Japan’s Prime Minister Shinzo Abe recently addressed parliament stating that he plans to reverse the trend of issuing bonds to raise money but raise more in taxes. Japan cannot beat deflation and a strong currency (yen) if it adheres to the same policy of the past decade.
However his speech comes after the announcement of a $226.5bn stimulus package earlier in the year and this when Japan already has some serious debt issues – public debt that is almost three times the size of the Japanese economy.. He also wants the Bank of Japan to maintain an open-ended policy of quantitative easing (QE) and a doubling of the inflation target – 2%. Hopefully the fiscal stimulus package accompanied by more QE will drive down the price of the yen which will make Japanese exports more competitive. He stated his three arrows of economic policy:
1. Aggressive Monetary Easing
2. Flexible fiscal spending
3. A growth strategy that would induce private investment
Who knows if it will work but Shinzo Abe stated that it is worth the gamble.
Here is a recent chart from The Economist. This is the first data on inequality to come out of China for 12 years – remember 0=perfect equality and 1=perfect inequality (all the income is earned by one person). It seems that poorer countries like South Africa, Nigeria and Brazil have benefitted from growth over the last few years but it hasn’t trickled down to lower income groups. As well as being better off Japan and Sweden seems to be more equal societies as opposed to India and China where most people are equally poor.
The New York Times recently reported that the Japanese authorities are once again trying to stimulate a rather moribund economy with injecting more money into the circular flow.
* A ¥11 trillion is to be added to an asset buying programme
* The Bank of Japan will supply banks with cheap long-term funds in the hope of stimulating borrowing.
* Base interest rate to stay at 0-0.1% – see graph below
* These measures will stay in place until inflation has reached at least 1% – Bank of Japan forecast of this figure is March 2014.
There has been some return to growth with the reconstruction after the 2011 earthquake and tsunami. However global demand has declines and the issue of territory with China hasn’t helped – Japanese goods are not being favoured by Chinese consumers. Japan’s deflationary decade hasn’t been helped with a contracting population and monetary policy needs to be accompanied by government fiscal policy as private sector companies don’t have the confidence to invest in major expansions. To this end the government have thrown money at the economy to the tune of ¥422.6 billion (in the form of government spending) but this is already twice the size of the Japanese economy. A strengthening yen hasn’t helped matters as exporters find their products uncompetitive.
Since the start of the global financial crisis in 2008 and with the exception of Germany, none of Europe’s biggest economies have returned to the level of economic output they had in the pre GFC days. In Japan in the 1990’s there was the need for the central bank to aggressively fight deflation, and let banks take credit losses quickly, suggesting that expansionary fiscal policy did not offer a way out of low economic growth.
According to the New York Times – economic growth not realised represents investments in education that were never made, research was never financed, businesses that failed and careers that ended too early or never got off the ground.
Economists warn that the euro zone is on the same path as Japan was in the 1990’s, when failure to deal with weak banks led to a decade of stagnation. The Japanese never fixed their banks and as banks in Europe have limited cash reserves they are reluctant to take the risk of lending money. Although the ECB has supplied banks with significant amounts of cash they cannot force them to lend the money out to investors which ultimately creates growth and jobs. Below are some statistics which allude to this.
Demand for housing loans in Q1 2012
Italy – business loans 38%↓
Recessions can be beneficial as they can improve efficiency and reduce risky lending. However for the eurozone this is no normal recession in that its duration will be significantly longer than the norm. See the interview below with investor George Soros.
The recent CPI figures published by the Dept of Statistics in Wellington show that there was a 1% in the CPI from the June 2011 quarter to the June 2012 – the lowest annual rise since 1999. This is at the bottom of the Policy Target Agreement which stipulates that the CPI should be kept between 1-3%. The question now is whether annual headline CPI inflation can avoid dipping below the bottom of the 1.0% and whether the threat of deflation is a serious concern?
Deflation – why is it a concern?
In the short-term a period of deflation can help the economy. Falling prices mean that consumers can buy more with their income and rising purchasing power would provide a boost to confidence and could assist the economy by increased growth.
However a longer period of deflation can be very damaging to an economy for two reasons:
1. Expecting prices to be lower in the future consumers put off purchasing goods and services in the expectation that they will get lower. This leads to a contraction of demand and ultimately lower growth. Japan in the 1990’s is a good example of this – see graph below.
2. A more dangerous scenario is debt deflation. As prices fall the real value (nominal – CPI) of debt increases – just as it decreases if prices are rising.
The increase in debt that people have taken on over the last 5 years makes this latter point very worrying. However, commentators have suggested that deflation shouldn’t become a problem in NZ.
