Japanese Phantom Growth

Et tu, Japan? Says Dr. Richebacher: "Japan’s statisticians have learned from their American colleagues how to conjure up the perception of an economic recovery that does not exist."

Lately, international investors have become enthusiastic about Japan’s economy and stock market.

Several American investment banks have trumpeted that the turnaround of Japan’s economy has arrived. Foreign investors have been pouring money into Japanese stocks, boosting the yen in the process. Officially, Japan’s real GDP grew in the second quarter by a sensational 3.9%, beating America’s growth rate of 3.3%.

Our knowledge about Japan’s economy comes exclusively from the monthly reports of its central bank, the Bank of Japan. Its September report stated:

"Economic activity still continues to be virtually flat as a whole, although signs of improvement have been observed in such areas as the environment for exports. With regard to final demand, business fixed investment is recovering gradually.

"Meanwhile, private consumption continues to be weak, housing investment remains sluggish, and public investment is declining. Net exports are virtually flat. Industrial production continues to be basically level in response to these developments in final demand, and corporate profits are on a moderate uptrend."

Japan’s Economic Prospects: Statistical Hoax

This hardly reads like the description of an economic recovery. But how to reconcile this dismal description of the economic situation with the officially reported stellar real GDP growth rate of 3.9% for the second quarter? Putting it bluntly: It is exactly the same statistical hoax as the 3.3% simultaneously reported for the U.S. economy. Japan’s statisticians have learned from their American colleagues how to conjure up the perception of an economic recovery that does not exist.

Yet in Japan’s case, there were some critical comments in the press. A report in the Financial Times quoted an economist as saying that "the government deliberately manipulated statistics" using in particular an "incorrect measure of deflation."

This, in turn, provoked a reply from the head of the Japan’s Department of National Accounts, a Cabinet Office. In his letter to the FT, the director explained that the "basic price statistics used in Japan’s GDP deflators, such as the consumer price index and corporate goods price index, adopt the hedonic method to track price changes accompanying quality improvement in it goods" – stressing that this is common international practice.

To be precise: Just like the practice of annualizing quarterly numbers, this is an American, not an international, practice. Without the annualization, reported real GDP growth would have been 1% in the quarter, and 3% year-over-year. In today’s world of sluggish growth, that would also be impressive, if its main source was not hedonic pricing of computers. Under its impact, nonresidential investment grew 4.7%, or a stunning 20.2% at annual rate.

Measured in current prices, a radically different picture emerges: Japan’s nominal GDP grew during the quarter by a dismal 0.3%, or 1.2% at annual rate. Year-over-year, it was up 0.5%. Repeating the first sentence of the above citation from the Bank of Japan: "Economic activity still continues to be virtually flat as a whole."

Japan’s Economic Prospects: 3.9% or 0.3%

Assessing the Japanese economy’s performance and prospects, there is a broad choice. If you want to see an economy and a stock market powering ahead, focus on the 3.9%, as measured in real terms and annualized; if you want to see an economy that remains stuck in the post-bubble aftermath, focus on the 0.3%, as measured in nominal terms and without annualization.

Such a vast difference in measured economic activity is, of course, laughable. One of them must be completely out of whack with economic reality. For us, there is no question which one – the 3.9%. It has two main statistical sources that we regard as outright phony: first, annualized quarterly figures; and second, a very low GDP deflator.

Take these two statistical gimmicks away, and you end up with the earlier mentioned mini-growth rate of 0.3% in nominal terms for the second quarter. From the above citations of the Bank of Japan, we conclude that it, too, favors this measure.

But which of the two is the better measurement of economic activity? "Real" figures attempt to measure the physical volume of goods produced and sold in the economy by adjusting nominal figures with calculated inflation rates. Falling prices essentially increase real GDP growth, and rising prices decrease it. By contrast, the nominal figures simply add up the amount of money that has been spent on various demand components.

We have to say that we are principally opposed to translating falling prices into rising real GDP growth. It corresponds, of course, with the opposite practice to deduct inflation rates from nominal GDP growth. Mechanically, both seem equally logical, but economically, this equal treatment makes no sense. Consider that the steeper the fall of prices, the higher the economy’s real GDP growth rate.

For us, the decisive consideration is that the real figures tell us nothing about the movements of incomes and profits. These only show in nominal figures, based on money transactions. This may have been less important in times of high inflation, but in our time of protracted economic sluggishness, the money measure is far more important than the volume measure.


Kurt Richebacher,
for The Daily Reckoning

December 11, 2003

Dr. Kurt Richebächer’s articles appear regularly in The Wall Street Journal, the U.S. edition of The Fleet Street Letter, The Fiancial Times and other respected publications. France’s Le Figaro magazine did a feature story on him as "the man who predicted the Asian crisis." Dr. Richebächer is currently advising his readers how to steer clear of the Fed’s monetary policy mistakes.

The tax cuts and rate cuts have done their work. Americans have gone deeper into debt…while believing they were getting richer.

Since the beginning of the Dollar Standard era in 1971, debt has increased about twice as fast as GDP. That is, for every new dollar of output…$2 of new debt were added. But as liabilities increase, it takes more debt to move the economy forward, while still covering previous borrowings. Last year, for example, debt increased 7 times faster than GDP.

