Facebook Blogging

Edward Hugh has a lively and enjoyable Facebook community where he publishes frequent breaking news economics links and short updates. If you would like to receive these updates on a regular basis and join the debate please invite Edward as a friend by clicking the Facebook link at the top of the right sidebar.

Monday, December 25, 2006

Doubts Continue About Japanese Consumption

The Japanese Cabinet Office have just released another report on the state of the Japanese economy. Unsurprisingly they one more time draw attention to the lacklustre state of Japanese domestic consumption:

the report, which looks at a variety of economic factors besides gross domestic product, warned of weakness in consumer spending, saying sluggish growth in wages was keeping spending flat.

Domestic demand, which accounts for more than half the economy, undercut growth in the July-September quarter, forcing the government to downgrade its economic outlook earlier this month.

The latest report echoes concerns that although Japan has emerged from a decade-long economic stagnation — with robust exports contributing to record profits at Japanese companies — those profits have not driven up wages and spending.

The Japanese economy's recent growth is also less stellar than the double-digit growth it experienced from the late 1960s. The economy grew at an annualized pace of 0.8 percent in the third quarter.

Prime Minister Shinzo Abe later told reporters that he would work to realize economic growth that "can be felt by the general public."

The BoJ governor Toshihiko Fukui was unusually downbeat:

"We can keep an accommodative monetary environment led by very low interest rates for some time," Fukui told business leaders at a year-end meeting of the Japan Business Federation, also known as the Nippon Keidanren.

"We will tighten monetary policy if economic activity and prices develop in line with our projections," he said.

My feeling is that they are worried, not rattled, but worried, and they have reason to be. If cLuas and I are right here, and domestic demand isn't going to recover as anticipated, there are important policy changes to be made, and if they are to be effective these need to be made sooner rather than later.

Thursday, December 21, 2006

Japanese Exports Continue To Power Ahead

Japan's export growth accelerated in November:

Exports rose 12.1 percent, helping the trade surplus widen to 915.9 billion yen ($7.7 billion) from 594.4 billion yen a year earlier, the Ministry of Finance said today in Tokyo. Imports gained 7.5 percent, down from 17.5 percent in October.

The yen's decline against the dollar and euro has helped reduce the effects of slower overseas demand, bolstering exports. Shipments abroad grew at the slowest pace in six months in October, causing concern that the economy would stall amid sluggish consumer spending at home.

The reason for the increase isn't too hard to pin down:

``There is no doubt that the yen's weakness remains an engine for Japan's exports,'' said Yoshimasa Maruyama, an economist at BNP Paribas. ``Today's numbers confirm Japan's exports maintain more momentum than we had expected.''

and there is evidence that relative movements in currencies are being reflected in the differing rates of increase to the receiving countries:

Exports to the U.S. climbed 8.6 percent, the slowest in five months. Shipments to the European Union accelerated to 12.9 percent from 8.7 percent. Exports to China quickened to 19.5 percent from 18.3 percent.

The yen is trading about 7 percent below the average rate last year, making Toyota cars and other Japanese goods cheaper abroad. The yen has fallen 7 percent against the euro in the past six months, buoying the value of imports. Exports to the region measured by volume, which don't take into account price changes, only grew 2.9 percent in November.

That is you only get the relatively higher number for the euro region (12.9% vs 2.9% when you take into account the yen value of products sold in dollars). Then note the following:

Japan's economy expanded an annual 0.8 percent in the third quarter and would have shrunk if it weren't for strong export growth and corporate spending on factories and equipment. Consumer spending, which accounts for more than half of the economy, had the biggest decline in almost a decade.

Not only is the Japanese economy dependent on an export model, but it will actually start to shrink if exports lose momentum. So while this is not the full recovery everyone has been expecting, it is sustainable, just as long as the export growth continues. Quite a delicate situation, and one which explains the sensitivity of Japanese stocks and bonds to each and every jitter in the United States. Given that they are now becoming more and more dependent on Europe, I guess the sustainability of Germany's recovery is now also very much a matter of concern to them.

More Thoughts On Emerging Markets

The Financial Times has another fascinating story today about how yield-differentials on emerging market debt are once more back at historic lows (see my other posts on this over the last few days):

Risk premiums for emerging market bonds fell to match their record low on Wednesday, only two days after the shock imposition of capital controls in Thailand reminded investors of the potential risks associated with the sector.

Investors measure the risk of emerging market debt by comparing their yields with those of US Treasuries, seen as the safest sovereign bonds. As measured by JPMorgan’s EMBI+, a benchmark indicator, that spread fell on Wednesday to 172 basis points – one basis point is equal to 1/100th of a percentage point – over US Treasuries, equalling a record low hit last in May.

So we are back where we were in May: before Iceland, Turkey, Hungary etc.

And why, may we ask, is this? Well, first of all let's look at this problem the other way round: why did they start to widen in the first place?

The EMBI+ last reached a record tight level of 172bp on May 1. The spread subsequently widened to 238 basis points by June 27, as investors worried that central banks were poised to tighten monetary policy more aggressively as oil prices approached $80 a barrel.

So we need to think about two things, oil prices and central bank tightening. Well oil prices have now stabilized somewhat (although if growth really takes off again somewhere they won't stay at this level for long), and equally importantly, despite the fact that Trichet promises to be extremely vigilant (although in December he was perhaps promising this a little less forcefully than he had been) the markets appear to be taking the view that the better part of this raising cycle may now well be over, and the real debate is moving to how soon rates in the OECD world will come down, and when they do do so, how fast will they fall.

Obviously Japan is going to be a key test case here, since if the BoJ cannot raise, or can only manage a belated token quarter point, the implications will be quite significant. While the jury is still out, noone seems to anticipate any large raise in the foreseeable future.

So where does that leave us? Well back with the attractiveness of emerging market debt, that's where it leaves us.

Analysts attribute the bullish performance in emerging markets to strong demand by investors hungry for yield. The class has become attractive as economies have improved in recent years, partly on the boom in commodity prices.

Now this last, lone little paragraph, in fact contains three very important points:

a) Pension funds are growing, so the need to find better yield than US treasuries only grows with them. As I keep saying I think low yield rather than the meltdown of anything is going to be the big pensions issue.

2) Emerging markets are growing as a whole slew of countries pass through their Demographic Dividend, while the low fertility culture spreads even faster than anyone ever imagined (globalisation and behavioural changes).

c) The commodities countries ride on the back of the other two, but again there are even more feedback mechanisms at work

So the big point is, if interest rates in the developed world start to trend down, then interest payments in India (and elsewhere) will also do so, which will indirectly aid productivity growth, since effectively capital deepening will get cheaper, apart from all those funds flooding in hungry for yield.

Now one last issue occurs to me, but this is more in the form of a question than anything. Thinking about it, isn't there a danger of this whole thing tipping over at some point, or at least of a tipping point being reached?

I mean, lets imagine that investors are not totally stupid, and that they do want to make money (innocent enough assumptions I would think).

So, even with all the froth, property in Delhi and Shanghai has certainly got a lot more to offer over the next 10 to 15 years in the way of return than property in Barcelona or London. Not only that, the respective currencies are going to rise significantly (Brad is certainly right here, Bretton Woods II is not sustainable indefinitely in these circumstances). On top of this a big chunk of the emerging world is now about to become a sure bet. I mean the risk of instability could be much greater in Italy or Japan in a not too distant future. So when markets finally wise up to this posibility, what the hell is going to happen? Could we see a higher risk premium being demanded for some developed economies? And if this outcome were to happen, just how far are we away from such a point?

One last untimely thought: what would be really interesting would be to understand the social/economic mechanisms by which India and China got to have such a large population, and what connection (if any) did this population explosion have with the early rapid growth of the now developed world. After all it is the sheer size of these two countries which now is going to produce all the turbulence, and while all that anti-imperialist stuff we still hear about in India may be just so much nonsense, there may actually be feedback mechanisms to be identified somewhere along the line here. I mean it may be more than mere coincidence that some get caught in a poverty trap that produces only children while others take off, but if there is a mechanism, what the hell does it look like?

Wednesday, December 20, 2006

Japan: Fiscal Tightening Ahead

Koji Omi, Japan's finance minister, claimed yesterday that the gross domestic product deflator - an important measure of deflation - would turn positive in the year to March 2008 for the first time in a decade:

“The GDP deflator for the current fiscal year was minus 0.4 per cent, and that will become plus 0.2 per cent in fiscal 2007/08,” he said. “That shows the economy will become normal.”

Not everyone is completely convinced however:

Robert Feldman, economist at Morgan Stanley, said the disappearance of deflation as measured by the GDP deflator would be an important moment if it came true. However, he said that five years of economic growth were feeding through more slowly than expected into inflationary pressure.

