If only the central banks could print babies

The Financial Times has kindly printed my letter below, arguing that central bank stimulus can’t restore growth to previous Super Cycle levels.
FTSir, John Plender’s excellent analysis “Central banks’ waning credibility is the real threat to confidence” (Insight, February 17) highlights the need for a new narrative to explain the economic slowdown of recent years.

It was always rather surprising that investors ever believed central banks could control the economic destiny of the world’s 7.3bn people, simply by adjusting short-term interest rates and printing electronic money.

Instead it is perhaps time to rehabilitate Masaaki Shirakawa, former governor of the Bank of Japan, who was retired in 2013 by prime minister Shinzo Abe’s new government. His argument that demographics drive demand, not central bank money-printing, has certainly stood the test of time. Common sense, after all, suggests that a paradigm shift has been under way in the global economy since 2001, when the oldest baby boomers joined the low-spending, low-earning ‘new old’ 55-plus generation.

The boomers were the largest and wealthiest generation in history, and it was no surprise they created an economic supercycle during the 1980s as they moved into the wealth creator 25-54 age group, when incomes rise exponentially and people often settle down and have families.Now we are seeing the downside of this process, as the boomers also have the longest life expectancy in history.

UN data suggest that a record one in five of the world’s population will be new olders by 2025, while the collapse in global fertility rates (which have halved to just 2.5 babies/woman since 1950), means that relatively fewer wealth creators are now supporting an increasing number of new olders. Central bank stimulus programmes have succeeded in temporarily boosting the prices of financial assets, at the cost of increasing the debt burden for the future. But in terms of demand growth they are impotent, as they cannot print babies.
Paul Hodges
Chairman,
International eChem,

Bank of Japan admits stimulus policy is modelled on Peter Pan

Japan Jun15Peter Pan’ is one of the world’s most-loved children’s stories.But I hadn’t realised it had also become an economics textbook, at least in Japan.  Yet the Governor of the Bank of Japan (BoJ), Haruhiko Kuroda, described his stimulus policy last week as follows to an invited audience:

“I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it.’  Yes, what we need is a positive attitude and conviction,”

As readers will know, I have consistently argued that the central banks were guilty of wishful thinking, with their idea that printing money could somehow stimulate growth in an ageing population.  So it is good to know they recognise there might be some truth in the argument.

The chart above, based on Statistics Japan data, highlights the impossibility of Kuroda’s wish to restore inflation and constant growth to the levels seen before Japan’s population began to age:

  • Its BabyBoom began earlier than in the West, and averaged 2.2m babies/year between 1920 – 1952
  • Births then slowed between 1953 – 1983 to average only 1.7m/year
  • Births have since fallen further to average just 1.2m/year over the 30 years between 1984 – 2014
  • Last year actually saw a record low level of only 1m births

Thus Japan has simply run out of realistic options for growth.  Its population is now set for steady decline from 2010′s level of 127m to just 108m by 2050, according to UN Population Division forecasts.

Japan Jun15aWe also know, again from Statistics Japan data, that spending peaks in the 25 – 54 age group, as the second chart shows.  After this, people already own most of what they need, and their incomes decline as they enter retirement.  These spending patterns also matter for the economy, as consumption is around 60% of Japan’s GDP.

Japan has one of the oldest populations in the world, with a quarter aged over 65 years.  Therefore it really is wishful thinking of the first order to imagine that it can possibly return to the growth levels seen when its BabyBoom was in its peak spending mode .  After all, the youngest Boomer, born in 1952, is now 63 years old.

And it is also hard to imagine that the problem can be solved by either increasing fertility rates dramatically, or boosting immigration:

  • Adding more babies now would simply increase the dependency ratio, which measures the number of young and old as a ratio of the working -age population.  It would do nothing to boost growth for another 20+ years, till the babies began to enter the workforce
  • Boosting immigration would require millions of people to migrate to Japan, and would create enormous social tensions as a result.  Japan has never accepted the idea of immigration, and it is unlikely to be accepted now

The great moral of ‘Peter Pan’ is that children have to grow up and join an adult world.  They cannot live in the magic world of Neverland forever.  What a pity that Japan’s policymakers obviously never read to the end of the story.

Of course, if you hand out Yen 80tn/year ($480bn) in stimulus, as the BoJ is now doing, and devalue 50% versus the dollar, you will get a short-term jump in the growth rate.  But then the rate will fall back again, as Japan’s working age population has to pay for the cost of this short-term stimulus through higher taxes.

The greatest pity is that premier Abe chose to ignore the wisdom of the BoJ’s previous Governor, Masaaki Shirakawa. He understood all too well that demographics are far more powerful than monetary policy.

Oil price fall set to push Japan back into deflation

Japan CPI Nov14Could Japan actually go bankrupt at some point in the future?  This was the question left hanging in the air after Friday’s panic at the Bank of Japan, when its Governor forced through his new stimulus policy on a 5 – 4 vote.

Financial markets’ first reaction was to assume this was a coup de théâtre on his part, meant to ‘shock and awe’.  But central banks typically try to be as boring as possible, and very predictable.  Also, Japan is the land of consensus.

