Japan Real Time Charts and Data

Edward Hugh is only able to update this blog from time to time, but he does run a lively Twitter account with plenty of Japan related comment. He also maintains a collection of constantly updated Japan data charts with short updates on a Storify dedicated page Is Japan Once More Back in Deflation?

Thursday, December 05, 2002

Is Japan Trying

This question may seem a strange one, but appears to be worth asking since one US economist after another has been suggesting that, one way or another, the Japanese are simply not trying to find a way of getting out of their mess. First Cecchetti got the ball rolling with the following in the Financial Times:

"What about the zero nominal interest-rate floor, the point at which central banks supposedly become impotent? Listening to officials from the Bank of Japan, you would think that once they set their interest rate target to zero, there was nothing else they could do about stagnant growth and falling prices. Again, I do not believe it."(see my article here)

Then Ben Bernanke added his tuppence-worth:

"The claim that deflation can be ended by sufficiently strong action has no doubt led you to wonder, if that is the case, why has Japan not ended its deflation?.......Japan's deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has. Thus, I do not view the Japanese experience as evidence against the general conclusion that U.S. policymakers have the tools they need to prevent, and, if necessary, to cure a deflationary recession in the United States."

In fairness Bernanke does not suggest that the Japanese have failed to use monetary easing. But his analysis of what the Fed might do almost all revolves around the use of monetary and exchange rate policy to produce inflationary expectations, thus the claim that all will be well in the US 'since the US has the tools it needs' might be thought to ring somewhat hollow. If the problem in Japan revolves around political constraints, constraints like an unwillingness to bear the weight of the impact of structural reform, then perhaps he might have done better to address the reasons these political constraints will not be operative in the US. Absent this, the assurance that the US will be different seems to imply that there is a mix of monetary and economic policy (short of collapsing their economy completely by closing half of it down) which the Japanese are NOT using. This however seems doubtful.

On the fiscal front what Bernanke terms 'the heavy overhang of government debt' is cited as making ''Japanese policymakers more reluctant to use aggressive fiscal policies". Now this public debt overhang is a product of Japan's ageing population, so are we really to believe that the US might not face similar dilemnas as we get further up this decade? Further, as Paul Krugman has suggested, Japan has not been exactly backward in coming forward with fiscal policy:

"What about the second line of defense, fiscal policy? Japan has tried that, and it has worked -- sort of. Let me explain. .....If you have visited Japan recently you know that it does not look like a country in the midst of a depression. There are strong similarities between Japan in the 1990's and the United States in the 1930's, but there is also a big difference. America descended rapidly into depression. Japan's crisis has unfolded far more gradually........

The other reason that Japan does not look like a country in the midst of a depression is that the government has found a concrete solution to the problem of mass unemployment. By ''concrete,'' I don't mean serious, hardheaded, substantial. I mean concrete, as in roads, dams and bridges. Think of it as the W.P.A. on steroids. Over the past decade Japan has used enormous public works projects as a way to create jobs and pump money into the economy. The statistics are awesome. In 1996 Japan's public works spending, as a share of G.D.P., was more than four times that of the United States. Japan poured as much concrete as we did, though it has a little less than half our population and 4 percent of our land area. One Japanese worker in 10 was employed in the construction industry, far more than in other advanced countries.

Now for the bad news: deficit spending has slowed the Japanese economy's slide, but it has not reversed it. That is, the public works programs provide only temporary, symptomatic economic relief. The favorable effects last only as long as the spending itself. They don't seem to lay the basis for a permanent turnaround.
The Fear Economy

Well, you might think that the case was far from clear. So why don't the Japanese complain at all this unfair coverage of their economic and financial policy. Well, that's just what two of their politicians do in yesterday's Financial Times. Of course their solution is not particularly unconventional: stop China. They begin with a scarcely value sideswipe at the ECB:

Monetary policymakers around the world are still fighting the old enemy of inflation, not the new foe of deflation. There is an urgent need to switch to global reflation in order to avoid a deflationary spiral. In order to cope with economic stagnation, there has been aggressive fiscal expansion since the early 1990s. Several years after the collapse of the bubble, the Bank of Japan belatedly shifted to easy monetary policy. Then it gradually guided the short-term money market rate below the discount rate, but without much success in stopping price deflation, let alone reviving economic activity.

Last year, with the short-term rate virtually at zero, the BoJ abandoned the use of interest rates and shifted to a quantitative easing policy by targeting the current account balances of commercial banks held at the bank. Despite the injection of liquidity into the markets, the BoJ has not stopped price deflation. Its ability to conduct an effective monetary policy has also been hampered by a dysfunctional financial sector. Commercial banks, saddled with large non-performing loans and inadequate capital positions, have been unable or unwilling to extend loans even though they have abundant liquidity.The Japanese experience demonstrates that traditional monetary policy can lose potency in a deflationary environment. Since the nominal rate cannot fall below zero, a central bank can lower real interest rates and so provide monetary stimulus only by drastically changing price expectations.
Source: Financial Times

One Japanese observer who has some experience of watching how monetary policy evolves as interest rates approximate to zero (ZIRP) is Morgan Stanley's Takehiro Sato. In a post in early November in the Morgan Stanley Global Economic Forum he made the following observation in connection with Greenspan's recent 50bp reduction in the Federal Funds Rate.

The Japanese economy can be viewed as the front runner in a global deflation race with no apparent end. The central banks of other industrialized economies will gradually come to understand the BoJ�s struggle, having completely exhausted traditional policy measures. Central banks fought inflation through the mid-1990s, but the battleground has changed to the uncharted territory of deflation. In some respects, it is positive that overseas policy authorities and academics will begin coming to terms with the tough challenges of fighting deflation in a ZIRP environment, which is something that only Japan has experienced until now. The BoJ should benefit from overseas financial authorities giving serious consideration to the implications of a "purposeless" policy of quantitative easing (basically a zero interest rate with a �15-20 trillion reserve floor) should the FRB and ECB move into the ZIRP realm. The unfavorable scenario for the BoJ would be foreign central banks having unexpected success with quantitative easing and such easing ironically spurring a recovery for the global economy. In this case, the BoJ is likely to face criticism for being slow on the draw with policy action.

Japan�s experience thus far suggests slim chances for the latter scenario. Once the policy rate drops into the lower 1% range, the game is already over for monetary policy. While monetary policy can be effective in restricting total demand when necessary, it lacks the wherewithal for demand creation. Since the elasticity of real money demand from nominal rate fluctuations rises to an extreme level with a zero interest rate, the short-term money market endlessly absorbs liquidity supplied by the central bank, just like spraying water in a desert. Liquidity never makes it to the real economy. This can also be understood in terms of zero opportunity costs for reserve deposits. There is no pain from holding an infinite amount of reserves ("no pain, no gain"). Additionally, the BoJ has gradually raised its liquidity provision mechanism of Rinban operations (which is equivalent to coupon pass). However, these operations wind up strengthening flattening bias on the yield curve, and actually contribute to deflation expectations through the financial market�s expectation formation dynamic. ZIRP poses the danger of getting caught in a policy trap that cannot be easily escaped.
Source: Morgan Stanley Global Economic Forum

Monday, December 02, 2002

Japanese Unemployment Continues to Rise

Japan's industrial production fell last month and families cut their spending after unemployment rose to a record high, adding strength to the growing view that Japan's economic recovery may be running out of steam. Of course much of the future for unemployment now depends on what really happens in the wake of the NPL debate.

Production unexpectedly fell 0.3 per cent in October from the previous month, the Ministry of Economy, Trade and Industry (Meti) said on Friday. With the second second consecutive monthly decline, Meti changed its outlook for the index from a "gradual upward trend" to "flat". The data suggested that industrial production, which has been driven by exports, and the economic recovery , probably peaked between July and September, boding ill for Japan's already high unemployment rate.

