Does Japan’s economic implosion mean anything?

Overnight, the Japanese government released figures for Q4 2008 GDP that pointed to a depression-like fall in the Japanese economy.  GDP contracted 3.3% from Q3, or 12.7% using the U.S. convention of annualizing those numbers.  This is the largest such quarterly contraction in Japan since 1974.  While a very poor number was expected, this number was even worse than forecast.

Ken Worsley of the Japan Economy & News website has a good summary of the situation:

While PR fallout has yet to land concerning Finance Minister Shoichi Nakagawa’s seemingly drunken appearance at the G7 meetings in Rome this past weekend, data released today by the Cabinet Office shows Japan’s GDP as having fallen 3.3% in the October quarter, annualized at a 12.7% decline. This is the largest fall since since an annualized 13.1% decline in the January-March quarter of 1974.

For comparison, while Japan’s October-December GDP declined 3.3% against the third quarter, the US saw a 1% fall while the EU experienced a 1.5% contraction.

Where were the declines seen? Here’s a breakdown of performance by major categories, compared against the third quarter:

Domestic Demand: -0.3%

Private Demand: -0.6%

• Private Consumption: -0.4%
• Household Consumption: -0.4%
• Household Consumption (excluding rent): -0.6%
• Private residential investment: +5.7%
• Private non-residential investment: -5.3%

Pubic Demand: +0.6%

• Government consumption: +1.2%
• Public investment: -0.6%

Capital Spending: -2.9%

Exports of goods and services: -13.9%
Imports of goods and services: +2.9%

The largest drag on GDP figures is clearly in the export category, which fell at an annualized 45.0% in the fourth quarter. Is there any end in sight for this? With bankruptcy figures still climbing and machinery orders still falling, the head of research at the Bank of Japan, told reporters last week that there is a possibility that the first quarter of 2009 might see worse numbers than what was reported today.

Japan’s GDP number is important for a number of reasons.  First, despite massive stimulus – economic and fiscal, Japan has never fully rebounded from the  stock and property market crashes that began nearly two decades ago.  While one cannot rule out demgraphic shifts as a major reason for the economy’s continued sluggishness, the Japanese experience reinforces the notion that stimulus is inadequate without a robust  financial sector policy response.

In addition, just as in the U.S. Q4 numbers, there was a significant inventory build in the figures which artificially goosed the final figure.  The GDP number would have been even worse were it not for the inventory build.  Given the massive layoff announcements in Japan and elsewhere, it is evident that companies are looking to reduce inventories drastically in Q1 2009, that is going to depress GDP figures.  I expect a serious downside surprise in Japan and the United States at a minimum.  Such a nasty surprise could have an important psychological impact for markets and consumers.

Further, the Japanese figures demonstrate the huge falloff in global trade as exports collapsed in Japan.  Similarly large falloffs have been witnessed across Asia including in Taiwan, Singapore, and South Korea.  Therefore, the figures in Japan bolster the notion that China’s economy is suffering mightily due to its export orientation.  This would also suggest that Sovereign Wealth Funds domiciled in China and elsewhere in Asia will have much less appetite for overseas investments, which could be a meaningful loss of investment demand should Western markets come under pressure.

As they plot their future investment strategies, SWFs are trying to gauge how deep the recession will be, how long it will last and what shape a recovery will take.

Some funds are facing pressure to invest more at home instead of abroad. The French government announced in November that it would establish a 20 billion euro SWF not just to help local companies cope with the effects of the credit freeze but also to prevent the takeover of strategic French firms by “foreign predators.”

Other SWFs in Asia and the Middle East, burned by investing early in the current crisis, are wary of going back into the market until they are more confident an upturn is in sight and the financial system has stabilized.

Lou Jiwei, chairman of the $200 billion China Investment Corp., said in December that “we don’t have the courage to invest in financial institutions anymore, because we don’t know what problems we’ll have.” Like the Singapore SWFs and some Gulf Arab funds, CIC invested early in the crisis in Western financial services companies and has lost billions of dollars on paper.

Analysts say China’s other SWF, the $312 billion SAFE Investment Company, is also sitting on book losses on some of its foreign investments, although they appear to be smaller than those of CIC.

Before buying abroad on a significant scale again, SWFs will have to make an assessment about the future strength of the global economy, and where its most vibrant growth centers and sectors will be. This recession is the worst since World War II, and possibly since the Great Depression in the 1930s. Unlike previous downturns, it has hit all major markets, both developed and developing. Demand for exports is down everywhere.

 
Finally, recent news from Japan overnight suggests that the economy is still headed down. One should see this as a harbinger of global economic trends.

Japan’s government may cut its economic assessment for a fifth month, Nikkei English News said, without citing anyone.

The Cabinet Office report, to be released on Feb. 19, is likely to downgrade it description of the economy from “worsening rapidly,” the Nikkei said.

The report may also cut its assessments for employment and personal consumption, the news wire said.

In sum, I see the Japanese numbers as big news. It has meaning far beyond the Japanese economy. This was a downbeat number which suggests that the global economy is indeed getting worse.

Sources
Japan’s GDP contracts 3.3% in fourth quarter, 12.7% annualized – Japan Economy & News Blog
Former saviors racking up losses – Japan Times
Japan to Cut Economic Assessment for Fifth Month, Nikkei Says – Bloomberg.com