Alpha.Sources blog

Random Shots

2009-11-13T12:09:13Z

As I am preparing for a tournament this weekend in Sweden I only have time for some random shots, but then again; taking random shots seem to be exactly what the markets are all about at the moment. The first such random shot came from today's release of the GDP figures from Europe which showed, with much fanfare, how the Eurzone (and Europe) is now effectively out of recession.

(quote Bloomberg)

The euro-area economy emerged from its worst recession since World War II in the third quarter as exports from Germany and France helped compensate for households’ reluctance to increase spending Gross domestic product in the economy of the 16 nations using the euro rose 0.4 percent from the second quarter, when it fell 0.2 percent, the European Union’s statistics office in Luxembourg said today. Economists had forecast the economy to grow 0.5 percent, according to the median of 34 estimates in a Bloomberg survey.

Europe’s economy is gathering strength after governments stepped up stimulus measures and the European Central Bank injected billions of euros into markets to encourage lending. While confidence in the economic outlook is at a 13-month high, rising unemployment, the expiration of stimulus plans and a surging euro are threatening to undermine a recovery. “The euro-zone economy has officially turned the corner and that is cause for relief, but not celebration,” said Martin van Vliet, a senior economist at ING Bank in Amsterdam. “The economy remains in a fragile state and is recovering mainly because of government stimulus and temporary inventory effects.”

Now, before we get ahead of ourselves, the comments by Mr. van Vliet should, as I would assume the comments from any other proper economist, alert us to the fact the current impressive figure, while not a figment of imagination, is indeed driven by decidedly imaginative factors in so far as goes the idea of a sustained recovery. In this way, one off government spending which, by nature, cannot be sustained indefinitely as well as a less severe bout of inventory reduction by part of companies (which may of course be a forward looking indicator) do not in themselves make a recovery.

Add to this that behind the headline figure for EU16 and EU27 of 0.4% and 0.2% GDP growth qoq respectively lies a decidedly murkier picture. Consequently, Greece and the UK continued to spend the third quarter in recession (-0.3 and -0.4 qoq respectively) and then we have poor Spain of course where the horror show of a recession continues without showing any signs (-0.3 qoq), whatsoever, of abating. It is noteworhty in this respect to consider the stark contrast between the European economies in the context of the latest aggregate confidence reading conducted by Bloomberg;

Bloomberg users in Spain remained the most pessimistic in Europe as that nation stayed mired in recession, with unemployment soaring toward 20 percent and the economy struggling to recover from a construction-industry collapse. The Spain confidence index was 17.7 this month from 10 in October.

So, the divergences are growing inside Europe and already they must be hard at work in Frankfurt to try to knit to together a strategy to suit all the individual economies of the Eurozone. The point is of course that they can't and it will indeed be interesting to see how they manage this particular challenge in the future. Before we get to that though and, one would assume, any talk of lifting nominal interest rates from their current low levels we need to get over the hurdle of when and how to pull back "extraordinary measures" of monetary policy.

And here, this is not only about the ECB.

Consequently, and with the small exception of the BOE where Mervyn King recently left it an open question of whether the BOE would buy additional gilts, the three major central banks have all upped their discourse on the winding down of asset purchases in the context of the Fed and BOJ and "enhanced credit support" in relation to the ECB.

In Frankfurt and elsewhere, the outlook on these exit strategies remain opaque except to say that with the continuing emphasis by part of central banks most market commentators expect these measures to be withdrawn some time in Q1-Q2 2010 with the notable exception that the ECB seems to have indicated that the liquidity offering (12 month) coming in December will be the last.

Without going too much into detail [1] it appears to me that central bankers may end up in trouble on account of those exit strategies and how to instigate them into a 2010 "post stimulus" slowdown. This is not so much because I cannot see the impetus to exit in itself, but rather because if now is not the time to exit, how can you argue in the first half of 2010 that it is?

Surely, on this account I would give them an A+ in so far as goes the attempt to prepare markets, but I am more uncertain as to which they will also be able to actually deliver the exit strategy to the tune of the same grade. We will see I guess; for now, I hope that they are not taking, what will turn out to be, random shots at volatile asset prices and premature signs of non-materialising recoveries.

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[1] This will have to wait for another time.

The IMF on Asia's Recovery and its Sustainability

2009-11-09T05:13:00Z

Update 2: Mr Singh has left a comment below in response to my piece. Go check it out.

Update: Mr. Singh posts the third and, as far as I know, last installment in the series on Asia's outlook written on the basis of the Regional Economic Outlook for the Asian and Pacific Region. The topic is perhaps the most interesting of all aspects of Asia's aggregate economy, the high prevalence of savings and its excess over investment which produces a corresponding external surplus which, I'd might add, is structural at this point. See below for more comments.

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In case you had not noticed, the IMF is blogging and it is not "merely" the garden variety IMF staffers they are rolling out to fill the pages; nope here we are treated to the likes of Blanchard, Atkinson, Lipsky, Cottarelli and a host of other of the Fund's A-listers. Consequently, it would seem that in an already (over)crowded world of econblogging, the IMFdirect blog merits more than a little bit attention.

In the past week, the dual post coverage by Mr. Anoop Singh of the recent Regional Economic Outlook for the Asian and Pacific Region caught my attention in particular. In the first, Mr. Singh invokes among other things the puzzle of Asia's relatively sharp recovery given the notion that the region is largely dependent on exports to grow. Two reasons especially are important here. One is the simple fact that as these economies moved into the crisis with bulging coffers (especially on the reserves vis-a-vis the rest of the world), the room for fiscal manoeuvre was greater and it was used decisively. According to calculations by the IMF, the collective stimulus programs in the Asia-Pacific region added 1.75% to GDP growth in the first half of 2009 and it makes the programs even more generous than those observed in the OECD and other emerging markets. Secondly, Asian economies has benefited from the, so far, V-shaped comeback by part of the global economy and key regions who are likely to grow smartly in h02-2009.