Unemployment in September revisited Japan's post-war high of 5.5 per cent, matching a record high set last December, according to government data on Friday. Although the ratio of job offers to applicants rose slightly to 0.56 - meaning there were 56 offers for every 100 jobseekers - the data showed the labour market remains weak. "With the expected faster disposal of NPLs, corporate bankruptcy and involuntary job losses will likely increase," said Takehiro Sato, economist at Morgan Stanley. "Our calculation suggests a �29,100bn increase in final NPL disposal would lead to 700,000 more job losses and a 6.5 per cent unemployment rate."
Source: Financial Times

Japan Banks Claim to Tackle Non-Performing Loans

According to the Financial Times there are signs the pressure being put on Japan's banks to deal with their bad loans is starting to bear fruit in the fact that the country's largest lenders used the publication of their first half results to simultaneously announce more aggressive action to tackle the problem. my feeling is it would be better to adopt a wait-and-see approach on this before starting to cheer.

SMBC, Japan's second largest bank, increased its forecast for loan loss provisions for the full year from �500bn ($4.1bn) to �700bn, while UFJ, the fourth largest lender, said it would transfer �1,000bn in bad loans to a new group company. SMBC said net profit for the first half rose 61 per cent to �55bn and added it expected to report a �30bn profit for the full year. It incurred loan loss charges of �266bn for the six months compared to �1,540bn for FY2002. It said in the first half it wrote off bad loans worth �953bn and that it had bad loans worth �5,700bn left on its balance sheet, of which �3,000bn were loans to companies considered in danger of bankruptcy or already bankrupt. UFJ said it made a net profit of �72bn for the period compared to a loss of �67bn for the same period a year ago. It forecast a profit of �70bn for the full year and confirmed it would transfer �1,000bn in non-performing loans to a new company to be set up next March.

Mizuho, the world's largest bank in terms of assets, said net profits for the half dropped to �39bn compared to a loss of �264bn previously but said it now expected to make a loss of �220bn net loss for the full year. The bank added it had bad loans of �4,970bn at the end of September compared to �5,000bn at the end of March. It increased its forecast for loan loss charges from �600bn to �1,040bn. MTFG reported a group net loss for the first half of �188bn compared to �96bn for the same period last year. It cancelled its interim dividend and said it now expected to make a group net loss of �185bn for the full year. MTFG said it had problem loans worth �3,6800bn at the end of September compared to �4,270bn at the end of March.
Source: Financial Times

Japan: What is The Economist Missing

According to the Economist it WAS just possible to find a nugget of good news about Japan�s economy on November 19th. However rose-tinted glasses, they suggest, were needed to spot it. On a day which saw another round of declines in the share prices of Japan�s biggest bank the Organisation for Economic Co-operation and Development (OECD) changed its mind about the economic outlook. Yutaka Imai, an OECD economist, said the organisation no longer expected Japan�s economy to contract this year. Instead, he said, it was likely to remain flat.

That zero growth is an improvement is a telling indication of Japan�s economic mess. Mr Imai was in Tokyo to talk about the OECD�s newly published survey of Japan. New data since the survey was completed makes the OECD�s economists slightly more optimistic about this year. But this has not altered their broader assessment: that the economy is in serious trouble. The prospect is for virtually no growth till the end of 2004. There is no sign yet of an end to deflation, now in its third year. And the problems created by Japan�s crisis-ridden banking system are in ever more urgent need of attention.

Besides the banking sector, the OECD identifies deflation, fiscal policy and the burgeoning government debt, and the uncompetitive nature of much of the economy as areas in need of urgent remedy. With the downside risks greater than they were, and no sign of an end to deflation, the OECD thinks monetary policy needs to move into uncharted territory. It urges the Bank of Japan to consider a range of new measures to tackle deflation. It also says that inflation-targeting might eventually have a role to play.But the OECD is far more concerned about the large part of the economy that is not export-oriented. Japan has what the organisation describes as a dualistic economy: the domestic, or protected, part of the economy is �remarkably unproductive�, which reflects poor resource allocation underpinned by, above all, poorly enforced competition law and regulation.

Reform is beginning, in some areas at least, to move in the right direction�though the OECD describes much of this as �timid�. So far, the ambitious reform plans of the prime minister, Junichiro Koizumi, have been more noticeable for their absence than their effectiveness. The OECD is not, on the whole, prone to exaggerate gloom. That is why its report on Japan makes such depressing reading.
Source: The Economist

Let's run this last paragraph again. The reform is begining. After ten years we can really believe that things are so simple. And even after ten years they remain 'timid'. Plans are ambitious, but remain notable for their absence of effectiveness. Our learning curve doesn't seem to be very steep at this point.

One of the problems with the Japan debate is that much of the material fails to tackle the problem head-on. For instance the well-publicized Federal Reserve research report "Preventing Deflation: Lessons From Japan's Experience in the 1990s" rather surprisingly manages to miss one of the most important factors driving the Japanese deflation: DEMOGRAPHICS.

So all of this is like Hamlet without the prince. And the OECD report which forms the basis for the Economist article isn't any better. It simply ignores the problem. Non of this analysis then really helps us understand why Japan government debt is growing out of control - after all with deflation even government supplied services should get cheaper, and why raising interest rates at any point is going to be difficult.

Many of the arguments rest on the assumption that eventually Japan will solve the slow growth problem. Well, I wouldn't be too sure, if the problem is a wrong diagnosis how the hell do you expect the medicine to work (although they did just discover that statins may reduce c-reactive protein as well as cholesterol, so there is hope, it's just that this reduces economic policy to a lottery).

At one level Paul Krugman is surely right, if Japan could spark inflation then things would get easier (although not necessarily for all those old people who are net savers), trouble is it seems it can't. Japan lived for fifty years on short term credit being wiped out by a steady inflation in land and property values, but when the labour force numbers hit the ceiling all that came to a fairly unpleasant end. I doubt it can start another assett driven buble, if it can't it isn't for want of trying. But if there's no petrol in the bike tank, then all the kick starting in the world won't help.

Another problem is the assumption that the Japanese are simply living on credit. Were things so simple! If you want to talk about debtor nations then you need to talk about the US, and all those dollars the Japanese have on deposit inside the Federal Reserve System which partly pay for those nice fat trade deficits. The IOU's are going from the US outwards, Japan is a net international creditor. And if one day push comes to shove and the Japanese take their money home, the first impact will be on Wall Street.

Another typical misunderstanding seems to relate to the debt service problem, and when it might begin to look problematic. When should we expect a risk premium on Japanese Government Bonds that really starts to bite. The problem here is that the Japanese govt though the postal bank and savings system effectively buys it's own bonds (or constrains savers institutionally to supply the funds which makes this possible) so they are, at present relatively immune to these downgradings. Japan is not Argentina.

That is the Japanese savings rate isn't just cultural, it's also structural, it's been engineered. Which leads to another misconception. The late-great Rudi Dornbusch was prescient enough to foresee that in the case of Japan "one day there will be a creditors strike, the investors leave for foreign assets (just as with any delinquent emerging market) the currency crashes, the debt crashes....".

But with Japan, as ever, things are not so simple. This creditors strike will not be as easy as it sounds. Cultural factors do have a role, and it is hard to see Japanese citizens abandoning their country anytime soon (again the Japanese are not the Argentinians). So they will attempt to keep paying the debt. As for the currency, there are relatively few Yen in international circulation, the MOF has seen to that as part of an explicit policy, so for the time being Japan has more control over its own currency than any other country. If the Yen does come down it will be because the MOF, or the MOF plus Washington want it that way. Of course one day everything will snap. Put another way all this will continue until it can't.

