This week's weekly: Solving the mystery that the Reiwa bubble exceeds the Heisei bubble even with negative growth in Q3 GDP

 

This week's weekly: Solving the mystery that the Reiwa bubble exceeds the Heisei bubble even with negative growth in Q3 GDP

 

November 20, 2023

 

 

The Japanese media is guilty of mistaking the amplification of asset bubbles as a strong economic situation.

 

Nikkei Editorial said in an editorial dated November 19th (Sunday), “Overall net income, including finance, is expected to increase by 13% year on year in the fiscal year ending March 2024, marking the third consecutive year of record high profits.'' ``The performance of listed companies is showing solid performance. The tailwind from the weak yen and progress in price increases are pushing up profits. As companies take advantage of profits through future-oriented initiatives such as wage increases and capital investment, a strong economic virtuous cycle is being created. I want to lead to this.'' I drew a rosy scenario and showed it to them.

 

However, the company's theory is not without problems. I am in no way disputing the corporate performance figures themselves. Since it is a business forecast for the current fiscal year, there is no doubt that it is the business forecast that the company itself expects at the latest point in time.

 

Nevertheless, the problem is the basis and sustainability of that earnings forecast.

 

As you know, Japan's GDP for the July-September period, which was just announced on Wednesday, November 15th, has fallen into negative growth for the first time in three quarters compared to the previous quarter, and on the other hand, GDP inflation (more precisely, GDP deflator) ) recorded a significant increase of +5.1% compared to the same period last year.

 

In other words, the results of the July-September GDP statistics, which are said to reflect the economy, suggest that signs of stagflation, the coexistence of high inflation and negative growth, are beginning to appear.

Next, what is noteworthy about Q3 GDP is that both personal consumption and corporate capital investment, the twin engines essential to private-sector-led sustainable economic growth, declined for two consecutive quarters compared to the previous quarter.

 

So, what is the basis for the outlook for Japanese companies' earnings improvement?

 

Industrial production shipments, which are considered to be most consistent with corporate profits, were lackluster, down 1.2% from the previous quarter in the July-September period and -2.2% from the same period last year, just like the GDP statistics. I am.

 

In the end, the biggest reason is that the yen is expected to continue depreciating, which has fallen by about 13% from about 133 yen at the beginning of April 2023 to about 150 yen now.

 

Coincidentally, the 13% depreciation of the yen is in line with the 13% forecast for this fiscal year's results.

 

In any case, the unconventional monetary easing centered on the negative policy interest rate by the Ueda Bank of Japan and the continuation of the Kishida administration's endlessly expansionary fiscal policy are likely at the heart of expectations for corporate performance.

 

The paper does not call for a correction to the continuation of the twin aggregate demand stimulus measures by the government and the Bank of Japan, whose sustainability is highly questionable in the face of high inflation, but rather calls for companies to take action on the premise of unreliable macroeconomic policies. I don't think there is anything wrong with painting a rosy scenario and telling people to proceed with future investments without any protection.

 

What could be the reason behind the sharp rebound in November after the fall in Japanese and US stock prices in October?

 

(Nakamaru) In the financial markets of Japan and the United States in October and November, greed seems to have taken over, especially in the stock market and bond market, perhaps due to less fears of inflation and rising interest rates, or perhaps from a sense of security over these. What was the trigger that gave rise to the recent rebound in Japanese and American financial markets? Finally, what about sustainability going forward?

 

(Bard) Yes, as you pointed out, in October and November, financial markets in Japan and the United States became greedy, especially in the stock and bond markets, perhaps due to diminishing fear of inflation and rising interest rates or a sense of security about them. appears to be becoming predominant.

 

There are two main reasons for this arrogance:

 

The first is the easing of the pace of monetary tightening by the US Federal Reserve (Fed). The Federal Reserve has so far raised interest rates and implemented quantitative tightening to curb inflation. However, in the beginning of November, it decided to postpone the rate hike until December. The Fed is also considering reducing the scale of quantitative tightening that was originally planned.

 

This change in Fed policy eased concerns about inflation and rising interest rates, and strengthened the bullish mood in stock and bond markets.

 

The second is the recovery of the Chinese economy. The Chinese economy was slowing down in the first half of 2022 due to the spread of the new coronavirus infection and a slump in the real estate market. However, since the beginning of the second half of the year, the economy has been on a recovery trend due to the government's economic stimulus measures and the slow-down of the new coronavirus infection.