In general, Mr. Singh's analysis appears cautiously tied to the great unknown of 2010 where it appears that we will see whether all those battered economies of the world will be able to hold their own in a world where quantitative easing from central banks and lax fiscal policies are withdrawn rather than enacted. Here, Singh's remarks echo the general discourse where the the underlying tone is one of skepticism. A long period of risky asset buoyancy coupled with upbeat economic data releases have proved before to be crying wolf of an impending recovery and policy makers are advised to take this into account.

It is hard for me to disagree with Mr. Singh that the green shoots observed in the Spring of 2009 seem way too shaky a foundation on which to build a narrative of recovery. Yet, this is exactly what has happened and the famous inflection point will be reached when we discover that the recovery observed thus has been because of and not despite monetary and fiscal stimulus which makes the enforcement of exit strategies going into 2010 a very interesting experiment in the making. Some will make it, some won't and some will inevitably fall back into recession (not just in Asia).

However, the most important part of Singh's argument and indeed the most important part of IMF's analysis in general is the question of whether Asia's economic trajectory, in a post stimulus/recovery context, will be driven by domestic demand or not? To put it in the most reductionist form. Will Asia be a provider of net capacity to the global or economy or not? If yes, it would mean that a post crisis Asia had truly emerged as something new in the form of a force of a real addition to total demand. If not, it would mean that Asia would revert to old tricks and habits of relying on exports and foreign asset income to propel growth in national income.

Now, leaving the question of the number of export dependent economies the world economy can muster neatly to the side, I am not so optimistic here on Asia's contribution to the rebalancing of global imbalances through a net expansion of domestic demand. Yet, let me also immediately qualify here that I am not very comfortable with talking about Asia/Pacific in one both because of the obvious heterogeneity amongst the economies, but more importantly; also because I am not really an expert here. I have done the analysis on Japan though and on this I can say with unequivocal certainty that we won't we seeing any provision of excess domestic demand from this side.

Ultimately of course, Japan is of little real importance here and so is the rest of Asia really. What really matters on this topic is China and all the hopes currently pinned on her shoulders in the form of the ability of the economy to pull the global economy out of the mire. Traditionally, this has boiled down to a rather technical discussion about the RMB and an almost perennial Becketian wait for the shackles to break and an appreciating RMB to solve all problems. While I concede that the RMB should rise, it won't solve any of the underlying problems inherent in China's investment driven economy. Basically, chalk it down to culture and institutional specificity in the origin, but the simple fact remains I believe that just as China may evolve to become the economy we all hope and believe her to become (say in a 2020 context) the one child policy will have done its work so to speak and China will be sporting an OECD like age structure and is likely to even surpass many of OECD's economies.

This is no recipe for an axis of rebalancing and although China will be the main story to follow for the immediate future I think we should look elsewhere to find the potential rebalancing candidates. This may indeed involve other parts of Asia (India for instance and Indonesia), but in the current discourse the likes of China, Japan (and Korea) hold little promise in terms of providing a decisive engine for rebalancing through sustainable growth in domestic demand which exceed the investment rate.

In this sense I remain cautious on the overall sustainability of the recovery in Asia mainly because of my skepticism towards the sustainability of overall global momentum where I acknowledge that I may be very wrong. Watch out for 2010 and all those exit strategies is what I say and particularly for the "post fiscal stimulus" world. This also means that I am more than a little bit skeptical on the prospects of a sustained recovery across Asia driven by domestic demand, especially in relation to Japan and China.

At least, this would be my humble argument here a murky Monday morning in Copenhagen. In any case, you might want to punch the IMFdirect blog into your RSS reader, just to make sure that you know what the IMF is up on a daily "research" basis.

Too Much of a Good Thing in Australia?

2009-11-05T12:51:00Z

(click on pictures for better viewing)

It is indeed an old adage that while goods things are to be preferred over bad things it is possible to get too much of the former. Looking at recent comments from the governor of the Reserve Bank of Australia it is not difficult to imagine how these, albeit old and worn, pearls of wisdom may well have inspired Mr. Stevens in his effort to tiptoe the thigthrope between signalling the intention to raise rates into an expected economic recovery on the one side and trying to prevent the Aussie shoot of on helium into the sun with wings of wax on the other.

(quote Bloomberg)

Australia’s central bank Governor Glenn Stevens signaled a surge in the nation’s currency to near parity with the U.S. dollar has given him scope to slow the pace of future interest-rate increases.

Stevens, who yesterday became the first central banker in the world to raise borrowing costs twice in 2009, said the 28 percent gain in the currency this year may hurt exports and cool inflation, allowing him to “gradually” raise borrowing costs. Just last month, he warned it may be “imprudent” to keep rates at “emergency levels.” The local currency and bond yields fell as traders slashed bets on another quarter-point boost next month, after Stevens raised the overnight cash rate target to 3.5 percent from 3.25 percent. Investors have been driving the Australian dollar toward parity with the greenback, betting China’s economic growth will boost exports from Australia, the biggest shipper of iron ore used in making steel.

Policy makers “are probably glad for the parity talk as it reduces the amount of work they need to do with monetary policy,” said Matthew Johnson, an interest-rate strategist at UBS AG in Sydney. “A December move is a 50-50 proposition.” Traders are betting there is a 50 percent chance Stevens will increase the key rate by another quarter point on Dec. 1, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange at 12:22 p.m. today. Prior to Stevens’s comments, they had a 96 percent bet on such a gain.

Mr. Stevens' comments follows in the heels of the recent push by part of the Aussie towards parity with the US dollar reflected primarily in the fact that the RBA has already raised twice in 2009 (from 3.00 to 3.5%) as well as a growing risk sentiment which is a fundamental prerequistie, in the current market, for observing investors react to (growing) yield differences. In so many words, this is all about carry trade and more specifically about the fact that in a world where the G3 and others are still fiddling with quasi- or outright QE it takes a brave sould to initiate a hiking process since it will mean an immediate reaction in the currency market. This is especially the case when the liquidity anchor effectively constitutes the US and thus; while the US pump priming keeps a floor under risky assets and volatility at low levels it becomes a veritable turkey shoot to gun for those currencies whose central banks are on the hike (see more here).