Tuesday, November 19, 2002

New OECD Study on Japan

The Organisation for Economic Cooperation and Development (OECD) has published a new economic survey for Japan. The OECD urges the Bank of Japan to ease monetary policy significantly, arguing that its existing actions have not worked and that the time has come to adopt a 'more adventurous' strategy. In the report the OECD argues that the central bank of the world's second largest economy should "move further into unchartered territory" if it is to stand any chance of bringing an end to deflation.It said the bank should raise the target range for current accounts of the banking system by considering purchasing more government bonds, expanding the range of assets it is prepared to acquire, and possibly setting an inflation target. These are measures the bank has itself described as "unorthodox", but with the reform of Japan's banking sector gathering pace consideration of such policy options is, it seems, becoming more likely.

Regarding government debt the OECD projects that a primary surplus of 1.75 per cent of GDP is likely to be necessary to stabilise the debt/GDP ratio at 180 per cent by 2010. With a primary deficit currently around 6.5 per cent of GDP, significant consolidation is therefore required. The OECD projects the primary deficit being reduced to 2.2 per cent of GDP by 2006. This of course, is a 'best case' scenario. I don't even want to contemplate what the 'worst case' one might look like.

The Japanese economy remains in a serious deflationary situation even while experiencing a cyclical recovery phase in mid 2002 underpinned by inventory correction and a sharp pick-up in exports. But the recovery is too narrowly based to represent a break with the pattern of generally low growth experienced through the 1990s. The still high capital/output ratio is likely to limit any pick-up in investment to a short term adjustment, while continuing weakness in the labour market is expected to restrain consumption growth to around one per cent per annum. More recently, a combination of factors � particularly low share prices in Japan and elsewhere, a marked appreciation of the yen and a moderating export expansion � has dampened growth prospects going into 2003.

All in all, the economy may grow by only around 1 per cent per annum to the end of 2004 with deflation continuing. But the balance of risks is now on the downside given signs of slower growth in the world economy and the possibility of a further deterioration in financial conditions, which might lead to a worsening of deflation. Thus Japan continues to be faced with the daunting challenge of radically and quickly improving the functioning of itseconomic system and halting deflation.

What needs to be done to control
public debt?

Beyond FY 2003, the central issue is whether or not Japan succeeds in placing its public finances on a credible consolidation path which would minimise the danger of a sharp increase in interest rates and increased household savings via a Ricardian effect. The OECD projects that, on a general government basis, a primary surplus of 1� per cent of GDP is likely to be necessary to stabilise the debt/GDP ratio at some 180 per cent by 2010. With the primary deficit currently around 6� per cent of GDP, significant consolidation is therefore required. In this light, the extent of fiscal consolidation envisaged in the government�s Medium-term Economic and Fiscal Perspective, agreed in January, is far from sufficient. The Perspective projects the primary deficit of the central and local governments to be reduced to 2.2 per cent of GDP by FY 2006, the end of their projection period, with a view to eliminating it as soon as possible after FY 2010. However, this involves an optimistic assumption about an end to deflation, which is unlikely to be realised in the near future. The Perspective is a small first step towards defining a medium-term fiscal policy framework. It needs to be made both more ambitious in its objectives and more concrete, and make use of shorter run real spending targets to improve credibility.

It should also spell out specific policy requirements that should guide current and future policy decisions. It needs to consider how the required revenues can be secured and spending cuts achieved against the mounting pressure for expenditure to rise, not least due to population ageing. In this respect, the heavy dependence of prefectural and local governments on the central government via public works and tax transfers, which has been a marked feature of public governance, also needs to be addressed. The government�s sense that deep changes are required in order to develop regional dynamism is appropriate. Reforms in this area will take time and should be linked with fundamental tax and expenditure reform.

Saturday, November 16, 2002

Who's in charge in Japan?

As I have already indicated (see blog post immediately below) there is considerable doubt and consusion about where exactly Japan is headed right now, and about what will be the real impact of Takenaka's reform programme. Morgan Stanley's Robert Alan Feldman seem to be in no doubt:

The media were wrong. A week ago, when the initial reports on the new plan for financial system clean-up were announced, the press universally dismissed the new plan as a humiliating retreat from the hardline position that Minister Takenaka had taken. Indeed, one reporter asked me if there was anything to write but an epitaph. Nothing could be further from the truth than these reports.

It is true that immediate enforcement of US standards for deferred tax treatment (DTAs -- see appendix table 1) was not in the package. However, the package did include a review of the standards (which was not even on the agenda under the previous minister), and a clear tilt toward tightening (see appendix table 2). Moreover, virtually every other component of the initial wish list IS included in the final plan, along with some enhancements. Many of these provisions are extremely strict. In addition, the final plan includes some provisions that will enhance the sustainability of the financial reform plan.

The most epoch-making part of the plan was the new concept of "special support financial institutions" (SSFIs). The plan specifies these as institutions in distress, capital shortage, or similar situations, and says that the government and BoJ will apply "special support" immediately. Such support will trigger various actions, including FSA resident inspectors and prompt removal of "danger of bankruptcy" or worse loans to the RCC or to revival funds. Once transferred, the plan calls for prompt disposal, e.g., by RCC to accelerated collection and sales of loans purchased, with prompt sale of those loans that cannot be collected quickly, creation of a market in distressed loans, and greater use of securitization and asset-backed securities market. Of course, the FSA will have to determine whether institutions fall into the SSFI category, and this cannot be done logically until after the next round of special inspections is complete -- barring unforeseen major bankruptcies. However, the SSFI concept is a powerful one.

Now that the bashing is over, there is considerable evidence that Minister Takenaka in fact has won some very important victories. Of course, much lift is still to be done, and investor skepticism will not fade easily. However, I believe that Minister Takenaka has made a very powerful start, and that momentum is with him.
Source: Morgan Stanley Global Economic Forum

Japanese Banks Set to Slash Lending

According to the Asahi Shimbun the toughening in Tokyo's bad-loan stance is forcing Japanese banks to react. The NBL disposal program being developed under Heizo Takenaka, minister for financial affairs and economic and fiscal policy, is supposed to make banks strictly appraise loans and set aside additional loss reserves to counter bad loans expected to surface as a result. Faced with tighter regulation, banks want to jettison loans, which count as risk assets, to prop up their capital levels. Much of the press has been skeptical about the intent of this reform, this early indication suggests that such skepticism may be misplaced, after all Japanese economic and monetary policy is caught between a rock and a very hard place. In which case watch out for the backdraft (See my blog: WILL HISTORY TREAT THE NAME TAKENAKA THE WAY IT ONCE TREATED YAMOMOTO here)

Threatened by the specter of state takeover under Tokyo's new bad-loan policy, the nation's four top financial groups plan to cut loans and other risk assets by 30 trillion yen in the current fiscal year, according to bank sources. Mizuho Financial Group, UFJ Group, Sumitomo Mitsui Banking Corp. and Mitsubishi Tokyo Financial Group will all significantly reduce their asset portfolios.To avoid hanging small, deeply imperiled corporate borrowers out to dry, and to dodge heat for crunching credit, the banks plan to scale back lending to foreign borrowers and securitize loans to major borrowers.

If higher loan-loss reserves drain too much capital, their capital-asset ratios may fall below the international floor of 8 percent, which is expected to trigger a government takeover. Assets of the banking groups carrying credit risks, including loans, totaled 273 trillion yen as of March, down 28 trillion yen from the previous fiscal year. By reducing such assets by 30 trillion yen, the banks will reduce their total risk liabilities by a greater margin in the current fiscal year.The offloading of assets is expected to bolster the banks' capital-asset ratios by about 1 percentage point.The biggest cut will be at Mizuho Financial, the world's largest banking group, which plans to shed 15 trillion yen from its asset portfolio. Sources said this is two to three times the initially planned amount.UFJ ranks second with planned cuts of 7 trillion to 8 trillion yen, followed by Sumitomo Mitsui Banking, which plans to add several trillion yen in cuts to its plan to reduce assets by 5 trillion yen.Mitsubishi Tokyo Financial, meanwhile, will slash assets by 2 trillion to 3 trillion yen.
Source: Asahi Shimbun


Having come out two weeks ago dramatising the possible consequences of a 'hard landing' in Japan in a way which may have been a little OTT for the taste of some people, it is heartening to see that one of the leading Japan 'experts' comes to similar conclusions, in a much more reserved way, of course.

