I AM privileged to be associated with the Asian Economic Panel (AEP), first convened in 2002 on the initiative of the Centre for International Development at Harvard University, Keio University and the Korea Institute for International Economic Policy.
This forum promotes quality analysis of key economic issues in Asia, and offers creative solutions by drawing on the collective wisdom of worldwide economists. The prime movers were Prof Jeffrey Sachs and Prof Eisuke Sakakibara. When Jeffrey moved to Columbia, his new Earth Institute replaced Harvard. Brookings has since come on board.
AEP last met at Keio University (Tokyo) on Sept 11. Observations on what’s happening in Japan by Prof Yoshino, a respected insider with deep knowledge of official thinking, were insightful. He is optimistic Japanese economic activity will gradually improve, shake off deflation and return to steady nominal growth since the bubble burst in 1990. Sure, the economy is stuck with deflation; public debt is rising, population is ageing and Japan still has to define and find its “proper place” in the world.
But Japan is unique. Contrary to conventional wisdom, it is simplistic to say all Japan needed is a strong leader with guts to do what everyone knows has to be done. Yes, Japan’s leaders have so far oscillated and shirked hard choices.
To be fair, solutions are far from obvious. A visitor to Tokyo sees no outward signs of crisis. However, lots of political intrigue is evident. Politicians and policymakers have bickered and schemed, but have chosen to leave things as they are. The Sept 10 set of disappointing “stimulus” measures reflects recognition of the complex web of bureaucratic intrigue and the public’s deep ambivalence about what is wrong and how to fix it. There are no magic solutions.
Sleep walking in slow motion
Since the bubble burst in 1990, Japan experienced three bouts of negative growth dips (’93, ’98 and ’02), with nominal GDP falling faster than real (price adjusted) GDP, reflecting deflation – the so called “lost decade.” In 2001, growth recovered but only gradually – since averaging 2% a year, with nominal income slackening (about 1% p.a.).
This trend was interrupted by the global crisis when GDP fell by 0.7% in 2008 and 6% in 2009. So, after two decades of virtual stagnation, nominal GDP today is at the same level as 1992. Growth in 2010 is expected at 1.7% (2Q’10 growth has been revised to an annualised 1.6% against just 0.4% earlier).
To put this in perspective, the world is expected to grow by 2.5% in 2010, with advanced economies recovering at an average 0.6% (with less than 1% each in the United States and euro-zone), compared with 7% in developing Asia, 8.5% in China, 6.5% in India and 3.7% in Asean-5. But the outlook for global growth will likely get worse.
Once heralded as the unchallenged economic giant of Asia, Japan is today a pale reflection of its old self. Although recovering, the vital signs are weak in the face of faltering global growth and a high yen. There is widespread concern that its fragile recovery could soon run out of steam as key export markets in Asia contract and the strong yen exerts new pressure on its exporters.
Already, corporate capital spending slipped in 2Q’10 even though inventory surged. Such spending, accounting for 16% GDP, is likely to moderate. Official data showed businesses becoming nervous about the outlook even before the yen’s continuing gain and as share prices tumble.
Japan has emerged as a key beneficiary of global recovery, helped by its proximity to Asia’s fast moving economies and its companies’ large presence in the region, especially China. In 1Q’10, Asia accounted for 55% of Japan’s exports (26% for the United States and 23% for Europe). This has heightened anxiety since Japan ceded ground to China as the world’s second largest economy.
Other indicators point to more of the same:
(i) private consumption spending (60% of GDP) was flat in 2Q’10. As a result, domestic demand subtracted 0.2 percentage points from GDP growth;
(ii) contribution to GDP from external demand (exports less imports) added only 0.3 percentage points in 2Q’10 (0.6 percentage points in 1Q’10), reflecting softening of demand, including from Asia;
(iii) weak job market weighed-in on consumer sentiment in June; unemployment hit a 7-month high at 5.3%; and
(iv) deflation continued to drag on recovery.
Persistent price falls encourage consumers to postpone purchases, waiting for prices to fall further; they also hurt business investment by weighing-in on firms’ bottom line and raising real borrowing costs. The GDP deflator (the broadest measure of prices) was -1.8% in 2Q’10 against -2.8% in 1Q’10. It continues to underscore how deeply entrenched deflation really is. As I see it, risk of protracted deflation is rising given the strong yen. It looks like Japan will remain in deep sleep for a while longer.
New stimulus
Clouding the outlook for deflation, exports and competition is the recent strengthening of the yen. Dollar-yen fell in mid-September to 84.72, its lowest since July 1995. No wonder the Japanese economy doesn’t instil confidence. It continues to wage a losing battle against deflation; population is ageing (and in decline); and government is struggling with a mountain of debt.