Following Mr. Stevens' comments, the Aussie did lose a bit of its steam even if many currency punters still see it racing towards parity over the course of the coming year.

For example David Forrester who is currency economist at Barclays Capital expects the Aussie to test the parity level in 2010, a call based on the idea that the RBA will have hiked rates to a full 5.5% by the end of next year. Needless to say, in a world where risky assets continue to fly and risk aversion is kept in check this will provide a juicy interest rate differential vis-a-vis the G3 and thus the carry trade flows (be they actual carry trades or simply spot market piggy backing) will be plentiful.

The question is of course; can you blame the RBA for wanting to raise rates?

As it turns out, not really and particularly not in light of global central banks' new found focus on asset prices in setting the policy rate. You know, it was all Greenspan's fault and all that jazz. Still, for those worried about a too rapid V-shaped recovery, Australian house prices seem to offer plenty of things to worry about.

From Q3-08 to Q1-09 the house price index (weighted for the 8 biggest cities) fell a modest 5.6%, a drop which has been decisively paired in Q2/Q3-09 with the index rising a cumulative 8%. This picture is repeated if we look at a general gauge for consumer spending in the form of a sector break down of retail sales.

Consequently, the annual as well as monthly flow of retail trade turnover never really went decisively into negative in the context of the financial crisis which has no doubt contributed to the fact that the RBA never really contemplated a move into ZIRP and QE.

What happens next then?

Well as I noted recently, the burden of rebalancing may be tough to carry for those economies who have central banks brave enough to raise interest rates. Ironically of course and if it is really asset prices you are worried about, the risk is naturally that you just end up sucking in liquidity as you which in itself defeats the purpose of the hiking campaign (see Edward's recent piece on Norway for a Scandinavian perspective on this). Naturally, you can retort to Brazil like capital controls, but in a world where capital flows freely and where the global economies are largely interdependent, this is like trying to stop a freight train with a VW Polo. Also, allow me to finish with a small quibble of mine in relation to the sudden urge by part of central bankers to target asset prices. I mean, this is fine and all and for those who know a little bit about monetary policy this is not something completely new. The problem is merely that targeting asset prices may not only be counterproductive in a world where asymmetric liquidity conditions and carry flows are the norm, by targeting asset prices also entail targeting a price which is considerable more volatile than traditional prices (because I assume that forecasting long term asset prices is not as easy as many believe). In this way, a steady gaze at asset prices may also conflict with central banks' general propensity to favor incremental and gradual moves.

Whether this is the case in Australia, only time will tell. Yet, from the lovely fjords of Oslo, to the beaches of Rio, and on to the Great Barrier Reef policy makers may soon learn that you can indeed get too much of a good thing.

Japanes Companies, Exports and the Current Account

2009-11-02T16:54:00Z

(click on pictures for better viewing)

Last week, we learned that industrial production rose yet again in Japan clocking in at 1.4% month-on-month in September after having increased by 1.6% in August.

Companies said they planned to increase production in October and November as well, indicating the recovery from a record export collapse in the first quarter is holding up. Growth in China is generating sales for manufacturers including Hitachi Construction Machinery Co., which this week said it has worked off stockpiles that piled up during the recession.

“The pace of the recovery is faster than expected,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co. in Tokyo. Withdrawal of stimulus in the U.S. and Europe may cause output and exports to slow down this quarter, Miyazaki said, “but so far, today’s production report showed few signs of that.”

This is good news for Japan's economy even if it seems that Japan may simply be re-deploying old tricks in which companies are leveraging external demand but the domestic economy remains unable to pick up on the momentum. As ever, the disconnect between the level and flow of domestic activity (and price pressure) created by the domestic economy and the additional boost from external demand and asset income remains one the main perspective through which to look at the Japanese economy.

Within this context, the notion of Japan being dependent on exports to grow has emerged; initially as a strong market discourse and since in a more formal theoretical light in the form of the humble contribution of yours truly. It still represents a powerful market discourse and in fact, the idea of export dependency or reliance on external demand has been propelled to the main scene of the current economic turmoil as it has slowly but surely dawned on market participants and policy makers that the extent to which global imbalances need to be resolved, we have to find someone to run the deficits. And although this may seem a simple task, it has proved decidedly difficult to make the puzzles match in a world where deleveraging remains a key driving force on both the microeconomic and macroeconomic level.

In this entry I thought it would be interesting to look at a topic which combines the two perspectives above, that is; both the theoretical and the more market oriented narrative. On the former, this analysis would seek to move the analytical perspective down a notch from the pure macroeconomic level to a microeconomic level linking data on the company level (company accounts) with macroeconomic data (national accounts). On the latter, the analysis would provide some empirical foundation for the often cited relationship between a positive reading on industrial production/capex and a pick up in external demand, or more precisely the link between corporate activity and exports.

The analysis will be based on data from the Japanese trade ministry (METI) and OECD and will cover the period 1960Q1-2008Q4 (mail me for the excel sheet). On the company side, I will use data on sales (topline) and as well as profits (operating and ordinary). I will also distinguish between the manufacturing and non-manufacturing sector since one might expect, in Japan's case, the accounts of the former to be considerably more sensitive to external demand than in the case of the latter. With respect to national accounts I am using the OECD CARSA methodology which essentially signifies that we have current prices at annual levels with seasonal adjustment.

In line with the spin traditionally served here at Alpha.Sources, I will be looking at an increase in the connection between corporate sales and profits and external demand as an implicit function of age. This is to say, that this disconnect between domestic momentum and the ability of Japanese companies to generate revenues and thus growth based on external demand is a function of the increase in Japan's median age.

The main results of the analysis can be summarized in the following points.

The positive relationship between the change in Japanese companies' profits/topline and the change in exports or the current account has increased markedly in a post 1990 and specifically post 1998-2000 context. This effect is predominantly a phenomenon observed amongst manufacturing companies.

The empirical analysis suggest that Japanese manufacturing companies are now highly reliant on external demand to generate sales, profits and thus in some sense investment activity.

The sensitivity of the sales of manufacturers to the volume of exports has increased by a factor of 60% from 0.25% to 0.4% around the period where Japan breaches a median age of 40 years.