By Akio Mikuni and R. Taggart Murphy
An upheaval in Japanese finance, bringing with it a complete restructuring, is not impossible. But such a restructuring would produce shocks that would reverberate around the world. Japan as a nation holds nearly $3 trillion in dollar-denominated assets, many of them ultimately supported by the very deposits that would be withdrawn in a wholesale reorganization of Japanese banking. Those dollars have played an indispensable role in permitting the United States to swell its trade deficits far beyond the levels of most nations.

That so many foreigners are willing to keep their earnings from trade inside the United States banking system � what "holding dollars" literally means � helps the United States tolerate its deficits. But this situation is precisely what restructuring in Japan threatens. If banks were forced to call in loans to pay off depositors, and if those loans financed their customers' dollar holdings, Japanese companies would be forced to sell their dollars for yen. Real money and purchasing power would then leave the United States as the conversion weakened the dollar, forcing a rise in interest rates and import prices and further raising the risk of recession. That is what usually happens to countries that run excessive trade deficits � foreigners lose confidence in these countries' currencies, interest rates rise, the economy goes into recession and, as people can't afford to buy so many imports, the trade deficit begins to close. The United States has escaped this fate largely because of the very problems with Japanese finance that Mr. Takenaka promises to attack. Washington ought to be careful what it wishes for.
Source: New York Times


Japan seems to be on track to enter its fourth consecutive year of deflation - something not seen in any post-war industrialised country - as the country's core consumer price index dropped for the 36th consecutive month in September. The core nationwide CPI fell 0.9 per cent in September, year-on-year, according to government sources. In October, the Tokyo CPI fell 0.8 per cent from the same month the previous year, its 38th consecutive monthly decline.

Heizo Takenaka, the country's embattled economics minister, said on Friday that further debate was needed regarding the Bank of Japan's possible adoption of an inflation target.

"The (Bank of Japan) has said it will keep up its efforts until prices stop falling, and you can call that loosely an inflation targeting. In any event, there are various opinions among experts and we need to further debate this issue." Mr Takenaka - who was this week forced to postpone the announcement of his plan to accelerate the disposal of bad loans after objections from members of the ruling party - has stressed it would be difficult to pursue aggressive moves to clear up bad debts in the banking sector, conservatively estimated at Y43,000bn ($347bn), without equally strong efforts to tackle deflation. Consistently falling prices whittle away at revenue and undermining companies' ability to repay loans.
Source: Financial Times


News from Japan these days is contradictory. There seems to be no consensus whatsoever about whether Takenaka and his team of 'hard landing' specialists are going to get the political backing they need. Risking a revolt in his own party, Japanese Prime Minister Junichiro Koizumi has today ben giving the appearance of standing firm in support of his besieged banking regulator, amidst heavy signalling from the Bank of Japan that it would operate monetary policy to try to help ease the pain of the tough-love reforms being proposed. Of course the consequences for all of us should the Takenaka proposal prosper are far from clear ( See: WILL HISTORY TREAT THE NAME TAKENAKA THE WAY IT ONCE TREATED YAMOMOTO, blogged Saturday October 5, 2002).

The critical nature of Japan's situation can be sen from the fact that when the names of the reform task force (especially that of Kimura) were made public the Nikkei crashed to a 19 year low, the market then began to slowly recover as things went quiet, and no that there's real talk that the reforms may be sidetracked, well, the market is going back down again. This seems to suggest that Japan is near to going critical, and for this reason my guess (and it's only a guess) is that the reforms will go forward. So watch out.

Japan's ruling Liberal Democratic party on Tuesday appeared to have staged a last-minute rebellion against plans to deal with the country's troubled banking sector, accusing Junichiro Koizumi, prime minister, of pursuing a "unilateralist" and economically damaging strategy.The Financial Services Agency was forced to postpone the announcement of its plan to accelerate the disposal of banks' non-performing loans, citing "political reasons". It would release details of its plans in the next few days, it said.

There had been speculation ahead of the announcement that Mr Takenaka would issue a much watered-down version of his plan because of strong political opposition from those who say a hard landing could tip Japan into economic crisis. But legislators were clearly still uneasy about some aspects of the plan. Attention has focused on possible proposals to deal more strictly with the categorisation of bad loans as well as to reassess what banks can count as capital. In particular, a proposal to deal more strictly with deferred tax assets - potential tax refunds counted by banks as Tier 1 capital - could have a devastating impact on some of the country's biggest banks. If banks' capital adequacy ratios fell below international requirements of 8 per cent as a result of such changes, they
would be exposed to a possible enforced injection of state funds and nationalisation. Mr Koizumi said that an injection of state funds was not fundamental to improving the health of banks, but could result from a stricter categorisation of bad loans.Until last month, when the Bank of Japan called dramatic attention to the lingering banking crisis, the FSA and the banks were adamant that they could write off bad loans by 2004 from profits.
Source: Financial Times


Japan's Asahi Shimbun has this inteesting piece about the capitalisation situation of Japanese banks. According to this Japanese daily the major banks still have capital adequacy ratios of 10 percent or higher, meeting the internationally accepted minimum of 8 percent. But much of this capital consists of previous government bailouts and deferred tax assets, posted in anticipation of tax refunds. Accumulated profits are apparently near zero, following numerous bad debt write-offs. The question to ask then is major banks really as healthy as they claim they are?

Capital contributed by shareholders, accumulated profits, shareholdings, gains on real estate and other items are considered the tangible capital that constitutes shareholder equity and can be used to cover losses. The last two injections of public funds, in 1998 and 1999, are supposed to be paid back, and deferred tax assets are also considered artificial capital.

Each banking group's capital-adequacy ratio was raised by 2-3 percentage points through the previous injections of public funds, and only Mitsubishi Tokyo Financial Group has repaid that assistance. Although public funds are considered part of shareholder equity under Bank for International Settlements standards, they are not true equity in that they are debts that must be paid back to the government. Banks have almost no surplus cash after writing off bad debts, and they may not be able to pay back the government.The banks, however, counter that the purpose of the public funds was to boost their equity to begin with, and ease their reluctance to lend money. They say it's irrational to claim their capital is weak because it includes public funds.

Real estate property assessments also pose a problem. Since March 1998, banks have been allowed to top up their capital by booking any increase in a property's assessment over its acquisition price as an unrealized gain. Now that major banks are facing unrealized losses on their commercial real estate holdings, however, their equity will likewise have to be revised downward. Banks haven't reappraised their real estate since before its market value fell below its book value, so unrealized losses due to falling land prices remain hidden. The banks say they have disclosed their latent losses in their financial statements, and do not intend to hide them. Land prices, meanwhile, continue to crater.

The use of deferred tax assets-expected future tax refunds-is another questionable technique the banks use to pad their capital. It was introduced in March 1999 to encourage banks to set aside taxable reserves against bad debts. The BOJ says banks' combined deferred tax assets totaled 10.6 trillion yen in March 2002, up 3.5 trillion yen from the previous year. Over the same period they rose to account for 36.5 percent of shareholder equity, from some 20 percent. Deferred tax assets have swelled in tandem with the increase in tax credits the banks are receiving for disposing of bad loans.The maximum amount of deferred tax assets a bank can post is based on its future profit projections. Some analysts want closer scrutiny of banks' profit projections, lest an overly rosy outlook allows a bank to pad its capital too much. Banks can also include up to five years' worth of expected taxes in their shareholder equity. In the United States, on the other hand, they can only post deferred tax assets for the coming year.
Source: Asahi Shimbun


Japan is going to burst. Left on its present course, like the proverbial nineteenth century steamship with the boiler overheating, one day one too many of the bolts will sheer off, a boiler plate will give and then the devil take the hindmost.

