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Thursday, February 22, 2007

Export Dominated Growth In Germany and Japan

Well it is now more or less official, growth in the fourth quarter was largely a story of strong export performance in both Germany and Japan. Domestic consumption remained congenitally weak in both cases.

In Germany, as Bloomberg reports:

Booming exports drove an unexpected acceleration in German economic growth in the fourth quarter, capping the best year for Europe's largest economy since 2000. Sales abroad jumped 6 percent from the third quarter, the Federal Statistics Office in Wiesbaden said in a detailed report on the fourth quarter today. Private consumption rose 0.3 percent. The economy grew 0.9 percent after 0.8 percent expansion in the previous quarter

As the Federal Statistics Office makes clear growth was largely a story of exports (and the domestic capital expenditure necessary to fuel them) and demestic consumer demand (when you strip out an element for the advance purchasing influenced by the VAT hike) was virtually flat:

As regards GDP use, growth in the fourth quarter of 2006 was based both on domestic and foreign demand, as was the case in the quarter-on-quarter comparison. However, also in a year-on-year comparison, the particularly dynamic foreign trade contributed by far more to the economic upturn in the reference quarter than did domestic demand: The continuing demand from abroad produced two-digit growth rates, which were even much higher for exports (+15.9% in real terms) than for imports (+10.3%). The resulting export surplus (net exports) contributed 2.8 percentage points to economic growth. As mentioned above, the strong increase in exports was positively influenced by belated declarations received in foreign trade statistics.

The 15.9 % y-o-y increase in exports is large indeed, and does raise the question as to such whether such rates of increase can be sustained going forward.

In the case of Japan, again as Bloomberg points out:

Japan reported an unexpected trade surplus for January, buoyed by a 50 percent surge in exports to China and a drop in oil imports.The surplus was 4.4 billion yen ($36 million), compared with a deficit of 353.5 billion yen the same month a year earlier, the Ministry of Finance said in Tokyo today. Exports climbed 18.9 percent, twice as fast as economists expected.

So here again the increase in exports is pretty massive - 18.9% y-o-y - and the same sustainability issues arise. What is strange about all of this is how few commentators seem to be picking up on the underlying picture.

Employment in Germany

As the Financial Times reported earlier in the week, the numbers of those employed in Germany has been rising rapidly in recent months.

The number of people in work in Germany reached a five-year high in 2006 with a further surge in job creation expected this year, underlining the strength of the rebound in Europe’s largest economy.Employment rose last year to 39.1m, compared with 38.8m in 2005 and 39.3m in 2001, the most recent highpoint, according to official data published on Tuesday.

Now this is undoubtedly very good news. What the FT didn't spell out though is the fact that this increase has occured against as background of a steadily declining total population and a gradually reducing economically active population, as can be seen from the table below, which comes from the website of the Federal Statistical Office.

So when we note that:

Headline unemployment is likely to fall below 4m by late 2007, compared with 4.25m in January and more than 5m in early 2005, experts predicted on Tuesday.

we might also like to take note that roughly half of this decrease in unemployment is a result of people actually leaving the labour force to retire faster than new entrants are arriving, and this offers an important, and often neglected, part of the overall picture. Now it remains to be seen just how much of the real improvement in employment is sustainable during the cooling down process which is likely to take place over the coming months. Methinks we are a long way from being able to cry victory here.

Tuesday, February 20, 2007

Japan: To Raise or Not to Raise, That is the Question

Well in some ways this is an interesting week in Japan. The Boj has to take a decision on whether or not to raise interest rates. As Claus Vistesen says in an aptly titled post, this is just too close to call. Nonetheless I will stick my neck out just a little, I don't think they will raise, but I wouldn't attach a very high level of certainty to this, since there are a lot of pressures in both directions. But the underlying issue is one of asymmetric risk (ie the presence of so many downside factors, plus the need to do something on the fiscal front). Nevertheless I a may well be wrong, since the international pressures on Japan at this point are enormous. If they do raise I am categorically of the opinion that this would be a BAD decision, and indeed bending to political pressures rather than going by economic fundamentals.

I won't dwell more on this here, since Claus has already covered the ground in two excellent posts on Global Economy Matters (here and here).