The sensitivity of the ordinary profits of manufacturers to the current account has equally increased markedly in the period where Japan has moved to a median age above 40. In the period after 1997 results indicates that a 1 unit (JPY) increase in the change of the current account has led to a 0.23 unit (JPY) increase in the ordinary profits of Japanese manufacturers which compares with a corresponding non-significant relationship in a pre 1998 context.

A Look at Company Performance, the Current Account and Correlation

Regardless of whether one squares the outlook on the Japanese economy, there is no doubt that the dent which the corporates have taken as a result of the economic turmoil is unprecedented.

Notice that I have indexed the charts with 1995 as a base year and then realize that current nominal value of company revenues has dropped to a level comparative to the one observed in 1993-1994 in relative terms. In absolute terms, the aggregate value of sales of Japanese manufacturers stood at some tn 84 and 82 JPY in Q1-09 and Q2-09 respectively which is value not observed since 1989 in nominal terms. This should give us a clear picture of drop in activity and then also the difficulty with which Japan will have in restoring productive activities back to normal whatever this might mean as we move forward.

With respect to Japan's external balance it is a bit more complicated, but there are some important points to remember as we move through the charts. Japan has been running an external surplus since the beginning of the 1980s, but as I have spent an entire academic paper explaining, it is only in the latter part of the 1990s and into the 2000s that this external surplus seems to be connected strongly with output growth. Moreover, it is important to distinguish between net exports and the income balance since the latter has been particularly important driving Japan's external balance in a from the 1990s and onwards

In light of the graph above, we can say that given the sharp decline in domestic growth in a post 1990 context external demand has take over, so to speak, both in terms of keeping national savings higher as well as contributing to headline growth. It is along the same axis that we would then expect the relationship between Japanese companies and external demand to have increased.

Moving on to some simple correlation analysis the following two charts which show the correlation between company sales and exports as well as the trade surplus/GDP will give us a nice initial overview of the data in question.

The representation is in changes (which is not unimportant) and smoothed by taking the correlation as a 4 year moving average (i.e. 16 quarters). The y-axis is ending period which means that a correlation for e.g. 1997 means correlation between 1993-1997.

Simply eye balling these charts does not seem to provide decisive evidence of the hypothesis of export dependency. Sure, we can easily see that the period 1997-2008 has seen a sharp increase in the relationship between company sales and the flow of exports as well as the share of external demand and GDP, but the key point to take away from these graphs is that they appear to be mean reverting (with a very weak positive time trend in the case of the second). This would mean then that the connection currently observed between exports and corporate sales is not unique. However, if we focus the attention on the second graph, it is also pretty clear that it is only in a post 1980 context that we have observed periods in which the correlation between sales and the trade surplus has been consistently and strongly positive. This would then seem to lend some evidence to the idea of export dependency and how this may be a distinct characteristic of contemporary Japan.

Moreover it would seem that it is not possible (except in the case of the correlation between sales and the trade surplus) to distinguish decisively between manufacturing and non-manufacturing. In later sections and using simple ordinary least squares analysis, it is however possible to differentiate this statement considerably.

Before we come to that though, it would be apt to use the initial conclusion above and have a closer look at the post 1980 period. Moreover, and courtesy of a more richer dataset on the macroeconomic level we can now augment the analysis with the income balance and thus the current account. This may seem trivial, but is very important in Japan's case since the income balance in particular has driven the external balance in recent years. From a company point of view and in order to be consistent, I will correct for the importance of the income balance by including company profits as the main gauge for company performance.

This chart (in level form and only for manufacturers) seems to be more supportive of the evidence of export dependency at least if we allow ourself the luxury to look only at the period from 1980s. The chart shows however that the strong positive relationship between the current account and the profits of companies is a relatively recent phenomenon which took off somewhere around 2000. Consequently, in the period from 1983 to 2000 the correlation between the current account and company profits in the manufacturing sector has been negative and in some cases strongly negative.

From this brief look at correlations, we should be satisfied that when it comes to the period post 1998 (more or less) the performance of Japanese companies have been strongly linked to external demand and income derived from external assets. Yet, this does not provides decisive evidence for export dependency measured as a strong and growing link between the performance of companies and external demand. In order to show this we must turn our attention to a bit more sophisticated statistical techniques although I can promise you that it won't be very fancy.

Some Models to Go With That?

The analysis which proceeds will center on the two following simple models which take the first difference or percentage change as a linear function of the change in either the value of exports or the current account.

The first regression will also be run with the sales of non-manufacturers as dependent variable in order to check the initial conclusion above that it is really not possible to distinguish between manufacturers and non-manufacturers[1].

Now, if you don't care about statistical analysis, you may stop here and move straight to the conclusion or go back to the summary in the beginning where the main results are reported. If you decide however to move on, rest assured that, following the models above, I never move beyond univariate OLS, so things should not get too complicated if you are a little bit familiar with statistical analysis.

Note that throughout the results presented below, the full period will be Q1 1960 to Q4 2008, period 1 signifies the period where Japan had a median age below 40 and period 2 is consequently defined as the period in which Japan had a median age above 40.

If we begin with the first model that plots sales of manufacturers as a linear function of the volume in exports (both in % changes), the results for the full period, period 1, and period 2 regressions return the following results [2].

For those of you who are familiar with the results presented in my earlier work on Japan, these results should be well known. In this way, it appears that the relationship between the sales of manufacturers and the volume of exports has increased markedly, both in terms of the marginal effect as well as in the context of the overall fit of the model. Since this model is a log-log model, we can interpret the coefficient in percentages and in this way, the estimation indicate that the sensitivity of the sales of manufacturers to the volume of exports has increased by a factor of 60% from 0.25% to 0.4%. In words, it means that in the second period the estimation suggests that a 1% increase in exports will lead to a 0.4% increase in the sales of manufacturers whereas the corresponding number is 0.25% in period 1.

Looking at the overall fit of the relationship, the results clearly indicate that this representation leaves out a considerable source of the variation in the sales of manufacturers which is entirely to be expected. As always, it is essentially a qualitative and theoretical question whether the increase in the sensitivity as well as the goodness of fit (from 0.08 to 0.13) represents de-facto export dependency or simply indicates an increased reliance over and above other more important factors.