Of course one of the few remaining debateable points is whether or not there is really anything left to be done. Common sense says there is, and sheer humanity says that there ought to be. That's the easy part. The tricky bit is what.

This weeks news of a cabinet reshuffle over in Tokyo could be interpreteted as a positive signal. Something is finally to be done about all those bad loans clogging up the banking system. That has to be good news doesn't it. Well yes, and no.

For one thing, the response in the Tokyo stock markets shows that some people have had a very nasty fright. The declared stance of Takenaka could cause even the not so faint of heart to tremble a little, and the appointment of Kimamura with his hitlist of 30 'zombie companies' to the FSA taskforce, could indicate that this time we should take all this seriously. Other will of course say that in Japan 'we've seen it all before'. That is, that there will be a lot of noise but little action as the warring factions battle it out. This could well be, but Koizumi has summoned a special meeting of the Japanese Diet for the 18th October, the day after the anti-deflation plan is to be announced, and Takenaka's strong talking is building up a lot of expectation. The question could be asked, can Koizumi survive politically if he does not deliver this time?

Be that as it may, the problem still remains as to whether we have really got to grips with the heart of the matter yet. Drastic surgery is, after all sometimes necessary. It's just that first it might be worth checking out whether we have a reasonable diagnosis. You see, collapsing an economy is not too difficult, it's reviving one which is often the hard part.

Morgan Stanley's Robert Alan Feldman groups the possible approaches to Japans deflation problem into four groups:

The Monetarist Approach
The IS-LM Approach
The AS-AD Approach
The Trade Theory Approach
Source: MS Global Economic Forum LINK

Actually this division is a bit schematic since of course there may be considerable overlap in policy proposals between these four lines of analysis. Thus both the monetarist and IS-LM lines can concur that monetary easing should continue, despite the fact that, as Feldman says, "the sharp acceleration of the BoJ balance sheet and of base money has been answered by equally sharp declines of the money multiplier in recent years. On the other hand those following the IS-LM approach will tend, following Krugman's lead, to emphasise fiscal expansion. Again, the best that can seem to be claimed here is that such fiscal policies have avoided an even worse recession. They do not seem to offer hope for a cure.

The trade theory analysis addresses the problem that with declining import prices relative to domestic prices consumer wlfare can actually improve within a golbal macro negative situation. This can help us understand why there are so many internal comments from Japan about what's really so bad about inflation, but offers little policy leverage apart from protectionism, which given the fact that many of the domestic industries in trouble are export dependent could prove disastrous.

This brings us to AS-AD and Takenaka. I'll let Feldman explain:

The aggregate supply curve comes from the relationship of nominal wages (and other cost components) to the price level. At a given level of nominal wages (or interest costs or oil prices), a higher level of prices would imply higher profits, and therefore more output. Thus, the AS curve is upward sloping relative to the axes just mentioned. The intersection of AD and AS curves generates an equilibrium. In order to raise the price level (i.e., to stop deflation), one can use either the AD or the AS curve. This is where things get interesting.

Traditionally, the AD curve is seen to respond more to monetary and fiscal policy than the AS curve. (Indeed, the latter is assumed to be inert with respect to policy changes.) However, this is precisely the assumption that appears to fail in Japan today. Indeed, fiscal policy over the last decade was aimed largely at keeping inefficient producers (in construction and real estate) in business, thus artificially pushing the supply curve far to the right side of the diagram, while pushing the demand curve only slightly to the right. The small movement of the AD curve may be attributable to (a) Ricardian equivalence, which pulled private demand inward when government demand moved outward, and (b) low return on capital, which lowered the multiplier effects of government programs. Ironically, according to this view, both monetary and fiscal policies actually worsened deflation.

The AS-AD approach is very much in concert with the ideas that Minister Takenaka has been proposing ever since he was the driving force behind the Economic Strategy Council of 1998. The report of that council, whose report was shelved by PM Obuchi because of the political consequences, was dusted off and improved in Mr. Takenaka�s "thick bone report" or June 2001, and reasserted in the sequel of June 2002. Moreover, the identification by the PM himself of the need for industrial restructuring lies very much in the spirit of the AS-AD approach. Because of the long association of this thread of economic theory with Messrs. Takenaka and Koizumi, the AS-AD approach is likely to be the driving force in the new cabinet. The negative effects on the economy from supply-side policies are likely to be offset by tax cuts and/or expanded unemployment benefits.

In other words, and to put it bluntly, the axe is coming out. The so called NPL (non-performing loan) problem is going to be resolved - over other peoples dead bodies. As Robert Feldman accepts in a later post "An aggressive stance on NPL disposal will inevitably create deflationary and recessionary pressures, thanks to large-scale unemployment". To attempt to accommodate this the government is also said to be preparing an emergency fiscal package to try to offset the recessionary effects of the NPL solution.

This is where, in my book, we hit the one variable too many problem. This problem has nothing to do with a well known problem in systems of simultaneaous equations. No, my version of this refers to the number of variables we economists seem able to hold in our heads when contemplating policy outcomes (a recent example of this was seen in Argentina where what appeared to be a miracle cure for hyper-inflation, the peso-dollar peg, had only one drawback, it's impact on Argentine external trade - and it is here, and only here that some similarities between the two sitautions can be seen, in the incapacities of relatively overpriced home industries to compete in their own domestic markets). The variable which seems to be being omitted from the calculations here is that of the projected consequences for national debt dynamics.

Japan already has an extremely difficult and onerous situation with its government debt, a situation which is only made liveable by the very low current interest rates. Now the resolution of the NPL problem seems to involve numbers in the region of 8% of GDP (estimates vary, and only time will tell). To this will have to be added the cost of any fiscal expansion (which could be relatively large given the size of the anticipated problem) plus any drop in revenue from the ensuing recession (which again could be large).

My point here is that this latest twist in anti-deflation policy in Japan, could be a one-shot, all-or-nothing play. Remember Japan's population is aging rapidly. Pressure on national debt can only mount in the future. (Economists like lead-lag situations, but in demography the lags are truly important: 20 years or so before any benefits can be seen. And remember even if the birth rate went up, during the first 15-20 years that would only make the problem worse as the dependency rate actually increased.) At the same time savings in health and old-age care have associated consequences for female labour market participation rates as women stay home to care for relatives. All in all a kind of negative feedback spiral. So that if this policy turn fails, and if the analysis is wrong (and if, for example demographic, pressures have a large part to play in telling the Japanese story) then it may well fail, the future for Japan and its people looks bleak indeed.

All this brings me back to the title of this piece, and its associations with Pearl Harbour. As Stephen Roach has been reminding us all for some time, the global economy
isn't exactly highly stable right now. In fact balanced-on-the-edge might be closer to the point. So what could be the consequences for a fragile global economy of a sudden and dramatic collapse in Japan. Put bluntly: would some of the flying debris find its way to New York and Frankfurt.

A minor nineteenth century economist once expressed the view that previously the the world had been over-interpreted while the real point was to change it. From where I'm sitting we abound in projects to change the world, it's on the interpretation side that we're a bit weak. Ill thought out ideas are extremely dangerous. Look at Argentina and the Peso-Dollar peg and you'll see what I mean.

