Japan. When talking about the outlook for the Japanese economy, the first question is normally about the success or otherwise of Abenomics. The question almost inevitably focuses on the real side of the economy. This is a mistake. The problem with Japan is not the real economy but the nominal one. Let us first look at the real economy. That has been growing over the last 20 years, albeit slowly at about 0.8%pa. After allowing for working population decline, this works out at about 1.5%pa per head, not brilliant but not bad either, and slightly below the G7 average. This is hardly the stuff of crises. The problem for the real economy has been investment spending which has declined from 27% of GDP in 1995 to 20% now. If, say, that percentage had been maintained, real growth would have been 1.1% pa. But real investment had to fall; at 27% of GDP, it was too high and for the other 6 members of G7 it is under 20%. The decline in investment spending has been an important structural headwind for the economy. In comparison, real consumption has grown slightly faster than the overall economy, at 0.9%pa, and helps to explain why Japan always looks prosperous when one visits the country that is supposed to be struggling. Now look at the nominal economy. The problem is that it is more or less unchanged over the last twenty years. Thus with real growth of 0.8%, and nominal growth of zero, deflation has been 0.8%. Even with extremely low interest rates, zero nominal growth makes it impossible to service the debt burden. As with the real economy, consumption is not the problem as it has risen by 0.3%pa over the period. As with the real economy, it is investment which has fallen by 1.1%pa. The trade account also has not helped. The rise in the yen has forced exporters to cut prices and the rise in the oil price effectively makes it more difficult to service debt costs. Thus the question we need to ask is whether Abenomics has succeeded in increasing nominal GDP growth, and the answer to that is a qualified yes. It has to be qualified because we are only looking at three years of data, which is too short a time period to reach any real conclusions. What we are looking for is both positive nominal growth and one that is greater than the real rate and that is what we have had. Over this short time period, nominal growth has been 1.1%pa compared to real growth of 0.3% implying inflation of 0.8% and roughly the same applies to the subsectors of the economy, most notably exports which has seen nominal growth of over 8%pa over the three years and real growth of 4.0%. The key of course is the fall in the yen, the most significant consequence of Abenomics. This is not a trade war; real imports have risen by 4.7% and net trade has made zero contribution to either real or nominal growth. In addition to the short time period, the other problem has been the battle over the consumption tax, the rise of which last year came close to derailing the whole project. The increase was misjudged; Japan’s problem at the moment is not excess debt but deflation. The time to solve the debt problem will be when the economy is growing in nominal terms. Despite this, the evidence is that Abenomics has successfully changed the dynamics of the Japanese economy, primarily through the decline in the exchange rate.

Latest PMI data. The latest PMI monthly data indicate that the global economy is growing at a moderate pace, probably a bit over 3%, with very little evidence of a breakout on either the upside or downside. In the last two or three months, growth has weakened ever so slightly, but not sufficiently to force anyone to revise their overall growth forecasts. The OECD countries are probably doing a bit better than the developing countries albeit the OECD lead indicators suggest the outlook for developing countries is slightly better. The gradual fall in Chinese growth rates will have an impact on overall growth rates but it is unlikely that this fall will actually impact growth rates elsewhere. Latin America is not doing well at all with Brazil in a oomplete mess. But it is a mistake to focus too much on potential bad news. There is quite a lot of good news out there, namely the fall in the oil price and continuing monetary stimulus. Most of Asia is benefitting from the oil price as will most of Africa (outside of the oil producers) and also much of Europe. The European situation has improved a bit over the last two or three months helped no doubt in addition by the fall in the euro. Overall it would be a mistake to get too pessimistic about the outlook.

