Wednesday, August 15, 2012

Japanese Interest Rates

Economist article

One of the baffling economic mysteries of the past twenty years is how the government of Japan is able to sell debt to their citizens at near zero interest rates.  In an article published in the Economist on August 14, 2012 titled Defying gravity the mystifying Japanese investors' motives are explored. The author explains that if the Japanese investor used rational analysis they would not accept the low yields of the country's debt. He states numerous advanced countries offer higher rates. He questions whether solvency of Japan is ensured when the countries debt is over 230% of GDP.  Even considering all those factors a Japanese investor must still be giving an unrealistic value to debt that yields less than 2% the author argues.

The author makes some good arguments, but he should read Dan Ariely's book, Predictably Irrational, to understand what is going on. The Japanese investor is not making a rational decision. Investors have the right and often do choose investments not based solely on yield. Many angel investors make investments in projects that have little chance of success, but they feel some pull to try to challenge the inevitable even though the odds are ridiculously low. Clearly, Japanese investors feel it is important to support the home team even when the returns are extremely low. The author believes the day of reckoning is getting closer for Japanese bond dealers. Step back, the motives for purchasing will not change with worsening economic conditions in Japan. The Japanese investor is on board is unlikely to jump ship.

Next, the author proposes that the reason for this anomaly is government persuasion or regulatory manipulation. This is an explanation I can support. Please see the last half of my new book, Rule of Money: a solution to the global debt crisis. I discuss the long history of government managing the economic system within their borders to benefit themselves. On the other hand, most people believe government is working to secure the public's best interests, but this is contrary to the most basic tenet of economics: we act in own best interests. People in government are no different from you and I. They are going to do what secures their future first, and then if any money is left over, take care of the citizenry.

The author concludes foretelling disaster, maybe not tomorrow, but soon. I am not so sure. The author assumes that eventually, foreign lenders will be the only recourse and, of course, they will demand higher rates. Think about it. Is it possible foreign banks might buy the debt and sell options to gain on the likely lost in value compared to the purchaser's own currency. In fact, the opportunities through the option market regardless of the face value of the debt  is always a factor. I suspect issuing debt in the future will be more about dealing the cards for another round of poker and less about the cost of the cards. The game will continue and Japan is positioned to continue playing.

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