Japan’s GDP growth figures show the problems with a fiscal stimulus whilst Italy faces a heavier burden

Right at the beginning of today and indeed this week the land of the rising sun provided some economic news that did at least raise some cheer. After recent news we were in need of it I think. The news was that according to her Cabinet Office that the Japanese economy had grown by 1.5% in the third quarter of this year. Care is needed here as many places show these as an annualised number and report 6% growth! For Japan herself the image of a rising sun was indeed appropriate as a strong level of economic growth of 1.5% replaced the preceding -0.3,-0.7 and -0.7. So as you can see Japan had returned to recession in the spring under the definition of two quarters of economic contraction and you may note that this had happened pre-tsunami. Actually post-tsunami the situation had begun to improve.

Breaking the numbers down

One feature of these numbers was strong export growth as they expanded by 6.2% on the quarter and Japan also supported overseas producers as she imported an extra 3.4%. However some care is needed her as much of the import growth is likely to come from her post-tsunami construction efforts and include raw material as much as products. So as you can see net exports were a strong feature in the reported growth. If we look at private consumption we see that whilst it grew strongly the fastest rate of growth at a heady 21.7% annualised was private residential investment or post-tsunami reconstruction.

Some expected government consumption to contribute strongly in this quarter but in fact it fell overall as an increase in ordinary government expenditure was offset by a 2.8% fall in public investment and the total contribution was -0.1%. So in spite of us now having just received a third supplementary budget last week where a further 12.1 trillion Yen of extra spending  was promised which comes on top of the past 6 billion Yen we see that even 6 months later government stimulus measures are not helping much. If we go back to times when I was discussing fiscal policy and fiscal stimulus measures ( for example America’s Recovery Act) I made the same point. They take so long to work that by the time that they do the stimulus may be less appropriate or not appropriate at all. Often the image presented by politicians is of a tap which can be turned on at will when the reality is that it is quite some time before water flows from the tap.

The US Recovery Act is a test case

If we stick with the US Recovery Act it was passed on the 17th of February 2009 with an intended fiscal injection of US 787 billion dollars planned. As I type this only some 723 billion dollars has been spent ( and it is out of a revised target of 840 billion). So over 2 and a half years later only 92% of the original plan has been spent. One lesson is that tax cuts  appear to operate more quickly although care is needed here as the real effect comes from what happens next with the tax cut money! But I hope to leave you with the realisation that whilst discussion often surrounds the leads and lags of monetary policy there is much less discussion of the usually larger lags in fiscal policy.

Japan’s disinflation continues

A regular feature of Japanese economic life is disinflation or falling prices. One measure of this is provided by GDP economic growth numbers and it is called the implied deflator. Over the past year it has fallen by 1.9%. If we go back to the third quarter of last year then we now have a sequence of numbers for this indicator which have gone as follows, -2.3%,-1.7%,-1.9%,-2.2%,-1.9%. Considering that these are annualised numbers they are in fact remarkably consistent and as the Four Tops put it.

It’s the same old song

Please remember this fact when you read any article claiming that x ( the UK or US has been popular) is the new Japan! If they do not mention persistent falling prices then the analysis is flawed as in my view you cannot be Japan-like without it. As neither the US or UK has exhibited anything like it if you allow for the depth of the recession and the lack of a “normal” recovery then such articles are ill thought out.

Japan going forwards

Unfortunately the burst of sunshine for Japan looks unlikely to last. Even the numbers themselves are subject to possible considerable revision as Japan has had problems with such statistics and it remains to be seen if the new version is any better. However on the 28th of October I pointed out that the fourth quarter of 2011 had started badly.

Industrial Production in September decreased 4.0% from the previous month, showing a decrease for the first time in six months.  It showed a decrease of 4.0% from the previous year.

