Japan Stagnates - Again

Excerpt from John Makin's latest commentary:

Almost unnoticed amidst the credit-market turmoil in the housing-driven Anglo-Saxon economies was Japan's quiet slippage into ominous negative growth. Sharp downward revisions to second-quarter capital spending that appeared early in September resulted in a negative 1.2 percent annual growth rate for Japan's overall economy--somewhat shocking in view of the fact that the initial reports on the quarter had put the growth rate at above 2 percent.

Almost simultaneously, although not primarily driven by the weakness in the economy, Japanese prime minister Abe was forced to resign after a tenure of only twelve months. Meanwhile, Japan's deflation persisted with the core inflation rate (excluding food and energy) falling at a 0.5 percent year-over-year rate in July, marking a deceleration downward from the April drop of 0.2 percent. Against this negative economic background, Japan's stock market fell sharply, by more than 10 percent from July to mid-September, while Japan's currency appreciated as nervous carry trade investors brought money home to Japan. This remarkably negative set of economic and financial developments convinced the Bank of Japan, albeit reluctantly, to announce no increase in its official lending rate after its July 18 meeting.

While Japan's economy has not been highly dynamic, it has contributed to global growth with year-over-year GDP increases averaging about 2.5 percent over the last several quarters. Clearly, a slowdown in Japanese growth would be less than helpful in the global economic environment. As in much of Asia, Japan's growth depends almost entirely on continued strong growth of exports to China as the domestic economy is virtually stagnant due to a fiscal drag of about 1 percent and weak wage growth. The sharp drop in Japanese capital spending is an ominous sign regarding the perceived outlook for continued rapid growth of exports. Export volume to the United States has slowed sharply while exports to China have continued strong.