What I will do is draw attention to an intersting piece from the FT Japan correspondant David Pilling. Pilling offers an interesting rundown of the history of Japanese central banking and monetary policy since the bursting of the bubble at the end of the 1980s. He also draws attention to the crucial dilema now facing Japan:

On one side of the debate, many academic economists argue that it is ludicrous even to consider raising rates now. Stripped of energy costs – the normal practice in other advanced economies – Japanese prices are still falling. Few textbooks, to put it mildly, advocate tightening at such a juncture.

Furthermore, sceptics say, the BoJ’s central scenario on which it bases monetary policy is patently failing to come to fruition. The bank has said it expects profits gradually to feed through to wages and consumption, exerting upward pressure on prices. But wages have barely budged, as companies have held tenaciously on to their earnings. Although consumption grew strongly in the fourth quarter, as revealed in the GDP numbers, that merely cancelled out an equally sharp drop in the previous three months.

As he says many academic economists argue that it is ludicrous even to consider raising rates now (and I would be among these I guess) but on the other hand:

Mr Yamakawa at Goldman says there are big risks to the BoJ’s policy objectives if it does not raise rates this time. “If it doesn’t move, the markets will receive a clear-cut message that the BoJ will not increase rates until it sees very definite signs of a recovery in consumption and the CPI. That means it would be waiting until everybody, including the politicians, was happy.”

But waiting for what he calls the “full set” of data confirming Japan’s transition from a deflationary to an inflationary economy “risks a distortion in the process of asset price formation”, Mr Yamakawa says. In particular, if markets conclude that rates will stay at 0.25 per cent for another six months, the carry trade is likely to swell further, increasing the impact of any sudden reversal.

I think this is only partly right, the risk to asset prices is not in Japan, but elsewhere (via the carry trade) and this is why there is so much pressure on Japan.

There is one more element to add to this potent mix. In the past few weeks, Tokyo has come under pressure from European – though not US – officials over the weak yen which, in trade-weighted terms, is at 20-year lows. Some European finance ministers have linked the issue to Japanese interest rates being 5 percentage points below those in the US and the UK. As well as making Japan’s exports “unfairly” competitive, the criticism goes, the wide differential has fuelled the so-called carry trade, encouraging people to convert cheap yen into higher-yielding foreign assets.

The issue came up at this month’s Group of Seven finance ministers meeting in Essen, although the final communiqué contained no direct demand that Japan should act. Some bond traders speculated that Mr Fukui may have helped head that off by hinting that Japan would raise rates soon.

So the risk here is that the BoJ may be forced into taking a bad decision (and against all sound macroeconomic advice) for political reasons, but these political reasons would be external and not internal ones. This is not the basis for sound monetary policy, and is a likely recipe for a loss of central bank credibility inside Japan, with unknown subsequent consequences. As Pilling notes since gaining independance back in 1998 the BoJ has already made one bad call (by starting to raise rates back in 2000, only to be forced to backtrack as deflation persisted), can it really now afford to make another one?

One last detail, and one which makes me lean towards the idea that the BoJ will continue to hold, the US situation. Now as Pilling notes:

The bank could be further emboldened by recent strength in the stock market and increasing evidence that the US economy, on which Japan depends for exports, will not fade nearly as quickly as once feared.

But if we look at the latest set of housing data from the US the position is by no means as clear as it was only last week:

Construction of new homes and apartments plunged by 14.3 percent in January, the Commerce Department reported Friday. The bigger-than-expected drop left construction at a seasonally adjusted annual rate of 1.408 million units, the lowest level in nearly 10 years.

Now don't get me wrong, the US economy is clearly not set on any kind of downward tailspin course, but it does seem that the immediate outlook is a little weaker than some had been hoping for. And the Japanese are deeply sensitive to any indications of ongoing weakness in the all important US consumer market, and this is the reason I feel that they will most probably come down on the side of caution.

Update: this piece in Bloomberg seems to confirm my view to some extent, certainly the markets are not anticipating a change, and comments from Japanese Finance Minister Koji Omi stressing the importance of central bank policy supporting economic growth seem to confirm this. Also the suggestion that Bank of Japan Governor Toshihiko Fukui will judge not only what's good for the economy but also what's good for the reputation of the central bank can be read in both directions. We will see.