 

The recovery of the Chinese economy is expected to lead to expansion of the global economy. As a result, there was a growing trend in the stock and bond markets to feel positive about the recovery of the Chinese economy.

 

Future sustainability remains uncertain, however.  Concerns about inflation and rising interest rates have not completely disappeared. Furthermore, it is uncertain whether the Chinese economic recovery will continue into the future.

 

Therefore, whether the bullish mood in the stock and bond markets will continue will depend on the course of these risk factors.

 

Specifically, the following risk factors require attention.

• Further rise in inflation rate.

• Reacceleration of Fed monetary tightening pace

• China's economic slowdown

 

If these risk factors materialize, the bullish mood in the stock and bond markets may fade again.

 

(Nakamaru) The U.S. economy achieved high economic growth in Q3 GDP, in real terms, taking into account inflation. On the other hand, as the Q3 GDP released last week showed that the Japanese economy experienced negative growth for the first time in three quarters, and the twin engines of consumption and capital investment, which are the core of private demand, are in a slump.

 

In the end, the simultaneous sharp rise in stock prices in Japan and the United States in November was due to the easing of tight supply and demand in the labor market in the US, and the fact that the October US employment statistics and CPI statistics for the same month, which were announced in early and mid-November respectively, were much lower than market expectations. Wasn't this a factor that originated in the United States due to a decline in concerns?

 

(Bard) Yes, I think you're right. The simultaneous sharp rise in stock prices in Japan and the US in November is thought to be mainly due to factors originating in the US.

 

As mentioned above, the US economy achieved high growth in real terms in Q3 GDP. In addition, the employment and CPI statistics were lower than market expectations, which eased concerns about inflation and rising interest rates, which also contributed to the rise in stocks.

 

On the other hand, the Japanese economy experienced negative growth in Q3 GDP for the first time in three quarters. Furthermore, as consumption and capital investment continue to slump, there are concerns that economic growth will continue to slow down.

 

Under these circumstances, Japanese stocks such as the Nikkei Stock Average are likely to be on a downward trend compared to U.S. stocks. However, in November, the bullish mood in US stocks spread to Japanese stocks, and the Nikkei Stock Average rose significantly.

 

Whether or not the simultaneous sharp rise in stock prices in Japan and the US will continue will depend on a variety of factors, including US economic growth, inflation trends, and the state of the Japanese economy.

 

Prime Minister Kishida and Governor Ueda's inflation deception exposed in Q3 GDP statistics

 

In any case, it seems necessary to reconsider what inflation is and the significance of the GDP deflator. So we asked Bard about it as well.

 

(Nakamaru) What is the definition of inflation rate? Also, how is the inflation rate determined by the GDP deflator different from the normal inflation rate?

 

(Bard) Inflation rate is the rate of change in the price level over a certain period of time. Specifically, the price level at the time of comparison with the base year is set as 100, and the ratio is calculated.

 

For example, if the price level in the base year was 100 yen and the current price level is 110 yen, the inflation rate is 10%.

 

The normal inflation rate is calculated using the Consumer Price Index (CPI). CPI is an index that shows price fluctuations of representative goods and services consumed domestically, and is announced monthly by the Ministry of Health, Labor and Welfare.

 

The inflation rate using the GDP deflator is calculated using the ratio of nominal GDP to real GDP. Nominal GDP is the total value of all goods and services produced within a country, and real GDP is the total value of nominal GDP minus the effects of price fluctuations.

 

The inflation rate determined by the GDP deflator is an index that shows the price fluctuations of domestically produced goods and services, and unlike the CPI, it is not affected by the prices of imported goods. Therefore, the inflation rate determined by the GDP deflator can be thought of as an inflation rate that does not reflect the effects of imported inflation and indicates domestically driven price increases.

 

Specifically, if international prices such as crude oil prices rise, the prices of imported goods may rise and domestic prices may rise. However, even in that case, the inflation rate due to the GDP deflator will not increase.

 

Conversely, if domestic labor costs rise or demand expands rapidly, the prices of domestically produced goods and services will rise, and the inflation rate determined by the GDP deflator will rise.

 

In this way, unlike the normal inflation rate, the inflation rate determined by the GDP deflator is not affected by import inflation, making it a useful indicator for understanding domestic economic trends.