Yet, the yen has risen steadily and is now at its highest in 15 years. Most economists, including Yoshino, think Japan is in a lull but the risk of going into a double-dip remains low. Amidst strong calls for government and Bank of Japan (BoJ) to do more to support growth and ease business concerns facing a bleak future, is the unmistakeable and urgent need for them to take strong supply-side and tax measures to encourage companies to grow.
In response, on Sept 10, the Kan administration unveiled a 915 billion yen stimulus package to ward off dangers of double-dip recession in the face of increasing downside risks from a strong yen and slowing global demand. The measures comprised
(a) about US$10bil of fiscal stimulus offering support for jobs, investment, consumer spending, disaster prevention and deregulation; these efforts are expected to boost GDP by 0.3 percentage points and create 200,000 new jobs; and
(b) a 10 trillion yen top-up (to 30 trillion yen) from BoJ of soft loans at 1% for local banks to help bolster their lending. Not surprisingly, the impact felt like water off a duck’s back since what the market wanted was strong supply-side stimulus; after all, the banks are already so flushed with funds and so risk-adverse that more funding doesn’t help.
Yen intervention
A week later (Sept 15) in a measure that took the market off-guard, Japan broke international convention and intervened directly to weaken the yen for the first time in six years. The impact was swift when selling orders hit the market early as US dollar fell to a new low of 82.57 yen. It hit one yen higher and was trading up 1.6% on the day at 84.50 yen. It closed midday in New York at 85.59.
Effects have already begun to fade with the rate at 84.91 (Tokyo) on Sept 22. Historically, Japan has not intervened since March 2004 after a 15-month, 35 trillion yen (US$422bil) selling spree aimed at stopping the strong yen from railroading economic recovery. However, the yen rose to its highest since 1995 in the face of surging carry-trade business made possible by low US interest rates, bringing the yen closer to its record peak of 79.75 set in 1995.
Japan is not alone in this. The Swiss National Bank intervened to hold the Swiss franc (SF) down against the euro in a move in March 2009 as part of a package to fight off deflation risks. The euro has since fallen 12% this year.
Similarly, the strengthening yen is of concern to Japan’s neighbours in the face of a weakening US dollar. Prior to the intervention, the US dollar fell 4.2% against the Singapore dollar so far this year. It has also fallen against other Asian currencies: down 8.7% against the ringgit, 6.6% against the baht, 4.4% against the rupiah, and 3.4% against the Philippine peso.
Asian authorities worry swift and sharp rises in their currencies can become destabilising. It also makes their exports less competitive. But it’s anti-inflationary. In comparison, the US dollar had devalued by nearly 10% against the yen.
As I see it, Japan is fighting fundamentals. Like the SF, the yen has strengthened because the market doesn’t like the US dollar (with its weak economy and high deficits) or the euro (so crisis stricken). Swiss intervention could not hold back bags of monies flowing in for safety.
Similarly, its own 2003-04 experience points to only slowing down the yen’s rise. However, this time Japan may have an advantage. Deflation (near zero interest rate) means its interest rates are still too high; hence, more QE (quantitative easing). Printing money to buy US dollar has similar impact, by allowing US$23.5bil through intervention to remain in the market. Japan may not be able to hold back yen’s rise. But the side-effects make it worthwhile.
Deflation, status quo and recovery
For Japan, deflation remains a constant worry. Make no mistake, deflation is becoming more alarming. Prices in Tokyo (a leading indicator) fell again in June. Nation-wide core deflation (excluding food & energy) was 1.2%, the sharpest fall since 1971.
Yen strength is asphyxiating exporters and feeding (through imports) a self-reinforcing spiral of lower prices and wages. This process raises the real burden of private debt; public debt to GDP ratio is a whopping 190%. Yet, bond yields are stubbornly low and living standards high.
This is not sustainable for three reasons: (i) as expectations of deflation become entrenched (35% of Japanese expect prices to be the same or lower in 5 years’ time), consumption will be depressed; (ii) as Japan ages, savings will run down, and less monies will be invested in JBGs (government bonds). Even with savings rate maintained, gross debt will exceed gross household savings by 2015. Already six persons of working age supported one retiree in 1990. By 2025, the ratio will fall to two. That’s a harsh reality check; and (iii) Japan can’t count on export-led growth.
Without a much stronger economy, tax revenue is insufficient to reduce rising debt (borrowing exceeds revenue for first time in the 2010 budget). Getting out means structural reforms to raise productivity, fiscal tax restructuring and strong monetary stimulus. Politicians prevaricates bold moves. BoJ argues there’s only so much it can do: QE can’t resolve a problem it can’t fix. In the end, Japan is still stuck with the status quo.