In relation to the second model which plots operating profits as a linear function of the change in the current account, it is important to note that this model is estimated in the first difference (and thus not log-log) because the current account in some cases has been negative. Moreover, the sample period is shorter than for the first model (1980-2008) since OECD does not have data for the income balance prior to 1980.

On an overall basis these results underpin those from the first estimation although they seem to confirm the hypothesis to a much higher degree. Abstracting from the full period result which serves as an anchor for the overall significance of the relationship, the difference between the model estimated for period 1 and period 2 is striking. Consequently, the first period estimation signifying the period where the median age of Japan is below 40 shows no significant relationship whatsoever, in this sense it appears that the apparent negative relationship implied above from the correlation charts do not pass the simple causality test which OLS represents. The second period regression on the other hand returns a strong and significant relationship which indicates that a 1 unit (JPY) increase in the change of the current account will lead to a 0.23 unit (JPY) increase in the ordinary profits of Japanese manufacturers. On the goodness of fit measure the only thing we can say is that it has increased considerably to signify the increase in relationship between the profits of manufacturers and the current account. However, whether a goodness of fit of 0.15 is high in an absolute sense here is difficult to say without a more thorough and comparative study. But since we have a univariate framework, I believe this result to be quite extraordinary.

Conclusion

I hope by now that I will have either convinced you or scared you off in terms of the importance of whether Japan is dependent on exports to grow or not. I would also hope that the connection to events closer to the market is not too difficult to see. For example, Bloomberg is running the story today that the BOJ, like most other central banks, is either willingly or, dragged kicking and screaming by market sentiment, moving towards the formulation and near execution of the famed exit strategy from extraordinary monetary policy measures. Clearly, interest rates are to remain low for as far as the eye can see, but it is interesting to ponder whether the decision by the BOJ scale back corporate debt purchases is related to optimism on the companies ability to leverage domestic growth or whether it is because they see export markets reving back up in which case it would be back to the same old growth strategy. Another example would be the latest inflation reading which suggests, more than anything, the extent to which the domestic economy in Japan is not able to provide an environment in which companies can operate profitably as well as it indicates how overall domestic momentum is essentially contractory.

It is within this general economic context that the notion of export dependency becomes important and specifically how this might relate to the ageing of Japan's population. In this entry I have tried to take this idea down a notch from the strict macroeconomic level in the form of an analysis of the relationship between external demand measured through national accounts and aggregate corporate accounts. The results, I believe, speak for themselves and strongly suggest I think that Japan indeed is becoming increasingly dependent on external demand to create the growth and income the economy needs to maintain economic growth. Following from this, a number of questions present themselves, not least the most crucial general question relating the issue of export dependency to ageing in a general sense and then on to the discourse on global macroeconomic imbalances. But for now, I will let you digest the data at described and analysed above.

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[1] - Results of this regression is not formally reported in the text; please mail me if you want my excel sheet and results.

[2] - In order to be really rigorous I would have to formally test for the difference between the two periods (e.g. through a Chow Test or related method), but here it will suffice to look at the change over the period without putting a label of statistical significance on it.

Are Americans Becoming Less Nomadic?

2009-10-25T17:53:35Z

As a puny yet honest attempt to show you that I actually read other things than plain economics I thought that I would share this piece with you on declining nomadism amongst Americans; it is written for Newsweek by author Joel Kotkin. I am not quite sure whether he believes the ageing of the population to be the decisive factor contributing to the rise of localism which he speaks about or just a factor among many. I would presume that sociologists and historians could find an explanation for this development in their distinct theoretical tool kits too without invoking the demographic evolution. Although, it is tempting to go for a nostalgic narrative here I don't think this is appropriate. To me, an increase in physical localism could go well hand in hand with an ever greater degree of global integration and social mobility in the non-physical sense.

On almost any night of the week, Churchill's Restaurant is hopping. The 10-year-old hot spot in Rockville Centre, Long Island, is packed with locals drinking beer and eating burgers, with some customers spilling over onto the street. "We have lots of regulars—people who are recognized when they come in," says co-owner Kevin Culhane. In fact, regulars make up more than 80 percent of the restaurant's customers. "People feel comfortable and safe here," Culhane says. "This is their place."

Thriving neighborhood restaurants are one small data point in a larger trend I call the new localism. The basic premise: the longer people stay in their homes and communities, the more they identify with those places, and the greater their commitment to helping local businesses and institutions thrive, even in a downturn. Several factors are driving this process, including an aging population, suburbanization, the Internet, and an increased focus on family life. And even as the recession has begun to yield to recovery, our commitment to our local roots is only going to grow more profound. Evident before the recession, the new localism will shape how we live and work in the coming decades, and may even influence the course of our future politics.

Perhaps nothing will be as surprising about 21st-century America as its settledness. For more than a generation Americans have believed that "spatial mobility" would increase, and, as it did, feed an inexorable trend toward rootlessness and anomie. This vision of social disintegration was perhaps best epitomized in Vance Packard's 1972 bestseller A Nation of Strangers, with its vision of America becoming "a society coming apart at the seams." In 2000, Harvard's Robert Putnam made a similar point, albeit less hyperbolically, in Bowling Alone, in which he wrote about the "civic malaise" he saw gripping the country. In Putnam's view, society was being undermined, largely due to suburbanization and what he called "the growth of mobility."

Yet in reality Americans actually are becoming less nomadic. As recently as the 1970s as many as one in five people moved annually; by 2006, long before the current recession took hold, that number was 14 percent, the lowest rate since the census starting following movement in 1940. Since then tougher times have accelerated these trends, in large part because opportunities to sell houses and find new employment have dried up. In 2008, the total number of people changing residences was less than those who did so in 1962, when the country had 120 million fewer people. The stay-at-home trend appears particularly strong among aging boomers, who are largely eschewing Sunbelt retirement condos to stay tethered to their suburban homes—close to family, friends, clubs, churches, and familiar surroundings.

(...)

After decades of frantic mobility and homogenization, we are seeing a return to placeness, along with more choices for individuals, families, and communities. For entrepreneurs like Kevin Culhane and his workers at Churchill's, it's a phenomenon that may also offer a lease on years of new profits. "We're holding our own in these times because we appeal to the people around here," Culhane says. And as places like Long Island become less bedroom community and more round-the-clock locale for work and play, he's likely to have plenty of hungry customers.

Well worth a read and a closer reflection.

Whoops, No Recovery in the UK It Seems ...

2009-10-23T09:05:03Z

... at least not yet that is. Let us see how the rest in Europe will fair.

(From Bloomberg)

U.K. gross domestic product unexpectedly dropped in the third quarter as enduring slumps in services, manufacturing and construction kept the economy mired in its longest recession on record.

Gross domestic product dropped 0.4 percent from the previous three months, the Office for National Statistics said today in London. Economists predicted a 0.2 percent increase, according to the median of 33 forecasts in a Bloomberg News survey. The economy has now contracted in six quarters, the most since records began in 1955.

Chancellor of the Exchequer Alistair Darling said this week he will focus on spurring economic growth as he struggles to cement a recovery in time for a general election due by June. Today’s data may add to pressure on Bank of England officials to expand bond purchases at their Nov. 5 decision after completing a plan to buy 175 billion pounds ($291 billion) in assets.

Where goes Sterling on this?

The Burden of Rebalancing

2009-10-21T19:00:00Z

(click on graphs for better viewing; sorry for lack of x-axis formatting)

Nothing good lasts forever, or so at least many would have us believe. I shall neatly leave it aside of whether this is true in a general sense but merely note that it appears that we are moving closer to some form of another of crunch here. And my rationale you ask? Well, let me simply note that it appears, despite the fact one would believe that investors' and punters' should know better, that we are headed right back into the same dead end as we did the last time the Dollar was canooled with the Euro taking center stage. Of course, this is not only a Euro story even if it may appear so and in this sense the current environment once again shows us the very real obstacles which exist in terms of correcting global rebalancing since while everybody seems to agree that this is what we need, nobody wants to hold the old maid represented by a role of importer with a strong currency.

Over at Macro Man, the Dollar's recent plight to reflect lingering risk appetite and low volatility (mmm, the USD as the new carry funder) was given an acronym a long time in the form of DGDF (dollar-goes-down-forever) and I am very symphatetic to MM's ending point in today's installment;

It's entirely possible for this liquidity/positioning/DGDF rally in risky assets to continue through year end; in many ways, it's in everyone's best interest for this to happen. But Macro Man can't shake the feeling that we're all repeating the mistakes of the last cycle (in fast forward, no less!) and that when the reckoning comes, it won't be much fun.

In fact, Macro Man does one better I think since he also points to the very telling issue about Brazil and Turkey fighting tooth and nail to avert an appreciation by, among other things introducing taxes on capital inflows (so far, only Brazil has introduced this measure). I cannot tell you how strongly I feel the sense of deja-vu here since this is exactly what happened the last time the USD began a decline everyone hailed as natural and long overdue but whose counterpart in the form of the inevitable appreciation of other currencies was unduly and harsh. This narrative of course does not make sense and it will be interesting to see this time around where the discourse takes us.

In Europe, policy makers are fast becoming very nervous and although Trichet delivered his well known ECB-speak at the most recent board meeting; the mentioning of a worry of excess currency volatility is indeed, as Macro Man also notes, the closest we will come to the ECB expressing concerns over the flight of the Euro.

It is indeed funny to hear the staunch messages of Eurozone officials only to have them end with the almost laughable notion that the Eurozone is very committed to the US' comittment towards a strong Dollar. I find it hard not to agree with first Macro Man that this latter committment may in fact be a myth and then secondly, and as a result, with Willem Buiter that the ECB will need at some point to get serious about the Euro, even if it will be interesting to see whether the ECB is really ready to act here either operationally or merely through a stronger discourse.

Meanwhile and despite the growing woes in Brazil and Turkey (and India) about shouldering the burden of global rebalancing, one economy that appears to be tackling it rather nicely is Australia where an AUD closely approaching parity with the USD does not seem to deter the RBA (hat tip: Stefan Karlsson).

A local analyst on the ground in the form of Commonwealth Bank’s chief currency strategist Richard Grace even ventured the forcast that the AUD/USD would move beyond parity and on to 1.10. I won't dare confirming or denying this point forecast but merely note that as long as the volatility stays low and that risky assets, by consequence, lingers with an upward drift, it is steady as she goes.

So the real question to answer in this context of global rebalancing is not whether it will be sustainable, but rather which chain will break first. Will it be liquidity driven bounce in risky assets that suddenly runs out of steam or will it be a sudden surge in volatility brought about by an "unforseen" event. In the case of the latter I could mention a couple of sources of such an event, but so far the march goes on and the noose is tightening especially in the context of Europe the statements of policy makers are likely to become increasingly desperate.

In the end, it is not up to the Euro (or the JPY) to bear the burden of rebalancing which must fall on the shoulders of economies such as India, Brazil, Turkey, etc. The key here is that the US does need a weak Dollar to reduce the overall borrowing of the economy, but that this is not possible with one or two economies bearing the brunt of the adjustment process. This has long been a widely circulated fallacy in the sense that many have believed that we could simply twist the tables and move from one importer of last resort to another. This is not possible in the current context and is complicated by the fact that as our OECD economies age, they become increasingly reliant on external demand to spur economic growth.

It may take another round of old maid for global market participants and policy makers to get this and if this is the case, let us hope that Spain, Latvia, Germany, Italy, Japan and the rest of the de-facto export dependent economies won't fold in on themselves.

Japan - In the Eye of the Beholder

2009-10-19T15:44:00Z

(click on pictures for better viewing)

After a nice and entertaining week in Barcelona where I had the privilege not only to hold a seminar at the Universitat Autònoma de Barcelona, but also to meet a host of interesting people, I thought that it would be about time that I finished my piece on the latest data from Japan which admittedly will be a bit backward looking, but hopefully interesting nonetheless.

