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Business Conditions, Capital Spending, Industrial Output all Down, Yet Consumer Spending Holding Up

The Cabinet Office published its monthly Index of Business Conditions for January earlier today, and we have seen a decline in all three indexes for the first time since September of last year. This report generates three scores, which are referred to as diffusion indexes. The three categories reported are the leading index, the coincident index, and the lagging index. The leading index is meant to evaluate business sentiment for the future, the coincident index measures sentiment in the current period, and the lagging in the period previous to the report. For each index, a score below 50 indicates pessimism, while a score above 50 indicates an optimistic result.

January results showed the Leading Index falling from 50.0 in December to 30.0 in January, while the Coincident Index dropped from 63.6 to 22.2 and the Lagging Index fell from 66.7 to 62.5 (incidentally, we have not seen all three indexes below 50 since February 2007).

The fall in the Leading Index is what tends to worry economy watchers the most. Although it stood exactly on the fence at 50 in December (a figure which has since been revised down to 45.5), the score had seen an encouraging rise from the previous four months, when it checked in at 25.0, nil, 16.7 and 16.7.

Just last week we noted that industrial output had slid 2.0% in January, and that figure seemed to have been caused by nervousness over the course of the US economy. The Leading Index supports that supposition, though fears may be even reach beyond worries over the US economy.

To make matters worse, on Wednesday the Ministry of Finance announced that capital spending fell at its steepest pace in five years during the October-December quarter. According to the Ministry’s data, capital spending declined 7.3% during the fourth quarter, greatly exceeding the expectations of most Japan watchers.

What does this all mean? For starters, the government is due to release its revised GDP figures for the fourth quarter on March 12, and it’s looking as though those will be revised downward significantly, from an initial 0.9% quarterly growth to about 0.6%. We were suspicious of the original GDP figures when they came out on Valentine’s Day, and it’s starting to look as though those suspicions were well justified.

Consumer spending, however, seems to be holding. As Claus Vistesen points out over at Japan Economy Watch, “Save the recent pick-up in household spending I have not seen any indications that counters the fundamental point that Japan’s much hailed recovery is in for a real test.” In December, the last month to be included in fourth quarter GDP data, household spending rose by 2.2%, on the back of increased education, transportation and medical care costs. In January we saw a further 3.6% rise, again with education, transportation and medical care costs leading the charge. Increases in these categories, however, are not exactly what we should be looking for in terms of growth from the consumer sector (though auto and television sales have also been up). One is tempted to think that increased consumer spending in the past two months might be related to the 12.1% increase in bonuses that was seen in December.

One thing is for sure: When the data comes out, households will not have spent as much in February as they did in January or December. February spending tends to be about 30,000 yen less than in January and have an even greater gap from December’s figures. Will the leap day bring in more consumer spending for February? It’s possible, but while we saw the average household spend 309,826 yen this January, last February’s average household spending increased 1.3% to hit 272,763 yen. Given strong rises in December and January, and the possibility that higher bonuses might have had something to do with this, should we expect households to tighten their belts a bit in February when all this negative economic news is hitting them within the context of political failures to nominate a new Bank of Japan Governor, higher oil prices, increased food prices on the horizon and the prospect that higher medical fees are here to stay (even if they’re paying for the parents)?

Here’s what we really need to keep in mind. Yes, the Ministry of Health, Labour and Welfare reported that wages were up 1% in January, hitting an average of 280,550 yen. This figure includes bonuses, and thus represents the average total income for workers. However, monthly income per household fell 1.4% in January to 438,998, while consumption expenditures increased 3.0% for workers’ households, and 3.6% at all households with two or more people.

Thus, the average worker earned more money in January while the average household brought in less, while spending more. There are several possible reasons for this, foremost of which would be the increase in single person households, as well as what appears to be fewer women participating in the workforce (more on this in an upcoming post).

What we see, however, is that it is not just the carefree singles living in the big city who are spending more than they’re earning, at least recently. Households are seeing spending growth outstrip earning growth, and not only in January; in December household income was down 2.7% while spending was up 2.2%.

The point is, the average consumer might not care all that much about the macro trends. They might not care much about subprime, Mr Muto, the DPJ, industrial production or capital spending. Or, maybe they do care about those things. Either way, it seems that when you give workers a little bit of an extra bonus, they’re pretty eager to spend, especially when increasing numbers of them are living alone. And if they don’t live alone? Well, they’re probably older, live further from the city and spend more money on traveling - not to mention medical fees.

Spending growth simply cannot outstrip earnings growth forever.

After all, the Leading Index was down on fears over exports, right? No one’s daring to suggest that Japanese firms might actually be nervous over the future of domestic spending just yet, not after these two past strong months…

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