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.
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