Japan's QE-driven inequality will continue to grow

Yesterday the Bank of Japan announced that it will be buying Japanese equity ETFs as well as property funds (REITs) to boost demand for risk assets. The BoJ has done this before but the timing of this announcement suggests a new push to accelerate monetary easing. This action is coming on the heels of the Government Pension Investment Fund's (GPIF) recent announcement that it will increase its allocation to Japanese and foreign shares to 25% from 12%.

The yen continued to sell off as a result of this accelerated easing and is now hovering around a 7-year low.

With the support from weaker yen and the official sector's renewed demand for shares, the equity markets had one way to go. The Nikkei 225 broke through 17k - a levels we haven't seen since 2007.

But while investors cheer this flood of liquidity, Japan’s lower-wage workers are being left behind. Wage increases in Japan are simply not keeping up with rising import prices (due to weaker yen) as well as with higher consumption taxes. And as the yen takes another leg down, many of Japan's workers, especially those who are non-union and part-time, will see their real wages decline further. Meanwhile, financial assets will be hitting new highs.

Source: Natixis

For those who believe that "unconventional" monetary easing widens the gap between the wealthy and the poor (and there has been plenty of debate around the topic), Japan could become a prime (and possibly extreme) example of QE-driven inequality.

As a further confirmation of this trend, today's report on household sentiment was worse than expected. Negative real wage growth is just not being offset by rising share valuations - especially for households that simply have not participated in the rally. With no end in sight for BoJs unprecedented monetary expansion, the nation's households are likely to face more hardships ahead.

Source: Investing.com

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Convergence

The ECB can continue to argue that economic conditions in the Eurozone are nothing like those in Japan. The markets say otherwise ...

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From our sponsor:

The Bank of Japan may put further easing on hold

Expectations of Bank of Japan accelerating securities purchases at the October meeting have fallen considerably. Majority of economists now expect any type of change in policy to take place no earlier than December/January, if ever. In fact an increasing proportion of Japan watchers are suggesting that faster securities purchases are unlikely to take place at all. The chart below shows the percentage of those who believe further easing is imminent.

Source: Credit Suisse

This relatively sudden change in views is not due to any significant economic improvements in Japan. Japan's consumption tax hike has created a material drag on growth, with industrial production starting to decline again.

The BoJ in fact admitted that a substantial slowdown is taking place and the tax hike is to blame.

WSJ: - The Bank of Japan said Tuesday that industrial production was showing signs of weakness, acknowledging for the first time since the sales tax was raised in April that the move has had a notable negative impact on a key driver of economic growth.

The admission confirms what private economists have been stressing for months—that the higher tax rate has taken a significant toll on the economy. It also comes as a separate government indicator pointed toward the possibility that Japan may have already entered a recession.

In a statement released after a two-day meeting, the BOJ’s policy board maintained its assessment that the economy “continues to recover moderately as a trend,” but that “some weakness, particularly on the production side, has been observed.”

Moreover, the central bank's 2% inflation target remains elusive. Inflation expectation (breakeven) implied by the 10-year JGBs is barely above 1%.

Source: Japan Bond Trading Co

So why do many economists now think the central bank is not going to accelerate QE - at least not in the nearterm? The reason has to do with the increasing uncertainty around the benefits of a weak yen (discussed here). While large exporters benefit from currency depreciation, smaller businesses and consumers are hurting.

Bloomberg: - Debate is increasing over the costs and benefits of the weakening yen, which is increasing costs for importers and households while it bolsters profits for some companies. Further depreciation could risk support for the Bank of Japan’s unprecedented stimulus program, even as the government says there is no gap with the BOJ in its stance on the yen. ...

Exchange-rate depreciation has raised the cost of imported products including energy, something that’s helped end Japan’s deflation and stoked profits for companies with earnings abroad. Smaller businesses have become increasing vocal in opposing the fall, even as Kuroda says that the negative effects are outweighed by the positive.

Kuroda was told by business leaders in the industrial city of Osaka last month that the yen’s slide was boosting costs of imported fuel and raw materials and may spell trouble for the economy. 

