Tuesday, January 30, 2007

Japan should raise rates

It's simple, and not conventional wisdom. Japan should begin a gradual raising of interest rates. Their central bank's rationale for not raising rates is their chronically weak economy and lack of consumer spending. They miss the point.

The financial big shots of the world love Japan's low, or no, interest rate policy. They can borrow in a stable democracy that is financially strong and reinvest elsewhere with an arbitrage that is just wonderful. It's called the "carry trade". In a globalized economy, the wealthy of Japan support this as well.

This situation, however, guarantees a perenially weak Japanese economy. Their demographic is one of an aging population that was devastated by the Nikkei and real estate collapse of the late 80's. This conservative aging population has no appetite for "speculative" investing in equity or property markets. Staying in fixed income investments means almost no income at this point. That simply means that they do not spend, they do not consume, and they do not pass on their wealth to the younger generation because they fear for their own financial security. Modestly raising interest rates will over time spur consumption and revitalize the domestic Japanese economy. This may seem counterintuitive, but just look at the U.S. experience in recent years and there is a model.

Shortsighted Japanese bankers and industrialists fear interest rate increases as their export dominated economy always wants a currency, the yen, that is competitive. On top of that they can participate in the global hedge markets in a way that the great majority of Japanese cannot. Their view is wrong. A robust Japanese domestic economy is a long term necessity, and interest rate increases will underscore the confidence in the turnaround that has taken place finally in this economy and that can thrive with better management.

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