This is just the point. As I have been arguing, consumer demand is proving to be much weaker than might have been expected, and this is raising doubts whether Japan can, finally, escape deflation.

Inflation has yet top break the 1% mark, and the yen is running still at historic lows against the euro, and is fairly weak against the dollar, both circumstances which are likely to be inflation positive.

At the same time Prime Minister Shinzo Abe seems determined to try to move forward to address the government debt situation, so that may well help explain the reluctance, commented on yesterday, of the BoJ to raise interest rates.

In fact the cuts they are looking at are no mere trifle:

Japan's government may eliminate its budget deficit earlier than the target date of 2011, Finance Minister Koji Omi said, confirming Prime Minister Shinzo Abe's commitment to cutting the world's largest public debt.

``If we just persist a little longer we may even be able to come in ahead of schedule,'' Omi said today in Tokyo after his ministry proposed reducing new bond sales by a record and curbing spending on public works in the year starting April 1.

The so-called primary deficit, the gap between revenue without new bond sales and annual spending excluding interest payment on debt, will decline to 4.4 trillion yen in fiscal 2007 from 11.2 trillion yen this year, improving for a fourth year. The government in July said it wants to eliminate the primary deficit by 2011 to stop the public debt from expanding.

So they would be aiming to make 7 trillion yen of savings in one fiscal year. Since this saving is only to come from a reduction in borrowing, and since interest rates are still only at 0.25% (and thus could not be claimed to have been excessively driven up by government borrowing), it is hard to see where the uptick in demand is going to come from to compensate for the cuts.

So it is hard to see the BoJ being especially vigorous with trying to raise rates, and it is hard to see where the inflationary pressure they are going to need to get themselves out of the mire of deflation is actually going to come from.

Tuesday, December 19, 2006

No Change At The Bank of Japan

Unsurprisingly, the Bank of Japan kept interest rates unchanged yesterday.The decision was unanimous. . Obviously that now opens the question as to whether they will in fact ever (in the short run I mean) be able to get round to raising. It depends on the external environment, and how much exporting they will be able to do in Q1 2007, I guess. But still they won't be going very far.

Bonds rose and the yen fell after Fukui said the bank wants to check more statistics on consumer spending and prices, which he described as ``somewhat weak.'' The bank isn't under pressure to raise rates because the economy, while in its longest expansion since World War II, grew at the slowest pace in almost two years last quarter.

``Fukui admitted that the some sectors of the economy, such as spending, are weak,'' said Hitomi Kimura, a bond strategist in Tokyo at JPMorgan Securities Japan Co. ``Such comments reduced expectations for higher rates.''

The yield on the benchmark 10-year bond fell 5 basis points to 1.63 percent at 5:54 p.m. in Tokyo. The yen declined to 118.12 per dollar from 117.92 before the announcement the key lending rate would be unchanged.

Tankan Report

The yen had its biggest drop in four months last week as reports, including the Tankan survey of business confidence, failed to provide enough evidence that the economy is accelerating.

The Tankan survey released last week showed confidence among large manufacturers rose to a two-year high and companies increased their forecasts for spending, profit and sales. They also said production capacity was the tightest since 1991 amid the most severe labor shortages in 14 years.

That survey wasn't enough to allay concern that the economy is slowing that followed the third-quarter gross domestic product report. The economy grew at an annual 0.8 percent pace in the period, less than half the government's initial estimate, as consumer spending slumped.

Meantime Cluas Vistesen has another timely post digging a bit deeper into the Japan phenomenon.

Private Consumption in Italy, Germany and Japan

Following a short debate in comments on this post, Sebastian Dullien of Eurozone Watch blog mailed me the following chart for private consumption 2000 - 2006 for Germany, Japan, Italy and the Eurozone. Curiously Japanese consumption (which is far from strong) is near the eurozone average (which of course incorporates Italy and Germany). As Sebastian notes (see below) "consumption growth in Germany since 2000 has been less than a fourth of that in Japan and only half of that in Italy".

Clearly there are more factors than simply the demographic ones at work here (latent German pessimism?), but all of this is certainly taking the debate into the right ballpark.

Here is Sebastian's full e-mail:

Dear Ed,

as I do not know how to post graphs in a comment, here my comment by e-mail:

You might be right that demographics plays a role in the consumption behaviour – something you can see also when looking at individual cases. This is indeed a very important issue, which has largely been neglected.

However, it seems to me that consumption in Germany has been much weaker than what can be explained by demographics alone. You quote yourself statistics that the median age in Italy, Germany and Japan are about the same. However, consumption growth in Germany since 2000 has been less than a fourth of that in Japan and only half of that in Italy (data from EU commission) In order to get a decent growth performance, Germany does not need a consumption growth in the magnitude of that of the US, but if our consumption had grown with the same speed as Japan’s, without any multiplier effects, average GDP growth over the past six years would have been 0.6 percentage points higher.

Incidentally Sebastian, I don't think the issue of graphs in comments is a question of your knowledge. My impression is that blog hasn't quite got there yet, but doubtless it will come. Thanks all the same.

Productivity Miracle In India?

Indian Economy Blog's great new find Nanubhai, has a most enlightening post up about tend growth and productivity in India. One to watch.

Back in the late 1990s, economists were trying to figure out what it was that led to the secular acceleration of economic growth in the United States: the longest and largest peace-time economic expansion in the 20th century (see footnotes). How was it that a country could grow so much and for so long without causing inflation and overcapacity? Was the business cycle dead?

During the boom, the US economy benefited from an unprecedented acceleration in productivity growth. This was driven primarily by the efficiencies created by technological and financial deepening – particularly in the retail, wholesale, electronics, semiconductors, and financial services industries. While the dot-com’s and Stanford techies in pastel suits got the glory, the economy itself was being powered by the Wal-Marts, Intels, and GEs – who were innovating rapidly – and implementing that innovation in long-term strategies to enhance their bottom line.

Now before I get to how this compares to India today, a brief economics refresher.

continue reading

Brad Setser, The Times They Are A Changin, And How!

Brad Setser has a post today about the Thai Baht issue I mentioned yesterday. As Brad Says, a sign of the times, Jimmy, a sign of the times:

In 1998, Russia defaulted after Treasury Secretary Robert Rubin refused to throw good money after bad, and blocked NSC pressure to continue disburse more than $5b of the IMF's $15b credit line to Russia. In 2006, Russia added over $100b to its reserves even as it repaid almost $25b of debt to Germany and a host of other official creditors.
RGE Media Center

In 1998, credit spreads blew out. Volatility went crazy too. In 2006, credit spreads collapsed. Volatility fell to record low -- some would say crazy low -- levels.

In 1998, private capital flowed out of emerging economies in a big way. In 2006, private capital flowed into emerging economies in an even bigger way. Into emerging market funds. But also into emerging economies -- and specifically into the coffers of emerging market central banks.

In 1998, an Asian emerging economy facing responded to pressure on its currency by imposing draconian capital controls. Well, that hasn't changed. In 2006, another Asian emerging economy responded to pressure on its currency by imposing draconian capital controls.

Back in 1998, Malaysia was worried that speculative pressure was driving the ringgit down too far and too fast. Thailand, by contrast, is currently worried that speculative pressure is driving the baht up too far and too fast.

A sign of the times.

So Ok, we know that the weather has changed - since money is now fleeing into emerging economies and not out of them (see eg the comments on this post on property in India) - the question is what drives the weather. Whoever gets to understand that will have understood a lot.


The Thai government have now revoked the main part of the measure. The reaction was just too fierce for them, but this still leaves the question of why funds are flowing in this direction, and why it is proving so hard to stem the flow.

Thailand was forced into revoking draconian controls on equity investment one day after imposing them, after Bangkok stocks suffered their biggest drop since 1990.

The country’s benchmark SET stock index plunged as much as 18 per cent as investors rushed to dump holdings. The SET recovered slightly to end 15 per cent down at 622.14 but the sell-off wiped Bt773.63bn ($22bn) off the index’s value.

The controls aimed to force offshore investors to keep their money in the country for at least a year or face stiff penalties for early withdrawal and are aimed at dampening speculation that has sent the currency 17 per cent higher against the dollar this year.

Mr Pridiyathorn earlier called the decision on capital controls an “historic” effort to counter speculation. The baht’s sharp rise this year - more than any other Asian currency - has caused Thai exporters to suffer in overseas markets.

Monday, December 18, 2006

Europe's Trade Deficit With China

Brad Setser is almost certainly right to keep drawing our attention to the way in which the rise in the Euro has lead to an increased inflow of Chinese goods. Today there is news that Europe's trade deficit with China surged 19 percent year-on-year in the nine months up to September. This is a pretty hefty rate of increase:

The trade deficit with China grew to 63.4 billion euros ($83 billion) in the nine-month period, the European Union's statistics office said today. China is poised to overtake the U.S. this year as the second-biggest source of imports to the euro area, behind the U.K.