With wage growth remaining sluggish (particularly for non-union workers), rising import costs could undermine consumer demand - particularly in the face of higher consumption taxes. Given these headwinds, there may be sufficient political pressure to put the BoJ into a holding pattern.

It is important to point out however that even without adjusting its policy, the BoJ's current QE effort is by far the most ambitions monetary expansion program by a developed economy in recent history.

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From our sponsor:

Japan moves from Paul Krugman's liquidity trap to Haruhiko Kuroda's "indefinite QE" trap

Japan's 10-year government bond yield is hovering around 0.5%, an all-time low.

Clearly this is the result of the Bank of Japan's unprecedented securities purchases via the ongoing quantitative easing (QE) program that was accelerated last year.

BoJ's holdings of Japanese government securities (source BOJ) 

While a number of economists such as Paul Krugman fully support this effort as a way of exiting the so-called "liquidity trap", the central bank's purchases are eroding the JGB market.

The Economist: - The BoJ is buying ¥7 trillion ($67 billion) of JGBs a month. It now owns a fifth of the government’s outstanding debt. Trading volumes have fallen dramatically, as has volatility in prices. One day in April there was no trading at all in the most recent issue of the benchmark ten-year bond.

Last year's QE acceleration started to take more securities out of the private market than is being issued by the government.

Source: Deutsche Bank

The Bank of Japan was hoping that as yields decline, the banking system will begin replacing JGBs it holds with loans to the private sector, thus stimulating growth and releasing more bonds into the market. But banks have been slow to get out of JGBs.

The Economist: - Part of the reason that bond prices remain high is that financial institutions have not sold as many JGBs as the BoJ had hoped. It had assumed that falling yields would prompt banks to shift their holdings into riskier assets, stimulating the economy. Although Japan’s biggest banks sold JGBs in the months immediately following the BoJ’s first purchases in 2013, they have now largely stopped. Regional banks, the most notorious JGB-addicts, hung on to their bonds, and are now purchasing more.

With rates on private sector loans now also at historical lows (around 0.8%–0.9% according to DB) and the overall private inventory of government paper declining, JGBs remain attractive on a relative basis, even at current rates. In fact, measured in terms of returns on regulatory capital, private sector lending looks terrible. Just as the case in the Eurozone, holding government paper is quite rational for banks.

Moreover, markets are pricing in an ongoing QE effort for the foreseeable future, which will end up taking even more paper out of private hands.

Deutsche Bank: - ... note that implied volatility in the JGB futures market is now abnormally low, which would appear to reflect a general expectation that the BOJ will persist with its massive bond-buying operations indefinitely. Put simply, very few market participants currently believe that the central bank is capable of achieving its +2% "price stability target", and therefore assume that it will remain in easing mode for the foreseeable future.

Exiting this program in a market that has become increasingly dysfunctional will be more difficult and disruptive with time. And given the government's unparalleled debt problem, is exit from QE even possible without nudging the "unsustainable equilibrium" (vicious circle of rising rates and rising debt burden)?

Japan has moved from Paul Krugman's liquidity trap to Haruhiko Kuroda's "indefinite QE" trap.

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From our sponsor:

10-year JGB yields near 0.5%

The 10-yr government bond yield in Japan is now around 0.5%, following an almost linear decline that started in 2006. The only way to rationalize buying 10-yr JGBs at 0.5% is believing that Japan will have a deflationary environment over the next decade and/or the central bank will absorb (or even monetize) the bulk of new issue bonds.

Moreover, these record low yields will do some serious damage to the Government Pension Investment Fund, which invests two thirds of its assets into local bonds. A significant portion of the population will tap the pension fund in the next 10 years. There will also be pain for Japan’s insurance industry that now faces a nasty asset/liability mismatch.

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The Bank of Japan's QE program diverges sharply from other central banks

Many investors seem unaware of just how large Japan's QE program has been relative to other central banks. While the Fed, the ECB, and the BOE have roughly converged to the same level (as a proportion of their GDP), the Bank of Japan's balance sheet is more than double that of its counterparts abroad.

Source: BIS

The official goal of course is to stimulate credit growth to the private sector by lowering longer term rates and boosting excess reserves in the banking system. The 10-year Japanese government bonds now yield 0.57% and the reserves have indeed spiked.

