On Japan

The Japanese economy (relative to the US) strikes me as particularly interesting, just at the moment. First, the Bank of Japan wants to increase their interest rates, for a truly odd (seriously) reason.

BOJ Members Said Low Rates Caused Subprime-Loan Rout

Bank of Japan policy makers said the U.S. subprime mortgage collapse was caused by keeping interest rates too low, signaling their intention to increase the world’s lowest borrowing costs to prevent investment bubbles.

The Bank of Japan is concerned that keeping its benchmark interest rate at 0.5 percent risks seeding future asset bubbles.

US interest rates were low because, amongst other things, fiscal policy was doing bugger-all to shift real incomes and/or real GDP over the last however-many years. Why on earth would rates increase? The cause of the mess scattered all over “the markets” has, largely, followed bad regulatory oversight, and only recently bad working definitions of inflation.

The effect? Well, the Yen had been trended upwards against the dollar anyway.


One wonders whether the 100:1 JPY:USD threshold is waiting idly by (after the parity of the AUD:USD) for honorable mention in our financial papers. The US dollar is already trading down, generally, as markets are already gambling that a third rate cut is in the offing (no, no sympathy. A Federal Reserve chair really ought to know the price of blinking).

What made it interesting was most of the other Japanese economic news floating about. To wit:

Japan Increases Budget for Wheat, Barley Imports as Costs Rise

Japan, the world’s largest net food importer, added 55 billion yen ($481 million) to its budget for wheat and barley imports after exhausting 243 billion yen allocated for the year to next March amid rising grain prices.

Rising oil prices threaten health of wide range of companies

… the current high oil price spike, which started in 2003, will continue for as long as 15 years, although prices may stabilize after shooting above $100.

Meanwhile, rising oil prices have so far shown no sign of accelerating the rise in the prices of goods in unrelated industries — as happened during the oil crises in the 1970s — amid global price competition, Matsumura said. More worrisome, he said, is the impact on consumer sentiment, given that prices are already rising in sectors affected by the high oil prices.

Japan minister warns that higher oil prices, lower housing investment could slow growth

Economy Minister Hiroko Ota warned Friday that declining housing investment and high oil prices could put pressure on Japan’s economic growth.

Ota also said that she shares the Bank of Japan’s concern that the economy faces greater risks amid concerns about a slowdown in the U.S. economy, a vital export market for Japanese companies.

“We see downside risks to the economy with more emphasis,” she said. “Japan’s economy is recovering, but we need pay attention to the U.S. economy.”

“I am concerned about declining housing investment and high oil prices,” Ota said.

Japan’s Housing Slump Threatens Growth, Ministers Say

Japan’s worst housing slump in four decades and rising oil prices threaten growth in the world’s second-largest economy, Cabinet ministers said.

“There is concern that a decline in housing investment will become a factor pushing down gross domestic product,” Economic and Fiscal Policy Minister Hiroko Ota said in Tokyo today. “I’m more focused on the downside risks to the economy.”

Not, one would think, an ideal macroeconomy in which to increase interest rates. However.

Japan has an odd relationship with interest rates. Specifically, over its decade or so of dead-flat GDP growth, as it tried to do everything to kick-start its macroeconomy (government expenditure on capital works topped USD1tr for the period, during which official real interest rates were even negative). Many arguments have been that Japan needed to increase interest rates, during this period – increasing costs, increasing prices, in effect generating inflation. By generating some inflation they would have conquered the deflation holding back purchases of durable goods, i.e. the economy itself (why buy a washing machine this month that would be cheaper next month?)

Quite telling (for me) is the Austrian school’s explanation for why these approaches failed (hint: because they weren’t of the Austrian school – no surprises, there):

The Austrian theory of the business cycle is more accurately a theory of an unsustainable boom than a theory of a depression (Garrison 2001, p. 120). Japan’s experience in the late 1980s is what Austrian theory describes as an unsustainable boom that must collapse. The recession or depression that follows an artificial boom is not something to avoid but is essential to the alignment of consumer time preferences and the structure of production. According to Austrian theory, the late 1980s boom was artificial, caused by the Bank of Japan’s expansionary monetary policy. The 1985 discount-rate reduction began the central bank-induced boom.