Economic and Fiscal Policy Minister Hiroko Ota today said consumption is basically flat and it's up to the BOJ to decide policy. She declined to say whether the government will exercise its right to ask the bank to delay any decision to raise rates.

Central Bankers and Political Pressures

Sorry I've been away for a while: too much work chasing too little time.

Now this interview in the FT today with Barney Frank, Democratic chairman of the House financial services committee, is reasonably interesting. Frank is worried about any possible decision by the Federal Reserve, following the lead of Ben Bernanke, to introduce inflation targeting as policy:

In an interview, Mr Frank told the FT that Mr Bernanke “has a statutory mandate for stable prices and low unemployment. If you target one of them, and not the other, it seems to me that will inevitably be favoured.” Mr Frank noted that Alan Greenspan, the former Fed chairman, always resisted an inflation target on the grounds that it would reduce his operational flexibility. “I think Alan Greenspan was right not to do that in the 1990s,” Mr Frank said. The lack of a formal inflation target helped Mr Greenspan probe how low unemployment could fall without generating inflation.

This interview follows a piece in Bloomberg yesterday Central Banks Face Rising Pressure From Politicians which covers some similar ground at a more general level:

When politicians tried to pressure former European Central Bank President Wim Duisenberg, he used to say: ``I hear, but I do not listen.'' These days, a growing number of central bankers worldwide are hearing a lot -- and some are listening. The Bank of Japan refrained from raising interest rates last month in the wake of government pressure. The autonomy of banks from Ecuador to India is under attack. French presidential candidates are demanding the ECB meet a goal for growth.

All of this raises a number of issues. In the first place the US debate seems potentially to be a bit muddled if you look at the Frank quote, since in the first place there are the genuine loss of flexibility concerns of Alan Greenspan (which I personally have a lot of sympathy with) and then there is the targeting of unemployment as a separate issue.

Obviously any rate call decision involves some sort of trade off between inflation and growth, and this is always very tricky, but of course the issue that is generally being raised is a political one about the ability of the central bankers to take decisions that the politicians would like to take, and here, normally, I would side with the central bankers.

But things aren't really what they used to be on this front, since the central bankers, via the framework of the G7, have been embarked for some time now on a rate 'normalisation' process which often seems to belie both the inflation objectives (Trichet's citing of money supply numbers, rather than the actual inflation data, for example) and run the danger in some areas of generating sub-par growth (the eurozone, Japan).

Also the attempt to portray Japan's recent decision as a politically inspired one is strange, becuase on many counts it could be seen as responding to economic fundamentals, and Japan's inflation (which is again hovering dangerously close to the deflation level) would hardly call for a series of rate rises at this point.

The underlying problem is, of course, the level of global liquidity, and what to do about this (things like the carry trade) but if the central bankers persist with what many could consider to be an unreal strategy, then the danger really is there that they can lose credibility, and this would be, of course, the point where the politicians once more start to enter stage left. So the situation is a little preoccupying. One symptom of the problem was the recent G7 declaration on the Japan recovery:

“Japan’s recovery is on track and is expected to continue. We are confident that the implications of these developments will be recognized by market participants”

Belief in the Japanese recovery seems to have converted itself into more or less a statement of faith, with almost quasi religious undertones (although some would doubtless call this spin).

Interestingly Maria Demertzis, of the Nederlandsche Bank, has an interesting piece on Central Bank communication practices over at the new Euro Intelligence site. She clearly doesn't get into the underlying economic fundamentals aspect of the present situation, but she does have some timely points about the dangers of spin doctoring, and in favour of the ever present need for flexibility, an argument which is presented of course from a very different perspective than that of Berni Franks.

My point therefore, would be that it is perhaps difficult to keep doing a good job if you are left with little to no room for manoeuvre. Circumstance will some times warrant some flexibility. I would let the experts then decide when and how much that flexibility should be.

And the risk of spin-doctoring is augmented if the demand for communication exceeds the supply of information because your emphasis shifts entirely from the message you are trying to convey, to the way you are trying to convey it. My point is that one should be aware that requests for more transparency or for communication go hand in hand with a greater risk for miscommunication.

This is I would say the big issue, the central bankers have left themselves with little room for manouevre, and economic realities may soon force them to change discourse, whilst in the meantime they have fallen into the trap of engaging in a certain amount of "spin-doctoring". Worrying.