Soft data in the US and Japan was not enough to spur central banks in either country into action over the last two days. For me, it highlights first how vulnerable the global economy is. But, more than that, it points to the ineffectiveness of present monetary policy as a way of delivering sustainable economic growth. Some thoughts below
Before I get into the specifics, let me say at the outset that the macro picture is of a world that has absorbed a massive amount of labor from China and the former Soviet Bloc in the last generation. And while absorbing this labor was difficult on middle class incomes in developed economies, until recently lower interest rates and increased private debt masked the deflationary pressure this influx of labor supply has had. Only in Japan, which has been living through a post-debt bubble period for longer than elsewhere in the developed world, was the deflation open for all to see. But now that most of the rest of the developed world is also constrained by private debt, and the Eurozone’s fiscal space is severely limited by the institutional framework, we see the deflationary forces. If Chinese growth wanes further, these forces will be still more acute.
That’s the macro backdrop against which slowing global growth has to be seen. Moreover, we also need to remember that rates are at zero and negative right across developed economies. And this limits monetary policy options were the global economy to slow any further. In Japan, consumer prices fell last month by the most in three years. The -0.3% number in March for year-on-year core CPI was also below expectations. And while production rose 0.1% year-on-year, this is no signal of strength due to that series’ volatility. It is spending that matters here and household spending dropped 5.3% from a year earlier, while retail sales fell 1.1% year-on-year.
For me, the data signal an impotence in Japan’s policy making. Abenomics was supposed to break the deflationary cycle. It hasn’t done. And to make matters worse, the yen soared the most in eight months and stocks tanked because the Bank of Japan added no new stimulus measures despite the awful data. There are a few conclusions one could draw, with the most obvious being that the Japanese central bank could do more. This is what market monetarists advise. I don’t see it that way. I think the political constraints to doing more are large. Let’s remember that we have negative interest rates and quantitative easing in Japan already. Moreover, the Bank of Japan owns 55% of all Nikkei 225 ETF contracts. And this makes the central bank a top 10 owner of the shares of 90% of the Nikkei. That’s a remarkable level of market support and stimulus.
On the fiscal side, the Japanese government has never allowed its efforts to take hold and push up inflation before dialing back under pressure to raise taxes and cut the deficit. But the fact of the matter is the deficit spending has been extreme nonetheless.
How much more can the Japanese do politically at this juncture? How much worse would things have to get before they did more? I think those are the right questions to ask.
In the US, the question I was asking yesterday was about Fed policy in an election year of slowing growth. And today we saw that growth was only 0.5% in the first quarter. Mind you, the first quarter has been sluggish repeatedly during this economic cycle. And if you look at the rolling nominal GDP growth number, there was a slight uptick with the Q1 numbers to 3.24%.
Nevertheless, the real GDP number ticked down ever so slightly to 1.95%, a tad under the 2% level I consider stall speed.
Against that backdrop the Fed has dropped its risk assessment verbiage in the FOMC statement. Basically, the FOMC upgraded the assessment of the global economy – perhaps due to financial conditions. And they downgraded their assessment of the US economy, but decided to look through that data and stay true to their two-hike ‘commitment’. And I write commitment in quotes because there is a sense in which Fed policy of providing such detailed forward guidance could lock them into a policy path by anchoring expectations. Right now, the market is saying there will only be one hike in 2016. SO the Fed has some room to come down without roiling markets.
But the bottom line in all this is that the Japanese inaction has led to the Yen’s inexorable rise as deflation becomes an issue again. And that makes further maneuvering in the currency wars a potent threat. I think the deflationary macro backdrop will continue to overwhelm monetary forces. And at some point soon, we will see more fiscal policy or a global downturn.