Richard Jerram | Jul 28, 2008
Inflation in Japan has two features that make it unusual. First is that the headline rate is still within the target range of the central bank, even though that range is an unnecessarily – and inefficiently – ascetic 0-2%. The underlying rate – excluding food and energy – is flat even though the economy is experiencing its longest post-war expansion.
Second, and more controversially, is the argument that higher inflation can help the economy. This has been receiving most of the attention in recent weeks, but the first point should not be ignored.
When ending its quantitative easing policy in March 2006 the BOJ produced a new framework to act as the guide for monetary policy. One of the striking features of the framework was a belief that price stability in Japan was naturally lower than in other developed economies, defined by the BOJ as an inflation rate of 0-2%. This is where the ECB started out, although it has since recognised that a more efficient inflation rate is “close to, but below 2%”.
Apart from the basis of the argument, the BOJ’s framework was undermined by its claim that there was “no significant bias” in the measurement of CPI. A few months later a base year revision took around 0.5ppt off the measured rate. This took inflation back into negative territory, which was awkward for the BOJ, as it had undertaken not to tighten policy until inflation was positive and expected to remain so.. An NBER paper by Christian Broda and David Weinstein titled “Defining Price Stability in Japan: A View from America” calculates that if the US methodology were used, then the measured inflation rate in Japan would be almost 1% lower.
The BOJ uses a Phillips Curve approach as its basic guide to policy. This is implicit in the rhetoric of officials, as well as in the bi-annual economic forecasts, which focus on the question of whether growth is above or below trend. The justification for tightening has been that excess capacity has been eliminated, growth is above trend, policy is loose and so inflation will accelerate.
Coming out of over a decade of poor economic performance due to financial system and deflation there should be even less confidence than usual in any attempt to measure trend growth or the output gap, so this forms a poor basis for policy decisions. And so it has been, with GDP growth averaging 2.1% over the past five years, but underlying inflation remaining negative.
Japan stands alone in the developed world with underlying inflation still flat and headline inflation within the central bank’s target range (it was 1.4% in the April-June quarter). Efficient fuel use means that energy is only 7% of the CPI basket, while a complex import regime means that food prices have not risen significantly. These two items accounted for 1.1ppt and 0.9ppt of the 2.0% YoY inflation rate in June.
Underlying inflation should grind higher in coming months as a result of stronger wage growth. Headline inflation probably peaks in the July-September quarter, but wage inflation should help to prevent it from slowing too sharply.
So much for griping about the policy framework. The more intriguing claim is that inflation might help Japan. This sounds like one of those “Japan is different” arguments that we sometimes hear. For example the former Economy Minister (and prime ministerial hopeful) Kaoru Yosano recently joined those pushing for an increase in interest rates to help to boost growth.
In fact the argument about the positive effects of inflation is really an argument about real interest rates. Inflation due to rising commodity prices hurts Japan in the same way that it does other commodity-poor economies, through deteriorating terms of trade.
So far that damage has been partly offset by the commodity exporters spending some of their windfall gains on manufactured goods from the developed world, with Japan fortunate to have retained a relatively large industrial sector. As a result export volumes have been growing as fast in CY08 as they did in CY07, despite the obvious difficulties with demand from the US, which takes around 20% of Japan’s exports. Unfortunately, this looks unsustainable, as inflation is leading to policy tightening in various developing economies, which is likely to cut into Japan’s export growth.
It seems unlikely that commodity prices rises will lead to front-loading of spending decisions. Japanese consumers have shown themselves to be highly sensitive to small changes in prices, for example buying cars and housing in advance of the increase in the sales tax from 3% to 5% in 1997. However, food and energy purchases do not really lend themselves to be front-loaded, especially in a country where space is at such a premium.
The unique issue – and potential positive – for Japan comes from the unusual portfolio selection of households. Over half of all financial assets (which amount to three times GDP) are in the form of cash or bank deposits. While some cite this as an example of the conservative nature of Japanese savers – with the majority of funds managed by those over the age of 60 – in part it simply reflects the impact of sustained deflation. No other country has endured a similar experience with deflation, so it is unsurprising that the resulting portfolio choices are unusual.
Over a decade of deflation and falling real estate prices meant that the returns on cash in Japan were relatively attractive. Households are not wedding to this choice, and funds trickled out of the banks in 2005-06 when real interest rates on bank deposits turned negative and other assets looked more attractive.
Real interest rates are now clearly negative, and the perception is even worse. A recent BOJ survey showed that respondents thought prices had risen 10% over the previous year, and would rise a further 7% over the coming year. This should make people nervous in having such heavy weighting of risk free assets. So far it seems that fear over the impact of global financial crisis is a stronger factor than the need to seek better nominal income, but when markets stabilise, a flow out of the bank should resume.
At the margin the flow has already begun. I estimate that there is 4-5% of GDP being held in the form of bundles of cash held for savings (non-transaction) purposes
I calculate that this money is starting to come out from the mattress and into interest earning bank deposits, presumably in response to the perception of high inflation.
The game of asking where some of this Y775tr (US$7.2tr) of cash and deposits might be heading is entertaining, but probably not particularly useful. Some will be spent. Much will head for assets that are still low risk, but offer slightly better returns. Domestic equities, foreign assets and real estate all have their champions and with such large sums involved, even a small flow could potentially have a large impact.
The discussion can turn more fanciful, with some seeing the search for yield translating into pressure on corporate management to increase payout ratios, or to manage their business more efficiently in order to increase shareholder returns.
In my experience the revulsion to the basic “inflation is good” nostrum means that people are neglecting the potential impact from negative real interest rates on portfolio choices. This could be the source of a new era of carry trade at some point in the coming year.
