Japanese Rates and Sub Prime Crisis
In a bid to keep its economy chugging after the great real-estate-and-stock-market boom and bust of the late 80s, Japan kept lowering its interest rates.
This continued until 1997, when rates hit rock bottom at 0.25%, and could not be lowered any more. The low Yen favored Japan-based exporters, which was OK from Japan’s point of view, given that their domestic economy was so well developed that it could no longer be a growth engine for Japanese companies.
However, Wall Street did not fully realize the potential for arbitrage (more commonly called Yen-carry trade) until around January 2006.
This presentation titled “The Broad Yen Carry Trade” (url: http://www.princeton.edu/~hsshin/www/yenliquidityslides.pdf) discusses how the Yen-carry trade affected the Western financial markets. The slide on page 5 titled “Interbank Liabilities of Foreign Banks in Japan” shows how borrowings by foreign banks really picked up around the beginning of 2006.
The Yen-carry trade made possible the low mortgage rates in the US. This is important when you consider that the sub-prime crisis started in full earnest in March 2007, just succeeding February 22 when the Bank of Japan raised its interest rates from 0.25% to 0.50%.
This is, of course, not to suggest that BoJ deliberately or consciously caused the crisis. However, circumstances do suggest that the rate hike caused problems in the sub-prime sector to become a full blown crisis – by removing liquidity at a time when it became crucial to sustain the sector.
Monday 12 May 2008
Friday 9 May 2008
Japanese Example
Repeat of Japanese Example
When discussing the advantage that the US economy will get from a weaker currency, the existing example of Japan is forgotten.
Japan also tries to maintain a low currency, for it aids exports. Japan however has a few natural advantages over US when it comes to such activities.
A low currency has the disadvantage that is increases import price. And if a country is not naturally well-endowed, a rise in international commodity prices can play havoc with its inflation rate.
However, Japanese population growth is well under control, and the personal consumption rates are also stable. This gives their policy makers the freedom to treat the internal economy as a constant. So, beyond a particular point, they can devote their energies to managing their ‘external’ economy – in other words, the currency rate.
It was this relative freedom from internal constraints that enabled the Japanese to keep interest rates low for such a long time.
HISTORICAL SIMILARITY
An interesting feature of the present US dilemma is that it is a repeat of what happened in Japan almost two decades ago.
The Japanese real estate prices inflated to such an extent in the late-80s that it was rumored that the land of the Imperial Palace in Tokyo was worth more than entire California.
The subsequent crash led to a decade long economic depression.
Japan eventually found its salvation when it discovered low interest rates, and maintained 0.25% since 1997 until February 22, 2007.
The low interest rates not only gave an unnatural export advantage to the Japanese economy, which suffers from an aging population, but also insulated its domestic markets from foreign competition.
America seems to have discovered the same panacea. But it is still too soon to say which way the bamboo will fall, because there still is one crucial difference in the two economies.
AHISTORICAL DISSIMILARITY
Japanese economy was driven by re-investment. The collapse of its real-estate and stock markets deprived its corporations of the wherewithal to invest, and led to the emergence of corporations from its long-standing rival South Korea.
US economy is consumption driven. The collapse of its real-estate and stock markets (not to mention the high fuel prices) will drive down consumption – and consequently the profits of all those companies whose ultimate customer is found in the US.
Rather than lead to the emergence of new rivals, this crisis is likely to have a Boa-like strangulation on (US-focused) companies across the world.
This will eventually have a sobering effect on raw-material prices.
The medium term outlook for raw-materials (perhaps excluding energy) is bearish, given the fact the bottom has been knocked out of global consumption.
When discussing the advantage that the US economy will get from a weaker currency, the existing example of Japan is forgotten.
Japan also tries to maintain a low currency, for it aids exports. Japan however has a few natural advantages over US when it comes to such activities.
A low currency has the disadvantage that is increases import price. And if a country is not naturally well-endowed, a rise in international commodity prices can play havoc with its inflation rate.
However, Japanese population growth is well under control, and the personal consumption rates are also stable. This gives their policy makers the freedom to treat the internal economy as a constant. So, beyond a particular point, they can devote their energies to managing their ‘external’ economy – in other words, the currency rate.
It was this relative freedom from internal constraints that enabled the Japanese to keep interest rates low for such a long time.