The statistics office also said today that the euro area's overall surplus narrowed to a seasonally adjusted 1.7 billion euros in October from a revised 2.4 billion euros the previous month.

And with Germany's exports increasing at a whopping rate, this means that someone else's deficit is taking something of a beating.

Also note that China is not alone in benefiting:

Imports from Japan to the euro region increased 6.7 percent to 41.6 billion euros in the nine-month period. The trade gap with Japan widened 17 percent to 16.2 billion euros.

All those surplus German savings which are getting recycled in the eurozone are it seems indirectly helping Japan with its weak internal consumption problem.

Capital Flows In Thailand

This news is pretty incredible really.:

Thailand's regulators required banks to lock up 30 percent of new foreign currency deposits for a year to stop investors speculating on gains in the baht.

Overseas investors buying baht from tomorrow will only be able to recoup all of their funds if they keep the money in Thailand for more than a year, central bank Governor Tarisa Watanagase told a briefing in Bangkok today. Those who withdraw the reserved amount in less than a year will be penalized 33 percent of that portion, she said.

``They're getting pretty aggressive, as when a central bank starts withholding money it's pretty serious,'' said Steve Rowles, a Hong Kong-based analyst at CFC Seymour Ltd. ``This is really going to put the breaks on the baht.''

So now we have capital controls, not to stem an outflow of foreign exchange, but to stop an outflow of domestic currency. Oh how the world has changed.

Of course, it should escape no-ones notice that with fertility now well below replacement (somewhere in the 1.6 tfr range) Thailand is now right in the middle of that Demographic Dividend/Demographic Transition process I keep talking about.

Now for some more from Bloomberg:

The baht has risen about 16 percent this year to a nine- year high as the economy accelerated and a Sept. 19 coup broke a political stalemate. Exporters including Thai Union Frozen Products Pcl, the world's second-biggest tuna canner, on Nov. 16 asked the central bank to stem baht gains that are undermining their competitiveness.

The baht slipped almost 0.8 percent to 35.53 against the dollar as of 5:24 p.m. in Bangkok, the most in almost three months. It earlier climbed as much as 0.5 percent to 35.08, the highest since Oct. 7, 1997, according to data compiled by Bloomberg.

A devaluation of the Thai baht from about 25 to the dollar was the trigger for a plunge in currencies and a collapse in banks around the region in 1997 and 1998. The Thai government has since sought to restrict inflows of foreign currency.

The baht, the third-best performer among the world's 71 most-active currencies, started slumping after Finance Minister Pridiyathorn Devakula said this afternoon the central bank would make a ``historic'' announcement. The rule applies to transactions worth more than $20,000.

A rising baht hurts exporters by cutting the value of their local currency-denominated profits and making their products more expensive compared with those of Asian rivals. China's yuan has added 3.1 percent against the dollar this year, Malaysia's ringgit has gained 6.3 percent and Singapore's dollar has climbed 7.9 percent.

The baht has appreciated even though the central bank earlier this month introduced measures to limit its gains. The monetary authority on December 4 asked companies and commercial lenders not to sell baht short-term debt securities to overseas investors.

Thailand's economy may expand 5 percent this year, exceeding an earlier estimate of as much as 4.7 percent and last year's pace of 4.5 percent, the government said on Dec. 4.

A military coup on Sept. 19 ousted prime Minister Thaksin Shinawatra and ended seven months of political turmoil. Prime Minister Surayud Chulanont, installed by the military junta after the coup, is planning record spending on roads, subways and other infrastructure projects.

Speculative cash has poured into Thailand this month. Foreign short-term inflows surged to $950 million a week in December, from an average of about $300 million a week in November, Tarisa said today.

Venezuela and The Euro

Funny things coincidences, they really are. I just went over to Brad Setser's blog to check a quote for my last post, and I noticed he had a new post on Venezuala's reserves, which was strange, since I had just been looking at a Bloomberg piece on the same topic. They do however seem to be taking slightly different angles on this.

Brad, for example, heads his piece:

"Isn't the surprise here that Venezuela still has 80% of its reserves in dollars?"

whilst the emphasis in the Bloomberg article is really that the US dollar is increasingly at risk by moves like those coming from Chavez.

Venezuelan leader Hugo Chavez is directing a growing share of the country's oil profits into euros as the dollar and crude prices fall.

The dollar, down 9.4 percent against the euro this year, may face more pressure in 2007 because Venezuela and oil producers from the United Arab Emirates to Indonesia plan to funnel more money into the single European currency.

Now Brad has actually been fairly skeptical all along about just how much central banks will actually diversify out of the dollar, and he is right so to be. At the end of the day business is business, and capital losses can be sustained if you leap the wrong way (or, fail to leap that is) as Brad doesn't tire of reminding us in the Chinese case.

But if, as Claus Vistesen points out, in the longer term - as we move away from Bretton Woods II - both the dollar and the euro (and for that matter the Yen) are likely to trend down, then the central banker's reserves problem is hardly a simple one. I wonder if Claus will soon have a post reminding us just what sort of capital losses the Banco Central de Venezuela might get into if Chavez's anti-US ardour leads them to go too heavy on Euros? And as he tells us in his most recent post, the Economist end of the dollar hegemony story is now very rapidly coming to look like yesterday's news. As he would probably tell us, it's the interest rate differential silly!

And now for a healthy extract from that Bloomberg article:

``The U.S. dollar has suffered a long process of deterioration,'' Domingo Maza Zavala, one of seven board members at the central bank of Venezuela, said in a Dec. 14 interview. ``The diversification strategy started this year.''

Banco Central de Venezuela has slashed the percentage of its $35.9 billion worth of reserves invested in dollars and gold to 80 percent from 95 percent a year ago, said Maza Zavala. The country, the world's fifth-largest oil supplier, has boosted its euro holdings to 15 percent, from less than 5 percent in the same period.

The dollar has slumped against the European currency in 2006 as growth in the euro region outpaced the U.S. for the first time in five years. It rebounded 0.7 percent last week to finish at $1.308 against the euro. The U.S. currency is little changed versus the yen this year, closing on Dec. 15 at 118.17 yen.

Bank Indonesia is boosting euro holdings, said Senior Deputy Governor Miranda S Goeltom in a Dec. 13 interview in Jakarta. Indonesia has $39.9 billion in reserves. Sultan Bin Nasser al- Suwaidi, the governor of the Central Bank of the UAE, last month said he was considering when to shift as much as 8 percent of the nation's $24.9 billion in reserves into euros.

The central banks are changing policy ``because the oil price has come down a long way and the U.S. dollar has been declining,'' said Michael Derks, chief markets strategist at Arch Financial Products LLP, a London-based hedge fund. ``The euro stands to benefit.''

The Organization of Petroleum Exporting Countries, which produces 40 percent of the world's crude oil, said at a Dec. 14 meeting in Abuja, Nigeria, that it would cut output by 500,000 barrels a day to boost prices. Crude gained 92 cents on Dec. 15 to $63.43, the highest close since Dec. 1. Prices have fallen from a high of $78.40 in mid-July.

Crude is priced in dollars and the U.S. is the biggest consumer, importing around $400 million worth of the fuel a day in 2005, according to data from BP Plc, Europe's second-biggest oil company.

The share of foreign-exchange deposits held in dollars by OPEC members and Russia, the largest non-OPEC oil exporter, fell to a two-year low of 65 percent during the second quarter, from 67 percent during the previous three months, Bank of International Settlements figures released last week show.

Venezuela may also be motivated by animosity toward the U.S., said Rick Arney, chief currency strategist in San Francisco at Barclays Global Investors, which manages $1.7 trillion in assets.

``There is a political overlay to all of this,'' said Arney. ``Buying the dollar is not politically popular for some of these folks.''

Chavez, re-elected as President for six years on Dec. 3, told the UN General Assembly on Sept. 20 that the U.S. is ``the greatest threat'' to the planet, and has repeatedly described U.S. President George W. Bush as ``the devil.'' He also says Bush's administration is trying to have him killed.

Chavez called on OPEC to sell oil denominated in euros rather than dollars at a meeting of the group in Caracas on June 1, supporting a proposal made by Iran.

Emerging Markets On The Up And Up

Well emerging markets are certainly rising again, and at a pretty hefty rate. This is, of course, pretty significant, and one of the reasons why I think India will see an investment boom next year (which means I pretty much disagree with this piece from Credit Suisse, since I think it will be the growth of investment rather than consumption in India which will be the big news in 2007).