OECD GDP growth. The OECD published an interesting chart a couple of week ago showing the breakdown of growth within the OECD area in the 3rd quarter of last year. Given all the doom and gloom about the outlook, these figures are actually quite encouraging. They show overall growth of 0.6% in the quarter (annualised 2.4%) with positive contributions from consumption,investment and net trade with the only detractor being a decline in inventories. This was after growth of 0.5% in all of the first half. So why the doom and gloom? The best explanation would seem to be the threat of deflation. Whilst real GDP growth looks just about acceptable, nominal growth does not and for this we have to thank Japan and Europe. Japan is struggling to scape deflation despite an aggressive monetary expansion but Europe still looks as if it is slowly but surely sinking into deflation. In the short run, the picture is reasonably encouraging. The Federal Reserve is moderately positive about the outlook for the American economy and the UK economy should do sufficiently well to boost the current government in advance of the election. The outlook for Asia is also positive helped by the fall in the oil price which should make life easier for Japan. Even Europe is showing signs of recovery as indicated by the German IFO survey and other monthly data. The longer term problem for Europe is that nominal GDP growth is unlikely to be sufficient for the periphery countries to escape the debt trap, which is a perfectly rational explanation for the collapse in their bond yields. They are all politically committed to remain within the euro area despite continuing deflation and very low economic growth. But in the meantime, the positive trend of the 3rd quarter of 2014 will extend into this year. THe fall in the oil price will boost real incomes throughout the OECD and must lead to stronger consumption. Whether that boost will be sufficient to persuade some central banks to raise rates towards the end of the year will be one of the imponderables of the second half of 2015.

World industrial and export trends. One thing not much discussed in the economics blogosphere is the aenaemic growth in world trade. This has been about 3%pa over the last two years as opposed to 15%pa in the years before the financial crisis. It is particularly noticeable for developing countries where there has been a dramatic decline in export numbers but also true of the OECD countries. There are many explanations, the end of out-sourcing, the collapse in commodities etc, trade barriers and so on. But whatever the reason, it all feels as if something has changed in the world economic order. Something similar has happened to industrial production but it is not so pronounced, and is more a reflection of weakish overall economic growth. Here the noticeable point is that emerging market industrial production growth has fallen to that of the OECD, whereas it used to be more than twice as strong (only partly due to China)

Should Greece leave the euro? The answer is probably yes. A Grexit is is almost universally portrayed as a disaster but to whom? Would it be a disaster for the Greek people? Possibly but possibly not; it depends on how Greece runs its affairs post a Grexit. In the immediate aftermath of a Grexit, there would be banking chaos as Greek banks went under with deposit outflows and assets overwhelmed by euro denominated debt. But is this a disaster - who cares for the Greek banks? The Greek people would benefit almost immediately from the sharply realigned exchange rate, an immediate external devaluation rather than the grinding and painfully slow internal devaluation. The one valid argument against a Grexit is that the internal devaluation is forcing a massive restructuring on the Greek economy turning it into something close to a modern competitive one on a par with the rest of Europe. A Grexit would stop that process which would be a shame. There is good evidence that the Greek economy is benefitting from its restructuring and the economy is growing again albeit after a 25% contraction. But the problem is that the debt burden is still rising. The economy is not growing fast enough to allow that burden to fall and the blame for that is Germany. If Germany wants Southern Europe to restructure, it must pursue a domestic agenda that will allow those economies to grow fast enough to repay their debt, and that means inflation. Inflation within Germany would allow the readjustment between German prices and South European prices to happen much more quickly than it is currently. Driving down the value of the euro does not help; that principally helps German exporters and does not affect the relative prices between Germany and her fellow euro members. Other arguments against a Grexit are specious, and are mainly to do with protecting European banks. When European politicians argue that a Grexit would be disastrous, it is not the Greek people they are thinking off but rather it is the impact on European banks that concerns them, who would be forced to write off Greek debt and bankrupt themselves in the process. We see a Japanese scenario here from the early 1990s; do whatever to protect the banks and avoid an extremely painful but necessary restructuring. The sad thing about the whole mess is that the extremist political parties who are benefitting from it are probably right.

FMOC. The FOMC’s minutes seemingly suggest that its members do not think that low inflation (brought on in part by low oil prices) should prevent them from raising rates sometime in 2015. This is a little bit surprising for as well as weak inflation the US economy has softened a bit in recent months. This puts the FOMC in a bit of bind. In the short term, the economy is weakening and inflation is falling; this means no rate increase is required. Falling oil prices, however, means a boost to real incomes which in the medium term should help consumer spending and so sustain the economy on its 2% to 3% path. If the economy can maintain such a growth rate, the first steps to normalising interest rates cannot be too far away.