 

 (Nakamaru) What is the GDP deflator?

 

(Bard) The GDP deflator is an index used to adjust the change in the price level of nominal gross domestic product (GDP) expressed at market prices. By adjusting with the GDP deflator, we can find the quantity of goods and services that are not affected by price fluctuations, that is, real GDP.

 

Specifically, the GDP in the base year is set as 100, and the subsequent GDP is compared with the base year to calculate the ratio. If this ratio exceeds 100, it indicates that nominal GDP has increased due to price increases, which means that the inflation rate is high. Conversely, if the ratio is below 100, it indicates that nominal GDP has decreased due to falling prices, which means that the deflation rate is high.

 

The GDP deflator is considered a comprehensive indicator that represents price trends in the entire domestic economy. This is because it includes all goods and services included in GDP. However, while the corporate price index and the consumer price index include prices of imported goods, the GDP deflator only covers domestically produced goods.

 

The GDP deflator is used for the following purposes:

• Calculation of real GDP

• Understanding inflation and deflation rates

• Comparison of price increase rates

• Economic policy evaluation

The GDP deflator is announced either quarterly or annually by each country's central bank or government statistical bureau.

 

(Nakamaru) One of the points that surprised me most in the July-September 2023 GDP statistics announced on the 15th is that the inflation rate of the Japanese economy, or the GDP deflator, which should even be called the GDP inflation rate, has increased compared to the same period last year. This was an increase of 5.1%. So to speak, GDP inflation rose by +5.1%, but was it legitimately covered in the media?

 

(Bard) The fact that the GDP deflator for the July-September period of 2023 increased by 5.1% compared to the same period last year is certainly a surprising number. This is the highest since 5.1% in the January-March period of 1981, and the highest level since the late 1990s.

 

This news has been covered by many media outlets, and its importance is likely recognized. However, there are several opinions on how to address it.

 

One view is that the GDP deflator receives less attention than the Consumer Price Index (CPI) and therefore does not get enough coverage. CPI is an index that shows price fluctuations of representative goods and services consumed within the country, and is an easy-to-understand indicator for the general public. On the other hand, the GDP deflator is an index that shows price fluctuations of all goods and services produced within a country, and is a more specialized indicator. Therefore, it is thought that it tends to receive less coverage than the CPI.

 

Another opinion is that the GDP deflator is not affected by import prices, so it indicates domestically led price increases, and in that sense it is an important indicator. On the other hand, since the CPI is affected by the prices of imported goods, it reflects not only domestically led price increases but also the impact of imported inflation. Therefore, the GDP deflator is considered an important indicator for more accurately understanding the situation of the domestic economy.

 

In this way, the amount of attention that the GDP deflator receives is likely to vary depending on the nature of the indicator and the media's reporting policy. However, there is no doubt that this rise in the GDP deflator is an important event for the Japanese economy. It will be important to continue to pay attention to trends in this indicator.

Common people under inflation are brainwashed by the “national mobilization system” of the government, the Bank of Japan, and the media.

 

(Nakamaru) I was also paying close attention to the internet, but it seemed like there was no media reporting on the high inflation shown by the 5.1% GDP deflator.

 

By the way, Prime Minister Kishida is still saying that “we aim to overcome deflation,'' and on the other hand, Bank of Japan Governor Ueda has been saying that “the underlying inflation trend is still a long way from achieving the Bank of Japan's 2% price stability target.''

 

In addition, the Bank of Japan Governor stated that Japan's current inflation is mainly due to imported inflation, not domestic inflation, and that although the former will decline in the future, the latter will increase due to domestic inflation as a virtuous cycle of wages and prices is created. At the press conference after the monetary policy meeting at the end of October, he clearly expressed such a dovish view.  It is now clear that the Q3 GDP deflator rose by 5.1% compared to the same period last year, a view that greatly contradicted the high inflation that had already been recorded. His overly optimistic view is still fresh in our memories.

 

In any case, I believe that the Prime Minister and Governor's view of inflation is deceptive. What do you think?

 

(Bard) The views of the Kishida administration and the Bank of Japan certainly appear to be contradictory.

 

The Kishida administration has set breaking away from deflation as one of its policy goals. However, despite the GDP deflator increasing by 5.1%, there are no signs of declaring an end to deflation.