So I'll close this with one thought. At the present moment reviving Argentina seems a Herculean task, not least because the responsible political class has lost all moral authority. How did it lose it? By defending with the aid of $40 billion from the IMF an untenable idea. If the Argentinians had not been asked to sacrifice so much so pointlessly during 2001. Let's hope we're not about to make the same mistake with Japan.

Japans core consumer price index fell for the 35th consecutive month in August, down 0.9 per cent year-on-year. Unemployment in August was just below post-war highs at 5.4 per cent. The number of jobless increased by 250,000 year-on-year to 3.6m. To cap this extremely depressing batch of economic data household spending fell 2 per cent in August month-on-month. This seems to indicate that Japan is as much in the grip of deflation as ever and should give the G7 leaders assembled for the Washington summit plenty to muse over. Meanwhile, in an attempt to deflect criticism, Japan's leaders are suggesting that they may be prepared to act more agressively on the bad loans problem that plagues the banking system:

Japan will tell fellow members of the Group of Seven industrialised nations in Washington this weekend that it is prepared to use public money to bail out its debt laden banks, Masajuro Shiokawa, finance minister, said yesterday.

But the veteran politician offered no details of how the potential injections would take place and insisted the bailout would only proceed "if necessary", offering policymakers a range of options to avoid having to abide by this strategically timed pledge. Members of the G7 have been calling for a meaningful resolution of Japan's bad debt problem for many years and Mr Shiokawa's statement is likely to mollify them. But it could backfire if not backed by action. "At the meeting I will stress the importance of banks' liquidation of corporate borrowers in serious trouble. As a result we may inject public funds into banks, if necessary," Mr Shiokawa said yesterday.

Despite the rumours of his demise, Mr Yanagisawa - Japan's Financial Services Minister -was in unrepentant form yesterday, insisting an injection of funds is not needed but making his first public commitment to a scheme that would help the banks by expanding the role of the Resolution and Collection Corporation (RCC).Mr Yanagisawa said yesterday he would accept the use of public funds only if they were used to cover losses incurred by the RCC when it offloaded the loans it had purchased from the banks.The minister's comments neatly capture the core of the debate over how to deal with the bad loan problem. One view - the true bailout scenario - involves public funds being injected directly into the banks, wholesale management changes, a short-term rise in bankruptcies, rising unemployment and potential political and social unrest.The other view - the quasi bailout scenario - involves the bad loans being transferred to the RCC, which will offer a better price for them than previously. This will restore the banks to health but leaves borrowers just as bankrupt as before, but able to struggle on.
Source: Financial Times


Perhaps the best introduction to this latest faux pas in the unwinding Japan saga is the comment from Merrill Lynch bond strategist Masuhihsa Kobayashi who is quoted as saying: "It seems that fiction is becoming a reality." The backdrop to this rather painfully reality recognition (actually life has always been stranger than fiction) is todays withdrawal the Y1,800bn on auction offer since the bid volume was only Y1,185bn. This latest embarassment - following the BOJ sally into the terrain of share buying earlier this week - only serves to underline the instability of the whole situation. This is the first time ever a bond offer has been withdrawn (of course the bonds themselves have been fully subscribed by the contracted underwriters) and gives the awful impression that there are few buyers for Japan government debt. Of course the reality might just be an internal factional shooting war, hitting back at the BOJ, and attempting to undermine its authority, in the wake at the share buying initiative, which could, in its turn have been only a way of turning up the pressure. Who outside of the Byzantine world of Japanese institutional finance knows? The only painfully obvious truth is that this cannot continue indefinately.

Investor confidence in Japan suffered another blow on Friday after a Y1,800bn auction of 10-year Japanese government bonds was undersubscribed for the first time in its history. Traders were unnerved by the unprecedented lack of demand, but chalked it up to a case of incredibly bad timing. Earlier this week, the Bank of Japan said it would buy shares directly from commercial banks in an effort to reduce their massive exposure to stock markets, a move which sent shock waves through the markets.

Masaru Hayami, governor of the BoJ, was unconcerned. "I am not that worried. I believe investors' appetite for JGBs is unchanged," said Mr Hayami. He added that 10-year JGBs were in a correction phase and that some market instability was inevitable.But investors thought otherwise, and the auction's failure sent the JGB market reeling. The yield on the benchmark 10-year JGB rose 12.5 basis points to near two-month highs and the key 10-year JGB futures contract fell more than a point to 139.04 in intraday trade.
Source: Financial Times


The latest news and economic data from Tokyo continue to cause concern. Yesterday the Nikkei average dropped 1.67 percent or 159.10 points to 9,362.53 after touching in one moment an 18 year low at 9,269.10. On November 10, 1983, it closed at 9,244.24.In part this downward movement is provoked by uncertainty concerning the immediate outlook in the US (and now in Europe judging by the latest survey data on August manufacturing). In part the fall is a reaction to talk of plans for large scale tax cuts, when it is absolutely clear that reducing government debt has to be high among Japan's priorities. And in part the move is a reaction to the continuing doubts about the real health of the Japan business sector as evidence accumulates that all is not what it seems.

It is hard to identify precise tipping points for Japan's agony, but in the past I have pointed to one indicator - a Nikkei below 10,000, for its feedback effects on the value of bank assets - as a possible candidate. Every day the Nikkei stays below that level marks one more day in which Tokyo moves a little bit nearer to the brink. Another possible candidate is obviously government debt, which continues to increase rather than decrease. My view is that no-one really has a firm, agreed figure for the value of Japan government debt as a percentage of GDP. In part this depends in what you count as debt. However for a long time now a widely quoted figure has been stuck at 130%. Well in this piece from the Reuters on Yahoo News they suggest the value is now 140% (remember with deflation the real value of debt automatically rises), so perhaps the stakes just went up.

It was only a matter of time until we fell this low," said Masanori Hoshina, head of global portfolio marketing at BNP Paribas. "Part of our weakness lies in concerns about the cloudy economic outlook in the U.S. But the key problem is that there are still no signs of a sustainable economic recovery in Japan," he added. Data on Friday showed the Japanese economy grew at a faster-than-expected 0.5 percent in the April-June quarter, but industrial production fell unexpectedly for the second straight month in July and other data showed deflation worsening. Declines in prices make it harder for Japanese companies to service their mountains of debt, adding to pressure on banks. High government debt levels are also a worry. "With a public debt of around 140 percent of GDP, the Japanese government doesn't have many cards left up its sleeve," said Hiroshi Nishiyama, senior portfolio manager at SG Yamaichi.

Against such a backdrop banks were pummelled. Mizuho Holdings Inc, the world's largest bank by assets, plunged 7.23 percent to 231,000 yen and was the highest traded issue by value on the first section of the Tokyo Stock Exchange. Rival UFJ Holdings Inc slipped 4.18 percent to 252,000. Japan's megabanks have large holdings of stocks on their books and falls in the stock market eat into their capital base, increasing fears of financial instability.

Another notable loser was Tokyo Electric Power Co Inc (TEPCO) , which extended its losing skid to six straight sessi ons and was down 1.46 percent on the day at 2,360. Shares in Japan's biggest power utility have come under heavy pressure since it said last week that it may have failed to accurately report cracks in its reactors. Traders say that a string of recent scandals in corporate Japan has helped undermine market sentiment and depress trading volume in recent weeks.


China is on the way to replacing the United States as the top exporter to Japan and could do it as early as this year, according to information provided by the Japanese government last Tuesday. China is still Japan's No. 2 trading partner behind the United States. But the figures indicate that China is rapidly passing the United States as the top exporter to Japan.

Roughly 17.8 percent of all good imported to Japan came from China during the first half of 2002, according to the Japan External Trade Organization. That's just behind the United States, which accounted for 18.2 percent of Japan's imports over the period.