Curiously Brad Setser is now using the expression savings glut (as in "And as China current account surplus has risen, it clearly become a big contributor to the global savings glut" - and this in a post specifically about Bernanke, has he finally crossed the Rubicon I ask myself):

Investors in emerging markets added more money to stock funds last week than at any time in seven months after record-breaking share rallies from China to Brazil pushed inflows for 2006 past last year's all-time high.

Funds investing in shares of developing countries attracted $1.65 billion more than they lost from redemptions in the week ended Dec. 13, figures from Emerging Portfolio Fund Research showed. The net fund inflow was the most since the weekly period ended May 10, when they drew $2.86 billion.

Investors have taken renewed interest in emerging-market funds, as faster economic growth and a boom in commodities demand propelled a rebound in shares of developing countries.

The Morgan Stanley Capital International Emerging Markets Index on Dec. 5 climbed past a record of 881.52 set on May 8. Today, the measure added 0.6 percent to 891.76 as 3:28 p.m. in New York.

The rally has helped the index recover all its losses after a 25 percent swoon in 26 days between May and June sent the measure to its 2006 low. Brazil, Russia, India and China, the so-called BRICs markets, have led the advance, with share indexes in each country setting records in the past two weeks.

The H share index of Hong Kong-listed Chinese companies that foreign investors can freely buy and sell has climbed 69 percent this year, while the dollar-denominated RTS Index has jumped 65 percent. In Index, the Sensitive Index has gained 45 percent and Brazil's Bovespa index has added 41 percent in dollar terms.

Among country funds, China-related funds attracted the most buying, adding more than $500 million in the week, according to Emerging Portfolio, a Cambridge, Massachusetts-based firm that tracks about 15,000 funds worldwide with $7 trillion in assets.

For the year, China funds have taken in about $9.5 billion more cash than they have paid out this year, almost half the total for all emerging-market stock funds and nearly quadruple the full-year record of $2.45 billion, set in 2003.

With about two weeks remaining in 2006, the funds have taken in $20.8 billion in a net basis, exceeding the record $20.3 billion they attracted in all of 2005. The amount is still less than the $32.9 billion the funds had attracted earlier this year, before the May-June slide caused investors to withdraw as much as $18 billion from the funds, on a net basis.

Sunday, December 17, 2006

German Output and Exports

This is more like working notes than an analysis, but just to point out two things about the October data:

Firstly German industrial output fell in October:

German industrial production fell unexpectedly in October, with construction and energy output hardest hit, but economists said the data were probably a blip and that the outlook for the fourth quarter remained good.

Output declined in October by 1.4 percent month-on-month in seasonally adjusted terms, undershooting all forecasts, preliminary Economy Ministry data showed on Friday....

The output drop, the second monthly fall in succession, comes two days after data showed German manufacturing orders unexpectedly declined by 1.1 percent in October.

On the other hand:

The output figures contrasted with trade data from October released earlier on Friday. These showed Germany’s trade surplus hitting a record high, driven by strong demand for goods from around Europe, but especially from outside the European Union.

Indeed October seems to have been a really good month for German exports:

German exports unexpectedly rose for a fifth month in October, suggesting sales in Asia will help Europe's largest economy cope with a U.S. economic slowdown.

Exports climbed 2.6 percent from September, when they gained the most in more than four years, the Federal Statistics Office in Wiesbaden said today.

And just look at this:

Exports climbed 23 percent in October from a year earlier, with sales to countries outside the European Union jumping 31 percent, according to the statistics office.....Germany's trade surplus rose to 17.3 billion euros ($23 billion) in October from 15.6 billion euros a month earlier, the statistics office reported. Imports slipped 0.2 percent from the previous month.

The explanation for the difference between the industrial output performance and the strong export position is of course two fold:

1) In the first place there is a structural transition away from manufacturing and into services taking place.

2) In the second place domestic consumption still remains weak. October retail sales actually FELL year on year. In terms of my ageing society analysis this is hardly surprising:

German retail sales declined slightly in October, confounding expectations of rising consumer sentiment, according to government figures released Thursday.

Sales declined by 0.2 percent from September to October adjusted for calendar and seasonal effects, the Federal Statistics Office said. Compared with October 2005, sales declined by 0.8 percent.

So assuming that some of these sales were actually being brought forward from 2007 - to avoid the VAT rise - I'm really not sure I can agree at all with Sebastian Dullian at Eurozone Watch Blog when he says Honey, I shrunk the German VAT shock, since my feeling is that this is going to turn into a much bigger deal than most are imagining, and that when the shouting is all done, we will look at tax hikes as a means of addressing deficit problems in a very different light.

The Future of EU Accession

In general all of this is really starting to worry me. I had a couple of posts recently on Serbia's plight on demography matters (and here) and obviously the knock-on impacts of many future Iraq scenarios are not pleasant to contemplate, so really expansion wearying at this key moment in time could have quite important consequences:

EU to start closing doors to the east

European Union leaders will on Friday evening toughen up the rules on eastward expansion of the club, in an admission that public opinion in the west has turned sharply against taking in new members.

The rigorous new EU membership rules will be a dispiriting signal to countries such as Turkey, Serbia and Bosnia, which already believe their road to accession is littered with obstacles. However, a two-day European summit in Brussels will confirm that the Union will honour its offer of membership to Turkey and the countries of the western Balkans when they are ready – and if the EU is ready to take them in.

Japanese Growth Revisited

This article on the downward revision of Japanese growth is a bit old now, but it does contain a few useful points:

Japan's economy grew at a far weaker pace in the third quarter than previously reported due to downward revisions in consumer spending and capital investment, the government said Friday, raising concerns about the recovery's strength. Gross domestic product expanded at an annual rate of 0.8 percent, well below the preliminary 2.0 percent announced in November, but marked the seventh straight quarter of expansion, the government said.

Since exports remained relatively strong, the big changes were a revision downwards of consumption and investment:

Domestic demand — which includes consumer spending, government spending and private investment — had contracted 0.2 percent from the previous quarter instead of inching up 0.1 percent, as previously thought.

Separately government data viewed as a key indicator for corporate investment, released Friday, showed core machinery orders rose a weaker-than-expected 2.8 percent in October from the previous month. That reversed September's 7.4 percent plunge but missed the forecasts by economists surveyed by Dow Jones Newswires for 5.7 percent growth.

The key to the picture would seem to be consumption, since the weak investment most likely is a by-product of an equally weak estimate of the likely direction of internal consumption:

Economy Minister Hiroko Ota blamed the downward
GDP revision mostly on weak consumer spending, but assured the public that Japan's economic revival was on track.

"The lower GDP was mainly caused by weak consumption," she said. "I don't have any concerns that the economy will fall into a downward trend. Nor do I see any signs of its entering a lull."

Although Japan's economy has been emerging from decade-long slowdown that ran through much of the 1990s, recent signs have underlined the risk that growth may be overly reliant on exports. Some analysts say the revival is dependent on U.S. and other overseas economies holding up.

Analysts also say paychecks and other realities that trickle down to workers don't reflect upbeat GDP numbers, as companies cut costs to keep up with global competition and the Japanese population ages and increasingly shifts to lower-paying jobs.

This weak consumption in Japan meme now seems to be catching on, as this article on the world economic outlook from AP this weekend seems to have already internalised the idea that Japanese consumption is the current big enigma:

Japan, Asia's largest economy, is steadily recovering from a decade of stagnation. However, consumer spending appears to be weakening, leaving the economy vulnerable to slowing demand for exports, its traditional source of growth.

Anyone interested in a fuller theoretical explanation as to why consumption is holding so weak could do worse than this post of mine, or this post from Claus Vistesen.

Friday, December 15, 2006

China: Retail Sales and Industrial Output

Two interesting pieces of information from China this week. In the first place retail sales are growing fast:

China retail sales grew 14.1 percent in November from a year earlier as rising incomes spurred consumer spending in the world's fastest-growing major economy.

Sales rose to 682 billion yuan ($87 billion) after gaining 14.3 percent, the fastest pace in almost two years, in October, the Beijing-based National Bureau of Statistics said today. Economists surveyed by Bloomberg News expected growth to remain unchanged from October.

Chinese consumers are spending more as the government raises minimum wages and increases welfare payments. Gome Electrical Appliances Holdings Ltd. and other retailers are benefiting from Premier Wen Jiabao's efforts to stoke consumption to make the economy less dependent on exports and investment in factories.

So one leg of the rebalancing process - the rise of domestic consumption - may be starting to fall into place .

So what about the other one, the export driven investment boom? Well the rate of growth in industrial output is certainly slowing:

China's industrial production growth held close to a two-year low in November, suggesting the government is achieving a gradual slowdown in the world's fastest-growing major economy.

Output rose 14.9 percent from a year earlier to 793.6 billion yuan ($101 billion) after climbing 14.7 percent in October, the National Bureau of Statistics said today. The figure may ease concern that the effects of a government clampdown on investment are waning after exports surged to a record last month, aggravating tensions with trade partners.

China's economy grew 10.4 percent in the third quarter, slowing for the first time in a year. The economy expanded 11.3 percent in the prior three months, the fastest pace in more than a decade.

Exports in November surged by 32.8 percent, matching the largest gain in a year. Retail sales growth stayed close to October's almost two-year high. Consumer prices rose by the most in 20 months, while producer-price inflation unexpectedly slowed.

So now the possibility exists that these excesses are rebalancing themselves. The next question is, if that is the case how will the slowdown in the acquisition of machinery and equipment affect the two major prior beneficiaries, Germany and Japan? Will they feel the squeeze, or will they simply move on to India?

December Tankan Index

Well the latest edition of the Bank of Japan’s Tankan survey is now public property, and it does register a marginal increase to 25 from 24 last time. Perhaps just as significantly though the companies surveyed expect the index to decline to 22 next time round, which means that the forward looking component is not overly strong.

Perhaps the most noteworthy point in the FT article was this one:

"One of the mysteries of the present recovery, now in its fifth year, is the slow pace at which record corporate profits and a tight labour market have transferred to wages and consumption. Mr Ogawa said companies would have to start increasing the share of profits given to labour over the next year or so, but he didn’t expect any dramatic rise in wages.

Well I hope that by now this feature of the Japanese situation should no longer be a mystery for regular readers of Bonobo Land or Demography Matters, or for that matter for readers of Claus Vistesen's blog. Basically a rising median age is affecting the savings component relative to consumption, while at the same time the tightening labour market is more a reflection of a reducing potential labour force than anything else. Thus:

The diffusion index for employment conditions at big companies in all industries registered minus 11, compared with minus 8 in September. A negative number reflects a labour shortage, a situation that is expected to deteriorate over the next three months when the index is projected to reach minus 13.

Given Japan's demographic not only should we expect this situation to deteriorate, it is hard to see how it can do other than deteriorate, and deteriorate.

Incidentally we have another version of the every cloud has a silver lining story running in Japan at the present time:

"Capital Economics, a London-based research company, said a rate rise next week would be “more Santa than Scrooge” since it could actually improve consumer sentiment by boosting the interest paid on savings. Economists regard domestic an improvement in consumption as vital to keep the recovery going and to consolidate the defeat of deflation."

Well the last time I thought about it, rising interest rates were thought to encourage saving, not discourage it. So although there may be some sort of wealth effect somewhere, the NET impact is sure to be negative for spending, not to mention what rising interest rates would do to the servicing problem for Japan's enormous mountain of public debt.

Incidentally, Claus and I are now both cross-posting on the Japan Economy Watch blog.

Thursday, December 14, 2006

Russia Still Turning The Energy Screw?

Well obviously news like this doesn't exactly send me off jumping up and down with glee:

Russia is preparing to cut off natural gas supplies to neighbouring Belarus and Georgia unless the two former Soviet republics agree by the year-end to pay much higher prices in 2007.

As the FT notes this comes nearly exactly a year after the Russia actually did cut of supplies to the Ukraine, this sort of news is in no way reassuring:

Coming a year after Gazprom, the Russian gas giant, briefly cut gas to Ukraine in a similar pricing dispute, such a move could provoke further international criticism that Moscow is using energy as a political tool. It might also intensify pressure on Russia to ratify the European Energy Charter treaty, which would require such disagreements to be resolved through arbitration.

Personally I have no great confidence that the signing of an agreement would be any real guarantee of gas supplies for the EU in a push comes to shove situation. The fact that Iran is the other major gas supplier on which the EU hopes to rely also somehow doesn't inspire an enormous amount of confidence either:

Georgia says it can replace Russian gas with supplies from neighbouring Azerbaijan and from Iran. But as well as trying to raise prices to $230 to Azerbaijan, Russia is reducing its gas exports to the country next year, limiting Azerbaijan’s scope to re-export surpluses to Georgia.

What we need is some really serious and coherent political assessment of where Russia and Iran are headed, and what kind of situations might arise if these two suppliers were ever to decide to try to collude in some way or other.

Obviously the path on which both countries seem set only threatens to produce more problematic situations in the future, and with the demographic outlook for Russia being so bleak (and here) I cannot help fearing that most observers are underestimating the potential for instability and consequent problems.

Certainly this kind of debate is to the point, but still leaves far too many questions unanswered for my linking. Russia certainly at this point could in no way be called a fascist stead, but where is it headed, and just what kind of socio-economic dynamic is operating in Russia right now? These are big questions, and at the present time they remain questions without answers.

Above all what the EU seems to lack is any clear energy strategy which doesn't involve dependence on Russia and Iran, and maybe this is the most worrying detail of all.

Wednesday, December 13, 2006

Chile Blazes the Trail

Something I agree with from Martin Wolfe for a change (behind the firewall unfortunately). As I have been noting here on Bonobo Land Chile certainly seems on the up and up these days. As I suggest in this post (and also here) Chile's demographics are pretty favourable these days (which is something which can't be said for say Bolivia or Ecuador), and if you add to that the very positive political dynamics then they certainly seem set to carve their place as Latin America's first tiger. I also like the way Bachelet has handled the Pinochet death issue, to ashes he has gone, and as ashes he shall remain. There is quite a good cartoon in one Spanish newspaper which has him trapped in a kind of netherland, he tries the door to heaven (the judges are away sick), same problem with hell, and then with pergatory. It seems he now wants at trial, but has difficulty getting one.

The deaths of Augusto Pinochet and the failing health of Fidel Castro mark the end of an era for Latin America. We should look back at the bearded revolutionaries and military despots, ideological fervour and utopian dreams, without any regret. Despite the recrudescent populism of Hugo Chávez in Venezuela and Evo Morales in Bolivia, a more sober style of democratic politics is cementing its hold across the region.

This is the theme of a fascinating book by Javier Santiso, deputy director of the development centre of the Organisation for Economic Co-operation and Development.* “Since its independence,” he argues, “one of Latin America’s core dependencies has been its belief in miracles: the miracles forged by the Marxist or free-market magicians, revolutionaries and counter-revolutionaries, on the basis of a few grand theories and paradigms.” There is, instead, “a dual movement of economic reforms and a transition to democracy”, a move to “the political economy of the possible”.

There does however seem to be room for improvement. Chile's growth has slowed somewhat recently and this has produced a heated debate inside the country as this article in the FT explains:

Andrés Velasco, the current economics minister, shows little sign of being a man under fire, patiently defending his government’s plans to smooth the rate of expansion and reduce the volatility resulting from highs and lows in the price of copper, which accounts for almost 60 per cent of exports.

Critics say the government’s rigid adherence to macro-economic orthodoxy has undermined its ability to take advantage of copper prices, which have tripled in the past three years. Mr Velasco rejects this. “They get short-term macro-economic performance and longer-term growth trends mixed up,” he says.

In an interview with the Financial Times, Mr Velasco blamed the slowdown in growth this year on short-term supply shocks, among them strikes and accidents in Chile’s largest copper mines and rising international oil prices.

On top of that, Argentina unexpectedly almost doubled the price of the natural gas it exports to Chile and cut volumes. Chile depends on Argentina’s gas for more than a third of its electricity generation, though industry was most affected by the cuts, being forced to use diesel fuel at up to five times the cost.

Although he has come under pressure to take advantage of increasing revenues from the copper boom to pump up spending in needy areas, Mr Velasco is sticking firmly to the counter-cyclical fiscal rule introduced in 2000. It requires a structural budget surplus of 1 per cent of gross domestic product, with spending targeted to revenues based on long-term copper prices, which for 2006 were calculated at $0.99 per pound – less than a third of the highs reached this year.

Mr Velasco says that because of this rule, Chile has had “dramatic success” in stabilising growth and he rejects criticisms that Chile should be growing more because of high copper prices: “The very purpose of macro-economic policy in Chile is to insulate economic activity at home from commodity prices abroad.”

Volatile growth caused by copper prices “was precisely Chile’s problem for decades and to have overcome that is the biggest achievement of macro-economic policy in Chile”.

However, in spite of success in stabilising the economy, the sagging growth has prompted a chorus of criticism, notably from the so-called “group of 20” of Chile’s leading economists, who are calling for the phasing out of the 1 per cent surplus rule to allow greater spending on education and to promote competition through tax breaks for businesses.

“We have to pay more attention to micro-economic problems but the government lacks ambition to carry out serious reforms in this area,” says Harald Beyer, of the centre-right CEP think-tank in Santiago and one of the group.

Felipe Larraín of the University of Chile, another of the 20 economists, highlights four main problems that must be tackled to stimulate growth: low education standards, a lack of innovation, rigidity in labour markets and over-regulation in areas such as the environment.