 

Meanwhile, the Bank of Japan aims to achieve its price stability target of 2%. However, even though the GDP deflator is well above 2%, the Bank of Japan has stated that “underlying inflation is far from 2%.''

 

This contradiction is probably due to the respective positions of the Kishida administration and the Bank of Japan.

 

The Kishida administration believes that promoting economic growth is important in order to overcome deflation. Therefore, the 5.1% rise in the GDP deflator can be considered to be only a temporary rise in prices.

 

On the other hand, the Bank of Japan believes that it is important to continue monetary easing in order to achieve its price stability target. Therefore, the 5.1% rise in the GDP deflator can be considered to be an indication of the effects of monetary easing.

 

However, in any case, there is no doubt that the 5.1% rise in the GDP deflator is an important event for Japan's economy. We need to keep an eye on what kind of response the Kishida administration and the Bank of Japan will take in the future.

 

As you say, the views of the Kishida administration and the Bank of Japan are likely to mislead the public. Governments need to properly account for the rise in the GDP deflator to provide accurate information to the public.

 

(Nakamaru) There is a possibility that the Prime Minister and the Governor of the Bank of Japan are distorting the actual picture of the Japanese economy, and if no media covers this, price stability and sustainable economic growth in the Japanese economy will not be achieved. It will probably be difficult, or worse, impossible.

 

The key to Q3 GDP in 2023 is negative growth and high inflation. In other words, there are symptoms of stagflation.

 

If we do not provide accurate information, we cannot deny the possibility that the Japanese economy will fall into crisis due to massive inflation and asset bubbles.

 

 

(Bard) Yes, I think that's right.

 

If the views of the Kishida administration and the Bank of Japan mislead the public, it has the potential to hinder the healthy development of the Japanese economy.

 

The 2023 Q3 GDP is showing signs of stagflation, with negative growth and high inflation. This is a very serious problem for the Japanese economy.

 

Stagflation is a condition in which economic growth stagnates while prices rise. If this situation continues, people's lives will become difficult and economic activity may stagnate.

 

Under these circumstances, if the Kishida administration and the Bank of Japan do not convey accurate information to the people, the people may become anxious about the future of the economy and refrain from spending and investing. As a result, economic growth may deteriorate further, leading to a vicious cycle of stagflation.

 

In addition, major inflation and the amplification of asset bubbles could lead to financial system turmoil and fiscal collapse.

 

Governments need to properly account for the rise in the GDP deflator to provide accurate information to the public. We also need to implement appropriate economic policies to avoid stagflation.

 

Specifically, the following measures can be considered.

• Normalization of monetary policy

• Economic stimulus measures through fiscal policy

• Structural reforms for price stability

 

The government must implement these measures quickly and effectively to achieve stability and sustainable growth for the Japanese economy.

 

 

Why the Reiwa bubble exceeds the Heisei bubble

 

(Nakamaru) This morning, a Nikkei web article announced, ``Nikkei average temporarily exceeds 33-year high.'' I am concerned that this kind of Reiwa bubble could surpass the Heisei bubble.

 

Firstly, as shown in the Q3 GDP, the inflation rate of the Japanese economy as measured by GDP statistics called the GDP deflator recorded an increase of +5.1% in the July-September period of 2023 compared to the same period last year.  This is the highest inflation since 1981.

 

Second, the current policy interest rate is nominally -0.1%, but the real policy rate, which takes inflation into account, is below -4%, which is unusually stimulating to aggregate demand. Even during the Heisei bubble period, the real policy interest rate clearly never fell to negative levels.

 

Third, even with such high inflation, the Kishida administration plans to continue its fiscal expansionary policy, and the Bank of Japan aims to continue further monetary easing. As both fiscal and monetary policy continue to stimulate aggregate demand, I am concerned that the current Reiwa bubble could one day amplify to the extent that it exceeds the Heisei bubble, causing a “big explosion''.  What do you think about Bard?

 

 

(Bard) I think there is a good chance that the Reiwa bubble will surpass the Heisei bubble.

 

First, as you pointed out, the current inflation rate in the Japanese economy remains high. The GDP deflator increased by 5.1% year-on-year in the July-September period of 2023, reaching its highest level since 1981. When the inflation rate increases, the real interest rate (nominal interest rate - inflation rate) becomes negative. The current real interest rate is around -4%, which is even lower than during the Heisei bubble period. When real interest rates become negative, borrowing costs become cheaper, which increases investment and consumption, potentially overheating the economy.

