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Economy in Brief

Japan's Trade Flows Wind Down... Will the BOJ Have to Respond?
by Robert Brusca  October 21, 2019

Japan's trade data showed a gain in both exports and imports in September, but both flows are contracting year-over-year. However, there is a lot of price weakness because of weak energy prices and in real terms year-on-year exports and imports still are expanding; but year-on-year imports are expanding faster than exports so there is still a net negative impact on growth from trade.

New reports revive old fears
New economic reports have surfaced today that are reviving some old fears about Japan's economy. The sector indexes and the all-sector activity index have been released. While the overall index is steady, there is clear and growing weakness in manufacturing and in construction. The services sector is holding up (tertiary sector), but Japan is challenged. The recent consumption tax hike was supposedly constructed in a fashion to not harm the fragile economy, but some things are easier to plan than to implement. A consumption tax naturally will give rise to 'leads and lags' (extra purchasing ahead of the tax hike and less purchasing immediately after it is imposed). So it may be hard at first to figure out if the encroaching weakness is real or just the same growth that has been rearranged around the time of the tax hike. The economy watchers index, that has an explicit future component, is decidedly and sharply weaker and is weakening. On that score, the future looks worse.

The global trade situation is a big fat negative
With that as background, it is no wonder that today's trade report with trend-exports weakening yet again is in the headlines. Taiwan also released data today showing weakening export orders; South Korean exports have been extremely weak as well. The U.S.-China trade war is creating the collateral damage everyone feared. At the same time, there is growing weakness in both the United States and China. China's housing data today showed less upward momentum in house price gains and a lesser breadth of house price increases across major cities. Japan clearly has an 'environmental' problem. The trade environment is much weaker than is Japan's own situation responsible for the problem. But a slowing economy is a problem whatever the cause and for the BOJ inflation lagging its target is also a problem.

'Environmental' concerns
But here again we run into an 'environmental' issue. The BOJ's ongoing inflation-miss does have to do with Japanese issues. The economy is slowing. A variety of indicators say so. Japan also has a shrinking population. Such demographic phenomena are expected to drag inflation lower. But inflation globally is low. Today Germany reported the first decline in its PPI in three years. In the U.S., inflation expectations are near all-time lows for the post war period. So once again Japan has a problem it shares with many other nations since neither the Fed in the U.S. nor the ECB are hitting their inflation targets and they both target a 2% pace the same as Japan.

Are risks snowballing?
Net exports, however, are dragging Japan's GDP growth lower. And weaker growth is not going to be the path to hitting the inflation target. Still, there are various risks here. There is the risk that this weakness will cause the inflation miss to get larger. There is the risk that continual missing of the inflation target will erode BOJ credibility. And there is the risk that apart from inflation growth itself will sour and that would set the stage for a far more difficult set of circumstances. That is a little bit like realizing that the time to act is before the large snowball begins to roll down the hill. Keeping it on top is less costly than trying to deal with it once it starts to roll downhill, gather more mass, and gain momentum. The problem is to assess if the snowball is really in danger of rolling. In this case, we can probably say 'yes.'

Would you take antibiotics if you had a virus?
Having laid out the problems and risks the question becomes, "does it make sense to use monetary policy to attack an issue that is in part demographics, in part due to an external trade war, in part due to the structure of the global economy and in part due to do Japan's own on past fiscal excesses that put fiscal solutions off limits?" And despite the 'snowball analogy' does it make sense to expend now whatever scarce monetary ammunition the BOJ has? And of course, all this occurs in the wake of government assessment of the economy that has recently been reduced.

Monetary decisions are independent… but then again they are not
The Bank of Japan will calibrate its policy on the back of what the Federal Reserve and the European Central Bank do. The ECB looks like it is done easing. Even Mario Draghi who will chair his last meeting has been warning of not overdoing stimulus (on his way out…). He is holding the door open for Christine Lagarde who has promised the Germans to look carefully into the issue of how stimulative negative rates have been. But in the U.S., there is still room to move (queue John Mayall). In the U.S., the Public comments of Fed officials are decidedly more neutral than they had been. Fed Chair Powell has been grappling more with balance sheet and Fed funds 'control' issues in his public statements. Those closest to the Chairman (Clarida and Williams) are simply saying policy will be made meeting by meeting. On that score, U.S. data are weaker, but the case for easing is still not winning over skeptics. The U.S. probably will cut rates again ahead of the BOJ meeting, but the ECB likely will hold pat with the stimulus that Draghi already has put in train. The real question is what does a central bank get from easing further? Everyone can't get the desired exchange rate outcome. Any cuts that lead to a stronger dollar will hear the 'tweet wrath' from Donald Trump. Having said all of that, the case for standing pat is not very compelling either. Some action or language to open the door soon seems more likely. The BOJ is in more of a hot spot that either the Fed or the ECB, especially with the recent economy downgrade.

Be careful what you wish for
So the stage is set for the next session of central bank meetings next week. Economic data are continuing to weaken, but monetary policy is already easy although not as easy as it may seem because of the low level of inflation and of inflation expectations. Maybe the solution is to overdo the easing even more to nudge inflation expectations higher? Maybe. But that is a dangerous game and central banks have tried so hard to get the upper hand on inflation. Now that they have that hand they don't seem to know how to play it. They are like the sports team that is so used to playing from behind that they don't know how to play with a lead.

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