Whatever the ins and outs of immediate policy issues (it is hard from this distance to judge) I am sure Chile is now firmly set on the right path. So let's hope Argentina and Brazil now continue to follow suit.

Tuesday, December 12, 2006

The French Enigma

There's a lot of interest focusing on the future evolution of the Eurozone economies at the moment. Claus Vistesen has been following the debate closely on his blog (and in particular this post).

Many observers are at this point fairly optimistic about the future of the eurozone economies as a group, but, as I keep pointing out, domestic consumption in both Italy and Germany continues to remain weak, and there may be sound theoretical reasons for assuming that this situation isn't going to change, and at the same time these two countries also face fiscal tightening problems as we enter 2007, due to the costs imposed by their rapidly ageing populations.

As Claus says:

Many Eurozone countries indeed need structural reforms .....Yet the thing we must ask ourselves is whether this will be enough? And this dear readers is where demographics come in and more specifically why we need to look at the population structure of for example Germany and Italy in order to really understand what is going on before our eyes. Why for example is consumer spending persistently low in these two countries and why is Germany running a trade surplus of 6% of GDP.

Of course, the ageing population in Europe is not a topic which has just appeared on the center stage of economic discussion and neither is the need for structural reform in Europe. In fact, these two aspects are often tied together; in order to amend the effects of an ageing population we need structural reforms on the labour market (to free up ressources), pension systems (cost cutting), and health care systems (cost cutting). The last two cannot be accomodated by slashing benefits all together and as such fiscal tightening is an integral part of this; just look at Italy and Germany at the moment.

But will structual reforms really neutralize the effects of ageing population effects in Europe? The bets are still out but I would argue that this is highly unlikely.

Now there is a lot of talk about Germany and Italy here, and there are of course other countries in the 12 nation zone, in particular Spain and France.

In fact France is an interesting case here, since in theory France's ageing problem is a lot less severe in the short term than that of either Germany and or Italy, and indeed in recent years, and despite having carried out a lot less in the way of structural reforms than Germany, French GDP growth has consistently outperformed the other two.

Which is why it was really something of a shock when France turned in a zero % third quarter GDP growth reading. Not that it should have been a complete surprise, since the slowdown in the rate of increase in industrial production in France in June and July was already something of an early warning for those who were watching.

However growth across the zone generally has been so strong through 2007 that one would have expected France to pick up again, but apparently this was not to be:

French industrial production unexpectedly fell in October after economic growth stagnated in the third quarter. Production at factories, utilities and mines fell 0.1 percent from September, when it fell a revised 0.8 percent, Insee, the national statistics office, said today in Paris. Economists expected a gain of 0.5 percent, according to the median of 22 forecasts in a Bloomberg News survey. Manufacturing of machinery and equipment fell 0.2 percent.

As I suggest, personally I was surprised when France came in so weak in the third quarter:

France's economy failed to grow in the June-September period, resulting in the smallest job creation since the second quarter of 2005. The 8.8 percent jobless rate, though down from 10.1 percent in May 2001, remains the highest in the 12-country euro region, according to Eurostat.

Now domestic consumption as I have also suggested is endemically weak in Italy and Germany, but they have been able to leverage exports to some extent (Germany a lot more than Italy):

``Industrial production in France isn't taking off,'' said Sylvain Broyer, an economist at Natixis in Paris. ``Growth in Europe is being pushed by investment, and France isn't strong with investment goods like other countries, such as Germany and Italy, are.''

So we could draw the conclusion that the French economy could survive better if internal consumer demand in some other eurozone countries was stronger, but since this isn't the case the weakness in consumption in Italy and Germany then feeds back into France.

This is just a hypothesis at this stage, but it did receive a bit more support from today's trade data from France:

France's trade deficit widened in October for the first month in three as the rising euro undercut exports and boosted imports. The shortfall grew to 2.71 billion euros ($3.6 billion) from 1.51 billion euros a month earlier, the Trade Ministry in Paris said today.

and this whole evolution has now lead INSEE to substantially revise downwards its growth estimate for 2007:

French economic growth will slow in the first half of 2007 as foreign demand cools, the national statistics office forecast.

The world's economic expansion will fade in 2007 to its weakest in four years, dragged down by a U.S. slowdown, the Organization for Economic Cooperation and Development said last month. Insee sees exports of manufactured goods rising 1 percent in each of the first two quarters, down from 2 percent in the last three months of 2006. Import growth will also slow to 1.5 percent from 2.2 percent, it said.

So what we have at the moment is indeed a curious situation as the two weaker economies continue to outperform what has, until now, been thought to be the rather stronger one. My own view is that in the course of time things will return to their natural order and Italy and Germany will underperform France in 2007 (and possibly by a wide margin) but for the time being we remain with the enigma, which is undoubtedly in some way associated with continuing euro strength. So it will now be interesting to watch this situation moving forward, and particulary over at the ECB where we may reasonably expect enthusiasm for further rate rises to begin to cool notably.

Immigrants and Italian GDP Growth

Looking for something else I just stumbled across this:

Italy’s 3.6 foreign residents are an added asset to the country’s economy and their labours account for 6.1% of its GDP, some 86.7 billion euros in 2005, according to a new report.

Published Monday in the authoritative financial daily Il Sole 24 Ore, the report pointed out how Italy’s immigrants were responsible for “keeping the nation from suffering two heavy recessions in recent years”.

Without their contribution, Il Sole explained, “Italy’s GDP would have fallen by 0.1% in 2002, 0.6% in 2003 and 0.9% in 2005.

Almost 2.1 million immigrants hold regular jobs and they totally dominate the domestic services sector, accounting for 80% of the sector’s contribution to the country’s GDP to the tune of 9.6 billion euros.

Immigrants play an even bigger role in the services sector contributing 37 billion euros to the nation’s wealth, equal to 4.3% of the sector’s GDP.

According to the report, the contribution immigrants make to the economy has been growing constantly.

From 1993 to 2000, GDP rose 15.4% in real terms, but this would have been 13.5% without immigrants, Il Sole calculated.

In the following five years, GDP rose by 3.2% “of which 3.1% was thanks to the work of immigrants. This is equal to 96% of the increase,” the study concluded.

The data presented here is fascinating. The picture is pretty similar in Spain, although since Spain's population ex-immigration isn't actually falling all we can say is that Spain's economy has risen substantially more than it would.

I suppose I don't need to ram this point home, but it does rather confirm my argument that those countries with ageing populations who cannot attract immigrants will actually see GDP shrink at some stage.

Wednesday, November 29, 2006

Chile, Argentina and the Demographic Dividend

I have already put up a short post on Chile and the demographic dividend earlier this year. Perhaps now is a good moment to take another look at this argument in the Latin American context. (A reasonable explanation about what the demographic dividend involves can be found here).

Basically from my median ages chart (a short introduction to why median ages are important can be found here) I have identified three countries in Latin America who should experience some kind of DD process in the years ahead: Brazil, Argentina and Chile.

Looking at today's news Chile still seems to be continuing nicely on course, as anticipated by the theory:

Chilean industrial production expanded at its fastest pace in five months in October, which may discourage the central bank from cutting lending rates as the economy emerges from a slowdown.

Manufacturing expanded 4.7 percent in October after contracting 2.6 percent the previous month, the government-run National Statistics Institute reported today in Santiago. Joblessness fell to 7.4 percent in October, its lowest level in eight months.

``This reduces the probability we're going to have a decline in interest rates,'' said Raimundo Valdes, an analyst at Santander Investment Inc. in Santiago. ``Private consumption and internal demand are going to be the drivers behind growth next year.''

The rebound in industrial production and an increase in spending on capital goods are signs investment is growing, which may help pull the country out of its worst slowdown since 2003, Valdes said. The economy will probably grow 5.7 percent next year after expanding just 4.4 percent this year, he said.

Now obviously we are yet to see Asian-style growth rates in Latin America, but still this sustained period of comparatively high growth is encouraging. If we turn to Argentina, we find that the situation is not that different:

Breaking the Boom and Bust Cycle?

The fastest-growing economy in Latin America is likely to do it again in 2007, but can this growth last? Argentina has been growing at nearly 9% for four years and we expect a similar, albeit more subdued, performance next year at 7%. However, sustainable growth has proven elusive for Argentina over the past half-century as the economy went through severe boom and bust cycles. While economic growth keeps roaring ahead, it is important to ask whether Argentina has graduated from its history of spectacular boom and bust cycles.

The Argentine economy has sustained four years of growth near 9%, and we see no crash in 2007. However, we see significant vulnerabilities on the growth front, given that much of it hinges on continued consumer confidence, subsidized by the negative real interest rates. As the government fights self-induced inflation and as questions abound regarding the ability of the energy complex to meet demand next year, it is easy to be pessimistic. Yet, we feel that in the near term, the broad macro backdrop is less vulnerable this time around than it has been for nearly a decade — investment has rebounded, as has the capital stock, after having been stagnant during the five years through 2004. Combined with a supportive global backdrop and absent a surprise on the energy front, the Argentine growth machine should be able to continue firing on most, if not all cylinders into 2007.

(Daniel Volberg Morgan Stanley GEF).

So Argentina may well be at last breaking out of the boom-bust cycle, the interesting question would be why? Clearly the political picture is not greatly improved:

Casi la mitad de los países del mundo tienen gobiernos que pueden calificarse de democráticos, pero las "democracias plenas" son sólo 28, según "El Mundo en 2007", un informe especial de la revista inglesa The Economist .

Casi el doble de esa cifra, 54 países en total, constituyen a partir del puesto 29 las "democracias imperfectas", por falta de participación ciudadana y cultura política. Entre ellas figura la Argentina, ubicada en el puesto 54 del ranking.
(My thanks to my Argentinian friend Fran for this link, you can find the latest edition of the Economist Intelligence Unit Democracy Index here.

The dark cloud on the Argentina horizon which many point to would seem to be energy infrastructure. On this topic
Luis Arcentales and Daniel Volberg recently conducted an analysis of the energy sector in Argentina with the following outcome

Energy tipping point?

Argentina’s handling of the energy situation has also come under heavy criticism. Oil, natural gas and electricity — the three main components in the energy sector — all have significant problems in Argentina. With the dearth of private investment in the sector due to price freezes instituted at the time of crisis in 2002, Argentina’s energy sector would appear to be the country’s Achilles’ heel. While our focus is on the macro, we thought it would be worthwhile to provide our initial thoughts on the energy risks and challenges for Argentina in 2007. After all, the single greatest challenge we suspect to our call for another year of strong growth in Argentina is a mishap on the energy front.

We doubt that the oil sector is likely to be a major problem in the coming year.

Argentina is an oil exporter, and while the government taxes crude oil exports heavily at 45% in order to maintain low domestic prices, we do not see any major cataclysms in 2007. In fact, we project that if production and consumption grow at the 2004-05 average levels, Argentina will remain an oil exporter until 2010. That said, there is a need for investment in exploration if Argentina is to keep a viable energy export sector.

Natural gas is another area that we doubt is likely to be a major problem in 2007, despite the fact that domestic prices are frozen at roughly one-fifth of current world market levels. Argentina imports a portion of its gas needs from Bolivia at market prices, and so the price freeze amounts to a hefty subsidy on the part of the government.

Another complicating factor in analyzing the gas sector is that gas in Argentina must be transported via pipelines, and thus supply is not very flexible. Thus, Argentina is a net exporter of gas at the same time that the Buenos Aires region is heavily dependent on the Bolivian supply. We project that at 2005 growth levels in production and consumption, Argentina will become a gas importer in 2008. The gas sector experienced problems in 2004 when Argentina had to redirect gas exports destined for Chile to satisfy growing domestic demand. However, investment since then has increased capacity, and a major gas pipeline system, the Gasoducto del Nordeste (GNA), is under construction and scheduled to come online in 2009 or 2010.

The sector we believe Argentina watchers should monitor the closest is electricity generation, but once again our preliminary results indicate that 2007 should not be a crisis year. Argentina has nuclear, hydro-electric and thermal (oil, gas and coal) electricity generation capacity, with thermal generation capacity accounting for roughly half of the total. The complicating factor when it comes to analyzing electricity generation is the volatile nature of demand and the limited publicly available data on actual fluctuations. Since the system is vulnerable during peak demand, we build several scenarios by assuming different proportions of peak strength relative to annual demand. We base our estimates on informal consultations given by our energy analysts, Subhojit Daripa and Rudy Tolentino.

We find that there is a possibility for problems during the course of 2007, suggesting that they might come during the winter (July or August), but this depends on the current public investment in generation capacity, the revival of the Yacyretá project experiencing delays, as well as the pace of demand growth. In fact, there are public and private investment projects scheduled to come on-stream during 2007, 2008 and 2010 that should expand generation capacity by 15% in 2010 and by nearly 20% in 2011. Thus, if there are no major delays, Argentina should be able to avoid blackouts, even if by a rather small margin.

So at the end of the day Argentina may continue to walk forward on both legs. Brazil is the third country on my list, and as I was arguing earlier in the week, also seems to fit the general pattern (you can find more systematic posting on Brazil over at my new Brazil Economy Watch).

What we would seem to have here is a relatively interesting coincidence between theory (the demographic dividend idea) and empirical data, which would rather tend to confirm the theory. Note that I am not arguing that the demographic situation provides a complete picture, but simply that it is one component in economic growth and development (as should be expected from Solow-type growth theory), and indeed that this component should have a rather heavier weighting than most are inclined to assign it (as should its converse, the Demographic Penalty, which we can of course see at work in Japan, Germany, Italy etc as Claus Vistesen rams home yet one more time today).

Tuesday, November 28, 2006

What's Funny About Consumption in Japan?

This question was being asked yesterday by Morgan Stanley GEF analyst Robert Alan Feldman (the post can be found towards the bottom of the page).

Now as Claus Vistesen will undoubtedly hammer home at some stage Feldman does get some important parts of the picture which I have referred to in my last posts (and here):

The data on consumption have certainly been a disappointment this year. Although the nearly 4%Y/Y rate reached at the end of 2005 was clearly not sustainable, the sharpness of the slowdown this year has been a surprise. In addition, the deceleration in compensation (whether measured by compensation per worker from the national accounts or by hourly earnings from labor data) has also been a surprise ? especially with record-high corporate profits. The weak growth of wages is all the more puzzling in light of tightening of labor markets shown by a number of indicators. Yes, the weather has been weird this year, but that cannot be the whole story. What is going on?

So far, the number of people saying "That's funny" is small. However, the longer the anomaly of strong capex and weak consumption continues, the more likely will emerge others (like myself) who will claim that high capex and low consumption is the correct structure for the economy.

Why? The idea is simple: As Japan ages, there will be a much faster shrinkage of the labor force than of the population. Hence, each remaining worker will need a lot more capital in order to keep productivity growth fast enough to maintain living standards. Economic growth theory ? in contrast to standard macroeconomic theory ? tells us that high capex and low consumption is just what an economy needs when aging. The implication for investors is equally simple: Stop worrying and love the high-capex economy.

Well really he is getting very near. But then note this:

"As a practical matter, however, consumers and investors will need more time before they accept that consumption need not become the engine of growth."

Well I would put a lot more names on this list other than consumers and investors, people like Brad Setser, Nouriel Roubini, the IMF, the BIS, US Treasury Secretary Paulson, Trichet and the gang at the ECB etc etc. In other words Feldman has, inadvertently walked right into the current global imbalances minefield by suggesting that Japan, as an aged economy (and the first of many more to come) will have to be high capex, low consumption, and logically, to sell the product, dependent on exports. What happens if this ever sinks in somewhere?

Basically he is not quite right about the contrast between macro theory and growth theory, since even though the Solow model is supply side oriented, it is normally situated in a general equilibrium model which includes demand side components and hence generates relative prices.

So you really do need a general equilibrium model running in your head somewhere to get to grips with the implications of what he is arguing. One of the factors he doesn't seem to think about - and why should he, he isn't a theoretical macroeconomist - is how the changed relative balance of consumption and saving affects interest rates, and thus the cost of all that capex, which with low interest rates is much less, and then of course you need to get onto relative prices, and especially if deflation persists.

Curiously he mentions Asimov, and Asimov was interested in robots (he could also have mentioned Zamyatin who wrote a novel called "I Robot"). Now the interesting thing is to think about VERY HIGH capex, at the levels we might see when robots get to build the machines, and then start thinking about whether this would be expensive (which is the story Feldman is trying to sell the investors, hence the possibility of good returns) or whether this would in fact be very cheap, being funded by virtually give-away money with very little of the really scarce and relatively expensive input (labour) being required and with the other constraint being the cost of the raw materials and power that the robots need in order to go to work. Of course, whoever develops the robots can make an initial short term 'rent' ( a la Schumpeter) while they still have a monopoly on the technology, but again there are winners and losers, since some will try and build the technology and fail.

Anyway, this point aside, Feldman is clearly in the right ballpark, and all people now need to do is take the relatively simple step (a small one for them, but a giant one for humanity, perhaps) of thinking this through to a much more general level, and contextualizing all this in what has come to be known as the demographic transition. Now just who the hell was that who ever said that demography isn't important to economists?

Consumption Decline in Japan

My friend Eddie Lee mailed me this morning about this news:

Japan's retail sales unexpectedly fell for a second month, reducing the likelihood that consumer spending will accelerate and lead to an increase in the lowest interest rates among the world's seven biggest economies.

