Japan: The mother of all miserable recoveries
Investors met the news that Japan’s economy has emerged from a bone-breaking recession calmly and rationally: they sold shares quickly and in large amounts and made bets that consumer prices are going to be falling for years to come.
That’s because Japan’s recovery, coming as it does after a global bubble in the production of what I call, for lack of a more technical term, “stuff,” is really not sustainable.
The fact that the consumer portion of the recovery is only a reflection of income transfers from government to individuals isn’t very encouraging either.
More importantly, given that hopes for Japan were low anyway, the vulnerability of its recovery point to some important challenges the nascent rebounds in the U.S. and Europe now face.
Japan grew at a 3.7 percent seasonally adjusted annual rate in the second quarter, in data reported on Monday, quite a contrast with the almost 12 percent annual rate of contraction in the three months before.
The recovery was heavily dependent on consumer spending, goosed by government subsidies for buying hybrid cars and green appliances, as well as a heavy public works spending.
Public spending in a downturn is a good thing, but it needs to set the stage for private investment and consumption later, and in Japan this does not seem to be happening.
“Japan’s return to growth in the second quarter is a prime example of a ‘feel bad’ recovery,” Lombard Street Research’s Michael Taylor told clients.
“Recovery may prove to be rather short-lived, as so far there are precious few signs that Japan is capable of sustained, domestically-driven GDP growth. The continued accumulation of inventories in Q2, albeit at a more modest pace than in recent quarters, also casts doubt on growth prospects through the second half of the year.”
The underlying figures were ugly. Private capital investment fell 4.4 percent compared to the first quarter, and real investment in housing fell by nearly a tenth. Cash earnings for Japanese workers has fallen 7.1 percent in the year to June.
The recovery in Japan is like a long lost and reputedly rich uncle who, now that he has come home, proves to be a poor bedraggled thing who rather than bringing hope and gifts only really wants to cadge a meal and a place to sleep.
WHY THIS TIME IS JUST NOT NORMAL
In a typical economic recovery, inventories, having been run down are rebuilt. This should prompt companies to make capital investments to gear up new production. People get hired, they spend money and so do others who are less fearful for their jobs. Companies become more profitable and the cycle reinforces itself.
But in Japan, and perhaps elsewhere, this recovery isn’t really working that way. Capital expenditure isn’t coming back. Company profits are being hit. Whatever profitability improvements we see globally are largely down to cost cutting.
This squeeze hurts already nervous workers who in their turn aren’t spending much money. Unless, of course, they need to in order to get their share of a government handout.
Even with inventories being restocked, the amount of spare capacity in the global economy is very substantial. Company managers too will have been taught a lesson about leveraging up to expand: not only is demand not always there sometimes the banks want their money back unexpectedly and usually at the most inconvenient time.
Consumers, and not just in Japan, aren’t very confident in the future of property and decide that what once looked like a prime investment now looks like avoidable consumption.
Policy makers in Japan and elsewhere understand these dynamics and they have made heroic efforts to break the cycle. Up to a point, they have succeeded.
It’s not so much that the policies – huge increases in liquidity and massive stimulus – aren’t appropriate but that our expectations for what they can do has been too high. We are no doubt better off than we would have been, but we have shifted the burden of re-making the economy and paying down the debt out in time. It will be a longer, slower process and will disappoint many investors who think we are back to the good old days.
One advantage Japan does have is its position in Asia, where it may be able to benefit if Chinese domestic demand takes off. But overall Japan is linked to global trade, which while it has bottomed, has made its recovery due to government spending which some day soon will have to be replaced.
As for Japan domestically, the fiscal stimulus will peter out in the first quarter of next year. What will arrive to take its place I cannot tell you, but if nothing does it will prove to have been a brief, miserable recovery.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )