Financial Watch

Signs are mounting among Japanese monetary authorities that the nation is moving ever closer to abandoning its long standing policy of near zero interest rates. Economic growth of 5.5% in the fourth quarter of 2005 and an unemployment rate hovering near 4% is once again showing clear signs the Japanese economy is once again regaining the luster it received during its incredible boom during the 1980’s. Japan’s economy is still far from reaching the robust performance it enjoyed during its best years where stock and real estate prices rose astronomically, but it is now clearly on solid footing. Worries over deflating are abating as consumers increasingly open up their pocket books. Also, the Asian nation is strongly benefiting from the emergence of China into the global economy. In the last couple years strong export growth to China has helped the Japanese economy land on its feet and China’s emergence should continue to fuel growth across Asia for many years to come.

The transition away from free money will have consequences for many. High savings rates among Japanese consumers have helped to keep interest rates low throughout the world. Rising interest rates in Japan would encourage Japanese investors to reinvest in their own nation rather than parking their money in U.S. and other nation’s debt. As investors moved their money back home, the yen might rise faster than Japanese authorities desire. Additionally, Japan recently posted its first monthly trade deficit in five years. Should a pattern of trade deficits emerge due to a rise in the yen’s value, there will be growing worries over a repeat of the Asian currency crisis of the mid 1990’s. Of further concern is how rising interest rates will impact budget deficits in Japan. Although the U.S. government receives a lot of flack for it’s proliferated spending, the Japanese government has a national debt 2.5 times larger than our own. Even a modest rise in interest rates could force Japan to take dramatic actions to rein in its budget deficit.

The end of free money will also result in some positive consequences for consumers. Global hedge funds play a disproportionate responsibility for the high fuel prices we currently are experiencing. It is not known how much of this money is financed through near zero interest rates in Japan. At even a minimum, high rates in Japan will lead to a modest retreat in commodity prices. It is probably not surprising that commodity prices have struggled of late in the face of increasing noise over what monetary authorities in Japan might decide to do. At this point there are a lot of questions over the policy that might be taken in Japan. With inflation hovering near zero it appears any initial moves will be very modest.