Two obstacles promote inaction: (a) many perceive these problems to be not as serious as portrayed. Sakakibara talks of “we should enjoy mild deflation, rather than to deplore deflation as a disease.” Japanese are reluctant to give up what they have got: low unemployment, a pacifist constitution, a homogenous, equitable society and high living standards; and (b) these problems are not so easy to resolve – the public is divided on what’s really wrong and how to fix it. Take raising sales tax (now just 5%). It has a troubled record. When it was raised from 3% in 1997, retail sales fell for the next seven years.
Problem is Japanese wants US tax rates with Swedish levels of welfare. Nice thought. At Jackson Hole, Fed chairman Bernanke remarked: “Central bankers alone cannot solve the world’s economic problems.” Now, over to the politicians.
●
Former banker Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome; email:
starbizweek@thestar.com.my.
Japan suspected of yen intervention
An employee at a foreign exchange trading company pauses near electronic boards displaying the Japanese yen's exchange rate against the U.S. dollar in Tokyo September 24, 2010.
Credit: Reuters/Issei Kato
By Masayuki Kitano and Yoshiko Mori
TOKYO | Fri Sep 24, 2010 1:56pm BST
Traders in Tokyo reckoned a sharp yen drop was likely due to intervention, though the fall happened at levels where authorities were not expected to act.
Some blamed corporate orders for triggering the move and others a rumour -- later denied -- that Bank of Japan Governor Masaaki Shirakawa planned to resign.
"At first, people thought that was intervention but it seems like the market was driven one-way by Shirakawa's rumour and so on. It was a bit like an accident," said Ayako Sera, market strategist at Sumitomo Trust Bank. "It's like everyone is afraid of ghosts in the market."
Japan spent an estimated 2 trillion yen (14.6 billion pounds) last Wednesday to combat a rise in the currency to a 15-year high against the dollar.
Prime Minister Naoto Kan, just re-elected as leader of the ruling party, faces a divided parliament so is keen to curb the strength in the yen, which has hurt Japan's stock market and sparked the ire of exporters.
But while Japan's unilateral action last week occurred throughout the global trading day and succeeded in driving the dollar up about 3 percent against the yen, Friday's dollar rise quickly faded and there was no sign of follow-through action.
Adding to the intervention doubts, authorities confirmed their yen selling on September 15, but on Friday officials declined to comment.
DOUBTS
Many currency dealers doubt intervention would succeed in reversing the yen's rise, which they argue is driven more by dollar weakness.
The dollar has tumbled across the board on expectations the U.S. Federal Reserve will ease monetary policy by boosting its bond purchases to help revive the faltering recovery.
Japan's unilateral intervention last week, the first in six years, prompted some grumbles among Group of Seven partners but most have stayed quiet on the issue.
Washington is focussed on China, pressuring Beijing to let the yuan rise more quickly.
Indeed, Japanese Prime Minister Naoto Kan and U.S. President Barack Obama did not discuss currency intervention in a meeting in New York, Kyodo news reported, a sign to some that Washington was taking a hands off approach.
The dollar surge happened at midday Tokyo time.
The currency rose to as high as 85.40 yen from about 84.55 yen in a matter of minutes, and several traders said it looked like the Bank of Japan, which acts on behalf of the Ministry of Finance, had been selling yen.
Last Wednesday's intervention drove the dollar up to near 86 yen from a 15-year low of 82.87. But the yen has clawed back about half those losses.
Despite doubts about whether Tokyo intervened on Friday, analysts expect authorities to step into the market if the yen's rise against the dollar accelerates from current levels.
"They sent out a message that they are ready to intervene in the market again if the yen firms beyond what they believe is a proper level," Seiji Adachi, senior economist with Deutsche Securities in Tokyo, said of Japanese authorities.
"In terms of the economy, it is still going to be tough unless they bring the yen down to 90-100 against the dollar. But they probably can't do that. So they are going to just try to stop it going any higher."
NERVOUS TRADING
Showing the uncertainty over whether authorities had intervened, the dollar drifted back towards 84.70 yen as no government confirmation emerged.
After climbing into positive territory on the intervention speculation, Japan's Nikkei share average .N225 also drifted lower, closing down 1 percent on the day.
Both Finance Minister Yoshihiko Noda, who has said Tokyo must gain global understanding about its intervention, and the BOJ declined to comment.
Some traders watching the yen's every move speculated Tokyo was trying new tactics to scare dealers and get the biggest effect from their yen selling.
"Rather than saying clearly whether they did or not, they may be trying to make market players jittery," a trader for a Japanese brokerage house said.
So far Japan's yen selling has generated grumbling by some policymakers, but no widespread fallout -- in contrast to the international outcry over the yuan's exchange rate.