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Tuesday, August 12, 2008
Japan: the land that inflation forgot
Burma's democratic revolution
The desire for freedom cannot be suppressed.Photo: AFP
Larry Jagan
THOUSANDS of people joined mass protests outside Burmese embassies throughout the world yesterday to commemorate the tragic events in Rangoon twenty years ago. Many international personalities, including actress Mia Farrow, joined them, all calling for the immediate release of the detained opposition leader Aung San Suu Kyi and a swift move towards democracy. Before leaving for Beijing to attend last night's opening ceremony for the Olympics, President Bush and his wife Laura added their support to the cause during their visit to Thailand.
"The spirit of 8.8.88 must never be allowed to die," said a leading spokesperson for the exiled opposition, Zin Linn, who participated in the mass pro-democracy demonstrations twenty years ago. Although there had been sporadic street protests and demonstrations for almost a year, the mass strike and rally called on August 8, 1988 marked a major turning point for the pro-democracy movement. The date was chosen because it was meant to be auspicious -- a reflection of the deep-rooted superstition that grips almost all Burmese.
Hundreds of thousands of students, civil servants and monks marched through Rangoon -- then the capital -- calling for democracy and an end to military rule. These protests grew, bringing Burma to a standstill for weeks and threatening to topple the country's one-party state. The universities had been shut several months earlier, after the initial student protests, and student leaders emerged to command the movement.
"We felt that there was no justice or freedom. So we decided we had to bring about an uprising that would end single-party rule," said one of these leaders, Aung Din -- now exiled in the US.
"We called for 'Democracy,' but none of us knew what it meant at the time," said another student activist, Aung Naing Oo -- now exiled in Thailand. "We had to look it up in the dictionary -- but we knew we wanted freedom and an end to military repression."
Six weeks after the start of the mass protests, on September 18, 1988, the army moved against the protesters, crushing the democratic movement. Thousands of students and activists died, as the military mercilessly crushed the protests. The foreign minister at the time, Ohn Gyaw, in an interview in Rangoon a few years after the events, insisted that only four people died, and that they were killed in the stampede, and not by soldiers' guns.
Most analysts suggest that some 3,000 people died in the military's mopping up operations, while many military officials openly admit -- albeit privately -- that at least 6,000 perished. In fact, a military intelligence officer close to the former intelligence chief, now under house arrest, told The Daily Star recently that General Kin Nyunt's own assessment was that more than 10,000 people were killed. "Many bodies were quietly cremated so that there was no evidence of the massacre," he said.
Since then, there seems to have been very little movement towards genuine political change. Many Burmese believed that, with twenty years of no progress, Burma is destined to remain under a military dictatorship for decades to come. "What is certain is that change will only come from within the country," said Aung Zaw, editor of the independent Burmese news website and magazine, Irrawaddy. "But more than that, I cannot predict."
Hopes of a new era were again raised last year, when the country's monks joined the street protests against the military regime, spawning a new movement dubbed the "Saffron Revolution." Again, the military's only course of action was to crush the movement with brutal force. The country's activists were jailed or forced underground.
But last year's events showed that things have changed in Burma over the last twenty years, even if much of it is intangible. For years, many local Burmese businessmen have described Burma as a social volcano ready to erupt -- all it needs is a spark, and that could come any time.
No one wants a repeat of the massive social upheaval that happened in the wake of the events of August twenty years ago. What most people don't understand is that the "people's movement" twenty years' ago came very close to toppling the military government.
"We were on the brink of giving into the protesters," the senior intelligence officer, Brigadier General Thein Swe -- now serving 197 years in prison for corruption and treason -- told a close confidante. "If the demonstrations had gone on for another two weeks, we would have been forced to give up and withdraw back to the barracks," he mused.
But the protesters gave up first -- leaving thousands dead -- and even more were forced to flee abroad. More than a quarter of a million Burmese have sought political refuge since the end of the student-led protests 20 years ago. The first batch took months to trudge through the jungles in Burma's border areas close to China, India and Thailand. They had to elude Burmese troops who would have killed them on sight, and suffered illness and disease on the way -- many were decimated by diarrhea, malaria, dengue fever and starvation.
Thousands have poignant personal stories of tragedy. Many left behind their parents and siblings; others left their own young offspring behind in the care of their grandparents, as they would not have survived the arduous journey to freedom. These young children have grown into adults without having known or seen their parents.
Although the "Saffron Revolution" cannot be compared too closely to the events twenty years ago, it did politicise a new generation of students -- all of whom are too young to remember 1988. They are likely to return to the streets as the root causes of last year's protests -- spiralling food and fuel prices have now been resolved. But one lesson of the last twenty years is that protests do not always produce political change.
"You can expect spontaneous demonstrations against the military -- but the problem is that you have to be organised," said Min Zin, a leading political activist who fled Burma more than a decade ago and is currently studying in the US. "My concern is whether it can lead to a genuine political change."
The junta now has forced the country to ratify a new constitution, which essentially institutionalises military rule, and promised a fresh election within the next two years. Burma's military rulers face a quandary, for they now have to garner the public's support as they seek to move from military to civilian government as outlined in the new constitution.
So the next two years will be uncertain as the regime prepares for these polls.
"It is in times of uncertainty that protest and change seem to happen in Burma," the independent Burmese academic at Chiang Mai University, Win Min, told The Daily Star. "The next two years are likely to be volatile -- with more protests, led by the monks and the students, are almost certain."
Larry Jagan contributes regularly to The Daily Star from Bangkok. He is a former Current Affairs Editor, Asia, BBC World Service, and covered the 1988 events in Burma.
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