But whereas imports from China increased over the period, imports from the United States decreased � narrowing the gap. "It is possible that, in terms of imports, China will surpass the United States in the very near future, perhaps as early as the second half of this year," said Masaki Yabuuchi, director of JETRO's China division.

Yabuuchi said imports from China were on the rise because Japanese manufacturers increasingly relocate their factories in China to take advantage of lower labor and materials costs. They then use China as a base for exporting back to Japan.

In terms of exports and imports, China accounted for 12.8 percent of Japan's total trade in the first half of the year, while the United States accounted for 24.3 percent.

The largest category of imports from China was machinery and equipment, comprising 33.9 percent, or $9.44 billion, of total imports. Japanese imports of communications equipment, including mobile phones, nearly doubled, $370 million, the report said.

Growth in Japanese exports was led by the automobile, steel and metalworking industries. The value of cars shipped to China in the period totaled $640 million � an increase of 60.5 percent.
Source: Yahoo News

Tuesday, November 12, 2002

Nikkei and Japanese Banks

The latest decline in the Stock Markets only serves to underline just how fragile the Japanese banking system actually is.The Nikkei 225 index fell below 10,000 for the first time in five months today dropping below a level at which it begins to threaten the health of the entire Japanese financial system. We don't know for certain what will be the 'tipping points' for the Japanese system, but a Nikkei much below 10,000 for any length of time could well be one of them:

"There's a direct connection between the stock market and the banking system, " said Marshall Gittler of Bank of America. "When it falls below 9,600, that's the point at which the main banks' capital adequacy ratios go below 10 per cent. These drop below [the mandatory] 8 per cent somewhere in the 8,000s, so there's a little way to go before they have to shut down the banking system."

Banks must close their books for the half year at the end of September, which may encourage the government to take measures to bolster the stock market. In February, before the end-of-year close in March, the government made little secret of the fact that it wanted to see the Nikkei rise above 11,000, as it duly did. Recently, members of the ruling Liberal Democratic party have proposed extending the scope of a body that buys shares from banks to permit it to purchase shares from companies in other sectors.

"The problem in Japan is that when anything goes wrong at some point it will start affecting the banks," said Peter Tasker of Arcus Investment. "And that of course can only be addressed by public policy."
Source: Financial Times


The NBER is about to publish the proceedings of a conference held in March 2002 and entitled "Structural Impediments To Growth" (available online HERE ). Among the many intresting papers is one by Robert Dekle of the University of Southern Carolina entitled "The Deteriorating Japanese Fiscal Situation:Future Prospects in an Era of Population Ageing (available online HERE ):

The deteriorating Japanese fiscal situation has attracted worldwide attention. If the Japanese fiscal situation does not improve, the huge public debt is expected to sharply increase Japanese interest rates; lower Japan�s international credit worthiness; and adversely impact the welfare of future generations. In this paper, we assess what current Japanese government fiscal policies mean for the future evolution of the Japanese public debt, and the economy in general, given the inevitable aging of the population. Owing to a very weak domestic economy, that lowered tax revenues and raised government spending, the Japanese fiscal balance worsened dramatically over the last decade. The government budget, in surplus until 1992, turned negative in 1993, and subsequently, deficits have continued to worsen, reaching over 10 percent of GDP in 1998.

Correspondingly, Japanese government debt ballooned. The government debt-GDP ratio increased by over 10 percent per year in the late 1990s. By 2000, Japan had the largest debt-GDP ratio among the OECD countries. The Japanese fiscal situation may continue to look grim, especially given the rapid aging of the population. The population aging is expected to slow economic growth, and raise future government healthcare and social security expenditures. The percentage of the population over the age of 65 has grown rapidly, and now stands at about 15 percent. By 2020, that percentage 2 should approach 25 percent, and by 2050, 33 percent.

In this paper, we first review how Japan got into this current fiscal mess in the mid- to late-1990s, from a healthy fiscal situation in the early 1990s. We next perform some calculations of debt dynamics, and show that with unchanged fiscal policies, Japan�s public debt-GDP ratio rises to between 260 and 380 percent in 2020 and to between 700 to 1300 percent in 2040-- clearly unsustainable levels. We perform calculations showing that for the Japanese public debt to be sustainable, significant increases in taxes, or cuts in government spending are necessary.

Finally, we report the results of a previous simulation exercise that explicitly incorporated, the effects of an aging Japanese population. In the simulation exercise, we explicitly modeled the interplay between government fiscal policies and household and corporate behaviors. This is important, since in reality, fiscal policies can clearly affect private behavior, and these changes in private behavior may, in turn, influence the dynamics of government debt.

The simulation exercises showed that absent cuts in government spending, taxes would need to increase from the current 28 percent of GDP to over 40 percent of GDP by 2020, for the government debt to be sustainable. The tax increases and the inevitable aging of the population are projected to sharply reduce household saving rates. As the labor force declines, and the need to equip workers with capital decreases, corporate investment rates are also projected to fall. The surge in Japanese government debt in the 1990s has raised questions about the sustainability of this debt, especially given the rapid aging of the Japanese population.

The dynamics of the debt to GDP ratio are highly sensitive to real interest rate and real GDP growth rate assumptions. We assume that between 2000 and 2040, real GDP growth averages about 1.2 percent, annually. We make two real interest rate assumptions, of 3 percent and 6 percent. Since the early 1980s, Japanese real interest rates havaveraged about 3 percent; the 3 percent real interest rate assumption is also used in other studies to project the path of future Japanese government deficits (IMF, 2000; Jinno and Kaneko, 2000).

In the future, however, the Japanese government may no longer be able to borrow at these low domestic rates, and may have to borrow at higher international real rates. Recently, the nominal interest rate on five to six year maturity Japanese Government Bonds (JGBs) have yielded close to 4 percent. Since inflation rates are essentially zero, the real rate on Japanese government borrowing is now close to 4 percent. The 6 percent real interest rate assumption reflects the average real cost of borrowing in international financial markets in the 1990s.

In this paper, we argued that the future prospects for improvements in the Japanese fiscal situation are grim, unless the government carries out significant fiscal reform--by raising taxes or cutting spending. For example, we showed that under unchanged spending policies, taxes would need to increase from the current 28 percent of GDP to over 40 percent of GDP by 2020, for the government to be solvent. Japanese citizens should brace themselves for painful adjustments in the near future, in the form of lower public services or higher taxes. A way out of these painful adjustments, however, is for strong growth in real GDP to resume. For example, if real interest rates are 3 percent, a real GDP growth rate of slightly in excess of 3 percent can imply falling debt-GDP ratios.

In this paper, we assumed that real GDP growth averages 1.2 percent per year from 2000 to 2040. This assumed labor augmenting technical progress of about 1.2 percent per year, or total factor productivity growth (TFP) growth of 2.0 percent per year. TFP growth of 2.0 percent is an assumption of the high side, since it is about equal to Japan�s average TFP growth between 1970 and 1990, and Japan in the future is not expected to be as innovative as in the past (Branstetter and Nakamura, this volume).

What lowers GDP growth from 2.0 percent to 1.2 percent is the dramatic 0.8 percent annual decline in the labor force, caused by the aging of the population. Thus, one way to increase GDP growth is to raise the labor supply. Ono and Rebick (this volume) argue for removals of structural impediments that restrict the movement of labor between firms and discourage women from participating to a greater extent. Another possibility that has received scant attention until now is to promote immigration into Japan. Of high priority are further studies on the impact of increased foreign immigration on Japanese growth, saving, andthe government debt.

Whilst I consider this paper to be useful in focusing attention on a problem which is going to make itself pretty well known to us soon enough, I have my doubts about the validity of these kinds of projections, simply because we do not really know yet what is going to happen in various key areas. In the first place we simply lack experience of the economic consequences of systematic population reduction (since the time of the black death at any rate, and the little we know about this particular moment in European history would tend to suggest it was none too poitive as a precedent). So when we say that possibly economic growth will reduce by 1% per year (or simlilar), we really are guessing.