So whilst the fiscal stimulus should begin to have an impact as 2011 ends and 2012 begins we can see that there are real dangers that exports and production may slow. Even todays upwards revision to those industrial production figures to -3.3% does not change the fundamental picture. Also the flooding problems in Thailand have affected Japanese manufacturers who have based activities there looking for a cheaper labour supply so whilst modern manufacturing is undoubtedly efficient it also seems to be more vulnerable to natural disasters.

The Japanese Yen is strengthening again

Late on Friday I pointed out on twitter that the Yen was strengthening again and I hoped that someone was still on duty at the Bank of Japan in spite of it being into Saturday morning there! Since then the Yen has moved even higher as an exchange rate 0f 77.10 has been replaced by one of 76.90 versus the US dollar. So the intervention of October 31st looks as though it may be wearing off already.

The Price of Contagion in Italy

Rising bond yields have a definitive cost to a country when it issues new debt and we have had an example of this in Italy today already. She issued some 3 billion Euros of 5 year bonds at a yield of 6.29% which compares to a yield of 5.32% at the most recent similar auction leading to a interest-rate cost of 0.97%.

This gives us an actual cost of 29 million Euros a year for Italy over each of the next five years from the current crisis. Putting this another way if she was to issue all of her debt on such a basis the increase in debt costs would be approximately 18 billion Euros a year. Whilst this is only a rule of thumb and would take years to fully operate the way that Italy’s yield curve has shifted upwards it works quite well. Also comparing the numbers shows both the slow initial effect (29 million Euros) which could build to a very large total effect (18 billion Euros) if it persists. Welcome to the dangers of rising bond yields for an economy with large debts as it is like a snowball rolling slowly down a hill.

If we return to the subject of fiscal stimulus measures the arithmetic displayed above is one of the reasons why I am cautious about fiscal stimulus measures at this time. Should you operate one and then find your bond yield rising and factor in the fact that when they rise these days we have seen several examples now of them shooting upwards rather than just rising then you would be left in a losing postion which you can do little or nothing about and you will be exposed to the economic equivalent of the elements. The image here I think would be of King Lear on the blasted heath of Shakespearian imagery and imagination.

The intial impact of this Italian bond auction has been to reverse the rally in her government bonds that began late last week when her political situation began to stabilise a little. Her ten-year bond yield had dropped to 6.35% but has since edged higher to 6.43%.

Comparing Italy with the UK

I discussed the two economies earlier thsi year. But for today I merely wish to draw your attention to the fact that in terms of benchmark ten-year bond yields we had a situation last week that Italy’s exceeded the UK’s by some 5%! As Italy’s surged above 7% the UK’s dropped to 2.1%. As many will focus on Italy let me leave you today with a thought, it is quite possible and indeed probable that it is the UK’s government bond market that is the bigger aberration. I have described it as a “bubble” before and fans of  West Ham United can describe it whilst also supporting their team.

I’m forever blowing bubbles,
Pretty bubbles in the air,
They fly so high, nearly reach the sky,
Then like my dreams they fade and die.
This entry was posted in Economy, Euro zone Crisis, General Economics, Japan's Economic Situation, UK Inflation Prospects and Issues. Bookmark the permalink.
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  • Drf

    “As many will focus on Italy let me leave you today with a thought, it is
    quite possible and indeed probable that it is the UK’s government bond
    market that is the bigger aberration. I have described it as a “bubble”
    before and fans of  West Ham United can describe it whilst also
    supporting their team.”  So true, Shaun, so true! The wonder is that this bubble has not burst already?  I suppose it is all a matter of focus; the markets’ focus has been directed elsewhere so far, but as the searchlight pans the reality may eventually be exposed?  And then!

  • Bkester

    UK sovereigns may be floating in a bubble but Britain won’t default because the printing press is well supplied with ink and paper.  The risk of investing in British bonds is Sterling devaluation through QE – although buying TIPS provides a measure of protection.  The risk of buying Italian bonds is (a) actual default and (b) the currency itself blowing up. This remains true no matter how long the Italians are subjected to the Full Monti (pun intended).  Seen in that way, some people might think the 5% spread is actually quite conservative!