But now, the whole debt machine seems to hesitate…

Mortgage demand is near an 18-month low, says CNN.

The money supply, M3, is ominously – and a bit mysteriously – falling.

The dollar is falling; foreign dollar holders are getting sick of being chumps. But despite a large drop against the euro and gold, the trade deficit continues. Foreigners scarcely seem more eager to buy American goods than they were a year ago. Nor has Americans’ appetite for foreign- made products declined. The dollar is linked to the Chinese yuan by decree; as the dollar falls, Chinese-made goods become even cheaper.

The dollar is America’s I.O.U. If the U.S. economy could stage a real recovery…the dollar might recover, too. But what could it recover from? The economy is in such a strange slump…it is any wonder the ‘recovery’ is just as odd? Jobs are supposed to be finally increasing – but last week’s number came in at less than half of what was expected. People are waiting longer to find new jobs, too – up to almost 20 weeks. And while layoffs from serious jobs continue, the NY Times refers to the new jobs as "restaurant hiring." If someone can explain how busboys and waitresses are supposed to lead the world’s largest and most-indebted economy…he has not explained it to us.

The dollar bounced a little yesterday, after 8 straight days of losses against the euro. Still, the surest bet around seems to be that the dollar will fall more. Even TIME magazine is talking about ‘hedging’ against the dollar’s fall. Meanwhile, the smart money – Soros, Buffett, Templeton, Rogers – is betting against the dollar, hoping to make epic profits as the dollar declines.

Our friend, David Galland, sends this note from his new publication, What We Know Now: "When the U.S. dollar historically begins to weaken, it stays weak for a very long time. To be more specific, we turn to Everbank’s head trader, Chuck Butler. "The first weak dollar trend of the period began in 1971 and ended in 1978, 7 years in duration. During that period, the Swiss franc gained +186% versus the dollar. The Deutsche mark gained 53% during the same period. "The next weak dollar trend began in 1985 and ended in 1996, 11 years in duration. During that time, the Swiss franc gained +138% versus the dollar. The Deutsche mark gained 53%. "As we are still not even two years into the current dollar weakness (the current downturn began in February 2002)…we have a rare opportunity to get in early into what could be a very long trend. While you have the luxury of waiting a week or so to see if the dollar manages a short rally – because it is almost certainly getting ahead of itself just now – but even if you don’t feel like waiting, don’t be overly concerned – based on all the evidence, the U.S. dollar has a long way to fall. Which means other currencies will continue to gain. "The easiest way to invest in other currencies is not through some fly-by-night commodity scheme, but through Everbank, which offers FDIC insured deposit accounts denominated in any of the major currencies."

Until then, here’s Eric with today’s scoops:

Eric Fry in New York…

– The Japanese bought themselves a nice little dollar rally yesterday. According to the scuttlebutt from the London trading pits, the Japanese central bank scooped up about 10 billion dollars in the open market yesterday, in an effort to prop up the ailing greenback. The dollar purchases, while large, were not out of the ordinary for the Japanese central bank. The Bank of Japan has sold a record 17.8 trillion yen ($164 billion) this year in order to weaken the yen against the dollar. We suspect these massive dollar purchases will go down in history as one of the worst Japanese investments since buying Pebble Beach.

– Yesterday’s contrived dollar rally produced a swift sell- off in gold and gold shares, while helping to support the struggling stock market. The Nasdaq recovered from early losses to post a modest drop of only 4 points at 1,904. The Dow slipped 2 points to 9,922. Treasury prices bounced a little yesterday, pushing the 10-year bond yield down to 4.32% from 4.35% on Monday. According to the newswires, the bond market rallied because investors expect the Japanese to spend most of the 10 billion dollar bills they purchased yesterday buying Treasury bonds.

– "Speculation that the BOJ will invest the dollar proceeds of its yen sales in the U.S. Government bond market boosted Treasury prices in early trading," Bloomberg News reports. "Fed holdings of Treasuries on behalf of foreign central banks have risen to record levels in each of the last three weeks, most recently $826.8 billion the week ending December 9." How many bonds can the bank of Japan buy, we wonder? And what would happen if and when they reduce their purchases?

– Gold shares struggled all day and finished the session on their lows, as gold for February delivery fell $1.90 to $407.00 an ounce. Gold’s modest decline would not have seemed so bad, except that the yellow metal touched $413.30 an ounce earlier in the session, the highest price since February 1996. But gold’s downward reversal during the afternoon seemed to break the spirit of gold bugs, who unceremoniously dumped gold shares of all shapes and sizes. Bellwether Newmont Mining tumbled more than $2 to $45.70, while The AMEX Gold Bugs Index collapsed more than 6%.