Clearly something is not right.  And Governor Kuroda’s press conference spelt out the issue – the return of deflation

“We are at a critical moment. There is a risk that victory over deflation may be delayed.”

Nor is it difficult to see why Japan might be about to topple back into deflation.  As the chart shows:

  • It has been in deflation for 2/3rds of the period from 1995 – 2013, 150 months out of 19 years
  • It was only out of deflation very briefly during this period – in 1996-8, 2006 and 2008
  • The latest increase, to 3.4%, took place in April this year, after sales tax was increased from 5% to 8%
  • Already the rate is turning down, and the impact of the sales tax will disappear from the index next April

Against this background, it would only take one “shock” for Japan to move back into deflation.  And, of course, just such a shock has occurred with the collapse of oil prices and other commodities over the summer:

  • Japan is the world’s 2nd largest importer of fossil fuels, after China
  • The Fukushima tragedy means it has been the world’s 3rd largest oil consumer and importer since 2012
  • Since June 16, the oil price has fallen 26% from $116/bbl to $86/bbl on Friday
  • On its own, this is highly likely to push Japan back into deflation

In addition, of course, the whole Asian region is seeing slower growth as China leads the Great Unwinding of policy stimulus.  There is little that Premier Abe or Governor Kuroda can do about either of these external developments.

ABE-KURODA’S ’3 ARROWS’ POLICY IS HIGHLY RISKY FOR THE ECONOMY
The problem for Japan is that the Abe-Kuroda policies are highly risky for its economy, as I discussed last December:

  • It has the oldest population in the world, with a median age of 46 years
  • According to the OECD, 42% of the adult population are over 65, and this percentage is rising
  • One in two adults are in the New Old 55+ generation, when spending declines quite sharply

There is therefore no chance that the new policies, known as Abenomics, could work.

The OECD also calculate that Japan’s net relative pension level equals only 38% of net average earnings, so the drop in spending power on retirement is profound.  In addition, the collapse in fertility rates since 1955 means Japan’s population is already declining, from 127m today to 108m by 2050 according to UN Population Division forecasts.

So its GDP must now be on a declining trend, especially as Japan’s consumer spending is nearly 2/3rds of GDP.

Even worse, however, is that the so-called ’3rd arrow’ of Abenomics policy – structural reform in the economy – has never been fired.  For example, female employment levels are just 63%, far lower than in other rich countries, and Abe has done nothing to change this.  Instead, he has focused on the other two arrows:

  • Massive monetary easing to push up stock market prices and create a ‘wealth effect’
  • Major government spending increases to try and boost demand
  • One key aim has been to devalue the currency to boost exports and create inflation
  • The yen has thus fallen 47% versus the US$ since Abe took office, from Y76 in January 2012 to Y112 on Friday

Friday’s announcement was more of the same.  The Y127tn ($1.14tn) Government Pension Investment Fund (GPIF) has been told to increase its stock market holdings by Y34tn, and to sell Y30tn of its government holding to the Bank of Japan.  The news led to an astonishing 3% fall in the value of yen versus the USD, from Y109 to Y112.

Kuroda’s policy announcement also showed he was aware of the bankruptcy risk.  Clearly no foreign investor would buy Japan’s government bonds – interest rates are near 0%, and they face a near-certain exchange rate loss.  This must be why the Bank of Japan will be buying the GPIF’s bonds.

But this type of manoeuver is essentially sleight of hand – Japan’s borrowing was in real yen, and will have to be repaid in real yen.  Similarly, its growing army of pensioners cannot live on electronic money.  They need real cash each week if they are to eat and to keep their homes warm in the winter.

And when deflation returns, it will increase the real value of the debt created by Abe-Kuroda, and so create a further headwind for economic growth.  Japan’s debt was already $80k for every man, woman and child back in March.  Abe-Kuroda’s policies are increasing this level on a daily basis.

Japan has not yet got to the point where bankruptcy has become a real risk.  But time is running out for it to accept demographic reality.  It needs to return to the sensible policies of Kuroda’s predecessor as Governor, Masaaki Shirakawa.  He understood very well the threat posed by current policies when warning in 2012:

“The implications of population aging and decline are also very profound, as they contribute to a decline in growth potential, a deterioration in the fiscal balance, and a fall in housing prices.”

 

WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:

PTA China, down 24%. ”End-users who are in the re-export business were seeking cargoes”
Naphtha Europe, down 21%. “Naphtha supplies lengthened further this week, with petrochemical buyers continuing to opt for LPG”
Brent crude oil, down 18%
Benzene Europe, down 13%. “Sluggish derivative demand meant that some length was growing.”
¥:$, down 10%
HDPE US export, flat. “Traders said prices need to drop at least 10 cents/lb more to compete with China and Asian values”
S&P 500 stock market index, up 3%

Oil price fall set to push Japan back into deflation

Japan CPI Nov14Could Japan actually go bankrupt at some point in the future?  This was the question left hanging in the air after Friday’s panic at the Bank of Japan, when its Governor forced through his new stimulus policy on a 5 – 4 vote.