Receipts at retailers fell a seasonally adjusted 0.2 percent in October from a month earlier amid warmer-than-usual weather, the trade ministry said today. Sales of winter clothes and electronics led the decline.

The retail ``report does make it somewhat more difficult for the bank to move because things aren't exactly adding up,'' said Jan Lambregts, head of Asian research at Rabobank International in Hong Kong. ``The Bank of Japan is taking an optimistic view on the economy.''

Now as Eddie says "i just found it a little amusing ..."

".. Bank of Japan Governor Toshihiko Fukui ``doesn't have the ammunition to back up'' a December interest-rate increase, said Kirby Daley, a currency strategist at Societe Generale Group's Fimat unit in Hong Kong. ``We are continuing to make excuse after excuse after excuse for why the consumer isn't coming to the table and it constantly is the weather in Japan.''

... ``The newspapers are saying that the economy is recovering, but that hasn't filtered down to households yet,'' said chain store association spokesman Masahiro Watanabe. Declining receipts at the nation's supermarkets are due more to restraint on the part of consumers than price competition, he said."

Exactly, something other than the weather is at work here, and the Japanese Stock Market seems to sense this:

Asian stocks fell, led by Honda Motor Co., on concern sales are slowing in the U.S and Japan. Li & Fung Ltd., a clothing supplier to American retailers, contributed to the Hang Seng Index's biggest points decline since the Sept. 11 terrorist attacks.

And following the line of thought expressed in Eddie's sense of humour, I couldn't help chuckling to myself at this point:

"``It's unavoidable to adjust interest rates in order to sustain economic growth for a long time,'' the BOJ's Fukui said today at a meeting of business executives in Nagoya, central Japan."

I was chuckling since what he was presumably trying to tell the poor guys who had assembled to listen to him was that afahic it is unavoidable to *raise* rates, whilst what they may well have been wanting to hear is that given weak consumption it is, in their view, unavoidable to go back to ZIRP.

Really Japan is becoming the big test for all the various imbalance theories. Once people finally accept what is actually happening in Japan vis-a-vis rising median age and consumption then the whole global picture will have to adjust, since these ages are set to go up even further and don't look set to come down again anytime this side of 2050, if ever. Meantime you can almost hear the pain as the neurones grind away while people try to figure this amazingly simple detail out.

The Fiscal Position In Japan

Glancing through the OECD Japan Economic Survey 2006 section on the Japan's current fiscal position, I couldn't help having some inconvenient thoughts.

Now as explained here, societies with high median ages and large fiscal deficits (like Japan, Germany and Italy) really face a very special problem: they need to generate sufficient economic growth on a sustainable basis (and since with high median ages they have comparatively low propensity to consume from additional income, and a comparatively high propensity to save, this means export-driven growth) to create sufficient revenue for the exchequer to be able to balance income and expenses. None of the three usual suspects have been able to achieve this balance in recent years - and they have therefore seen their net financial position deteriorating - so it is clear that if they are going to be able to convince the financial markets that long term their position is sustainable, then they need to be able to change course, and demonstrate an ability to maintain the change. This, I take it, is what all the fuss about the 'sustainable recovery' is all about.

The curious thing is that despite all the fuss about the fact that this has been the longest boom since the Izanagi cycle of the late 1960s you tend to read comparatively little about this problem, or about the macro implications of addressing it.

The OECD estimate the current level of the debt/GDP ratio at around 170% of GDP. Now this number is highly contested, since they do have assets in a social security fund, but, otoh, if you count these, so the argument runs, then you also need to take into account implied liabilities, and from here on in there is a large accounting and political wrangle.

I am inclined to take the same view as the Standard and Poor's guy who was very un-impressed by recent attempts by the Greek and Italian governments to reclassify upwards their GDP values by incorporating estimates for the informal economy (an attempt we should note which did to some extent cut ice with Almunia at the EU Commission, I guess those who inherently want to be convinced are grateful to anyone who can offer them a reason why they should be). Basically the S&P's guy said that all this makes little difference since what matters with sustainability is revenue and expenditure, and how they balance. This is what determines the dynamic of the debt, and informal activity by definition doesn't pay tax.

So the same goes for Japan. What matters isn't really the exact number to be attached to the debt/GDP ratio (which in any event is large) but whether the relation of expenditure to revenue is moving towards a balanced path or whether they are spiraling out of control. In the context of population ageing this issue is huge, since obviously stagnant GDP opens the possibility that such debts may NEVER be payable, something which no-one yet seems to want to contemplate, but this doesn't mean that at some point or another markets won't wake up, and maybe with a jolt.

(Incidentally, just a little side dish at this point. We have had a series of red-herrings in the great ageing debate, and one of these is the issue of stock market meltdown. In fact this confusion comes from applying a time horizon which is far too long - so many studies focus mechanically on the 'magic number' of 2050 - and a rigid idea of the life cycle theory, whereby people dis-save as they get to the oldest-old ages. What we can see is that you need to look at a much shorter time horizon - I would say 2010 to 2020, wasn't Keynes's big 'discovery' the ability to distinguish between short, medium and long terms, something which despite the frequent use of the 'in the long run we are all dead' quip, few seem to think about. Sometimes I think that, in economic terms, we live in something of a fools age. The other point would be that before we reach the dis-saving age - if we ever reach it, in fact the oldest old seem to be very spendthrift, so somehow I have my doubts here - we go to an age of increased saving, this is what we are seeing in the older countries across the globe. People are being very mislead here by the savings decline in the US. So I think that rather than stock market melt down what we may see is a very low rate of return environment - remember I am talking 2010-2020 - and the real issue is about what the pension funds can realistically offer their clients if this environment holds).

So I think that at some point the markets will wake up, and this is one of the reasons that I have become so interested in Hungary, since this may well become the first case in history of a country which finds itself stuck on just such an unsustainable (or rather self-evidently unsustainable, since Japan and Italy, IMHO, are already on unsustainable courses, but no-one wants to recognize this) path. Hungary may become the case where this conclusion becomes hard to avoid. I say may, and I mean may, but since the *possibility* exists this certainly makes it worth following for this reason alone, apart from everything else that can be learnt there, and the pure technical fascination of the situation for anyone interested in macroeconomics, it is just such a classic case in some senses, but a classic case with a new, and potentially deadly, ageing twist.

The thing is that if people do start to wake up over Hungary, then eyes will turn to Italy, and if there is a crisis in Italy, then this will obviously lead to a reconsideration of what exactly is going on in Japan. I think I am tentatively outlining a scenario (or possible scenario) here.

So to close, just one or two details on Japan:

Limiting the growth of government spending is the priority in addressing the serious fiscal problem. The FY 2001 Structural Reform and Medium-Term Economic and Fiscal Perspectives set an objective of freezing public expenditure at 38% of GDP through FY 2006, and this target is likely to be achieved. Such spending restraint, which was achieved in part through cuts in public investment, aimed at the goal of a primary budget surplus for the combined central and local governments in the early 2010s. On a general government basis, the primary budget deficit has fallen from 6.7% of GDP in 2002 to an estimated 4% in 2006, with about half of the decline due to structural factors, and the rest accounted for by the economic expansion.

What we should note here are really two things. Firstly that despite everything Japan is still running a substantial fiscal deficit, and that really this deficit hasn't reduced hardly at all if you take into account the fact that half of the saving has come from increased revenue during the boom, and that the other half, which has been a real reduction, may well reverse if 'automatic stabilizers' are applied during the downturn.

Then there is this:

The Reference Projection for the FY 2005 Reform and Perspectives shows a primary budget balance for the combined central and local governments in 2011. However, a balance would not be adequate to stabilise the level of public debt relative to GDP in the long run if the nominal interest rate on government debt exceeds the growth rate of nominal output. While the economic expansion and an end to deflation may push the nominal growth rate above the interest rate in 2006, assuming that growth remains higher would not be prudent for setting a medium-term fiscal objective. Indeed, population ageing will tend to slow output growth while possibly increasing the interest rate. In sum, stabilising the public debt to GDP ratio is likely to require a primary budget surplus for the general government of between ½ and 1½ per cent of GDP.

The point about interest payments is important since of course if rates were to rise in Japan this would put even more pressure on the budget deficit, since the costs of the debt would rise for the Japanese government, which is another reason why some at the finance ministry may be urging the BoJ to exercise caution in raising rates. Indeed Japan may already be in some kind of trap here, given the continuing weakness of domestic consumption. Fortunately (from this point of view) rates are not likely to rise (IMHO) and I fully expect Japan to be back in Zirp either sometime in 2007 or in early 2008.

Finally, I would draw your attention to the fact that Claus Vistesen and I are cross-posting to my old Japan blog, which may indeed attract a few more readers as we move into 2007.