– One reason the gold shares may have suffered such a steep drop relative to the modest sell-off in gold itself is that there’s a new kid in town. As Addison mentioned yesterday, Gold Bullion Securities Ltd. started trading on the London Stock Exchange on Tuesday. The new security is a kind of "paper gold" that trades just like a share of Newmont Mining – maybe too much like a share of Newmont Mining – but represents a claim on actual gold bullion. Presumably, some large percentage of the gold-stock-buying public would prefer to own the thing itself, rather than the shares of a company that mines gold. – "Gold Bullion Securities won’t act exactly like an exchange-traded fund," explains Dan Denning, editor of Strategic Investment, "but in principle, it’s the same thing. That is, it’s a proxy for physical gold, a way for you to profit from the rise of spot gold prices without having to buy, take delivery, or store the physical asset." – "GBS is backed by physical gold," Dan continues. "It will own physical gold, held in a vault, and then ‘securitize’ it by issuing shares. Each share of GBS will trade at 1/10th the price of an ounce of spot gold. Even though it trades in London, all the pricing will be in U.S. dollars…As institutional and retail investment demand for gold rises, GBS plans on adding more bullion reserves to its trust, and issuing new shares based on the new reserves. How many shares it ends up issuing depends on how much demand there is for gold-backed shares."

– Gold bulls hope that the new security will create a mini- boom for physical gold. Now that buying gold is so easy, they say, demand for gold will soar. The bulls may have a point. – "If GBS becomes a real paper proxy for physical ownership of gold, just how liquid could it become?" Denning asks. "One possible comparison is the QQQ, the ETF for the Nasdaq 100. On a good day, the "Triple Qs" trade around 60 million shares. That’s good enough to usually place them in the top 10 of the most actively traded public shares on any given day. For example, on Friday, volume on the Qs was 87 million… – "There’s not a gold stock among the top 50 most actively traded shares for Friday. Newmont (NEM) rolled in at 55th, trading just under 5 million shares. If a U.S.-listed GBS does to gold what the Qs have done to the Nasdaq, you’re looking at daily volume of at least 50 million shares trading hands, which raises an obvious question of how large a U.S.-listed GBS would become. At a gold price of $400, and with each share of GBS trading at 1/10th of an ounce of gold, a potential volume of 50 million shares a day implies just under $2 billion in bullion assets…" – Thanks to the new gold security, buying gold has never been easier. But why bother, says the Wall Street Journal. "The stock market swoon has ended," the esteemed journal triumphantly declared yesterday, "leaving investors freshly attractive alternatives to buy in lieu of gold."

– Hmmm…The Wall Street Journal still scorns gold. Maybe the gold bull market isn’t over yet.

Back in Baltimore…

*** California debt was downgraded, again, by Moody’s. U.S. debt won’t be far behind.

*** When the consumer stops spending, how will you profit?

"Besides Wal-Mart, I think shorting CountryWide Financial Corporation is a good idea right now," suggests Dan Ferris. "It represents 13% of the nation’s mortgage market. Its mortgage business has taken huge, double-digit hits in each of the past three months.

"And today, Washington Mutual, another big mortgage lender, revised its outlook downward due to weakness in its mortgage business.

"By the way, did you know that 85 million households are in the stock market now? Low interest rates have kept stocks and homes popular as investments, and speculations…and foolhardy purchases.

"Where will it all end? How?

"I don’t know the answers, but I’m going to sell Wal-Mart and CFC and buy debt collection agencies, gold, commodities and whatever dirt cheap, inflation-proof businesses I can get my hands on. I’ve found one of the latter for the current issue of Extreme Value: orthodontics!"

*** From a Daily Reckoning reader: "I remember a factual story of years ago when either Henry Ford I or Henry II was walking around the/a new Ford factory with Walter Reuther, then the head of the Auto Unions. Henry was talking about how many fewer workers this factory needed than other ones. He continued by saying that in the future, we would have almost NO workers building cars and trucks. Walter responded to Henry and said, ‘That’s great – who is going to buy these cars and trucks, then?’

"All this productivity is the same thing. Export jobs. Destroy the middle class. We will have Argentina and Brazil – where the wealthy live in gated communities, fearful to show any wealth, while the vast lumps hate them and look for ways to rob them.

"The difference is, now all the rest of the world hates us as well and ‘lumps,’ no pun intended, all of us together as ugly Americans."

*** "Gratuitous insults…"

That is what several readers have made of our comments on Americans. "What possible difference does it make how people dress?" asked one Daily Reckoning sufferer.

The Daily Reckoning is a free service. We feel entitled to insult whomever we please, at no charge. But, as we explained to Henry’s priest after he read our comments about him, the DR is also a new kind of journalism. Your editors give their opinions, their observations, their reflections – without malice, but also without worrying about whose feelings might be hurt. One reader accused of us being ‘anti-American.’ We deny the charge. But we admit that we are not ‘pro-American’ either. Fools, knaves, geniuses and saints are fairly well distributed across national borders, we maintain.

But we do worry about Americans…for they are us. We look in the mirror and wonder: Perhaps we have had it too easy for too long? Americans have come to believe things that can’t be true…but are too comfortable, too complacent, and too lazy to want to think too hard about it. We hate criticism…but it is probably just what we need. Or a kick in the pants. Americans seem so relaxed…so ready to go along with anything…so sure that everything will work itself out for the better.

Maybe it will. But we think we see the gods putting on their steel-toed boots.

The Daily Reckoning