Bank of Japan Preview And Japanese Lessons for Other Governments

January 21, 2009

A rate cut by the Bank of Japan on Thursday would be a huge surprise, since the benchmark overnight money target and Lombard rate are at at 0.1% and 0.3%, leaving no cushion short of a restoration of zero rates and adoption of quantitative easing.  These are options that BoJ officials continue to resist.  There have been two cuts of 20 basis points each, first at end-October and then after the last meeting on December 19th.  On the second occasion, the central bank also lifted its monthly program of outright JGB buying to Y 1.4 trillion from Y 1.2 trillion, widened the range of bonds that it will accept, agreed to purchases of commercial paper and introduce special fund-injecting mechanisms to ease corporate financing stress, and announced plans to develop other schemes to alleviate the corporate credit crunch. Officials will now follow up on that promise with liquidity-injecting operations including the buying of corporate bonds.

December’s 7-1 vote to cut rates had one dissenter, Tadao Noda.

Japan’s economic and financial circumstances have deteriorated substantially since the meeting on December 19th.  An 8% decline of the Nikkei has squeezed bank capital further.  The Nikkei is now 56.7% below its 2007 peak, which in turn was 53.1% below the 1989 all-time high.  Although the yen has not risen further against the dollar, it did advance another 8.5% against the euro and by even more against sterling.  Construction orders fell 12.5% in the year to November. The Economy Watchers’ index slumped to 15.9 in December from 21.0, and the Shoko Chukin index, another gauge of small service sector conditions dropped to 29.4 from 35.1.  Industrial production plunged 8.5% in November, and the ratio of inventories to slumping sales soared 12.9% that month.  The Tertiary index of service-sector activity fell 0.9% in November, twice as much as forecast.  Consumer confidence dropped to 26.2 in December from 28.4 in November, and department store sales posted a 9.4% on-year decline in December, the biggest 12-month drop since March 1998.  Core domestic orders for machinery fell 16.2%, and foreign demand for machinery tumbled almost as much (14.4%).  The PMI, a gauge of manufacturing, plunged to 30.8 in November from 36.7 in October.

Customs export volumes sank 21.9% in the year to November, and settlements-basis export values dropped 17.4% against the prior month.  Retail sales dipped 0.1% m/m and by 0.9% from November 2007.  In the labor market, new job offers were 23.7% lower than in November 2007, and their ratio to job applicants sank to a 57-month low.  On the price front, corporate goods price inflation of 1.1% in December is down from 7.4% in August, and corporate service price inflation is already back in the red at -1.9%.  Core CPI was halved to 1.0% in November from 1.9% in October and is clearly headed for sub-zero territory.  Wages fell 1.9% in the year to November, and the jobless rate moved up by two-tenths of a percentage point.  What looks like a rare bright spot, a much higher 3.7% on-year increase in bank lending, is in fact a sign of a completely frozen commercial paper market and cash hoarding by desperate firms.  The Ministry of Finance’s quarterly business survey revealed sharply revised investment plans, amounting to a 9.8% drop this fiscal year compared to a 2.4% drop predicted three months ago.  Japanese real GDP in calendar 2009 will probably drop at least 1.5% and maybe more than 2%.

Japan’s experience is an investor’s worst nightmare.  Japan’s banking system crisis happened in isolation.  Today’s crisis is affecting every country to some extent.  Japan was slow to react initially cut interest rates, and officials there were chronically behind the eight-ball in that regard.  Mistakes like a sales tax hike in 1997 and undue delay in getting toxic loans off banks’ books were made, but plenty of mistakes of omission and commission are being made by many governments now as well.  Once addicted, Japan never got off the wagon of extremely low interest rates, never recaptured its old trend growth potential, and has a stock price index of 7902 compared to 38916 at the end of 1989 some 19 years ago.  Public finances remain a complete mess.  Markets have shown great impatience with the incoming Obama administration for not unveiling a detailed and legislated agenda on Day 1.  The presumption is that if politicians make the hard decisions, allowing prices to adjust properly, a foundation for eventual recovery in economic activity and financial market functionality will be laid.  But what if no solution exists, or if no feasible solution can be imposed by a government where sovereignty resides with the people?   In the sea of uncertainty that has gripped economies since August 2007, the only consistent thread is that every policy and private-sector attempt to fix the mess has failed, if not immediately then after a while.  The consensus that many economies will begin to recover in the second half of this year or certainly sometime in 2010 remains faith-based.

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