One of the first problems is to make forward projections based on previous experience. One god example of this is illustrated by the Federal Reserve paper below which demonstrates how projections for Japanese economic growth were systematically revised downwards in the 1990's. Another problem is one of principal: what is the validity of making a partial equilibrium analysis of a process which is thought to be passing through a structural adjustment, and not steadily approximating to an equilibrium state.

For example Dekle experiments with various possible tax and spending scenarios. But both of these variables are likely to have important secondary consequences on employment creation and consumption. How sensitive, for example, is Japanese employment to every additional 1% hike in taxes? Or how sensitive are the values of accumulated private savings (housing values, equities etc) to demographic processes and declining GDP, ie what is the likely result of every 1% decline in GDP on equity values, and every 1% decline in population on property values? And how would this evident wealth effect translate itself into secondary consequences for the growth of GPD. That is far from having a system approach a stable equilibrium path, we could see one which is cascading away from one.

Another major incognito is the real level of outstanding Japan government debt. A wide variety of numbers are tossed in the air, largely depending on what factors are included and which excluded. The official net debt of the Japanese government is only of the order of 45% of GDP. A small enough figure it would seem. But this does NOT include unfunded social security liabilities - a not unimportant isue in a rapidly ageing society. Adding these in you reach a figure of between 70% and 80%, depending. But then ther are, as this paper spells out three more catgeories of unfunded liabilities.

Firstly there are potential losses on government assetts - eg soft loans that may never be repaid. Doi and Hoshi (see above) estimate that these liabilities could reach 9% of current GDP.

Secondly there are explicit government guarantees for private sector lending. This could amount to some 10% of current GDP.

Finally there are implicitly guaranteed private sector loans, in particular recognised in terms of the governments liability to recapitalise the banking system in the eventuality that this is neded - this could be a further 2% of current GDP.

It is by accumulating all of these contingent liabilities that the figures for Japanese government debt in the order of 130% of GDP are arrived at.

This paper is useful if only for the fact that it makes plain the serious scale of the Japanese problem, and for the fact that it at least concludes with a recognition that the problem of Japanese society confronting the ned for increased immigration is receiving 'scant attention'. This situation I fear, even if it were to change, would be a case of too little, too late for reasons whiach I will explain elsewhere and often.

The following article by a group of Federal Reserve economists attempts to come to grips with any connection there may be between Japan's burst bubble and the creeping deflation they are experiencing.

Abstract: This paper examines Japan�s experience in the first half of the 1990s to shed some light on several issues that arise as inflation declines toward zero. Is it possible to recognize when an economy is moving into a phase of sustained deflation? How quickly should monetary policy respond to sharp declines in inflation? Are there factors that inhibit the monetary transmission mechanism as interest rates approach zero? What is the role for fiscal policy in warding off a deflationary episode? We conclude that Japan�s sustained deflationary slump was very much unanticipated by Japanese policymakers and observers alike, and that this was a key factor in the authorities� failure to provide sufficient stimulus to maintain growth and positive inflation. Once inflation turned negative and short-term interest rates approached the zero-lower-bound, it became much more difficult for monetary policy to reactivate the economy. We found little compelling evidence that in the lead up to deflation in the first half of the 1990s, the ability of either monetary or fiscal policy to help support the economy fell off significantly. Based on all these considerations, we draw the general lesson from Japan�s experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus, both monetary and fiscal, should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity.

This paper is well argued and to the point. Of particular note are the repeated failures of all the standard forecasting outfits to see what was going to happen, they consistently overstated the short term growth possibilities (any bells ringing here?). The problem with forecasting is that it assumes that the future is going to be a re-run of the recent past, and sometimes, as we can see, it isn't like this. Another point that is clear is the 1995 before and after situation - is it just a coincidence that the US equity market boom really got going post 1995?

Equally it is chastening to note that the real problem only became apparent five years after the equity bust. Again they indicate the difficulty of making a determination of whether or not an economy is entering a deflationary phase. For just this reason it's very difficult to look at the progress of the US CPI over the last years and say que si or que no. We could be on the way in, but again we could not. The recent fall in the US dollar is one positive note for the US here - but for the US, not the EU! In the end if the majority of economists don't envisage a deflationary panorama it's because looking at the recent past it seems a safer bet not to. But this is no guarantee.

Perhaps the most important individual lesson they draw attention to is the change in risk weighting that is appropriate when there is a wiff of deflation in the air. The risks become asymetric. The downside risks of deflation are much greater than the upside inflationary problems, and policy should be formulated accordingly. I'll let Stephen Roach have the last word here:

The Fed paper makes it quite clear that just the risk of deflation in a nation�s aggregate price level should be sufficient to trigger aggressive reflationary policies. The popping of a major asset bubble at low levels of GDP-based inflation -- precisely the case in the United States -- only serves to underscore those very risks.

For that reason alone, the conclusions of this Fed research paper seem quite relevant to me in assessing the prospective stance of the US monetary authorities. The Fed staff argues that the Japanese authorities should have been more aggressive in pursuing monetary easing and fiscal stimulus. In effect, they waited until it was too late. In large part because of that delay, the Fed researchers also found that the effectiveness of Japanese stabilization policies was diminished in the post-bubble climate -- with the authorities basically "pushing on a string" as Japan became mired in a liquidity trap. Under those conditions, the Fed staff concluded, the risk of a policy blunder that might otherwise seem to be overly stimulative need not be taken seriously. It can always be corrected once the deflationary alert ends.

We tend to cavalierly believe that America is not Japan. And, of course, in many critical respects the comparisons are wide of the mark -- especially when a functional US banking system is compared with its dysfunctional counterpart in Japan. But the Fed paper argues persuasively, in my view, that just as it was the case in Japan, it�s not worth taking deflationary risks in a post-bubble US economy. This speaks of a Fed that will remain predisposed toward monetary accommodation for some time to come.
Source: Morgan Stanley Global Economic Forum

Japan: Hamburger Prices and Deflation

Apparently changes in hamburger prices are provoking quite a controversy in Japan, they seem to be seen as a symbol of deflation.

Recent news of a top hamburger chain reinstating price discounts indicates how far the speculation about an "end to deflation" a few months ago was missing the mark. Actually, some investors had been assuming that the end of the half-price sales of hamburgers as a sign of that deflation was coming to an end. Attempts to link hamburger prices and an end to deflation, however, confuse individual prices and the general price level, or partial equilibrium and general equilibrium in the economy. In the case of the major hamburger chain, based on a simple economic model, raising prices to pass along the impact of yen depreciation and other procurement cost increases encountered a "reverse supply shock" from reduced productivity, pushing the supply curve upward and resulting in weaker sales volume over the last several months.
Source: Morgan Stanley, Takehiro Sato (Tokyo)

As Takehiro Sato notes the challenge for an effective sales strategy under deflation is finding what he calls the diffraction point on the demand curve (the point at which it becomes vertical) attempting to use precise demand forecasts, and thus maximizing revenue within the context of a given and limited sales volume. In such a world, where the demand curve is partially vertical, corporate revenue and earnings can be negatively affected if prices for final demand goods move either up or down.

This blog is still under construction. It will bring together all my writings relating to the evolving situation in Japan. As can be seen from the blog title, I am not optimistic. My overriding preoccupation, apart from the inevitably tragic human dimension of what is about to happen over there in Japan, is that the main reaction here in Western Europe is likely to be one of incomprehension and profound fear. Maybe I have remained too much of a Hegelian, but I can't help believing that even if there is nothing to be done and a that a few cool heads will never calm the madding crowd, still understanding is in itself a constructive and worthwhile activity.