In a recent edition of The New York Times magazine Paul Krugman wrote an article discussing the role of Ben Bernanke as an academic versus that of being the Fed Chairman.
When the financial crisis happened in 2008 it seemed that there could be no better person to be Fed Chairman. Having studied the Great Depression and written various academic papers on this and the crisis in Japan in 1990’s economists felt that Bernanke was the man for the job. Although the Fed has done a lot to rescue the financial system there is still major concerns about the labour market and the rising long-term rate of unemployment. Remember that the Fed has a dual mandate of Price Stability and Maximum Employment. In order to stimulate growth in the economy, especially when inflation is low, central banks lower interest rates but when the Fed Funds Rate reached 0 – 0.25% on the 16th December 2008 they basically ran out of ammunition as rates couldn’t go any lower. Here you tend to get stuck in what we call a “liquidity trap” in that monetary policy is no longer effective. When Japan was going through very slow growth in the 1990‘s, in which it experienced deflation, Professor Bernanke stated that Japanese policy makers should be a lot more active in trying to stimulate growth and inflation. With interest rates already at 0% he suggested that monetary authorities were not proactive enough to experiment with other policies even though they might have been radical. This all harks back to the days of FDR (Franklin D Roosevelt) in which he created work schemes, infrastructure projects etc, in order to boost employment. I have summarised Paul Krugman’s article below in a table format which shows Bernanke policies for the US economy as a Professor v Chairman.
this is the effect of bullies and the Fed Borg*, a combination of political intimidation and the desire to make life easy for the Fed as an institution. Whatever the mix of these motives the result is clear: faced with an economy still in desperate need of help, the Fed is unwilling to provide that help. And that, unfortunately, make the Fed part of the broader problem.
*Krugman is a keen “Star Trek” fan and compares the Federal Reserve to a Borg — a race of beings that act based on the wishes of a hive mind, and present major threats to the Starfleet and the Federation.
Central Banks worldwide have agreed to provide cheap loans in US$’s to banks in Europe and other parts of the global economy. There is obviously serious concerns about the economic climate in Europe but will it calm the markets? The truth of the matter is that more liquidity alone is not going to solve the economic problmes of the eurozone countries. The graphic below does show some positive signs with bond yields on the way down which suggests that there is less risk associated with their purchase. However there is still a long way to go for stability to return. See graphic below from the WSJ.
Central banks have offered cheaper credit before:
March 2011 – interevened to reduce the value of the Yen following the earthquake and tsunami.
October 2008 – central banks cut rates to reduce the shock on financial markets when Lehman Brothers went under.
“The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.” combined statement form the 6 central banks. These include:
-US Federal Reserve,
-Bank of Canada, the Bank of England,
-Bank of Japan,
-European Central Bank and
-Swiss National Bank.
The recent special report in The Economist looked at the altering structure of the labour market worldwide. Obviously globalisation and technology have brought big changes in the nature of work, and levels of unemployment will remain high in the developed world as developing countries see their numbers employed being boosted.
Edmund Phelps, Nobel Economist, thinks that the US natural rate of unemployment in the medium term is realistically around 7.5% which is significantly higher than a few years ago. Remember the natural rate occurs when inflation is correctly anticipated – this level of unemployment results when the economy is at full employment.
Michael Spence, another Nobel prize-winning economist, agrees that technology is hitting jobs in America and other rich countries, but argues that globalisation is the more potent factor. Some 98% of the 27m net new jobs created in America between 1990 and 2008 were in the non-tradable sector of the economy, which remains relatively untouched by globalisation, and especially in government and health care. Lowering this natural rate will require the following:
1. changing education to ensure that people enter work equipped with the sort of skills required so that there is no mismatch
2. adjusting the tax system – incentivise work
3. modernising the welfare safety net – encourage those to find work
4. encourage entrepreneurship and innovation.
This is easier said than done.
This has increased dramatically in many countries – 58% in Ireland, 40% in both Spain and Japan, and 30% in the US, see graph below.
The concern with these figures is that the longer poeple are out of work the less likely there are able to find future employment. There are two reasons for this:
1. Their skills get out-dated very quickly and this is especially prevalent in the current labour market as technology is starting to takeover many procedural white-collar jobs.
2. Motivationally they find it hard to engage in the process of lookign for work and this is esepecially prevalent once a person is on a generous welfare benefit.
According to The Economist:
Long-term unemployment often turns into permanent unemployment, so governments should aim to keep people in work, even if that sometimes means continuing to pay them benefits as they work.
