When we get to 2020 China will still be significantly younger than South Korea, but is following the same trajectory. By 2020 Korea will be nearly as old as the three oldest societies - Germany, Japan and Italy - currently are, and will in all probability be older than slower ageing societies like the UK and France. The is a very dramatic change for a newly developed country.
So what do we know about growth to date in China? Well, lets look at the longer term chart.
Now when we come to look at this chart, we immediately face a number of important problems. The first and most obvious one is that the further back in time you go prior to 2000 the more unreliable the data is. So the fact that the maximum growth period seems to be in the mid 1980s, followed closely by the mid-1990s burst might, at first sight, seem strange, since it is the growth spurt which China has enjoyed post-1998 which has really been the most convincing. But it should be noted that China's demographic trajectory is virtually unique, and it is the case that it was getting some sort of potential demographic dividend or other well before 2000, so while the earlier data most probably does not give a complete picture, perhaps it would be a mistake to disregard it altogether. Of course, the more credence we give to the 1980s growth, the more we have to reach the conclusion that some significant slowing down or other may well be at hand, since following the trajectory of the line would suggest it. But as I say, maybe we shouldn't give too much credence to earlier data, so we need to be carfeul with this kind of argument.
What we do know is that from the late 1990s onwards China systematically introduced a very extensive labour and financial market reform process, and this certainly has served to unlease a huge amount of pent-up potential, and it is this which has given us the sustained growth since the early 1990s which has only been accompanied by one small dip between 1998 and 1999 (again the Asian crisis).
Now if we think about the currently rather fashionable coupling-decoupling arguments in this context, it is clear that China was effectively "decoupled" during the 2001 internet bust global slowdown, since it kept growing regardless. That is to say there is evidence that China was much more affected by events in surrounding Asia in 1998 than it was by the recession in the G7 in 2001/2002.
There are of course plenty of reasons for taking the view that things may not be the same this time round. China is evidently much more "locked-in" to global dynamics due to its systematically increased share in world trade. Also China was much more able during to trade increasing its market share for slowing overall world growth during the last recession, by using its price leverage - due to all that pent-up unused labour - but again there are reasons (and especially the domestic inflation ones) for thinking that things may not be quite the same this time. This would be doubly the case if China has been able to extend the post 1998 wave beyond its natural duration by taking advantages of the global imbalances situation, and its own currency and price leverage, to extend its export growth beyond what might be considered the normal sustainable extent. Basically I am very suspicious when I see such extended growth with virtually no humps, like we get in the Chinese case. As we can see for the other charts, growth should be more wave like, so we should at least ask ourselves what it is that has been going on?
The Intractable Inflation Problem
So the big question is when will the current wave come to an end, and when could we expect China to follow in the footsteps of South Korea and show us that steady but constant reduction in annual growth rates. Well... looking at the chart, and sticking my neck out, and also making some sort of back of the envelope estimation about how intractable the inflation problem may turn out to be (and of course recent Eastern European and Russian experience is relevant in this context), my feeling is we may well find China starting to slow this year, and the process continuing next year, and the one after etc - with the normal and anticipated ups and downs. So the Financial Times may well be right when it suggested that Chinese growth may slow and never quite be the same again, but there are grounds for thinking that they may perhaps have only captured part of the picture, and the grounds for thinking this are that they do not appear to have factored in population, labour market and inflation dynamics, and the ineveitable interaction of the three of them.
Certainly Chinese growth from now on is going to be constantly pushing up against limits which are increasingly set by the level of inflation. The inflation problem China has is a very real one, and at this point in time it is hard to see how they can adequately address it. Certainly the popular remedy - unchaining the yuan - could just as easily lead to an acceleration of capital inflows and a further increase in the overheating problem as to any more benign outcome, and I here I would suggest we treat New Zealand (and India for that matter) as the "Canaries in the Coalmine" (or if you prefer "smoking guns"). Conventional monetary policy is up against very clear limits at the present juncture.
And the recent resort to administrative measures seems almost destined to fail - as it is failing in the Russian case - since the problem is not a temporary one produced by high oil and food prices (which are anyway in part a by-product of Chinese growth), but is now becoming more endemic and structural. In the face of the present inflation surge the Chinese government has been gradually widening price controls, and finally took the plunge and froze all food prices last month while at the same time clamping limits on fertilizer prices and raising price supports for rice and wheat. These controls are meant to shield China's poor and working classes, who spend up to half their incomes on food. But the inflation spike is blamed on shortages of pork and grain, and it is obvious that putting a lid on prices simply shifts the hardship over to the farmers, discouraging them from raising output, and thus in the medium term reducing output and putting even more upward pressure on prices.
The recent extreme weather has only exacerbated the problem. In order to ease electricity shortages, thousands of trainloads of coal were rushed to power stations and hundreds of mines were kept running through the Lunar New Year holiday. But with the price of coal now forecast to climb by anything up to 100 percent this year, Beijing has yet to say how power companies will cope.
