Should Japan Be Worried about Its Trade Deficit?

Japan saw its first trade deficit in two years for January 2011, causing its current account balance to shrink by nearly half. Duhn, duhn, duhnnn! Is the world’s third largest economy in danger?

Before we get ahead of ourselves, let’s get down and dirty with the numbers.

According to the current account report for January, the value of Japan’s exported goods, services, income flows, and transfer payments came in at 1.09 trillion JPY. On an annual basis, the current account surplus stood at 461.90 billion JPY which is 47.6% lower than the 881.90 billion JPY figure we saw in January 2010. Yikes!

Some hotshots at Japan’s Ministry of Finance point to sluggish trade activity during the latter part of January as the reason why the surplus narrowed. The trade balance report for the printed a deficit of 394.5 billion JPY which, by the way, is the first negative reading recorded since January 2009!

Digging a little further into the report, I discovered that exports to China and the rest of Asia slowed down, which could be another reason behind the disappointing figure.

But don’t fret just yet… Economic gurus say that red-stained figures aren’t unusual in January when businessmen chug on more sake as year-end celebrations and Lunar New Year’s holiday festivities come in full-swing. With all those parties, they probably didn’t get much business done!

A closer look at the underlying figures reveals that exports aren’t faring so bad after all. In fact, they rose by 2.9% year-over-year in January. This increase was led by a whopping 43.4% growth in mineral fuel exports, on top of an eye-popping 58.0% rise in construction machinery shipments.

So if Japanese exports posted healthy double-digit growth during the month, why the negative trade balance?

Recall that a trade deficit or a negative trade balance occurs when a country imports more than it exports. So, no matter how impressive Japan’s exports are, if its imports are way stronger, it would still result in a trade deficit. And that’s exactly what happened this January.

Imports rose by an annualized 15.6% during the month, boosted by rising fuel costs. The increase also came in double-digits, as imports of refined petroleum products jumped by 38.6% while iron ore shipments skyrocketed by 69.1%. Crude oil imports rose by 10.6%, but bear in mind that the conflict in the Middle East was just starting in January. And if you’re reading Pip Diddy’s daily economic updates, you’d know that the “Oil Turmoil” just keeps getting worse!

Looking ahead, it’ll be interesting to see if Japan’s trade industries can wake up from the winter slumber and get back into surplus mode.

The fate of the Japan’s current account will largely depend on two factors: commodity prices and the global recovery.

As I mentioned, we’re right smack in the middle of ongoing conflict in the Middle East. As long as this continues, my good buddies Brent and West Texas (two of the more heavily traded types of crude oil, FYI) will keep seeing an increase in value. This in turn will continue to pile on pressure on input prices, which could make imports outpace exports yet again.

The second crucial factor is the state of global recovery. With China raising interest rates to avoid the creation of asset bubbles in its real estate industry, overall demand for raw materials could take a hit. Of course, this sucks for Japan, since China is its biggest trading partner.

But don’t fear my friends, not all hope is lost. It seems that the U.S. and the euro zone are seeing glimpses of hope. With both these economies on the rise, Japan might just be able to break out of its rut and hit the end zone for a touchdown.