Source: BOJ

But while we've seen small improvements in bank lending, credit growth in Japan remains tepid.

The primary reason for this trend has to do with the lack of demand for credit. Both households and companies are loathe to take on debt. One can't blame them of course - taking on fixed liabilities with looming risks of deflation is dangerous (imagine watching your assets depreciate, while liabilities remain fixed.) And as we saw in the US (see chart), other than during periods of frozen credit markets, quantitative easing has not been shown to be very effective in stimulating credit expansion.

As a prerequisite to get people to borrow, one needs a stable inflation rate. And while the BOJ has achieved higher inflation, question linger about its stability. A great deal of the price increases has been achieved by weakening the yen (see post). The yen depreciation however has been halted, with USD/JPY exchange rate remaining remarkably stable.

Chart shows US dollar appreciating against the yen (yen depreciating) during 2012-2013

In order to have a sustainable inflation rate, Japan needs stable economic growth that supports wage increases. But economists continue to question the nation's ability to maintain momentum.

CNBC: - "Economic activity has indeed picked up since the QE program began early last year, but there are now serious warning signs that this progress may not be maintained," Adam Slater, senior economist at Oxford Economics wrote in a report.

In the short video below Takuji Okubo questions a number of assumptions regarding the economy and wages in Japan.

All this will come to a head in October of this year, when growth and in particular the inflation rate will be benchmarked against the BOJ's target levels. If the projections are unsatisfactory, as some expect, the BOJ will be forced to accelerate the quantitative easing program. The already massive divergence between BOJ's balance sheet and that of the other major central banks will increase further.

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Japan's households stung by consumption tax

Japan's household spending fell sharply in May as the consumption tax hike took its toll. While some decline was expected, the 8% year-on-year drop puts the BOJ's optimistic economic forecast in doubt. As inflation cools with the diminishing impact of weaker yen (discussed here), the central bank is likely to accelerate asset purchases later this year.

Source: Investing.com

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From our sponsor:

Japan's manufacturing contracts for the first time in 14 months

Japan's consumption tax hit the nation's manufacturing sector harder than economists had anticipated.

Markit: - Japanese manufacturing firms saw a decline in output for the first time in 14 months in April. Alongside this fall in output was a deterioration in new orders which also decreased for the first time in 14 months. In both cases, firms linked the reductions to the rise in the sales tax.

PMI < 50 = contraction (source: Investing.com/Markit)

Many of Japan's consumers are expected to stay out of stores for a while, having bought all they could prior to the tax hike (see story). The BOJ had factored some of that slowdown into their analysis. The full extent of the damage to the economy however remains uncertain.

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From our sponsor:

Japan's inflation rate has stalled as impact of yen depreciation wanes

Today's inflation report in Japan shows that further significant progress toward the 2% target rate remains elusive. Analysts have been focused on the Tokyo CPI figure, which is reported a month ahead of the national number. The Tokyo result is the first post-consumption-tax-hike inflation indicator and provides a preview for how the nation is impacted by this increase. As expected, there was a spike in Tokyo prices.

Source: Investing.com

But according to the Bank of Japan estimates, the tax increase should have raised inflation by 1.7% in April. That puts the Tokyo tax-adjusted measure at 1% - unchanged from the previous month and below expectations. Some were hoping that a larger portion of the tax increase would flow through to the consumer, but it seems that Japan's companies simply lack the pricing power.

At the national level (through March), the core inflation seems to be stuck at 1.3%. If the Tokyo measure is any indication, the April increase nationally will be mostly tax driven - and therefore temporary.

Source: Investing.com

Japan needs to break through this CPI "ceiling" in order to comfortably move away from the deflation danger zone. However much of the inflation increase last year has been due to weaker yen. But now that the yen has stabilized, the currency-related impact on prices is dissipating.

Should Japan attempt to weaken the yen even further in order to move inflation higher? The problem with that approach is that it would exacerbate the "wrong" type of inflation. Over the past year in Japan, dairy products are up 4%, meats are up 5%, gasoline is up 6%, and electricity is up 10%. These are import driven price shocks and further yen weakness could spell trouble.

With wage growth remaining inadequate, the new consumption tax combined with these price increases could put severe pressure on the consumer. That makes further yen depreciation a difficult policy to embrace. Some however would argue that all the export growth created by weaker yen would more than offset these domestic issues. Making Japanese goods cheaper should result in better sales abroad (as it did in the past), more profits domestically, better economic growth, etc. The impact of the latest yen devaluation on exports however has been less than stellar - certainly not enough to offset these domestic price shocks. In fact, Japan's trade balance is now firmly in the red (see chart).

To be sure, currency weakness has helped Japan achieve a higher inflation rate, but at a significant cost. Further currency weakness could exacerbate the situation without necessarily boosting exports. Moreover, it is not clear how sustainable the price increases will be going forward, particularly in the event of consumer retrenchment. On the other hand, as the currency stabilizes and inflation stalls, it will become increasingly difficult to reach the 2% target rate.

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Risks of Abenomics "stalling out"

This coming Thursday Japan's Ministry of Public Management will be releasing the January CPI figures. The report will be closely watched to determine the progress of "Abenomics", as the nation tries to work its way out of the persistent long-term deflationary environment.

However, a number of analysts continue to be skeptical of Abenomics succeeding.

Derek Holt/Scotiabank - Here comes another round of Abe-hype, only this time, CPI inflation is expected to fall from the recent 1.6% y/y peak and that would further feed impressions that Abenomics is stalling out. The upturn in CPI inflation by December was still being heavily influenced by utility prices that were up 5.5% y/y due to the effects of yen depreciation on imported natural gas and oil prices, and higher electricity prices in the face of Japan’s continued shutdown of all of its nuclear reactors. Take energy and food — which is also probably under upward pressure in part due to yen depreciation — out of CPI and it is only up 0.7% y/y as food prices themselves are up 2.2%. Most of the CPI effects of the Bank of Japan’s efforts to depreciate the yen remain confined to a relative price shock to food and energy that crowds out spending power elsewhere in the economy on future second-round effects in the absence of a pickup in wage growth or credit access. 

In spite of high expectations, the boost to exports generated by weaker yen has been more than offset by the rising value of imports (see chart). With the sales tax hike looming and wages remaining stagnant, the risks of Abenomics "stalling out" remain high.

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From our sponsor:

Japan's current account firmly in the red

Japan's current account continues to deteriorate, with the December number coming in below expectations - hitting a new low. For the whole of 2013 Japan showed the lowest surplus on record.

Source: Investing.com

Energy imports and weaker yen continue to be the key culprits. Should oil prices rise further, the nation's deficit could worsen.

Bloomberg: - The yen’s slide and increased demand for foreign energy due to nuclear plants closures are causing imports to outstrip exports. A surplus in overseas investment income is staving off the risk of a sustained deficit that could undermine investor confidence in a nation with the world’s largest debt burden.

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From our sponsor:

Shinzo Abe betting on wage growth

Prime Minister Shinzo Abe: - "Japan’s economy is just about to break free from chronic deflation. This spring, wages will increase. Higher wages, long overdue, will lead to greater consumption."

Wage increases are vital for Abenomics - without them the current policies are simply unsustainable (see discussion). If consumers are squeezed (see post), spending will decline and the nation will face deflationary pressures once again. The government is applying pressure on the corporate sector to boost pay. According to ISI Research, the following 5 firms have announced wage increases.

• Nidec
• Nomura
• Daiwa
• Orix
• Fukoku

Is this the beginning of a real trend or just a superficial move by some firms who are trying to boost their image? Many analysts remain skeptical.

The Star: - Japanese companies are unlikely to raise wages significantly this year and inflation will be well below the official target, economists said in a Reuters poll, suggesting tough challenges for Prime Minister Shinzo Abe's drive to end years of falling prices and generate robust growth.

The forecasts bolster the view that, with a few high-profile exceptions, businesses are cautious about passing on higher profits to employees, which is seen as vital to Abe's hopes for sustained growth in the world's third-biggest economy.

The economists in the monthly survey are also pessimistic that the Bank of Japan can meet its goal of 2% consumer price inflation by next year.