Following this reduction, the Bank of Japan expanded the money stock by an average of 10.5 percent per year from 1986 until 1990 (International Financial Statistics Yearbook 2001). While this action would not concern other schools of thought, because of price-level stability at the time, Austrian theory identifies monetary expansion as the problem. “The market process set in motion by credit expansion does not depend in any essential way on there being a change in the general level of prices” (Garrison 2001, p. 71).

In Austrian theory, the rapidly expanding money stock artificially lowers interest rates, signaling businesses to invest more in longer-term and more capital-intensive projects. The problem is that these lower interest rates do not reflect consumers’ time preferences. The Economist Intelligence Unit profile notes that the boom of the late 1980s “encouraged consumers to spend and companies to invest as never before” (EIU 2001). From 1987 to 1990, private consumption increased an average of 5.6 percent per year while at the same time gross fixed capital formation increased by 10.63 percent per year (International Financial Statistics Yearbook 1994).

Sound familiar? The article is far, far longer than this unfair excerpt, but still. Their conclusion rings faint bells, also:

Japan has experienced an Austrian business cycle. The initial boom was created by a central bank-induced monetary expansion. Because of repeated interventions, the economy has not recovered. The greatest malinvestments took place in capital-intensive industries in the earlier stages of production. For Japan’s economy to recover the government must stop intervening in the economy and allow the market process to realign the structure of production to match consumer preferences.

Business Week, the same year, presented a similar problem:

To see what havoc deflation is wreaking on Japan’s economy, swing by a model-home complex in the upscale Tokyo suburb of Sakura Jyosui. There, big homebuilders such as Mitsui & Co. (MITSY ) and Misawa Homes Co. show off their latest homes, which boast elegant tatami rooms, wine cellars, and saunas. But there aren’t many takers these days. This despite the fact that Misawa and rival homebuilder S x L Corp. last year triggered a price war that has crunched prices for a new home by as much as 28%. “Times are awful,” says a Mitsui salesman. “And the competition is ferocious.”

Life is hell for such foot soldiers of the Japanese economy. Why splurge on a big-ticket purchase like a new home now, consumers figure, when it will likely cost less next year? And buyers aren’t likely to change their tune any time soon. While some observers hope the early March jump in Japan’s stock market signals a recovery that will put a floor under falling prices, such hopes are misplaced.

With food and fuel as they are, I don’t see real deflation kicking in, in the US. Similar outcomes may be observed – falling house prices, declining sales in durable goods.

The original point remains, though. With Japan’s macroeconomic indicators not exactly indicating a hot economy; with inflation practically zero, again/still: why on earth increase interest rates?

The effect on the Yen via carry trades, illustrated above, is at work already:

The yen traded near the highest in a week against the dollar on speculation further writedowns by banks will prompt traders to reduce investments funded with money borrowed in Japan.

Japan’s currency gained versus 13 of the world’s 16 most- actively traded currencies.

Which is fine. Ordinarily, “people” were borrowing Yen in Japan, then selling those Yen for Dollars, then lending the dollars in the US. Now (a) the dollar is depreciating in value, lowering the return on said lending; (b) US interest rates are down, again, and being bet on falling again, further lowering said return; and (c) said lending/investment is much more risky, now. Basically “people” aren’t borrowing Yen to sell for Dollars to lend – this decreases the supply of Yen, increasing its price. It also lowers the demand for US dollars, decreasing their price:

carry trades currency prices

This would look nicer if I could be assed (same for the grammar, and re-scanning it with Supply correctly labelled in the second graph – not with this scanner, I’m not). If HP actually has any expertise in making printers/scanners, I’ve never seen any evidence of it (same goes for Office X). In fact the mooted change in the mood of the BoJ is hard to label terribly significant: their rates are still incredibly low, and – apart from the US – everybody else’s rates are increasing as well.

This change says more, I think, about the demand for the US dollar, than anything else (the ForEx market is such that no single currency can fall at any one time, where speculation is involved. Usually one other currency will be involved – the Deutschmark and the Pound Sterling, for example, back in 1992).

Combined, this all counts for a few things. First, the argument made that, once the Fed started in on the rate cuts, the USD dollar would fall. This is an episode thereof, as the international borrowing/lending (arbitrage) behaviour corrects itself in response. Second, it will be interesting to see the effect on the Japanese economy itself. Their interest rates, not to mention their economy, appear nothing like sufficent to attract foreign investment, but increasing rates (or credibly suggesting such an increase is coming) can’t do much to help their economy.

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