In Japan, Strong Numbers Can't Cure a Bruised National Ego

Friday's first-quarter GDP figures were revised upwards, but rate concerns, a stronger yen and a wary, wounded populace still fuel pessimism.
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If you're looking for an economy on the mend, Japan might seem like one-stop shopping.

After its longest recession in the postwar era, the economy has begun growing. On Friday, first-quarter GDP figures were revised higher to 2% from the surprisingly strong 1.9% originally reported. Earlier in the week, the government said machinery orders, a key indicator of corporate investment, rose 6.3% in June.

The good cheer has spread to Japan's stock market, helping it rise more quickly than the headline-capturing American market. The

Nikkei

average is up 25.9% since the beginning of the year, while the

Dow Jones Industrial Average

has risen a comparatively paltry 17.5%. Japan's small-cap stocks have more than doubled in value over the same period.

So why are Japanese policymakers, like

Economic Planning Agency

chief Taichi Sakaiya, still so tentative?

One reason for the prolonged pessimism is that the economy is still dependent on a raft of government spending and interest rates at zero to keep it growing. Last week, Sakaiya pointedly stated the government needs to spend more to achieve a self-sustaining recovery. The markets already expect a 10 trillion yen ($86.33 billion) package -- half of which will be direct spending that produces an immediate effect. (The balance is expected to be tax cuts and other measures that take longer to work their way into the economy.)

Another is the stronger yen. As expectations grow that Japan may finally emerge from its decade-long downturn, currency markets have pushed the yen higher. Recently, it has risen to its highest level in six months, a development that threatens profits at Japan's big exporters, like

Matsushita Electric Industrial

(MC) - Get Report

and

Honda Motor

(HMC) - Get Report

. The strong yen (it rose to the level of 114 yen to the dollar on Friday) makes exported Japanese goods more expensive in foreign markets and shrinks the yen value of repatriated dollars earned abroad.

"I think a cyclical recovery is still premature," says Andrew Shipley, economist at

Schroders Japan

. "Everything will quickly unravel if Japan abandons its monetary policy and fiscal policy."

All eyes have now turned to second-quarter GDP figures slated for September 10. While expectations have moved higher, many of the major brokerages see the economy returning to a familiar (and unwelcomed) state of contraction.

Nomura

, the biggest and most optimistic of Japan's brokerages, sees zero growth for the quarter.

The

Japan Center for Economic Research

, a widely respected private think tank, expects GDP to come in at minus 0.3% from the previous quarter. The center noted in its last GDP report that "public works spending has run out of breath."

The most vexing problem, however, may be psychology. Shell-shocked Japanese have watched their once-vaunted economic miracle give way to an aching crisis, one reminiscent of the soul-searching Americans experienced in the 1980s. The country, which has watched its fiscal deficit swell to more than 100% of GDP, has seen its once-pristine credit rating cut by

Moody's Investors Service

and

Fitch-IBCA

. Unemployment has jumped to a record high of 4.9%, eroding faith in the practice of lifetime employment, a cornerstone of Japanese labor tradition.

While spending on computers rose nearly 40% over the past year, overall private demand remains slow. Regardess of the strong GDP and the booming stock market, the Japanese just don't feel too good about themselves.

Maybe the next stimulus package should include a provision for

Prozac

purchases.