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Tuesday
Dec192006

Adjusting the Views on Japan?

Japan.jpgI have finally emerged from my exam hibernation to re-commence regular blogging here at Alpha.Sources. I am furthermore going home to Denmark on Friday after having spent 5 months in Montreal at HEC Montreal  ... 5 great months I have to say! However, let us get down to business ...

In my comments on Japan here at AS I have consistently advocated a rather pessimist discourse on the economy primarily driven by my belief that the economy is in a structural bind with a continuing downward trend in consumer spending regardless of the how well the corporate sector (i.e. the export sector) fairs. In short, I do not see Japan returning to a balanced growth path anytime soon (neo-classical growth proponents, take note!) and my analysis fundamentally hinges on the strong life-cycle component of the domestic consumption trend or put in another words; demography matters here! 

Apart from my personal stubborn and persistently pessimistic position on Japan I also in all fairness have to point the data which has done nothing but support mine (and other's) narrative on Japan. Specifically, I am talking in a large (about 1 year) perspective. Consequently, it is sometimes nice to step back and look what has actually happened since Japan chose to end ZIRP back in the late spring this year. Back then, the move by the BOJ was widely seen as one of many steps in a long consistent process to mop up excess liquidity and normalize Japan interest rates, Japan was back amongst the leaders! Clearly, this has not been the case and one of the most striking features about Japan in the moment is how the BOJ just cant seem to find the economic justification to begin to turn off the money tap. Meanwhile, some of the most brilliant economic commentators still argue that it is only a matter of time before we see the much allured spill-over effect from the sparkly corporate sector to domestic consumption, that is the transition to a balanced growth path. We only need to wait. All this is of course being printed along side an inflation rate which is still flirting dangerously with the 0% mark and thus negative range and this has many thinking overtime because why is inflation so low in the light of a tightening labour market for example? Some indeed has come along way in seeing this correctly, and now also the big guns (i.e Morgan Stanley again) is also at least opening a backdoor as a hedge against the traditional positive stance ...

What we outline here is a risk scenario, not our main one. Nevertheless, we do not think it is a low-probability scenario, considering that the latest reading on price growth is very low, at just 0.1% YoY. In light of oil price trends, the Japan-style core CPI could contract again YoY in 2007 H1, contrary to our constructive economic outlook.

(...)

The recent, substantial, retroactive GDP revisions [see also here] confirm the weakness in the core of core CPI. For the F2006 national accounts, real GDP was revised downward by 0.9 ppt to 2.4%, which should have more than a negligible impact on estimates of the output gap since the economy’s potential growth rate is just shy of 2% at best.   Based on the revised GDP data, the pace of the contraction in the output gap in F2006 declines by almost 1 ppt. If the improvement in the output gap is only modest, the spillover effect on prices would naturally be that much weaker.

Also please take note of this ... the return to ZIRP is not a fairytale but a distinct possibility.

If the Japan-style core turns negative several months after the next rate hike, it would be easy to imagine the BoJ being in a politically difficult situation in terms of putting a crimp in the Cabinet/ruling coalition’s pro-growth policies.   Governor Fukui would not likely have to resign, but the choice of his successor after his term ends in March 2008 could be affected to some extent. To be more specific, Deputy Governor Toshiro Muto, who is currently widely expected to be the next governor, may be less likely to be promoted and the government and the ruling coalition may instead look for a candidate outside the BoJ

(...)

If someone with a strong monetarist bent is named to be the next governor, Japan could be stuck in an ultra-low rate environment for a long time, with price growth hovering very low. If policy is focused on an increase in money supply, the BoJ may increase the supply of reserve deposits and put the policy rate back to near 0%.

I think the key words for reading the Japanese economy at the moment is a bit of open mindedness in terms of what we could call the traditional/text book macroeconomic convictions. It should be quite clear for regular readers that I believe demography is a key determinant here. However, this does not mean that demography is the holy grail which can be applied universally to all macroeconomic issues. But in the case of Japan, the demographic economic analysis which is clearly an analytical field in development represents a very strong theoretical anchor for understanding what is going on; at least I believe this should be clear by now. 

Saturday
Dec162006

Adjusting to the Fundamentals?

money.jpgIt all depends on the state mind I guess but I for one am not surprised by this ...

(From Bloomberg - bold parts are my emphasis)

The dollar rose to a three-week high against the euro after a report showed foreign investors boosted purchases of U.S. securities in October.

The U.S. currency is also heading for its biggest weekly advance since September versus the yen as the report allayed concern international investors would shun U.S. assets because of the nation's trade deficit. The dollar also gained today against the British pound and Swiss franc.

``We are still seeing foreign inflow into U.S. assets,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. ``It seems like the U.S. doesn't have a problem attracting foreign investment.''

The U.S. currency advanced to $1.3085 per euro at 12:22 p.m. in New York from $1.3144 late yesterday, reversing an earlier drop on a separate report showing U.S. inflation is in check. The dollar has gained 1.4 percent this week to 117.98 yen, and reached a four-week high of 118.33 yen earlier. It is up about 0.9 percent this week against the euro.

The U.S. currency has gained 0.1 percent this year against the yen. It is still down 9.5 percent versus the euro as investors bet the European Central Bank will lift borrowing costs more than the Fed

My comment above about 'state of mind' is important since the fundamentals are exactly what we should be talking about. Consequently, the fundamentals would indeed seem to point to the need for the dollar to depreciate to correct the current account deficit or more specifically as a part of the overall mechanism (a recession?) which forces the US consumers to save more and spend less subsequently grinding down the excess demand typified in the large trade deficit. Yet, as I have tried to flesh out recently, there are another set of fundamentals we would be wise also to take a look at before we go out and hail the major dollar-meltdown. Another point I want to make is about the nature of the recent wobbles in the dollar which flushed a lot of pre-mature comments pointing to a impending re-balancing act (The Economist anyone :)). What we are seeing now is, I think, evidence that the recent dollar slide was driven by the expected narrowing of interest differentials between the FED and the ECB. Remember, that Trichet practically was locked in to raise back in the beginning of this month as a function of the ECB's own discourse. But also as a result of the ongoing struggle between the ECB and Eurozone policy makers and civil society; the ECB could not pause on the back of pressures from policy circles, even if it was the right choice in terms of the economic indicators.