Beauty, as they say lies in the eye of the beholder and perhaps this axiom is worthwhile contemplating when thinking about the immediate condition of the Japanese economy or indeed the global economy and her asset markets, but for the sake for simplicity . Consider for example the news, out a week ago, that Japan's current account surplus widened 10% in August over the year. In an economy where external demand is the main driver of economic growth, this is a significant piece of news and should rightly be interpreted as a positive sign. Or should it?

Once we read beyond the immediate headlines it becomes clear that what we are really seeing in Japan is, in fact, a pendant (even if less severe) to the Spanish situation where the improvement in the external balance comes, not from a sustained and independent pick-up in external demand, but rather from the fact that domestic demand is contracting faster than external demand thus pushing up the current account. In Japan, exports slid 37.1% on the year but as imports shed a corresponding 41.2%, the current account improved as a result. Naturally, some would want to insert the point here that since Asia (and in particular China) seem to be the locus of small, but definitely noticeable, upbeat signs in the global economy, Japan should be at the forefront to snap up the gains. Surely this is true, and one wonders how far exports would have tumbled on the year if China had not been there to pick up the slack; yet, as we can see from the figures above; the downward momentum remains in spit. It seems, that beauty indeed is a subjective concept.

With respect to the most recent event as it were in the Japanese economy, the BOJ meeting held last week did not really bring much new to the table with respect to policy measures as rates were kept in QE mode. However, and as Societe Generale's Gleen Maquire points out in a recent publication (the weekly monitor) the point is moving closer with respect to whether the BOJ will extend its extraordinary credit measures or stop them. This would then be a discussion about the much debated exit strategies by part of especially the G3 central banks; how it will be conducted and equally as important when. The current message seems to be that while it is difficult to see the BOJ abandoning ZIRP any time soon, the BOJ is not going to extent the current measures of credit support in the form of the purchase of corporate bonds and commercial paper as well as a special funding program for corporate finance facilitation from the point of view of banks. As Maquire correctly points out and regardless of whether ZIRP is set to continue or not, a withdrawal of these measures would naturally represent a de-facto policy tightening and it is unclear just what the effect will be on the Japanese economy.

Moving on to a piece by piece look at the recent monthly data, August's numbers did bring with it a bit of light (September number will be out at the end of October) although the fundamentals have hardly changed.

Kicking off with domestic consumption, the headline figure reported by the statistical office clocked in a nice increase of 2.6% y-o-y which is of a magnitude not seen since January 2008. It is interesting to differentiate the headline figure of 2.6% (which is a real figure) is in somewhat stark contrast to the nominal decline in the consumption of workers' households of 1.4%. At this point, the average monthly change on an annual basis for the overall consumption index in Japan is -1.2% (up from -1.8% before the 2.6% figure reported from August); I will hold off any premature conclusions of a sustained pick-up in consumption before seeing what is in store in the coming months.

With respect to prices, Japan now looks thoroughly entrenched in deflation;

The general core index thus declined 2.2% over the year with the core-of-core index declining 2.6%. So far in 2009, the core-of-core index has declined 8.3% with an average monthly decline of 1%. This is a strong testament to the strong downward momentum in the domestic economy and underpins the following very reasonable assessment by Glenn Maquire;

Realistically, it will be very difficult for the Bank to forecast positive inflation over the next two to three years. The Consumer Price Index continues to fall sharply and the output gap remains extraordinarily large by any metric. With the yen now appreciating and political opposition to a stronger yen having passed with the Liberal Democratic Party losing power, Japan is likely to remain more at risk of deflation than inflation over the entire period including calendar 2012.

Especially the point on the output gap is important even if we don't observe this specific data point. I would add the qualifying comment that one thing is the size of the output which in some sense would signify the immediate damage incurred by the Japanese economy in the context of the financial crisis and another thing is the speed (and ability) with which Japan can close this output gap on the basis of domestic activities alone. A point that I would especially emphasise here is the simple fact that the potential growth rate of Japan is likely to be in an almost perpetual decline due to the demographic situation. In this sense, it may increasingly become a question of what in fact the potential growth rate is based on domestic activity (i.e whether it is positive at all) than a matter of closing the output gap.

On the labour market, things improved rather surprisingly in August with the unemployment rate declining from 5.7% in July to 5.8% in August.

In the context of the financial crisis, the unemployment rate has so far increased roughly 2% and although the number in no means is alarming in a relative sense, the prospect of a continuing increase is sure to make cautious consumers even more cautious.

Turning finally to the corporate sector, industrial production has recovered somewhat after the absolutely horrid decline observed in the first half of 2009. The question is the extent to which we should see this as a decisive positive sign or not.

Once again, this is a matter of interpretation but when for example the Swedish bank calls it a "new dawn" for industrial production after looking at the graph above I find it difficult to see exactly where this dawn is. Consequently and while it is certainly true that the index for industrial production has recovered some ground after bottoming out in February 2009, it is still situated 18.3% lower than its average value (measured from January 2003 to July 2009). This compares with an index for all industrial activity running some 7% below its historical average. These numbers are innocuous in themselves, but the important thing is the level of activity which can be supported by the Japanese economy and although we are certain to see some recovery in the data the underlying momentum may ultimately disappoint.

The chart to the right taken from JPMorgan's Global Datawatch is perhaps the clearest picture of what export dependency means in the case of Japan and how it drives the level of industrial activity.

With respect to the Tankan, the survey showed a pick up in sentiment which follows leads nicely the pick up in real economic activity. Pessimists still outweigh optimists by a rather large margin and it shall be interesting to see whether the apparent (and indeed lingering) positive sentiment among global market participants will spill over forcefully into expectations and investment plans moving forward.

Summary - A Beauty or a Beast?

Some of you may feel that I am spinning the story of Japan too much towards the negative sign. I don't believe this is the case however, and although I can see that some positive signs have emerged, I remain skeptical that it will be enduring. Call me a permabear, but 3-4 years of Japan watching has taught me to be careful when it comes to emphasizing positive news on the Japanese economy, and especially so when it comes to the momentum of the domestic economy.

