Japan's Grim and Bear It 2009 Outlook

Things in Japan are looking grim and getting grimmer, and it doesn't seem they will be getting less grim anytime soon. To give you some idea of what this means, only this week we learned that Japan’s steel production fell 28 percent in December. This was the steepest decline in six decades. Meanwhile Hiroshi Yoshikawa, Tokyo University professor and head of the Japanese government business cycle measurement committee, said that Japan’s present recession may become the longest in the postwar era. “We’d better get ready for a three-year recession,” he said in an interview with the press this week. The decline “will be very severe, not only in terms of duration but also depth.”

And those famous exports, which dropped by an astonishing annual 35% in December, accounted for 61 percent of the growth in the last expansion, an expansion which was the longest in over 60 years. What this means, bluntly put, is that until exports recover, there isn't much likelihood of any more general economic recovery, and exports won't recover until global trade starts to expand again, and the bank and credit crisis is over, which means you can pretty much forget about 2009 as far as I can see.

Thus we are over to "do the best you can under the circumstances" mode, and to applying some sort of fiscal stimulus. And of course, Prime Minister Taro Aso has not been backhanded in coming forward in this regard (especially with elections looming at some point), and his second stimulus package has now been passed by the Lower House. But here comes the shocker - the package provides for an actual increase in deficit spending of a mere 1% of GDP - a drop in the bucket when you are talking about your worst recession since WWII. Even worse, the proposed fiscal 2009 budget - which begins on April 1 - provides no new stimulus. Newspaper reports, which mention an increase in spending of 6.5%, are misleading since they compare the proposed budget for fiscal 2009 with the initial budget for fiscal 2008. But the final budget for fiscal 2008 actually included two supplementary budgets, and the final readout ended up being a tad higher than what is currently proposed for 2009.

However even with spending staying flat (on the rather dubious assumption of no further packages), the Japanese government will still need to sell 33.3 trillion yen of new debt, the most in four years, since the economic contraction means there will be a revenue shortfall. The so-called primary budget deficit, the excess of spending over revenue excluding bond sales and interest payments, will balloon to 13.1 trillion yen from this year’s 5.2 trillion yen. And here we have Japan's dilemma, since something needs to be done to soften the blow of this recession, but with debt having been allowed to expand so rapidly over the last decade (see chart below), there really are limits on how much can responsibly be done.

click to enlarge
The most obvious problem is that increasing spending at a time when tax revenue is falling threatens the government’s goal of balancing the budget by 2011. But Aso has already indicated that the government shouldn’t prioritize fiscal discipline when the economy is ailing, and so far as it goes the argument is reasonable. This is a 'once in a lifetime' crisis (we hope) and so 'once in a lifetime measures' are in order. It's just that Japan has now been busily taking 'once in a lifetime measures' for over a decade, and we still don't seem to be getting anywhere. But we are ballooning government debt.

Many quibble with the widely quoted 2008 OECD debt-to-GDP number of 182%, since it is a figure for gross debt (which the OECD can easily justify for reasons that we don't need to get into here). But look at the green line above which shows net debt. This has also been rising and rising, and is now near to 100% of GDP on IMF data.

The point is we have just been through the longest expansion in over 60 years, and yet at no point did net debt-to-GDP start to fall. This is the real core of the problem that Japan faces in 2009, that previous fiscal policy did not attack the growing fiscal deficit in the good times, so there is little room to maneuver in the bad ones. Which is why Japan's economic outlook in 2009 is grim, grim and nothing but grim.

Comments

[Jim Hawthorne:]

A very succinct and to-the-point analysis, Edward. Thanks for posting it!

After about 20 years of pain, Japan finally took off and from May '03 through April '06 gave us some excellent returns. So much so that it almost came to be seen as scaled down 'safe-haven' compared to the rampaging China!

That aside, with 6 consecutive months of trade deficits, it is beginning to look like the only possible potential source of good news has dried up and Japan has backed itself into a corner. One wonders if there are any viable options!

Jan 27 01:53 PM

[Moon Kil Woong:]

Japan's deficit spending is nothing compared to the US. That is the reason why their currency remains so strong. Also, Japan is able to have domestic buyers for all it's debt and then enough to keep buying US treasuries. This is obviously not the case with the US deficit.

Their strong currency is destroying their ability to export or create artificial inflation. Poor Japan. They currently are a victim of fiscal prudence in a world gone mad with quantitative easing which they are 0% enthusiastic about having gone through a 20 year recession due to their own form of it.

You would think the Fed and Treasury would have learned from them before creating a Zirp policy without any solid planning. But then again, you would think we would have thought about our objectives before going into Iraq too. Or thought about how to spend $700 billion in TARP before asking for it. Or thought about how to catch Osama when we went into Afghanistan rather then cancelling the only operating unit who's soul duty was to find and capture him. I guess we should have expected Zirp policies without proper planning after all.

Jan 27 01:57 PM

[phaf:]

MIsery loves company; welcome to the 2009 worldwide weep-fest.

Jan 27 02:17 PM

[Chris B:]

Actually Japan has quite the long-term opportunity here.

-Because Japan's national debt is owned domestically for the most part, a good percentage of it will eventually be recovered as taxes and if they reduce deficits, the yen from expiring government bonds would flow back into the economy as domestic spending and investment. In other words, the Japanese people hold their own national debt, unlike Americans.

-Japan's superior public transit infrastructure and concentrated population centers make them the clear financial winners in a world of either (a) peak oil, or (b) wild swings in oil prices that devastate more oil-dependent economies like the US and even Europe.

-Japanese banks could emerge from the worldwide crisis as the only banks left solvent. This could allow them to acquire market share in the US and Europe and make Tokyo the new financial capital of the world. The long laughed-at yen could become the next international reserve currency in the event of capital flight from the US (If you think Japan is too small to be a global reserve currency and banking capital, explain how the British isles pulled it off in the 19th century.).

-World-class education, plus a manufacturing economy, the combination of which has always preceded the rise of great nations.

-Lower healthcare costs due to better diet, more exercise, and a more efficient healthcare system (than the US or UK for example) will mean that Japan suffers less economic damage from demographic graying than most people think.

-Japanese democracy should be more economically efficient in the long run than Chinese one-party psuedo-communism.

Jan 27 03:01 PM

[Trading to Win:]

Hi Edward,

I am really enjoying your excellent analysis.

I hope one day you can turn your analytical mind toward Britain. There is a raging debate going on, as to whether the country is heading for an IMF bailout.

I wonder if we are heading toward an 'event horizon' were our debts are too large to roll over and service.

Thank you

Jan 27 04:43 PM

[Bill Thompson:]

all of asia scares me right now, no spending, see here crashmarketstocks.com

Jan 27 09:24 PM

[Tradememe:]

Outlook grim indeed. But yen keeps getting stronger. I guess its huge forex reserve has something to do with it. The export crash will not last for ever. For if this happens, something worse is happening in the world economy.

Jan 28 12:26 AM

[Karim:]

Edward, despite the grimness Japan has been a very strong exporter and a successful business economy, and the Yen a fundamentally strong currency (even if that showed up only in the past year). Could you elaborate how the "grim outlook" (as you wrote it) would effectively affect the wellbeing of Japanese companies and the levels of the Japanese stock market? Thanks. Karim

Feb 10 11:44 AM