So I am really not that clear that China has any easy way out of the present inflation dynamic - and remember this is a huge change from the moment when China was reportedly "exporting deflation to the rest of the world", a process which at best has lasted from 1998 to 2007, but is unlikely to continue in the same way. In addition there is now significant evidence of labour market tightening in some parts of the Chinese economy. Wages and salaries of employees went up in the 3rd quarter of 2007 - the latest quarter for which we have data - by 22% (and by 27.2% if we take the private sector alone). And there are significant regional differences, with wages in the private sector in Beijing rising by 36.4% year on year. Even subtracting inflation these are sill very high rates of increase in real wages, and are surely not compensated for in their entirety by productivity increases. So China is steadily losing its competitive edge.
Clearly given the very low level from which Chinese wages started, and the restrained growth in the value of the yuan, it is possible to absorb to some extent such increases. The problem is that they may go on and on, and even accelerate.
And The Growing Difficulties In Finding Young Labour
The reason I say that we should expect worse to come in this regard is due to the underlying strong structural break in the Chinese population pyramid, a break which has been produced by many years of one child per family policy. Looking at those other canaries we have sent down the collective coalmine - Latvia and Estonia (and then, of course, Russia), then it does seem that push-comes-to-shove much sooner than any of us had been anticipating in the question of labour market tightening in the key 15 to 24 age group. In a way these could be thought of as the labour market equivalent of "first time buyers" in the housing market, since they tend to set the rates for others higher up the ladder. And just in case you have difficulty imagining how a country with a 750 million odd labour force could possibly have labour shortages, just remember that this labour force has been growing at an annual rate of 6 or 7 million to sustain the double digit growth rate, and even China can't find the additional people to keep explanding its labour force at this rate forever. And in particular it can't with generational cohorts which will soon be much smaller than those exiting the labour force at the upper age end, and with participation rates in the 15 to 24 age group bound to fall as people go for more and higher levels of education. Maybe it is worth bearing in mind here, that size doesn't mean you have less labour supply problems, au contraire you have more as time passes, and it is no accident in this regard that Russia and the US are the two countries with the largest annual migration needs. In theory we might expect the Chinese economy when it finally becomes the largest in the planet to also be the world's largest consumer of economic migrants, but this scenario hardly seems plausible.
As I say, 2008 could well be the year that inflation really gets a hold on China. Certainly the strong uptick in the latter months of 2007 is evident, as can be seen in the chart below.
Curiously this uptick coincides exactly with the peaking of the 15 to 19 age group, as you can see in the chart, and the decline in this age group from here moving forward is really quite dramatic, as you would expect from the drastic policy measure which was applied.
I have selected the 2022 horizon looking forward based on the fact that this is now known data. We can predict with a reasonable degree of accuracy just how many 15 year olds there will be in China in 2022, since they have now already been born. So we have a pretty good idea of China's new labour supply going forward. Obviously China can still get considerable growth by relocating the existing workforce across sectors to more productive ones. But the end of the labour intensive low economic value growth must now surely be in sight, and the big question is can China sustain inflation-free growth of the order of magnitude we have been seeing in recent years, bearing in mind that much of the recent growth in many of the higher growth developed economies - the US, the UK, Ireland, Spain - has been very labour intensive. My feeling is that it can't, this is why all those exhausted canaries swooning in Latvia have been so useful, and that we will see a slowdown in China which will not simply be cyclical, but rather structural. Possibly the moment of inflection (or tipping point) here will come around the time of the Olympic Games.
So, as I say the 15 to 19 age group has now peaked in China, and from here on in it is essentially downhill all the way, as far ahead as anyone can see. The truth is that no-one at this point in time knows what the consequences of this are going to be. But don't worry, since at least one thing is for sure: we are all just about to find out.
Friday, February 8, 2008
Inflation accelerated in the week as prices of manufactured goods, accounting for 64 percent of the wholesale price index, rose 0.3 percent from the previous week.
The Reserve Bank of India kept the benchmark interest rate unchanged last week on concern rising fuel and food prices may fan inflation. The central bank has also allowed the rupee to appreciate to reduce the cost of imports and curb price gains.
That's helped the government damp inflation, which reached a more than two-year high of 6.69 percent almost exactly a year ago.
Inflation is a sensitive issue in the $906 billion economy and rising prices may cause the Congress party to lose votes in forthcoming elections. The term of Singh's government ends June 1, next year. The ruling Congress party lost elections in four states in 2007, reducing its influence in parliament. The party was ousted in Punjab and Uttarakhand states and fell further behind in the nation's most populous provinces of Uttar Pradesh and Gujarat.
In the meantime the capital inflows continue, and India's foreign exchange reserves rose in the week ending February 1, to $292.6 billion dollars, from $288.3 billion a week earlier.