Reading Japan

July 23, 2008

Markets are bracing for another end-month round of weak Japanese indicators.  A consensus is building that 2H08 might even be recessionary.  The long-awaited pick-up of Japanese inflation has not been welcome.  Deflation battered growth in the 1990’s and at the turn of the century.  A restoration of headline consumer price inflation of more than 1% and domestic corporate goods prices of more than 5% are undesirable developments.  Surging commodity costs are sending corporate profits downward and not getting passed on to other prices or trickling down into better wages or incomes.  Vestiges of deflation linger.  True underlying inflation, which excludes energy as well as food, slid 0.1% in the year to June, telling a very different story from the headline that non-food core inflation had increased to 1.5%, most in 122 months.  The government’s monthly economic assessment in July predicted weak, flat, or declining trends in everything vital sign that matters during the near term: exports, industrial production, consumption, private investment, public investment, corporate earnings and jobs.  The Bank of Japan called consumption weak and downgraded its views on exports, production, and housing.  A monthly simulation of the central bank’s quarterly business diffusion indices revealed a disturbingly sharp drop in the manufacturing component to -10 in July from -2 in June and a slight further deterioration in non-manufacturing conditions as well.  Clothing sales slumped badly in June, according to industry releases.

Japanese quarterly GDP data continue to appear unreliable after many refinements to their preparation.  As every student of economics learns, the value of what is produced equals the value of what is spent plus changes in inventories.  GDP measures the size of an economy from the spending or demand side, while Japan’s all-industry index adds up the value of production in all sectors, giving a supply-side tally of economic size.  GDP is compiled quarterly.  The all-industry index is released every month, but quarterly changes in it should dovetail movements in GDP.  Alas, that hasn’t been happening.  In 4Q07, GDP expanded 2.9% saar, but the all-industry index eased 0.4%, and in 1Q08, GDP advanced 4.0% saar, whereas the all-industry index fell 3.7%.  An annualized 4.6% increase of the the all-industry index from its level in 1Q08 to its April-May mean is very misleading, flying in the face of a preponderance of other data and the performance of the Nikkei  and JGB’s since March.  The government isn’t fooled, and neither are investors and private analysts.

Present thinking is that it will be another 12 months before the Bank of Japan can raise its 0.5% overnight rate target, at which point 2-1/2 years will have elapsed in which Japan seemed too fragile to handle a money market rate of more than 0.5%.  Before February 2007, overnight rates were even lower than a half percent.  Astonishingly, overnight rates have not been allowed to trade above 0.5% since September 1995, a period of almost 13 years.  By comparison, overnight rates in Japan averaged 7.95% in the 12 months to July 1991 following the world oil spike associated with Iraq’s invasion of Kuwait. 



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