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From our sponsor:

When it comes to current account imbalances, one nation stands out

Over the past few decades there has been a great deal of focus on the large trade imbalance between the US and Asia - first with Japan and more recently with China. While that is still an issue, we may be facing a new imbalance that is starting to grab the attention of politicians, economists, and the markets. The chart below shows the current account balance as a percentage of each nation's GDP. And one nation clearly stands out - Germany.

Source: Tradingeconomics.com, Merrill Lynch

According to Merrill Lynch the massive German current account surplus will manifest itself in two major ways:

1. It is bound to generate friction within the Eurozone, particularly as German assets appreciate, while the periphery is experiencing deflationary pressures.

Merrill: - Germany’s surplus holds a deeper meaning for financial markets in 2014. First, it signifies the difficulty faced by ECB monetary policy. It should not be easy to achieve a balance between Germany with its growing current account surplus and where real-estate prices have started turning up [see Twitter chart from the ECB], and the periphery countries that are facing disinflation despite having somewhat reduced their current account deficits as a tradeoff for low growth. Whether it happens in 2014 or not, eurozone fiscal policy discussions will be necessary at some point, though politically difficult. Eurozone financial issues could still destabilize global financial markets at some point in the future.

2. This imbalance is likely to have an impact on the currency markets, especially with respect to the yen.

Merrill: - The second implication is for the exchange rate issue with Japan. While Germany’s current account surplus has expanded, it is Japan’s current account that has deteriorated sharply. Comparing Japan’s balance of trade in 2010 and 2013 (Jan- Nov for both years), reveals that it has fallen by ¥16.1tn (3.2% of GDP). Around half (¥7.5tn) of this is in non-energy trade. Of that ¥7.5tn, more than ¥2tn is due to trade with the EU, and the rest is versus Asia. Japan is expected to post a ¥11-12tn (1.2- 1.4% of GDP) trade deficit for 2013. Although its income balance will keep the current account positive, the surplus will likely be less than 1% of GDP.

...the change in current account imbalances seems consistent with our FX strategy team’s projection that the leeway for a rebound in the JPY is relatively limited versus the EUR, and the JPY should continue to weaken versus USD in 2014.

2014 should see an increased focus on this topic, as Germany's current account surplus continues to stand out.

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From our sponsor:

The unintended consequences of Abenomics

As discussed earlier (see post), Japan continues to struggle in its endeavor to generate demand-driven inflation. To a large extent price increases have been the result of costlier imports due to weaker yen, particularly items related to food and energy. Outside of those sectors, prices remain soft.

The danger of Japan's current policy (Abenomics) is that the outcome could turn out to be the exact opposite of what was originally intended. With wages stagnant, these import-driven price increases are hitting the Japanese consumer quite hard. As a result, spending on domestically produced goods and services could end up falling, constraining domestic prices instead of increasing them.

Scotiabank: - Key here is that the Japanese CPI inflation figures continue to showcase evidence of a relative price shock driven by imported food and energy price spikes significantly related to yen depreciation. Most CPI components not related to food and energy either continue to fall or remain soft as shown in the accompanying chart. The big gainers are prices for fresh food, utilities due to soaring electricity prices in the wake of the Tōhoku disaster coupled with rising imported energy costs, and the energy impact on rising transportation prices. CPI ex-food-and-energy remains largely flat. We maintain the year-long view that Abenomics would impose a relative price shock that would force wage- and credit-constrained consumers to spend more upon what they have to (food and energy) by restraining spending elsewhere in the economy in disinflationary fashion on the second- and third-round effects. That’s a very different inflation dynamic than would be the effects of a generalized increase in economy-wide prices in that it counsels future effects that will be bearish for the outlook for Japanese consumers. At the same time, the other main supposed benefit of Abenomics is an improvement in the trade account by stimulating export growth through yen depreciation, yet this is only evident via a price effect as export volumes remain weak [see post]. 

One sad consequence of Abenomics is the impact on Japan's elderly, whose ranks are swelling rapidly (see post). Isolation combined with rising prices on food and electricity makes survival for many older Japanese citizens a struggle. According to the National Police Agency survey, shoplifting incidents accounted for close to 10 percent of all crimes. And the number of shoplifting offenses is only growing among people 65 and older - with 68 percent of those cases representing food items. The latest 18.6 trillion yen stimulus package from the government is supposed to (among other things) provide additional help for the elderly, but it remains unclear how sustainable such efforts will ultimately be.

