Japan Posts Strong GDP Growth

Consumer durables and business investment push higher, but real return on capital continues to drop. Japan's fourth-quarter GDP rose at an unexpectedly strong 4.6% annual rate over the previous quarter. Domestic demand added more to the gain than did net exports, even though external demand has been a key feature of expansion. The main driver of this domestic strength was household consumption (excluding imputed rent), up a real 3.1%. Non-residential investment turned positive for the first time since the beginning of 2008. Additionally, revised data show that GDP has grown for three straight quarters, but remains 6% below its first-quarter 2008 peak. Consumer Durables Automobiles and household appliances are behind the strong household consumption figures. Government subsidies for environmentally friendly products pushed quarterly purchases of consumer durable goods up over 40% (annual rate). The nominal increase was 22%, despite accelerating deflation. Indeed one motivator for consumption is falling prices. The durables deflater, which had been falling a steady annual pace of 6% throughout the 2000s, is now close to -14%. The fall reflects intense competition, excess capacity and a consumer shift toward lower-priced goods, which is not fully reflected in the price index. Demand for non-durables and services barely changed even as durables soared, pointing to the potency of the stimulus. Business Investment Following a 25% collapse over six quarters, real business investment rose 4% (annual rate) at the end of the year. Driven by foreign and domestic demand for machinery and a rare decline in domestic capital stock, producers increased their purchase of investment goods. As exports continued to drive industrial output, core machinery orders jumped 20% in December and were positive for the quarter as a whole. Although the bulk of the increase was for overseas demand, domestic orders ceased their sharp declines. A survey of manufacturers forecast a continued increase in machinery orders into 2010. Trade Buttress GDP-based real exports of goods and services rose a price-adjusted 21.7% in the quarter, pushed along by strong demand from Asia, and not just China. Whereas goods exports to Asia rose at a nominal annual rate of around 33% in the quarter, sales to the United States rose a more modest 13%. Europe saw a rise of 29%. The locomotive effect from Asia continues to be the major driver of Japanese manufacturing, which in turn has moved the entire economy. Confidence is Returning The consumer confidence index, business confidence composite leading index and economy watchers diffusion index for future conditions all turned around at the beginning of 2009. GDP followed within two to three months. Although none of these indexes has returned to pre-recession levels, the recovery track mirrors the speed of the decline. Short-Term Outlook Environmentally friendly subsidies that stimulated consumption were countered by weak employee compensation, which has fallen in real terms by 2.5% from the plateau reached in 2006-2008. Total employment from the household survey has crept up from 2009 lows of 0.5%, but trended aggregate hours have not budged for the past year, and remain around 5% below the previous five-year average. The jobs survey of firms indicates cash earnings continue to fall across all sectors and are now about 10% below year-ago levels. Eventually the labor market should improve as trade recovers and pulls along industrial output. But persistent excess capacity will blunt a jobs recovery for another year or so.