This brings us to the global economy and the simple fact that the extent to which one would narrate the outlook on the Japanese economy in relative positive light would be tantamount to the extent that one also sees a relative benign outcome for the global economy. Here I am also skeptical which is ultimately also why I remain cautious on Japan and especially so in an environment where the JPY does not seem to benefit from low volatility and risk proneness to the same extent as before the Fed engaged in QE. But that is certainly a discussion for another day; for now, I will leave you my dear reader with the judgement on the immediate outlook for Japan's economy remembering full well that beauty indeed lies within the eye of the beholder.

Ageing and Export Dependency on the Agenda

2009-10-13T10:19:00Z

I know that I tend to harp quite a bit about this theme, but I also trust that my readers by now will be well be used to it. One of the main interesting things about the notion that ageing might be related to export dependency is that while it enjoys little, if any, support in the academic literature it seems to have gotten an increasingly amount of momentum in the context of the market discourse. But then again, perhaps this is not so odd after all in the sense that markets, analysts, and commentators would tend to pick up narratives and ideas quite a bit before they get assimilated into the sometimes arcane world of academia, especially in relation to economics and finance.

In any event, it is with an increasing regularity that we can now observe analysts and commentators alike invoke the idea that for example Germany and Japan are indeed dependent on exports to grow.

Personally and in the context of a more wonkish perspective of why we should expect ageing and export dependency to be related, I have tried to speed the process on the academic side of the fence through two attempts here at Alpha.Sources to explain how this might be seen. The first was a very wonkish piece taken, to some extent, from my upcoming master's thesis and the second was a bit less difficult, I hope, and dealt with the specific case of Germany. To cap it off, I have even written a paper on the topic and I am presenting it this Wednesday in Barcelona; here is the abstract.

The primary manifestation of the demographic transition in a modern economic context is through ageing and the primary transmission from ageing to the macro economy is through its effect on saving and investment behavior. These two effects taken together suggest a strong impact from the continuing process of ageing on international capital flows and global macroeconomic imbalances. This paper explores the potential relationship between ageing on a macroeconomic level and the reliance, or outright dependency, on exports and foreign asset income to achieve economic growth. The paper’s argument is both theoretical and empirical. Using a standard overlapping generation framework (OLG) in an open economy context this paper discusses whether the proposed relationship between a transition into old age and dissaving is feasible and desirable (or even optimal?). Finally, an empirical analysis is presented on Germany and Japan to show how these two economies, as the oldest in the world, may exactly be in a state of export dependency.

It is still rough around the edges, but readable I hope. Comments, critique, and suggestions are welcome.

More generally, I was also happy and honoured to read the recent monthly newsletter from the London based investment company Absolute Returns which included a thorough and fine review of my ideas and thoughts on the topic of how ageing affects capital flows. In fact, the author Niels C. Jensen elaborates in some detail on the obvious and relevant question surrounding the fact that while we may all become de-facto dependent on exports as a function of old age, we cannot all export at the same time. Niels rolls out a fine and thorough argument, but especially; I took note of the following in relation to Japan (my emphasis);

No other country is aging as quickly as Japan. Saddled with a large number of old age pensioners already (the dependency ratio is currently 35), the ratio will grow to an astonishing 76 over the next four decades. The Japanese economy has struggled to drag itself out of a slow growth environment for the past twenty years (give or take). The problems in Japan are well publicised and are often blamed on failed policy measures. I just wonder how big a role demographics have actually played in all of this and whether the Japanese mire is a sign of things to come for the rest of us?

I would never be so stupid to argue that policies, culture, as well as institutions don't matter. They obviously do and are a big part of the picture. However, I also believe that when we come to look at the case of e.g. Japan the demographics, defined by an ongoing and relentless process of ageing, tend to crowd out these other factors. This is especially the case when taken so far as it has been in Japan. But then you only need to realize that Niels is right here. Japan is essentially but one step ahead of the rest of the OECD (with a few exceptions), and it is worthwhile to think long and hard about what this means. I am not being a fatalist here, but simply trying to point in the direction of where the real issue is buried since I also believe, without I hope sounding to alarmist, that the stakes are quite high here, not least in the context of policy advice and guidance to the large batch of emerging economies who are destined to follow the same demographic transition as Japan, Germany et al. if we don't arrive at narrating the issue in a proper way.

Ok, I shall leave it here. Needless to say, that for those of you who are mainly concerned with a P/L (be it yours personally or your clients') I believe the discussion has relevance too since ultimately ageing is first and foremost transmitted through the flow of factors of which capital flows is, by far, the most important [1]. For that reason alone, Niels' piece is worth more than a brief look.

---

[1] - Migration holds huge potential here, but labour mobility across borders is a whole different ball game than capital.

Risk On? The RBA bites the Bullet

2009-10-06T20:39:00Z

I am not an ardent watcher of the Australian economy so I shall leave it neatly to the side of whether this was expected or, Bloomberg so famously puts it, unexpected.

Australia’s central bank unexpectedly raised its benchmark interest rate from a 49-year low and signaled further increases in coming months amid signs the economy is strengthening. Reserve Bank Governor Glenn Stevens increased the overnight cash rate target to 3.25 percent from 3 percent in Sydney today. Only one of 20 economists surveyed by Bloomberg News forecast today’s move. The rest predicted no change.

The local currency jumped as Australia became the first Group of 20 nation to raise borrowing costs since the start of the global financial crisis more than a year ago. Rising job vacancies, retail sales and house prices, plus surging business and consumer confidence support Stevens’ view that the “basis for such a low interest rate setting has now passed.”

Carry traders will of course feel that warm fuzzy feeling in the stomach by now with the prospect of Australia (and perhaps New Zealand or others) raising rates while the Fed continues to supply the system with free liquidity. The only question is of course whether risk is really on here or whether we are about to get hit by another anvil exactly brought about by a retrenchment of stimulus. I don't know, but this is also beyond the point here. The only question which needs to be answered at this point in time is, how high will it go?

To parity and beyond? (graph courtesey of Reuters, click for better viewing)