The 2011 March quarter GDP figures were quite amazing when you think of the tragic earthquake in the Christchurch area last February. The economy grew 0.8% (0.4% forecast) which signifies that the economy outside of Christchurch is very strong. If you compare the data from the other recent natural disasters, being the Queensland floods and the Tohoku earthquake/tsunami, New Zealand has actually grown – see figures and graph below:
* Australia had a 1.2% drop
* Japan had a 0.9% drop
The NZ$ and QE3
Also the NZ$ keeps motoring ahead – yesterday reaching US$0.85. However, with the official cash rate at 2.5% one wonders what is the currency reacting to? Most likely it was:
*the better than expected Q1 GDP figures outlined above and
*the words of US Fed Chairman Ben Bernanke who strongly suggested the US economy was in need of some more serious antibiotics in the guise of QE3 – Quantitative Easing 3 in which the Fed bascially print money.
Bernanke indicated that QE3 would depend on two conditions, economic weakness beyond current expectations, and a renewed threat of deflation.
The Fed is charged by Congress with minimizing unemployment, and some of its critics say that current unemployment rate of 9.2 percent should be a sufficient reason by itself for the central bank to expand its roster of economic aid programs.
Mr. Bernanke noted that the scale of the Fed’s existing efforts was unprecedented. The central bank has kept short-term interest rates near zero for more than two years. It also owns more than $2 trillion in mortgage-backed securities and government debt, the legacy of its two asset-purchase programs to reduce long-term interest rates.
New York Times
Future worry for NZ economy
These figures indicate strong underlying growth in the NZ economy but there are concerns about capacity contraints if the economy is to grow more. And if this is the case there will be significant pressure on prices and a sooner than predicted OCR increase by the RBNZ.
I am off on holiday for a week and will resume service on Monday 25th July.
Thanks again to Richard Well for this link to the BBC site. The BBC’s Power of Asia season examines how economies in the region have changed over the past 30 years. Use the chart builder below to compare countries in terms of wealth, health, life expectancy, education and energy consumption. It is very similar to the Gapminder site but the BBC version does give some useful information below the graphs. Click here to go to the BBC site.
Kobe in 1995 (and affected regions)
* Was responsible for 12.4% of Japan’s GDP (gross domestic product).
* Caused $120 billion in damages
* Declined to 24.4% by the end of June
* The Nikkei 225 regained its pre-quake level by mid-December 1995.
* Kobe was one of the biggest ports in Asia and a very industrial part of Japan
Tohoku in 2011
* Area not as industrialised as Kobe so only affected 7.8% of Japan’s GDP.
* Bank of Japan immediately injected $85-billion into the markets to show support
* The effect was more emotional rather than effecting the economy; the earthquake was on a bigger scale but effecting less of the industrial parts of Japan
* But many companies supply lines affected e.g. Toyota and Honda
The Kobe earthquake had little long term impact on the economy compared to the recent Tohoku earthquake, was on a bigger scale resulting in many more deaths. Long term affect still uncertain. However, as the damage is bigger in the Tohoku earthquake (because of the tsunami) even though it has not affected Japans industrial heart, it will take longer for the economy to recover. Overall it is hard to predict the long term affects as we are not able to say how the economy is going to be for the next year; considering Japan is still dealing with the nuclear radiation issue.
Nikkei stocks – affect of Tohoku and Kobe quakes
I saw this on the Tutor2u blog. Remember the Phillips Curve (named after New Zealander Bill Phillips) relates the level of unemployment to the rate of change of money wage rates (which are a proxy for inflation). If you look at Japan’s Phillips Curve from January 1980 to August 2005 we get the graph to the right. You can see the trade-off between unemployment and inflation – ie high inflation low unemployment and vice-versa.
However, Gregor Smith of Queen’s University Canada, found out that if you rotate the Phillips Curve around the vertical axis so that minus unemployment is now on the horizontal axis you see a map of Japan. Who said eocnomics is a dull science.
Here is an interview with The Economist writer Greg Ip which was screened yesterday on the PBS Newshour.
Key points are:
* Japan is the key supplier for a lot of manufacturers – it is the world’s largest suppliers of flash memory and of semiconductors over the last few years
* Japan has virtually no natural energy resources of their own – very dependent on nuclear power
* Loss of nuclear power will increase demand for fossil fuels – with this and the unrest in the Middle East global oil prices will rise
* Japanese seem to have the funds to rebuild the economy as they are very high savers. They have bought all their government’s debt to date
With the huge earthquake and tsunami in Japan one wasn’t surprised that there was an increase in demand for gold. Investors generally buy gold as a hedge or safe haven against any economic or political event. In this case a natural disaster. Below is the price of gold – notice the increase in price to US$1431.60 per ounce.
This event reminded me of a scene from The Corporation DVD with Carlton Brown, a commodities trader at the NYSE. He describes the tragedy of 9/11 as a blessing in disguise because for some people, it translated into great riches. Brokers celebrated the death and destruction of the Iraq war because “in devastation, there is opportunity”. An unfortunate way to look at how the market sometimes works when you consider the death and devastation in Japan.
With the terrible events overnight in Japan one wonders how the Japanese economy is going to be affected. However it was interesting to notice what has happened to the Yen against the US$ and the price of oil.
The US$ dropped against the Yen – was ¥82.8 but now is ¥81.8. Reasons for this:
1. The flow of insurance pay-outs that will no doubt follow the earthquake/tsunami.
2. Companies repatriating funds as happened after the Kobe earthquake in 1995
Benchmark Brent crude oil contracts fell 1.1 per cent to $114.16. Reasons for this:
1. The closure of Japan’s refineries damped immediate demand for crude oil.
2. Considering Japan’s huge oil consumption, around 4.4 million barrels a day, investors feared the demand would fall after the disaster at least temporarily, triggering large scale of sell-offs across markets.
According to the FT in London:
Natural disasters can actually be positive for growth because governments spend to repair the damage. After the Kobe earthquake in 1995, the Nikkei fell about 8 per cent in the following five days, then recovered 5 per cent in the next two weeks.
In a broader sense this earthquake is probably the last thing that the Japanese economy needed – namely its ability to pay in order to get the country back to a growing level of economic activity. However, although Japan’s government is highly indebted its people are very wealthy and there are many ways that you can tap into this wealth.
It seems that oil prices will be downward until the damage in Japan is fully assessed. But there always remains the threat of further political turmoil (sorry about the pun) in the Middle Eastern countries.
*National still maintain that intervention is not a viable option to reduce the value of the NZ$. They cite the experience of the Bank of Japan in the 1990′s and their attempt to devalue its currency – the Yen went from 330 to 80 against the US$.
*Labour favour the RBNZ intervening more actively to reduce volatility of the currency as it becomes difficult for exporters to plan ahead.
The recent QE2 by the US Fed has caused the US$ to fall against all major currencies. This with the Chinese resisting moves to allow the Yuan to appreciate faster against the US$ leads to the appreciation of everyone else’s currency. If NZ embarks on a competitive devaluation to make exports more competitive, by the RBNZ selling NZ$ on markets, there will be costs:
1. The extra dollars would be inflationary
2. The weaker NZ$ would make imports more expensive which may impact on higher input costs
3. With a weak labour market firms may pass on some of cost to their workers via lower real wages.
4. With inflationoary pressure a tightening of monetary policy might be required – higher interest rates. This will attract capital inflows and increase the value of the US$.
5. This would increase Government debt which puts pressure on the taxpayer.
However it is hard to conclude that there would be no benefits from a weaker NZ$. In 2007 the RBNZ did intervene in the foreign exchange market and sold NZ$. At present it would be hard to make the case that the NZ$ is unusually high – it is still 6% lower aginst the US$ than it was in 2007.
From the Wall Street Journal – criticisms Ben Bernanke made of Japan’s central bank a decade ago—saying it was too timid in stimulating Japan’s economy to prevent deflation—give hints of what the Fed’s next steps might be. As a Princeton professor in the 1990s, Ben Bernanke lectured Japanese officials for mishandling their economy. In a 1999 paper, Mr. Bernanke lashed out at Japanese officials, saying their country’s woes were the result of their own “self-induced” paralysis. Japan’s responses to deflation, he charged in atypically blunt terms, were confused, inconsistent and too cautious.Today, Tokyo’s economic problems are more than academic for the Federal Reserve chairman. They are a window into his own situation as he stares at what could be a long period of slow growth, high unemployment and declining inflation in the U.S. There are two lessons from the Japan experience:
1. be aggressive about providing stimulus to the economy in the early stages of a downturn and
2. avoid canceling it too soon.
Click here for the article in the Wall Street Journal. Also an informative interview with columnist Jon Hilsenrath
China has now overtaken Japan as these second largest economy in the world behind the USA. However, despite the huge development in infrastructure and modern conurbations China is still a developing country. Its GDP/capita last year was US$3,600 compared with Japan’s which was US$37,800. Between 2000 – 2008 Japan’s economy grew 5% compared to China’s 261%. Astonishingly GDP growth in China was 11.9% over the last quarter and over the last few years it has weathered the financial crisis very well. Some economists are uneasy about China’s reliance on exports and there is a need to increase local consumption to keep industry and GDP moving. But wage growth has been limited relative to GDP so one wonders how domestic consumption can increase at the rate required. The video clip from Newsy.com is quite informative. They source news from all the main media outlets.