This is a much better analysis than the standard Kruman stuff, which focuses only on the fact that nominal interest rates can't go below (slightly above) zero.
At 05:10 PM 10/28/01 -0800, you wrote: >Puzzle in Japan: Despite Lowering Rates > To Rock-Bottom, Banks Lack Borrowers > > By PHRED DVORAK > Staff Reporter of THE WALL STREET JOURNAL >October 25, 2001 > > HIROSHIMA, Japan -- Why does Japan's economy, despite > phenomenally low interest rates, keep wasting away? The > answer begins in a vegetable garden near here. > > Yuji Kawamoto spends Sundays tending his leeks and carrots. > He used to sprinkle them using only tap water, but now he > saves money by using bath water, rain water and water hauled > from a nearby stream in plastic buckets slung on a pole. His > wife, Kaoru, has shaved expenses by tossing out the television > set and cutting off the electrical power to their son's room. > > Mr. Kawamoto, who owns his spacious house and has a safe > civil-service job, is no victim of recession. And that is what > makes him a player in a central banker's worst nightmare. > > Economists are calling it a "liquidity trap," a phenomenon > postulated by John Maynard Keynes to describe what happens > when demand for credit remains weak no matter how low > interest rates go. Faced with an economy seriously ailing since > 1990 and resistant to every treatment, Japan's central bankers > have been doggedly applying the classic remedy of cutting > interest rates. This is supposed to persuade everyone from the > CEOs to the Kawamotos to grab and spend these cheap funds > and galvanize the economy. > > A Deep Pessimism > > But after more than a decade of economic slump, the > populace has sunk into a deep pessimism that threatens to > become self-perpetuating. The fear that profit and income will > only decline over the long term has persuaded corporate > executives and families alike that their sole recourse is to cut > spending. Slack demand has led to falling prices for goods and > land. Falling prices have bred deeper cost cuts by businessmen > and more heroic efforts to save by individuals. Companies are > paring down old debt rather than borrowing anew for capital > investment. > > The devastated banking sector gets a double-whammy, since > banks aren't making money from the interest on loans and > they are spending money to pay interest on savings accounts. > The central bankers, who have cut interest rates to virtually > zero and can't go any lower, have blunted their primary tool > for stimulating business. > > 'You Just Feel Like Saving' > > "Theoretically, if interest rates are lower, you should use more > money," says Mr. Kawamoto, in his baggy gardening trousers. > "But actually you end up not using it because things just aren't > looking that bright." Adds Mrs. Kawamoto: "You just feel like > saving." > > How to rescue Japan from this liquidity trap has sparked one > of the great economic debates of the age, one that has taken > on greater urgency since the Sept. 11 terrorist attacks > increased concerns about a world-wide downturn. Japan's > nominal economic output -- that is, unadjusted for deflation -- > plunged at an annual pace of 10% in the April-June quarter, > and many economists say the country is entering a contraction > even worse than the one suffered in 1998, amid a near-panic > in the banking system. > > Now, with the U.S. economy slow to respond to aggressive > rate cuts by the Federal Reserve, analysts such as Andrew > Smithers, head of British economic-research firm Smithers & > Co., have begun to wonder whether a global trap is emerging. > "The U.S. and continental Europe are teetering on the brink," > says Mr. Smithers. "And if they were to fall into it, you would > have a world liquidity trap." > > Acute Symptoms > > The liquidity trap, so named because people stuck in it would > rather hold cash -- be liquid -- than hold debt, was first > formulated by Mr. Keynes amid the global Depression of the > 1930s. For decades, the trap was just an ivory-tower concept. > Now, Japan shows acute symptoms: The Bank of Japan is > holding the key overnight call rate -- what banks charge each > other to borrow money overnight -- to around 0.001%, but > economic output and prices are still dropping. > >Monetary policy is supposed > to work through banks: The > Federal Reserve, for instance, > will cut the interest rates at > which commercial banks > borrow. That, in turn, tends to > lower the rates charged > businesses and consumers, > who invest in factories or > spend on cars. In Japan, that > chain has broken down, in > strange and alarming ways. > > Japanese banks are facing > customer flight -- not by > depositors but by healthy > borrowers, who are paying > down old debt or balking at > new loans. Outstanding bank > loans have fallen in Japan from > year-earlier levels for 45 > straight months, sucking about > $741 billion in credit out of the > system -- more than Canada's > annual economic output. Some > of the most eager borrowers of > Japan's low-interest money > aren't Japanese at all, but > foreigners -- such as the > governments of Tunisia, > Croatia and Argentina and many U.S. corporations and > investment banks, all of which have sold large bond issues at > low rates here. > > Lacking borrowers, Japanese banks are stuffing cash into > Japanese government bonds. They bought $198 billion in 2000 > alone, nearly doubling their holdings. That's risky because > bond prices might fall, costing banks more in lost portfolio > value than