What's Going Right for Japan

Japan’s leading indicators index for February surprised not only because it was comfortably better than the range of expectations, but because it was the strongest reading since January 2008, and was almost exactly a full standard deviation higher than the series average since 1990.  We’ve become utterly used to Japan being a neutral or negative contributor to world growth, so it’s easy to let this slip by unnoticed and unexamined.

But it’s only the latest in a bunch of data from Japan over the last three weeks which has surprised positively. Earlier in the week, the 0.7% YoY rise in cash earnings sounds miserable, but was far stronger than the 0.1% expected, let alone the 0.3% YoY fall recorded in Tokyo core CPI. Last week, housing starts annualized to their highest reading since August, retail sales rose 3.5% YoY (beating consensus and range),  and overall household spending rose 2.3% YoY (beating consensus and range). On the industrial front, March’s manufacturing PMI gave its best reading since August 2011 and the Shoko Chukin SME gave its best reading for a year.

So the jump in the Leading indicators index isn’t simply a blip: something is stirring in Japan.  But here are two cautions:

• Usually an upturn in the Leading indicators index is anticipated and confirmed by an earlier rise in the Leading indicators relative to the Coincident indicator.  This hasn’t happened yet.
• And do the Leading indicators really tell us about the future, or merely confirm the present? The evidence of the last 20 years or so calls its forecasting value into question.

Returning to those fundamental ratios with which I track all economies (return on capital, labour productivity, leverage, savings flows, monetary velocity, liquidity preference etc), there's only one which is currently surprising. But since it's 'terms of trade', it matters. 

And it matters for Japan particularly, because its international terms of trade have fallen so sharply and regularly over the last 20 years that one has to use a semi-log scale simple to show it correctly. One of the most baffling things about Japan has always been why it has been unwilling or unable to price its goods internationally.  Well, since May 2011, Japan's terms of trade have done a very good impression of stabilizing, after hitting bottom during the commodities frenzy of 2008.  It is tempting to see this as evidence that the bankruptcy of Elpida Memory is not in vain.

At the same time as the unexpected stabilization of Japan's terms of trade, the yen has also given back all the strength against the SDR of the last six months. The result is that not only is Japan's relative ability to price its goods better now than it was in, say, July 2011, but also the yen is less uncompetitive internationally than in July 2011. 

We have virtually no experience in how positively a stabilized terms of trade might affect profitability, cashflow and investment-morale of corporate Japan.  However, we can suspect that the reaction will be rather like that when you stop banging your head against a brick wall. Nice.  And  for now, that seems to be the reaction that Japan's data is picking up.