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From our sponsor:

Two key reasons for Japan's record trade deficit

Japan's Ministry of Finance just released the nation's trade balance numbers, showing the trade deficit hitting a new record.

unit = ¥ trillion (source: Investing.com)

While there are a number of reasons for this trend, two key items stand out:

1. Yen weakness has not generated the expected benefits in terms of exports due to slow global growth and challenging competitive landscape.

2. Recently domestic import demand has grown considerably, as buyers try to get ahead of next April’s consumption tax hike.

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From our sponsor:

3 key facts about Japan's deteriorating demographics

While there is a great deal of detailed discussion in the blogosphere about Japan's unsettling age demographics (see example), it's worth pointing out three key facts that add some urgency to the issue.

1. With zero immigration and falling birth rates, Japan's working-age population is declining sharply and is now at a level not seen in 30 years. The decline also seems to be accelerating.

Wells Fargo: - While the overall population has only recently begun getting smaller, the labor force has been shrinking for more than a decade. This has serious implications for both the size of Japan’s future workforce and for domestic demand. According to the IMF, the size of the working-age population is projected to fall from its peak of 87 million in 1995 to about 55 million in 2050. If realized that would roughly equal the size of the Japanese workforce at the end of World War II.

2. As a result, the percentage of Japanese who are over the age of 65 has risen above 25% for the first time (and the growth in that ratio also seems to be accelerating.) A quarter of Japan's population is now over 65. That compares to about 14% of Americans who are over 65 (see stats).

Source: Japan Statistics Bureau

Just to put this in perspective, the total sales of adult diapers in Japan is about to exceed that of baby diapers (see story). Also see this amazing story about "a program to promote the use of nursing care robots to meet expected increases in demand in the face of Japan’s rapidly aging population."

3. According to Wells Fargo this is creating some material distortions in Japan's domestic interest rates. In fact (and this is an amazing fact indeed), Japanese seniors are having a greater impact on bringing down JGB yields than BOJ's unprecedented QE effort (see post).

Wells Fargo: - In addition to reducing potential growth, the aging of the population in Japan is having a downward influence on interest rates [chart below]. According to the IMF, elderly households prefer to avoid risk and feel more comfortable with safe assets such as Japanese Government Bonds; so much so that the downward effect on rates from elderly purchases has a bigger impact than purchases by the Bank of Japan.

10y JGB yield (source: Tradingeconomics.com)

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From our sponsor:

In spite of currency disadvantage, Germany competes on brand

Germany's trade figures continue to surprise to the upside. The latest merchandise trade number came in at €18.9bn, while economists were expecting €15.5bn (according to Econoday).

Source: Econoday

The question of course is how does Germany do this given that it is competing directly with Japan in global markets. And Japan has had one key advantage - a weakening currency, which makes its product cheaper. The chart below shows the value of the euro in terms of yen (EUR/JPY), with the euro now at recent high against the yen.

EUR/JPY

Is there a different product mix between Germany and Japan? Certainly. But according to CIBC the product overlap with Japan is the highest for Germany vs. other Eurozone nations. Machinery, electronics and cars represent a substantial component of both nations' exports.

Source: CIBC

So how does Germany compete so successfully in spite of this currency disadvantage? The answer seems to be that Germany can compete on brand strength even at higher prices.

CIBC: - The [euro] strength against the yen will persist, a challenge largely for German exporters as they compete closely in areas such as autos and electronics. However, with many consumers prepared to pay a premium for German engineering, its exports are often less sensitive to price changes.

Indeed when compared with its Eurozone peers, German exporters boast the least price-sensitive merchandise. For example, a 10-20% higher price on a high-end German car is less likely to motivate someone to switch to a Japanese car - particularly in markets like China.

Source: CIBC

Going forward, German firms will be getting some tailwinds from Mario Draghi's accommodative monetary policy. The ECB overnight rate is now at record low. At least in theory that should limit the euro's appreciation and provide some price stability for German exporters.