  • Vegetarian

    UK government bond yields are low mainly due to their attraction as a “risk off” asset but in addition yields are artificially subdued due to QE. I would think that if there are signs UK inflation was going to remain permanently high or worries started to emerge about the outbreak of hyper inflation then these bonds could see a sudden collapse much like they have in Italy over solvency concerns.

  • Anonymous

    TIPS is a US Treasury, maybe you mean Index linked Gilts. 

    Markets price political risk into bond yields, the markets appear to dislike the fight between Tremonti and Berlusconi. It causes political instability.  What risk is there of Cameron & Osborne defaulting on their banker pals ?

  • Sean Fernyhough

    Italian deposit growth has been very weak and deposit flight from Italian banks is likely to start shortly.  Meanwhile there is continued deposit flight from Irish, Greek and Spanish banks.  People have forgotten about the Irish.

  • Bkester

    Yes Expat, I meant index-linked gilts, you’re quite right.  However, even with the Berlusconi – Tremonti conflict pretty much out of the way, Italy’s bond auction today ended with a yield of about 6.29% on average.  Huge debts coupled with close-to-zero growth and no ‘national’ currency cannot possibly result in low yields.

  • Anonymous

    Italy needs a comprehensive program of reforms and a convincing plan to reduce borrowing / repay debt. Berlusconi exits and  last week’s 7.49 yield drops to 6.29 – this is a good start. It makes the Italian yield less EZ inflation over +3%.

    By comparison the Gilt 10 year yields 2% less 5% inflation. That’s worse than -3%, Gilts look overpriced.

    For inflation rated bonds (TIPS, Index Linked Gilts etc) you need to trust the relevant inflation index. shadowstats numbers suggest TIPS are best avoided.

  • Drf

     ”… if there are signs UK inflation was going to remain permanently high…” I suppose it depends what you mean by “high”! Using Kings mutilation of the English language as with “temporary”, in addition to his mutilation of the Pound, I suppose more than twice over target for some long while could be malapropistically be designated as “low”?

  • Vegetarian

    Its a sign of how benign inflation has been over the last 10-15 years that just over 5% is now considered high. Yes its bad when compared with the BOE’s target and also given that deposit rates are only, say 3%. However its not the 25% inflation level of the 1970s. My point was just that if the belief switches that 5% inflation or worse is the new norm then the bond rate (around 3% for longer term bonds) will not fly any more even for a “safe” asset.

  • Anonymous

    Hi Guys

    If you are looking for a comparison with todays Italian auction then the 5 year UK Gilt yield is 1.08%. So because the Italian yield curve is much flatter than ours the situation is even worse at that maturity as they were 5.21% over us at the auction and afterwards their yields rose.

  • Anonymous

    Hi Drf

    The lesson of recent times is that bond markets can be asleep for quite a time but when they move they seem to have a penchant for moving violently rather than adjusting logically over time. It is another form of the “expect the unexpected” era I think.

  • Anonymous

    Hi Sean

    The last time I looked it was Spain which was leading the race between it and Italy for lower money supply growth and fears of “deposit flight”.

    Of the countries which are operating “emergency liquidity assistance” at their central banks then it is Greece who showed the most deterioration with a 20 billion Euro surge to 41 billion Euros. I gather they are arguing that 15 billion of it is something else, so what  is it then is proper reply? You hardly lose that amount down the back of the sofa.

    Ireland does have an improving trend as its ELA fell back from 53.26 billion Euros to 47.73 billion in September but the total if you add all the ECB borrowing to it is still enormous for such a relatively small country.

    Looking at it the other way the situation at Unicredit hardly inspires confidence does it? And frankly I mean for shareholders as well as depositors.

  • Drf

     Hi Bkester, “UK sovereigns may be floating in a bubble but Britain won’t default
    because the printing press is well supplied with ink and paper.”  but isn’t debasement a form of default? After all the effect on value distribution is the same ultimately?