they would gain with rising yields and putting the > already-troubled banking system in further jeopardy. So, some > banks are putting excess cash into savings deposits at rival > banks -- who are rejecting the money. > > In the perverse universe of deflation, where the prices of > goods and services are declining, saving at near zero-percent > interest makes sense. Since prices are falling at about 1.5% a > year, the real value of money is actually rising. Bank deposits > have risen about 2%, or $78 billion, during the past five years, > even though banks are now paying only 0.02% on savings. At > that rate, it would take 3,500 years for one's money to double > in nominal value. > > Need to Spark Inflation? > > The solution to Japan's liquidity trap, according to a number of > academic economists, is for the nation to spark inflation > intentionally. If prices are rising at a decent clip -- say, at 5% a > year -- and interest rates stay below that, companies and > consumers might snap up loans because the real cost of > borrowing would be negative. That might prod the > Kawamotos to dip into their savings and buy a TV set. > > Two weeks ago, Japanese Finance > Minister Masajuro Shiokawa called for > reflating prices back to their 1997 > levels. But calls for reflation are > meeting a stern response from the one > man who can deliver it: central bank > Gov. Masaru Hayami. He argues he > has already gone into dangerous > territory by slashing rates to zero and > pumping up the money supply. Going > further would risk sparking an > inflation, he warned earlier this month, > "whose fires will spread and could even ... burn furiously." > > The fight has drawn front-page coverage by tabloids. > Pro-reflation legislators are pushing for a law that would curb > the Bank of Japan's power by forcing it to target a positive > rate of inflation. One of the ringleaders, Yoichi Masuzoe, > called Mr. Hayami a "dictator" and challenged him to debate > monetary policy on TV. Mr. Hayami refused, and accused his > detractors of "throwing rocks." > > A look at the rusting industrial hub of Hiroshima shows why > monetary policy is sparking such emotion in Japan -- and how > an economy awash in money can wither away. > > Just 9% of Hiroshima-area firms say they plan to borrow for > investment, the Bank of Japan found in a recent survey. To > understand why, consider Mazda Motor Corp. The company, > which accounts for about half the falling industrial output in > this city of one million, this year cut 2,210 jobs and closed half > of its vast Ujina factory complex. The Ford Motor Co. > affiliate's sales fell to 334,000 cars in Japan last year, about > half its 1990 peak. That is gutting the profit needed to pay > down Mazda's huge debts -- equal to three times shareholder > equity -- to a target of half of equity, in line with standard U.S. > levels. For now, though, that crushing debt, coupled with > falling demand, means Mazda will keep borrowing to a > minimum, officials say. > > A few miles from Ujina, Masato Uno, president of car-door > supplier Hirotec Corp., says Mazda wants him to cut prices. > That will sharpen the pain of his shrinking sales volume, > already half of 1992 levels. Banks are still urging Mr. Uno to > borrow fresh money, though he considers it foolhardy to > invest in Japan. > > But he is taking advantage of the cheap credit -- by investing it > overseas, to start metal-stamping ventures in Thailand and > Mexico. Last year, Mr. Uno borrowed at a bit more than 2% > to invest 350 million yen (about $2.9 million) in Ingemat SA, a > Spanish maker of car-assembly equipment. His accounting > manager, Kenso Iwami, says banks are begging Hirotec to > borrow more: "They say they'll lend cheaper than other > places," Mr. Iwami says. "They want to steal market share > from each other, you see." > > Financing Stagnation > > Back home in Hiroshima, plentiful credit is financing > stagnation, as banks use cheap rates to keep ailing companies > on life support. The shelves of a discount auto-parts chain, > Monte-Carlo Co., are piled with unsold shock absorbers and > faux-leather steering wheels. Mazda workers, once the store's > best customers, aren't splurging on their cars anymore. > > Akira Okano, managing director, says car-navigation systems > used to be a big money-maker for the $150 million-in-sales > company, but now sell for an eighth of what they used to. > Monte-Carlo has posted losses for two years and groans under > a debt load of four times equity. But banks keep rolling over > its 6.7 billion yen in loans, on which Monte-Carlo pays hardly > any interest. "There are a lot of companies like us, ducking > their heads and holding on while the wind rushes over," says > Mr. Okano. > > Lenders can afford to be so forgiving in part because they are > swimming in cash. Setouchi Bank Ltd., a small lender based > just outside Hiroshima that is one of Monte-Carlo's two main > banks, has 700 billion yen in deposits, but just 600 billion yen > in loans. Banks earn their money by lending, so such an > imbalance can cut into revenue unless they have other > profitable places to invest funds collected from depositors. In > Japan, total bank loans fell below deposits in early 1999 -- and > now exceed them by about $300 billion. > > This liquidity surplus is driving Hidenori Nuibe crazy. As > treasury chief at Setouchi, he is in charge of investing 130 > billion yen of the bank's money but has run out of safely > lucrative places to put it. So in June, Mr. Nuibe took a > desperate step: He stuck the yen equivalent of $33 million into > a plain-vanilla savings account at rival Hiroshima Bank Ltd., > earning him interest of $17 a day. Hiroshima Bank, which > won't comment, howled in protest, and Mr. Nuibe says he > withdrew the money the next month. > > So Mr. Nuibe is stuck putting the cash in overnight money > markets. That's a money-losing proposition, since the bank > pays more on deposit insurance alone than it makes from the > 0.001% return, even before figuring in the salaries of Mr. > Nuibe and his team. Each day Mr. Nuibe invests 30 billion yen > -- more than the cost of a Boeing 747 -- in the overnight > markets, and earns just 800 yen. > > "We only get what a part-timer at McDonald's would make" > an hour, quips the 12-year trading and investment veteran. > "But it can't be helped." > > Pipes Have Gotten Clogged > > The dysfunction deepens in Tokyo, the center of the > overnight-lending markets where Mr. Nuibe is losing his shirt. > Those markets are the pipelines through which the Bank of > Japan channels money to banks. Each day, the central bank > injects far more money into the markets than banks need, in > order to drive down the price of credit and, hopefully, spark > some borrowing. > > But the pipes have gotten clogged. Japan's six money-market > brokers this year merged into just three, because demand for > the cash that they trade is so weak. In May, the system went > haywire: On 16 occasions, the central bank failed to find > enough takers for its money, leaving it powerless to ease credit > further. Atsushi Miyanoya, head of open-market operations, in > July doubled, to 120, the number of banks that can bid for the > BOJ's cheap funds. And he had the BOJ's computers > reprogrammed so the bank can price the interest on its funds > at even closer to zero -- a thousandth of a percentage point, > down from a hundredth. The overnight rate immediately fell to > 0.001%, its low-end limit. > > "If we took the unit down one more time, would that really > change anything?" laughs Mr. Miyanoya. "We're at the > nano-technology level." > > In fact, rates have fallen so low that credit is tightening, not > easing, bankers say. That's because many companies now > prefer to leave their cash idle rather than invest it in the > money-markets at near-zero rates. So when demand for cash > picks up for some reason, as it did earlier this month, there > aren't enough fund-suppliers to satisfy it, causing interest rates > to spike. "It's a truly weird situation," says Takeshi Ogura, a > money-market dealer at Sanwa Bank Ltd. > > Even so, critics say there's plenty more the BOJ can do. Many > politicians and economists are calling on the bank to purchase > huge amounts of dollars, thereby cheapening the yen and > ramping up the money supply, both of which would help push > up prices. Others suggest that the bank buy bad loans, > property, stocks -- anything to create inflation, so that > consumers will decide that they had better start spending again > before their money loses value. > > "Outside Japan, monetarists agree there's no technical problem > creating or controlling inflation," Ben S. Bernanke, chairman > of the economics department at Princeton University, told a > gathering of economists in Tokyo recently. > > Meanwhile, outwardly prosperous families like the > Kawamotos are clamping down even harder on expenses. Mr. > Kawamoto, a 49-year-old city-planning official, makes about > 6.1 million yen a year, a bit above average for his age group, > and puts about a third into term savings accounts at the post > office. > > Mrs. Kawamoto polices expenses, using a popular technique > that women's magazines have dubbed "the bag method." On > her husband's payday, the 47-year-old withdraws all the cash > she needs for that month, and divides it out into 11 clear > plastic bags, according to her prearranged budget. She buys > groceries with money from the "food" bag and shoes with > money from the "clothing" bag. Every morning, she checks > electricity and gas-meter readings and marks them on a wall > calendar. When she noticed water bills were high, she screwed > down the main water tap. This year, she threw out the old > television set, and hasn't replaced it. > > The Kawamotos have worked out a lifelong-savings plan, > plotting out income and expenses through 2023, but it doesn't > look pretty. They will soon have two children in college, but > Mr. Kawamoto's income isn't rising as expected, as the > strapped local government tightens spending. That will leave > them 5.5 million yen shy of the 30 million yen nest egg they > hoped to have by 2012, when Mr. Kawamoto wants to retire, > buy a little house in the country and try his hand at farming. > Already, the Kawamotos have amended their savings plan, by > expunging all the expenditures in the "pleasure" category until > 2006. > > And so it is that in Japan, a land once notorious for its $100 > melons and $6 cups of coffee, some people pine for the old > days of rising prices. Mr. Kawamoto, gazing out at his garden, > notes how his property's value has fallen back to nearly what > he paid for it in 1975. "It's easier to use money when prices > are high, because whatever assets you have, they're going up," > he says. > > Write to Phred Dvorak at [EMAIL PROTECTED] > > >-- > >Michael Perelman >Economics Department >California State University >[EMAIL PROTECTED] >Chico, CA 95929 >530-898-5321 >fax 530-898-5901 Jim Devine [EMAIL PROTECTED] & http://bellarmine.lmu.edu/~jdevine
