Japan’s Second Quarter Mirage

By Jeff Harding

Japan has the world’s second largest economy so we need to pay careful attention to what they are doing. The Q2 numbers just came out and real gross domestic product grew 0.9%, an annual pace of expansion of 3.7%. There are many commentators and economist already calling Japan’s recession at an end. However, I doubt that is the true situation.

Let me add a caveat here: I am not an expert on the Japanese economy. But I have been following Japan’s economy and economic history. I am also familiar with Japanese history and art if that means anything. If I make any mistakes in my assessment, I am sure that my readers in Japan will (I hope) correct me.

It appears to me that Japan is, has been, and will continue to try to boost their economy with the same failed Keynesian policies that were tried from the early 1990s to about 2004. Those policies not only failed to revive their economy, but burdened them with a very large national debt which continues to be a drag on their economy.

Japan has yet to fully recover from a stock and property market crash 20 years ago. The Nikkei is less than a third of its December 1989 peak, land prices have fallen in all but two years since 1992, and the country has suffered four recessions.

So why are they trying the same failed policies? It obviously has nothing to do with economic theory, but has everything to do with politics. There is an election on August 30 and the ruling LDP led by Prime Minister Taro Aso will probably lose. Aso’s government spent about $264 billion in fiscal stimulus to get the economy going again. The opposition DPJ promises to spend even more:

The DPJ promises to offer cash for childcare, abolish highway tolls and boost subsidies for farmers. Party lawmakers say they can fund the policies by scrapping wasteful projects, tapping reserves in government funds and reallocating budgets. The party has yet to specify how to contain the public debt, which has swollen to almost double the size of the economy.

The DPJ says rising interest rates will benefit savers. The growing public debt will cause interest rates to climb, perhaps more than they wish, so they are encouraging The Bank of Japan, its central bank, to buy the debt, thus monetizing the debt. I can’t believe anyone could seriously believe this since all it will do is burden businesses who wish to borrow to grow in order hire more workers. I guess it buys votes.

GDP rose for one reasons: government fiscal stimulus. First, exports, mostly to China jumped 6.6 percent. Where did that demand come from?  “China’s $585 billion stimulus package of new and already-planned spending and loosened bank lending has accelerated slowing growth, giving the region a boost.” Hong Kong said it had pulled out of its recession in Q2, and Singapore and South Korea reported improvements.

Second, it appears that internal growth was almost all due to Aso’s ¥25 trillion stimulus that boosted consumer spending by 0.8 percent. It was the first rise in three quarters, having fallen 1.2% in the previous quarter. Also government investment climbed 8.1 percent adding about 0.5% to GDP.

But once the stimulus money is spent, without underlying “real” economic growth, the stimulus effect will fade. This was the experience of Japan in the last cycle. As Seiji Shiraishi, chief economist at HSBC Securities Japan Ltd. in Tokyo said, “Once the fiscal stimulus fades, the underlying trend will emerge, which is basically weak income and weak consumption.” Japan’s politicians should heed Mr. Shiraishi’s advice.

So, what is the underlying trend as Mr. Shiraishi notes? Here are some clues:

Capital spending, which accounts for about 15 percent of the economy, fell 4.3 percent last quarter the fifth straight quarter of decline. “Companies are burdened with huge overcapacity in terms of equipment and people,” says Mr. Shiraishi. “It’s much worse than in previous recoveries.”

“Economists predict low production levels will drive the jobless rate to a record 5.9 percent next year from the current 5.4 percent. Japanese workers are also suffering unprecedented wage cuts that are likely to damp spending once the effect of the government’s stimulus package tapers off.” Companies such as Nikon Corp. and NEC Electronics Corp. are cutting costs and firing workers to stem losses.

Japan’s electricity generation declined for a 12th straight month in July, falling 11 percent from a year earlier, on lower demand from factories.

“Consumer prices plunged a record 1.7 percent in June and yesterday’s GDP report showed wages fell a record 4.7 percent from a year earlier.”

The deflation that took hold in the late 1990s had a devastating effect on household and business sentiment. And it never really ended. It took record price increases for food and energy over the past two years to produce a little inflation. Once they reversed, prices fell anew. Consumer prices plunged a record 1.7 percent in June. [Not all bad though.]

In my opinion, any pronouncement that Japan has emerged from the recession is incorrect and premature. In fact, based on Japan’s history with Keynesian economics, it appears that they will continue their two decade slump. China’s 7.9% growth (if you even believe their numbers) will also fade because consumer sentiment in the U.S. has changed, perhaps permanently. There are no drivers in the U.S. economy to spur spending (other than short-lived stimulus) as consumers reduce debt, struggle to keep jobs, increase savings, and try to save for retirement. That means China’s economy which depends on exports will need some serious readjustments. That does not bode well for Japan.