Financial markets’ first reaction was to assume this was a coup de théâtre on his part, meant to ‘shock and awe’.  But central banks typically try to be as boring as possible, and very predictable.  Also, Japan is the land of consensus.

Clearly something is not right.  And Governor Kuroda’s press conference spelt out the issue – the return of deflation

“We are at a critical moment. There is a risk that victory over deflation may be delayed.”

Nor is it difficult to see why Japan might be about to topple back into deflation.  As the chart shows:

  • It has been in deflation for 2/3rds of the period from 1995 – 2013, 150 months out of 19 years
  • It was only out of deflation very briefly during this period – in 1996-8, 2006 and 2008
  • The latest increase, to 3.4%, took place in April this year, after sales tax was increased from 5% to 8%
  • Already the rate is turning down, and the impact of the sales tax will disappear from the index next April

Against this background, it would only take one “shock” for Japan to move back into deflation.  And, of course, just such a shock has occurred with the collapse of oil prices and other commodities over the summer:

  • Japan is the world’s 2nd largest importer of fossil fuels, after China
  • The Fukushima tragedy means it has been the world’s 3rd largest oil consumer and importer since 2012
  • Since June 16, the oil price has fallen 26% from $116/bbl to $86/bbl on Friday
  • On its own, this is highly likely to push Japan back into deflation

In addition, of course, the whole Asian region is seeing slower growth as China leads the Great Unwinding of policy stimulus.  There is little that Premier Abe or Governor Kuroda can do about either of these external developments.

ABE-KURODA’S ’3 ARROWS’ POLICY IS HIGHLY RISKY FOR THE ECONOMY
The problem for Japan is that the Abe-Kuroda policies are highly risky for its economy, as I discussed last December:

  • It has the oldest population in the world, with a median age of 46 years
  • According to the OECD, 42% of the adult population are over 65, and this percentage is rising
  • One in two adults are in the New Old 55+ generation, when spending declines quite sharply

There is therefore no chance that the new policies, known as Abenomics, could work.

The OECD also calculate that Japan’s net relative pension level equals only 38% of net average earnings, so the drop in spending power on retirement is profound.  In addition, the collapse in fertility rates since 1955 means Japan’s population is already declining, from 127m today to 108m by 2050 according to UN Population Division forecasts.

So its GDP must now be on a declining trend, especially as Japan’s consumer spending is nearly 2/3rds of GDP.

Even worse, however, is that the so-called ’3rd arrow’ of Abenomics policy – structural reform in the economy – has never been fired.  For example, female employment levels are just 63%, far lower than in other rich countries, and Abe has done nothing to change this.  Instead, he has focused on the other two arrows:

  • Massive monetary easing to push up stock market prices and create a ‘wealth effect’
  • Major government spending increases to try and boost demand
  • One key aim has been to devalue the currency to boost exports and create inflation
  • The yen has thus fallen 47% versus the US$ since Abe took office, from Y76 in January 2012 to Y112 on Friday

Friday’s announcement was more of the same.  The Y127tn ($1.14tn) Government Pension Investment Fund (GPIF) has been told to increase its stock market holdings by Y34tn, and to sell Y30tn of its government holding to the Bank of Japan.  The news led to an astonishing 3% fall in the value of yen versus the USD, from Y109 to Y112.

Kuroda’s policy announcement also showed he was aware of the bankruptcy risk.  Clearly no foreign investor would buy Japan’s government bonds – interest rates are near 0%, and they face a near-certain exchange rate loss.  This must be why the Bank of Japan will be buying the GPIF’s bonds.

But this type of manoeuver is essentially sleight of hand – Japan’s borrowing was in real yen, and will have to be repaid in real yen.  Similarly, its growing army of pensioners cannot live on electronic money.  They need real cash each week if they are to eat and to keep their homes warm in the winter.

And when deflation returns, it will increase the real value of the debt created by Abe-Kuroda, and so create a further headwind for economic growth.  Japan’s debt was already $80k for every man, woman and child back in March.  Abe-Kuroda’s policies are increasing this level on a daily basis.

Japan has not yet got to the point where bankruptcy has become a real risk.  But time is running out for it to accept demographic reality.  It needs to return to the sensible policies of Kuroda’s predecessor as Governor, Masaaki Shirakawa.  He understood very well the threat posed by current policies when warning in 2012:

“The implications of population aging and decline are also very profound, as they contribute to a decline in growth potential, a deterioration in the fiscal balance, and a fall in housing prices.”

 

WEEKLY MARKET ROUND-UP
The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:

PTA China, down 24%. ”End-users who are in the re-export business were seeking cargoes”
Naphtha Europe, down 21%. “Naphtha supplies lengthened further this week, with petrochemical buyers continuing to opt for LPG”
Brent crude oil, down 18%
Benzene Europe, down 13%. “Sluggish derivative demand meant that some length was growing.”
¥:$, down 10%
HDPE US export, flat. “Traders said prices need to drop at least 10 cents/lb more to compete with China and Asian values”
S&P 500 stock market index, up 3%