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Abe gets ready to start "naming and shaming"

As discussed earlier (see post), the key issue with Japan's economy these dyays is wage growth - or lack thereof. And that is holding back the so-called Abenomics. Recent increases in prices (mostly from yen's depreciation) can not be sustained unless salaries keep up. Inflation and weak wage growth can squeeze consumer spending power and stall economic growth. And Japan needs to have a sustainable period of price increases to get out of the deflationary hellhole. With a long history of wage declines however, getting Japanese firms to change their behavior has been a difficult task.

Apparently Abe has had enough. According to TV Tokyo (h/t ISI Group) Abe will begin pressuring business leaders directly to raise wages. The goal is to start with a corporate wage survey. How would a survey help? In Japan if the survey is published with the companies' names shown, the strategy of "naming and shaming" just might work. Public image is critical to most Japanese firms and this just may push them to change the way they pay their employees.

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From our sponsor:

Demand-driven inflation remains elusive in Japan

Japan's National Statistics Bureau published the latest inflation figures last week. As expected, prices continue to rise, presumably lifting the nation from its prolonged cycle of deflationary pressures.

Source: Statistics Bureau

But as discussed earlier, prices are generally not rising due to stronger domestic demand - which is what the nation really needs. Instead a large portion of price increases is generated by weaker yen and costlier imports. And that could undermine consumer confidence.

Reuters: - Some analysts expect core consumer inflation to exceed 1 percent by the end of this year mostly on rising energy and food prices. That may weigh on personal consumption, which would also feel the pain from an expected sales tax hike in April.

"The rise in prices of daily necessities is negative for household sentiment and consumption," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute in Tokyo.

Source: Statistics Bureau

On the other hand prices on many domestically manufactured products (such as household appliances) as well as domestic services continue to fall.

Source: Statistics Bureau

The problem with domestic demand continues to be negative real wage growth. You can't have sustainable inflation without rising household incomes. And serious labor reform may be the only way to correct that trend (see post).

Reuters: - Economics Minister Akira Amari said it was too early to declare an end to deflation, stressing that wages and prices excluding energy costs had to rise more.

"Japan is in the process of emerging from prolonged deflation," Amari told a news conference on Friday.

"An exit from deflation will become distant if we're seeing cost-push inflation, where wages aren't catching up with rising prices," he said.

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From our sponsor:

Two key issues with Abenomics that many economists ignore

On its surface "Abenomics", which is focused on pulling Japan out of its prolonged deflationary environment, seems to be working. The CPI spiked to the highest level since 2009.

Source: Statistics Bureau

But there are two key problems with the way this policy is progressing thus far.

1. Price increases have been driven by weaker yen rather than pricing power improvements of domestic producers. Japan is generating the "wrong" kind of inflation - here are a couple of reasons for this recent spike in CPI.

Source: Statistics Bureau

2. This externally driven inflation is creating negative real wage growth domestically. The concept seems to fall on deaf ears in the economics community - we've received numerous emails from seemingly educated economists who don't see anything wrong with the current trajectory of Abenomics. Japan cannot pursue this policy without some badly needed labor reforms.

Japan's corporate practice of lower (on average) wages for workers who are older than 50 (see chart) combined with rapidly aging population (increasing numbers of employees older than 50) takes wage growth in the wrong direction. The combination of declining or stagnant nominal wages and rising prices is creating serious hardships for the nation's citizens. Here is a passage from the WSJ that zeroes in on the problem with Abenomics.

WSJ: - ... for the average person in the world's third largest economy, the recent budding signs of rising prices have brought more pain than gain amid sluggish income growth.

"I pay more when I go grocery shopping. I also pay more for gasoline," said Noriko Kobayashi, who works at an advertising agency. "As my monthly salary and bonuses haven't increased, the rise in consumer prices hurts me," the 39-year-old said. "I haven't felt any benefits from Abenomics."

Ms. Kobayashi's woes are shared by millions of others across the country who have seen their purchasing power shrink, and demonstrate that in the absence of solid wage growth, inflation isn't a cure-all for the economy.

SoberLook.com

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