Japan as an Outlier: Interest Rates

Back in May, European Central Bank President Christine Lagarde announced that they would end their experiment with negative interest rates by September. The ECB has had negative rates for about 8 years to try to encourage banks to lend out more money to increase liquidity in the markets. Now though, with inflation raging through global markets, all those who had pursued a loose money policy to boost their economies now raised interest rates to "turn off the heat" and bring down inflation. The United States, Canada, Mexico, Brazil, India, South Korea, the UK, Iceland, Sweden, Norway, South Africa, Argentina, Malaysia, the Philippines, Egypt; in total almost four dozen countries announced interest rate hikes to combat inflation. All except Japan, Switzerland and Denmark.

Bank of Japan Governor, Haruhiko Kuroda held a press conference last Friday to announce that Japan would be continuing its negative interest rates for the foreseeable future. This has created a drop in the value of the yen relative to the US dollar, which in theory boosts Japanese exports, but is much more complicated because Japan must in turn import so many of the components which go into its manufactured goods.

The yen has dropped to rates not seen since the early 2000s. Is this a good policy? The days of Japan as an export-driven economy are long gone. Japan's exports as a percentage of GDP is less than 20%, and its export to import ratio is almost at 1-to-1.

So why would Japan want to continue a policy that the rest of the world is exiting? Japan is affected by global economic trends just like all other countries integrated into the global economy. The answer might be found in Japan's (fairly) recent history. Around 1990, Japan was at the peak of its economic bubble. Its stock market and real estate were riding high. It was estimated that the book value of the land occupied by the Imperial Palace in downtown Tokyo (1.15 sq km or 0.44 sq mi) was greater than that of the entire state of California (423,970 sq km or 163,696 sq km). The real estate market was particularly overheated. Everyone assumed the value of real estate could only go up, and many people bought speculatively using lots of leverage. Property values rose to the point where occupancy was falling as homeowners and businesses could no longer afford buildings to live and do business in. In response, the Bank of Japan raised interest rates as high as 6.0%. Rather than easing out of the the rampant rise, the increased value of the yen hurt exports, increased lending rates meant prospective borrowers could no long afford to borrow the money that was propping up the housing market, and rather than gently cooling down, the economy stalled. Real estate speculators were now stuck with an asset they could not afford and couldn't sell, driving up rates of defaults dramatically. The Basic Land Act, which the government had enacted in 1989 and seemed a well-intentioned and morally based answer to the problems of ordinary Japanese citizens, instead added fuel to the flames as the economy burned down. The Bank of Japan responded by dropping interest rates almost as quickly as it had raised them, but by then it was too late. Japan's interest rates dropped to near zero by the end of the decade, and have remained within a few points of that ever since.

In Japan, the 1990s were referred to as the "Lost Decade," a term which has recently been supplanted by the "Lost Generation" as Japan's economy has remained weak for 30 years. The consequences of this economic catastrophe have been long reaching and difficult to shake. The Japanese population stopped growing in 2010 and has continued on a downward trend ever since. Projections are that Japan will return to the population it had in 1950 by about 2082. Japanese cities, particularly in rural areas, are hollowing out. Traditional skills and cultural practices are disappearing as those who know how to do them pass away. Japan is home to some of the world's oldest businesses, but several of them have in recent years been forced to close their doors or sell themselves off to competitors because there are no descendants to pass them on to.

Other nations face similar problems, but none seem to experience it as acutely as Japan. Japan has undergone a very long period of economic stagnation, so Japan does not fear inflation to the same extent that other nations have. There is no easy solution to Japan's problems. Immigration, which often serves as a safety valve for other countries, has never enjoyed wide popularity. Young Japanese are very pessimistic about the future. As a consequence, they are saying no; no to careers, no to marriage, and no to children. So if you wonder why Japan is not jumping on the "raise interest rates" bandwagon, this is the answer. It is, of course, not completely bleak. There are always glimmers of hope. Japanese startups are making remarkable gains. Japan's large businesses are changing their business models radically to continue to survive in a new form. But the question always is "is it enough?" Only time will tell.

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