HISTORICAL SIMILARITY
An interesting feature of the present US dilemma is that it is a repeat of what happened in Japan almost two decades ago.
The Japanese real estate prices inflated to such an extent in the late-80s that it was rumored that the land of the Imperial Palace in Tokyo was worth more than entire California.
The subsequent crash led to a decade long economic depression.
Japan eventually found its salvation when it discovered low interest rates, and maintained 0.25% since 1997 until February 22, 2007.
The low interest rates not only gave an unnatural export advantage to the Japanese economy, which suffers from an aging population, but also insulated its domestic markets from foreign competition.
America seems to have discovered the same panacea. But it is still too soon to say which way the bamboo will fall, because there still is one crucial difference in the two economies.
AHISTORICAL DISSIMILARITY
Japanese economy was driven by re-investment. The collapse of its real-estate and stock markets deprived its corporations of the wherewithal to invest, and led to the emergence of corporations from its long-standing rival South Korea.
US economy is consumption driven. The collapse of its real-estate and stock markets (not to mention the high fuel prices) will drive down consumption – and consequently the profits of all those companies whose ultimate customer is found in the US.
Rather than lead to the emergence of new rivals, this crisis is likely to have a Boa-like strangulation on (US-focused) companies across the world.
This will eventually have a sobering effect on raw-material prices.
The medium term outlook for raw-materials (perhaps excluding energy) is bearish, given the fact the bottom has been knocked out of global consumption.
Thursday 1 May 2008
Silver Lining
Benefit from the financial crisis to the US political-economy
The present financial crisis, despite its portentous appearance, does have some hidden benefits to the US economy, or at least to the political managers of the US economy.
How is that?
Well, the two most important economic issues facing the US economy for the next generation or so are its enormous external debt, and its aging population.
The external debt of the US is estimated to be around $13 trillion, according to official statistics - http://www.ustreas.gov/tic/external-debt.shtml, and is growing at the rate of $665 billion annually.
And the first of the baby-boomers started retiring in 2008.
Now, although it is commonly understood these two factors will cause strain in the US economy, what usually does not figure high in public perception is the specific nature of the impact.
Take the aging population.
We know this will reduce the percentage of workers in the US. We can infer that this will increase the burden on the younger workers – because each of them will be supporting more people.
This means higher tax burden. This further means that workers will have to have a much higher productivity in order to pay the higher tax burden. However, there is a way to instantly raise productivity levels in the international market – devalue the currency.
The current crisis allows US to do just that.
Now, take the high external debt.
A higher inflation rate will reduce the claims on US property that these debts represent. In other words, a weaker currency reduces the amount of companies that say – the Chinese sovereign fund will be able to buy.
KEYNOTE SUMMARY:
A devalued dollar:
1. Increases the international competitiveness of the US industry – reducing the pressure on the pension system.
2. Reduces the claims of the debt the US owes to the rest of the world.
The present financial crisis, despite its portentous appearance, does have some hidden benefits to the US economy, or at least to the political managers of the US economy.
How is that?
Well, the two most important economic issues facing the US economy for the next generation or so are its enormous external debt, and its aging population.
The external debt of the US is estimated to be around $13 trillion, according to official statistics - http://www.ustreas.gov/tic/external-debt.shtml, and is growing at the rate of $665 billion annually.
And the first of the baby-boomers started retiring in 2008.
Now, although it is commonly understood these two factors will cause strain in the US economy, what usually does not figure high in public perception is the specific nature of the impact.
Take the aging population.
We know this will reduce the percentage of workers in the US. We can infer that this will increase the burden on the younger workers – because each of them will be supporting more people.
This means higher tax burden. This further means that workers will have to have a much higher productivity in order to pay the higher tax burden. However, there is a way to instantly raise productivity levels in the international market – devalue the currency.
The current crisis allows US to do just that.
Now, take the high external debt.
A higher inflation rate will reduce the claims on US property that these debts represent. In other words, a weaker currency reduces the amount of companies that say – the Chinese sovereign fund will be able to buy.
KEYNOTE SUMMARY:
A devalued dollar:
1. Increases the international competitiveness of the US industry – reducing the pressure on the pension system.
2. Reduces the claims of the debt the US owes to the rest of the world.
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