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Has Japan overcome deflation?
Japan’s long-term quest to eliminate deflation has had a big and stubborn obstacle: what the Japanese themselves expect. The long history of little price growth perpetuates the expectation that companies cannot raise prices. Those who step out of line are penalized with reduced sales. So companies keep prices low, which leads to small wage increases. Because prices tend to remain fixed, consumers are in no hurry to spend their (stagnant) earnings. The whole economy falls into boredom.
Breaking this pattern is very difficult. But since last year’s commodity shocks, a reasonable path out of the deflationary muck has emerged. It might look like:
An external commodity cost shock drives up the prices of things like energy and food.
The yen weakened as Japan, which had to spend more of its purchasing power on energy and food imports, ran into a trade deficit. This increases the prices of other imported goods as well.
Inflation rises on the producer side, but for fear of putting off customers, companies bear high import costs for some time.
But eventually this becomes unsustainable, and as companies are forced to pass on price increases, consumer inflation rises.
Consumers, left to reckon with the new inflationary reality, begin to demand compensation for wage increases; They put their newfound purchasing power to work, and a virtuous spiral of wages and price ensued.
More or less it happened – other than the last bullet. The graph below shows consumer and producer inflation in Japan. Note that it took PPI to reach 9-10 percent over several months before CPI broke 1 percent:
Can Japan take the last step? Can imported cost-push inflation, which will not last forever, be exploited in domestic demand-pull inflation? This is what the Bank of Japan wants, and why it has moved mountains to keep the ultra-accommodative yield curve control policy in place. The problem is that inflation still seems mostly cost-driven. Wage growth, although significantly higher, fell in the latest reading for November, still below the 3 per cent rate that the Bank of Japan believes is needed to maintain an inflation rate of 2 per cent:
But there is good news. Kana Inagaki and Eri Sugiura of the FT report:
Fast Retailing, Asia’s largest clothing retailer and owner of fashion brand Uniqlo, will increase employee wages in Japan by up to 40 percent as inflation in the country rises at its fastest pace in decades…
While many Japanese companies have a seniority-based pay structure, the retailer will rate employees based on their performance and ability to contribute to the business, he added…
To counter rising costs, the group increased prices for flagship products at Uniqlo stores in Japan last year, with sweaters jumping from 1,990 yen to 2,990 yen.
Fast retail is not alone. Ahead of the annual union wage talks in the spring, a slew of Japanese companies recently announced proactive pay increases, including firm firms like Nippon Life Insurance (7 percent bump). Bandai Namco, the video game maker (and publisher of my favorite game of 2022), is raising starting salaries by 25 percent.
This all heralds a major shift in the psychology of inflation, thinks Pelham Smithers of Pelham Smithers Associates, the go-to Japan watcher. As explained to us yesterday, the general rate of inflation probably underestimates how deeply the wage and price dynamics have changed:
Two things have happened over the past year. The first is that inflation in Japan was a big media story. It would be very difficult to watch the daily news without getting caught up in the inflation story.
The second thing is that Main Street [retail] Inflation was basically double the national rate. [In contrast to, for example, rent inflation near zero] If you’re a high street shopping person, you’ve seen inflation of 6 to 7 percent. So you feel that prices are going up. . . Don’t think of “Oh, my rent hasn’t gone up” as an important factor. You just look at the price of flour and eggs and think, “Oh my God”…
Since large portions of Japanese household spending have not gone up, the headline rate is not that high. But the psychology of the Japanese about inflation is probably worse than the peak in the US or the UK, because they haven’t experienced it for 30 or 40 years.
Changing the inflation regime is likely to reshape the country’s stagnant stock market: nominal earnings may finally be expanding. This would make the attractiveness of investing in Japan more apparent to global investors. (Ethan Wu)
Are we heading towards a corporate debt crisis? (part One)
Americans for Financial Reform, a consumer advocacy group, is deeply concerned about the prevalence of risky corporate debt, and has just released a research paper on the topic of a “shadow giant.” There’s a lot we both agree and disagree with, and it’s well worth a read. The author, Andrew Park, believes the rapid growth of low-quality corporate debt is worrisome for five reasons:
It is largely used for purchases, dividend payments, refinancing and buybacks – not to expand companies’ productive capacity.
Its risks are masked by poor reporting practices: Rampant adjustments to ebitda, already a non-GAAP metric, mean that regulatory guidelines on leverage are regularly flaunted.
They are often issued and/or owned by poorly regulated institutions, rather than banks or mutual funds operating under proper oversight.
Much of it is securitized and/or packaged in collateralized debt obligations, which means originators don’t eat their own cooking and have incentives to hide low quality.
They are increasingly owned by insurance companies or, worse, private equity-owned insurers, creating systemic risk.
Many of these are familiar, as they are echoes of the underlying problems of the subprime mortgage crisis that began 15 years ago. And while each of them deserves individual attention, I’m more interested in a broader cause that underlies them all: the idea of existence Only a lot of low-quality debt is circulating around, and sooner or later it will explode in our facesor as the AFR puts it:
The explosion of substandard lending has sent US corporate debt burdens to record levels, a development that, in the coming years, is likely to bring a wave of defaults, slower growth, future job losses and potentially word-of-mouth instability. The opacity of this work
I think that’s always a good question to ask, and it’s an especially good question to ask now. It’s always important because humans, if left alone, will always keep adding to debt until something breaks. The strength of the leverage multiplying the return is sufficient to ensure this; Laws that give debt financing a huge advantage over equity only make it worse. It’s important to think about the question now because rates have gone up quickly, and will probably stay high. We don’t know how this large stock of outstanding debt, issued when rates were low, would respond.
The problem with thinking about the problem in general is that it is difficult to keep track of the amount of debt and how serious it is. AFR estimates that the total US stock of “mortgage” corporate debt (junk bonds, leveraged loans, direct lending) is worth $5 trillion. According to national accounts, non-financial corporate debt (bonds and loans) totals $12.7 trillion, making low-quality debt just under 40 percent of the total. But I don’t yet have a “mortgage” time series, so I don’t know how much 40 percent is for the date.
So what can we say about the seriousness of corporate debt in the United States? One thing we can say is that debt is less and less in the entities that are most regulated and supervised: banks. Here is a graph of the growth of total loans and rents held by all US commercial banks, since the mid-1970s (data is quarterly, and presented as a three-year rolling average):
As growth in corporate debt picked up, growth in bank lending slowed. It was crushed after the housing crisis and never recovered, pulled by the bond and securitization markets. Therefore, Park is absolutely right in saying that US corporate debt is being regulated more and more.
But whether leverage is really increasing is a more complicated matter. The following chart shows corporate debt as a percentage of GDP, which is on a clear long-term upward trend, and corporate debt as an earnings multiplier, which is not:
Debt-to-earnings before tax varies with the economic cycle, as one would expect, but it hasn’t gone up, and it’s not historically high now. One might be inclined to conclude that American corporations have added more debt because they have become more profitable, and they can afford more.
(Ideally, the light blue line would show debt relative to EBIT, but this is difficult to extract from the national accounts. The chart as is should reflect the right trend, but it would reflect the impact of lower interest rates, which would be good to exclude. I do. on him).
The graph does not show changes in debt quality over time, which is Park’s point. But it raises a good question. Rather than asking if there is too much debt, shouldn’t we instead ask whether historically high corporate earnings are sustainable?
There’s a lot to be said here, and we’ll mention some of it in the coming days and weeks.
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