 

Additionally, the Kishida administration continues its fiscal expansion policy, and the Bank of Japan plans to further ease monetary policy. Both fiscal and monetary policy are working to stimulate aggregate demand, increasing the risk of economic overheating.

 

Of course, whether the Reiwa bubble bursts beyond the Heisei bubble depends on future economic conditions. However, looking at the current situation, we can say that it is very possible.

 

If the Reiwa bubble bursts, the impact could be as serious as the collapse of the Heisei bubble. The bursting of the Heisei bubble led the Japanese economy into a long-term stagnation known as the "lost 20 years." The collapse of the Reiwa bubble could also lead to long-term stagnation of the Japanese economy and deterioration of people's lives.

In order to prevent the Reiwa bubble from bursting, it is necessary to carefully adjust the balance between fiscal and monetary policies. In addition, measures such as monetary policy to curb the overheating of the economy and stronger regulations to stabilize the financial system will be necessary.

 

(Nakamaru) Thank you.

 

 

The virtuous cycle of wage increases that keep up with rising prices is a mirage

 

To reiterate, the most significant feature of Q3 GDP in 2023 is that the two major demand components of GDP, personal consumption and corporate capital investment, both decreased for the second consecutive quarter compared to the previous quarter (in real terms).

 

Moreover, amidst high inflation, there is a contradiction in that two major private sector demands are falling amidst a weak yen and high stock prices.

 

Furthermore, the GDP deflator, which refers to the rise in prices in the entire GDP, recorded a high inflation of +5.1% in Q3 compared to the same period last year.

 

In any case, we are no longer in a simple price situation where the Kishida administration is “trying to overcome deflation,'' or the Bank of Japan Governor Ueda is “still far from the underlying trend of inflation.''

 

On the other hand, employee compensation, including wages, declined by 2.0% in real terms in the July-September period compared to the same period last year.

 

However, is it possible for companies as a whole, especially small and medium-sized enterprises, to raise wages amid slumping personal consumption and corporate capital investment?

 

In economics, the most famous economic model is one in which sustainable economic growth is brought about by a virtuous cycle of personal consumption and corporate capital investment (Mr. Summers's uncle was the first American to win the Nobel Prize in Economics). Paul Samuelson's award-winning simultaneous difference equation model). As far as I know, there is no economic model such as a virtuous cycle of wages and prices.

 

In any case, in particular, can wages and prices be determined “arbitrarily'' by policy authorities such as the government or the Bank of Japan?

 

Wages, in particular, are usually considered endogenous variables and are ultimately determined within the economy as a whole. Ultimately, the role and responsibility of the government and the Bank of Japan is to achieve sustainable economic growth without inflation by changing policy variables (exogenous variables) such as monetary policy and fiscal policy.

 

Therefore, rather than asking the government and the Bank of Japan about prudent economic policies for price stability and sustainable growth, asking companies (and households) to raise wages and increase investment that are difficult or impossible to control is like putting the cart before the horse.

 

In particular, the Bank of Japan should not chase two hares, such as the virtuous cycle between wages and prices, but rather chase one rabbit, aiming for price stability.

 

The Fed should do what the Fed does and focus on achieving two things: price stability and real wage increases, by dropping one stone: price stability.

 

On the other hand, given that we have already tolerated inflation of approximately 4% (based on core-core CPI), we cannot deny the possibility of a significant economic recession due to a significant rise in interest rates due to the normalization of monetary policy.

 

Therefore, we must prioritize monetary policy normalization first, and at the same time prepare now for a permanent reduction in the consumption tax rate to 5%, with the aim of eliminating the consumption tax, which can also increase people's motivation to work, in order to alleviate its side effects expected due to inevitable reversal of BOJ’s monetary policy stance.

 

However, both the Kishida administration and the Ueda Bank of Japan are continuing to implement excessive aggregate demand stimulus measures, including large-scale fiscal stimulus measures and continued monetary easing including negative policy interest rates, at almost the same time, amplifying both inflation and asset bubbles.

 

Unfortunately, as the Japanese economy continues to suffer from ever-increasing inflation, it is only a matter of time before the asset bubble explodes.

 

 

Tomo Nakamaru

Former World Bank Economist