The Wrong Growth Strategy for Japan

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Japan’s new government, led by Prime Minister Shinzo Abe,could be about to shoot itself in the foot.Seeking to boost economic growth, the authorities may soon destroy their onegreat advantage: the low rate of interest on government debt and privateborrowing. If that happens, Japanese conditions will most likely be worse atthe end of Abe’s term than they are today.
The interest rate on Japan’s ten-year government bonds isnow less than 1% – the lowest in the world, despite a very high level ofgovernment debt and annual budget deficits. Indeed, Japan’s debt is now roughly230% of GDP, higher than that of Greece (175% of GDP) and nearly twice that ofItaly (125% of GDP). The annual budget deficit is nearly 10% of GDP, higherthan any of the eurozone countries. With nominal GDP stagnating, that deficitis causing the debt/GDP ratio to rise by 10% annually.
Japan’s government is able to pay such a low rate ofinterest because domestic prices have been falling for more than a decade,while the yen has been strengthening against other major currencies. Domestic deflation means that the real interest rate onJapanese bonds is higher than the nominal rate. The yen’s rising value raisesthe yield on Japanese bonds relative to the yield on bonds denominated in othercurrencies.
That may be about to come to an end. Abe has demanded thatthe Bank of Japan pursue a quantitative-easing strategy that will deliver aninflation rate of 2-3% and weaken the yen. He will soon appoint a new BOJgovernor and two deputy governors, who will, one presumes, be committed to thisgoal.
The financial markets are taking Abe’s strategy seriously.The yen’s value against the US dollar has declined by more than 7% in the lastmonth. With the euro rising relative to the dollar, the yen’s fall relative tothe euro has been even greater.
The yen’s weakening will mean higher import costs, andtherefore a higher rate of inflation. An aggressive BOJ policy of moneycreation could cause further weakening of the yen’s exchange rate – and a risein domestic prices that is more rapid than what Abe wants.
With Japanese prices rising and the yen falling relative toother currencies, investors will be willing to hold Japanese government bonds(JGBs) only if their nominal yield is significantly higher than it has been inthe past. A direct effect of the higher interest rate would be to increase thebudget deficit and the rate of growth of government debt. With a debt/GDP ratioof 230%, a four-percentage-point rise in borrowing costs would cause the annualdeficit to double, to 20% of GDP.
The government might be tempted to relyon rapid inflation to try to reduce the real value of its debt. Fear of thatstrategy could cause investors to demand even higher real interest rates.
The combination of exploding debt andrising interest rates is a recipe for economic disaster.The BOJ’s widely respected governor, Masaaki Shirakawa, whose term expires inApril, summarized the situation in his usual restrained way, saying that“long-term interest rates may spike and have a negative effect on the economy.”
A spike in long-term rates would lowerthe price of JGBs, destroying household wealth and, in turn, reducing consumerspending. The higher interest rates would also apply to corporate bonds andbank loans, weakening business investment.
Even without the prospect of faster inflation and adeclining yen, fundamental conditions in Japan point to higher interest rates.The Japanese government has been able to sell its bonds to domestic buyersbecause of the high rate of domestic saving. The excess of saving overinvestment has given Japan a current-account surplus, allowing the country tofinance all of the government borrowing domestically, with enough left over to invest in dollar-denominated bonds andother foreign securities. But that is coming to an end.
The household saving rate has collapsed in recent years,falling to less than 2%. The combination of high corporate saving and lowbusiness investment has sustained the current-account surplus, allowing Japanto fund its budget deficit domestically. But the surplus has fallen sharply inthe past five years, from roughly 6% of GDP in 2007 to only 1% now. With afalling rate of household saving and the prospect of new fiscal deficits, thecurrent account will soon be negative, forcing Japan to sell its debt toforeign buyers.
Abe plans to supplement the easy-money strategy with anincrease in government spending of some $120 billion, or 2% of GDP. It is notclear why Abe and his advisers believe that this will deliver sustained realGDP growth of 2% a year. Although the $120 billion is presumably just for thecurrent year (if the spending can be made to happen that quickly), he alsospoke during his campaign about a ten-year rise in government spending of ¥200trillion yen, substantially more than the $120 billion annual rate. The impactof all of this on the national debt and on Japan’s interest rates could bestaggering.
Abe is right about one thing: Japan needs to get out of itsno-growth and deflationary trap. But the policies that he favors are not theway to do it.

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关键词：Strategy Strateg Growth wrong Japan government advantage economic interest likely

The interest rate on Japan’s ten-year government bondsis now less than 1% – the lowest in the world, despite a very high level ofgovernment debt and annual budget deficits.Japan’s government is able to pay such a low rate ofinterest because domestic prices have been falling for more than a decade,while the yen has been strengthening against other major currencies. Domestic deflation means that the real interest rate onJapanese bonds is higher than the nominal rate. The yen’s rising value raisesthe yield on Japanese bonds relative to the yield on bonds denominated in othercurrencies.

That may be about to come to an end. Abe has demandedthat the Bank of Japan pursue a quantitative-easing strategy that will deliveran inflation rate of 2-3% and weaken the yen.The yen’s weakening will mean higher import costs, andtherefore a higher rate of inflation.With Japanese prices rising and the yen fallingrelative to other currencies, investors will be willing to hold Japanesegovernment bonds (JGBs) only if their nominal yield is significantly higherthan it has been in the past. A direct effect of the higher interest rate wouldbe to increase the budget deficit and the rate of growth of government debt.

The government might be tempted to rely on rapidinflation to try to reduce the real value of its debt. Fear of that strategycould cause investors to demand even higher real interest rates.The combination of exploding debt and risinginterest rates is a recipe for economic disaster. A spike in long-term rates would lower the priceof JGBs, destroying household wealth and, in turn, reducing consumer spending.The higher interest rates would also apply to corporate bonds and bank loans,weakening business investment.

Even without the prospect of faster inflation and adeclining yen, fundamental conditions in Japan point to higher interest rates.The Japanese government has been able to sell its bonds to domestic buyersbecause of the high rate of domestic saving. With a falling rate of household saving and theprospect of new fiscal deficits, the current account will soon be negative,forcing Japan to sell its debt to foreign buyers.

Keynes or adam smith, is decided by who can lead a country's economy to flourish. developed countries seeking helps from the power of "visible hand"  gives us a clue that moderate way to adminatrat a country may be the best.