Obama urged Chinese Premier Wen Jiabao in New York on Thursday to take rapid steps to address a dispute over the value of China's currency and made clear the United States would protect its economic interests.
So far G7 officials have not complained loudly about Japan trying to stem the yen's strength.
In some ways, Japan is fighting the Federal Reserve.
Japan's purchases of dollars come as investors price in the risk of the Fed printing more dollars to purchase bonds in a quantitative easing policy. Such expectations have driven short-term U.S. Treasury yields to record lows.
"The signals from the Fed are countering the bullets fired by the BOJ," Adrian Foster, head of financial markets research with Rabobank International in Hong Kong, said.
($1=85.15 Yen)
(Additional reporting by Hideyuki Sano, Writing by Kevin Plumberg)
Japan’s savings crisis
Comment by Martin Feldstein
JAPAN is heading toward a savings crisis. The potential future clash between larger fiscal deficits and a low household saving rate could have powerful negative effects on both Japan and the global economy.
First, some background. Japan was long famous for having the highest saving rate among the industrial countries. In the early 1980’s, Japanese households were saving about 15% of their after-tax incomes. Those were the days of sharply rising incomes, when Japanese households could increase their consumption rapidly while adding significant amounts to their savings. Although the saving rate came down gradually in the 1980’s, it was still 10% in 1990.
But the 1990’s was a decade of slow growth, and households devoted a rising share of their incomes to maintaining their level of consumer spending. Although they had experienced large declines in share prices and house values, they had such large amounts of liquid savings in postal savings accounts and in banks that they did not feel the need to increase saving in order to rebuild assets.
A variety of forces have contributed to a continuing decline in Japan’s household saving rate. The country’s demographic structure is changing, with an increasing number of retirees relative to the workers who are in their prime saving years.
Surveys tell us that younger Japanese are more interested in current consumption and less concerned about the future than previous generations were. And the traditional notion of saving for bequests has waned.
The household saving rate, therefore, continued to fall until it was below 5% at the end of the 1990’s and reached just above 2% in 2009. At the same time, the fiscal deficit is more than 7% of gross domestic product (GDP).
The combination of low household saving and substantial government dissaving would normally force a country to borrow from the rest of the world. But Japan maintains a current-account surplus and continues to send more than 3% of its GDP abroad, providing more than US$175bil of funds this year for other countries to borrow.
This apparent paradox is explained by a combination of high corporate saving and low levels of residential and non-residential fixed investment.
In short, Japan’s national savings still exceed its domestic investment, allowing Japan to be a net capital exporter.
The excess of national saving over investment not only permits Japan to be a capital exporter, but also contributes – along with the mild deflation that Japan continues to experience – to the low level of Japanese long-term interest rates.
Indeed, despite the large government deficit and the enormous government debt – now close to 200% of GDP – the interest rate on 10-year Japanese government bonds is just 1%, the lowest such rate in the world.
But what of the future? While the current situation could continue for a number of years, there is a risk that rising interest rates and reductions in net business saving will bring Japan’s current-account surplus to an end.
One reason for a rise in the interest rate would be a shift from low deflation to low inflation. Prices in Japan have been falling at about 1% a year. If that swung by two percentage points – as the government and the central bank want – to a positive 1% inflation rate, the interest rate would also increase by about two percentage points.
With a debt-to-GDP ratio of 200%, the higher interest rate would eventually raise the government’s interest bill by about 4% of GDP. And that would push a 7%-of-GDP fiscal deficit to 11%.
Higher deficits, moreover, would cause the ratio of debt to GDP to rise from its already high level, which implies greater debt-service costs and, therefore, even larger deficits. This vicious spiral of rising deficits and debt would be likely to push interest rates even higher, causing the spiral to accelerate.
The larger deficits would also eliminate all of the excess saving that now underpins the current-account surplus. The same negative effect on the current account could occur if the corporate sector increases its rate of investment in plant and equipment or reduces corporate saving by paying higher wages or dividends. The excess saving could also decline if housing construction picks up.
Japan’s ability to sustain high fiscal deficits, low interest rates, and net capital exports has been possible because of its high private saving rate, which has kept national saving positive. But, with the current low rate of household saving, the cycle of rising deficits and debt will soon make national saving negative. A shift from deflation to low inflation would accelerate this process.
The result in Japan would then be rising real interest rates as the low private saving rate runs head-on into large fiscal deficits. That would weaken the stock market, lower business investment, and impede economic growth.
And if Japan’s domestic net saving surplus vanishes, the current US$175bil of capital outflow would no longer be available to other countries, while Japan might itself become a net drain on global savings. — © Project Syndicate
Martin Feldstein, professor of economics at Harvard, was chairman of President Ronald Reagan’s Council of Economic Advisors, and is former president of the National Bureau for Economic Research.
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