Japan's desperate bid to kick-start economy

By Ambrose Evans-Pritchard
The Telegraph, London
Thursday, October 30, 3008

http://www.telegraph.co.uk/news/worldnews/asia/japan/3286794/Japans-desp...

Japan is to give emergency cash handouts to every household in the country regardless of whether they are rich or poor as a part of $260 billion (L159 billion) blitz to kick-start the world's second-largest economy and prevent a slide back into deflation.

The raft of measures comes amid reports in the Japanese press that the Bank of Japan is mulling a cut in interest rates from 0.5 percent to 0.25 percent as soon as today, chiefly aimed at curbing any further rise in the yen exchange rate after its spectacular increase since the summer. The futures markets are pricing in a 50 percent chance of a cut.

"A harsh storm seen only once in 100 years is raging," said Japan's premier Taro Aso as he unveiled the spending plans in Tokyo.

The package includes payments of $600 for a typical family of four, as well as tax relief on mortgages, in the raft of measures worth $50 billion, or roughly 1.2 percent of Japan's GDP. It is the second fiscal package in two months.

The government is extending a further $210 billion in loan guarantees targeted at small and medium-sized firms struggling to rasie money or roll over debts as the credit crisis bites deeper.

The talk of combined fiscal and monetary stimulus helped lift Tokyo's Nikkei stock index above 9,000, ending its seemingly unstoppable slide. The bourse is still trading at levels first reached in 1983 -- a warning to the rest of the world of what can happen to equities once a country succumbs to debt deflation.

Japan held rates at zero for nearly six years in its decade-long struggle against deflation. When that was not enough it resorted to "quantitative easing", a technical term for what amounts to printing money on huge scale.

The Bank of Japan had hoped to nudge the country to normal rates over time but the violence of the global credit crisis has now brought the fragile recovery to a standstill. The economy began to contract in the second quarter. The trade ministry said industrial output is likely to fall 2.3 percent in October and 2.2 percent in November.

Leading exporters Toyota, Honda, Sony, and Canon have all slashed earnings forecasts, while the electronics companies Hitachi and Toshiba both reported a loss over the last three months.

"We think that Japanese rates will be cut all the way to zero again, most likely in January," said Mark Williams from Capital Economics. "We expect a return to deflation next year in the wake of the collapse in global commodity prices."

Japan remains the world's top creditor nation by far with a $15 trillion pool of savings and some $3 trillion in net overseas investments. The ups and down in Japanese sentiment can have a powerful effect on world markets.

A mixed army of life insurers, pension funds, and housewives with margin trading accounts, as well as foreign hedge funds, borrowed at near-zero rates during the credit bubble to chase higher yields across the world, pushing up asset prices from Australia to South Africa, Brazil, and Britain.

This yen carry trade -- estimated at $1.4 trillion in all its forms -- has now reversed violently as flight from global markets leads to yen repatriation. This has forced up the currency by almost 40 percent against the euro and sterling since August, and by almost 50 percent against the Australian dollar.

Those playing the carry trade with high leverage have been caught in a brutal squeeze as margin calls force investors to liquidate assets. This in turn has pushed the yen even higher, setting off a vicious circle. The yen has fallen back this week as US rate cuts and swap agreements with emerging market economies help restore a degree of global confidence, but few in Japan are yet convinced the coast is clear.

Michael Taylor from Lombard Street Research said Japan had enough leeway to "turn on the fiscal tap" after pursuing a tight budgetary policy in recent years, but doubted whether the latest spending package will achieve much over time.

"Japan is clearly in recession, so this will help," he said. "But you need continual, increasing doses to keep things going. Otherwise its just a one-shot gain."

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