July 20, 2006

No More Easy Money.  Global interest rates seem like the temperature in Texas during July…both keeping going up and up.

While the Federal Reserve continues to raise short term interest rates in the U.S. the Bank of Japan, standing up to domestic political pressure, ended its six year policy of zero interest rates.  But, unlike the Fed, don’t look for the BoJ to go on a non-stop interest rate raising spree.  BoJ governor Toshihiko Fukui stated very clearly that BoJ will not carry out consecutive interest rate increases.

The BoJ’s policy is in response to the rapidly (for Japan) expanding Japanese economy.  The BoJ’s quagmire is that after years of facing deflationary pressures they now have to worry about growing inflationary pressures.  What is interesting about this most recent Japanese expansion is that it is being driven, to a significant degree, by the Japanese consumers.

Here in the U.S. we are all too familiar with consumer driven economic expansions.  But in Japan they have been a rarity.  The Japanese household sector is well known for its thrift not being spendthrifts.  Thus, much of Japanese economic growth has been export based.  But perhaps things are changing.

A more balanced Japanese economy would be a good thing for the global economy.  Global consumer goods producers would love to see the (relatively wealthy) Japanese households being willing to spend on their products.

But…as with so many things in economics for any action there are many reactions.

One of the potential downsides of a more freespending Japanese consumer is that Japanese savings may stay in Japan in the future.  Over the past two decades a great deal of Japanese savings have made their way into the U.S. financial markets.  Especially since the early 1990’s when the Japanese real estate asset bubble burst and the Japanese economy slowed dramatically, the Japanese have been bringing their savings to the U.S.

This influx of Japanese savings in the U.S. is one of the reasons why U.S. interest rates have been so low for such a long period of time.  You may have heard Bernanke and others talk of a “global savings glut” and “easy money” in global financial markets.  A big contributor to this was the Japanese savings flowing out of Japan.

But that was when the Japanese economy was weak and there were not many credit worthy domestic borrowers in Japan.  Now with the Japanese economy growing and expanding might Japanese banks find more credit worthy borrowers at home and no long need to bring their depositors’ funds to the U.S?

Will the end of easy money mean significantly higher interest rates in the U.S?

Higher interest rates:  yes.  Dramatically higher interest rates:  Probably not.  As the Japanese economy grows, Japanese households will probably earn even more…and thus save even more.  Some of this additional savings will in all likelihood make their way to the U.S.  That is, as long as the U.S. remains an attractive place for foreign investment.

But, it does mean an end to the “easy money” of the last decade or so.  The U.S. can not continue to depend on cheap money coming from Japan to fund our deficits.  Thus, to keep U.S. interest rates from increasing too rapidly or too significantly (and thus choking off our own economic expansion) the U.S. has got to become more financially independent.   That means our households need to save more…and our federal government has to do more to reduce the size of its budget deficit.  Until these things happen U.S. interest rates are going to have to increase in order to attract capital from Japan and the rest of the world.

The summer heat in Texas will pass…temperatures will stop going up.  Let’s hope the same thing can be said for U.S. interest rates.

Macro Updates and technology.  The next edition of the Macro Updates may come to you in multiple formats.  The crack staff at the McCombs Marketing, Communications & Public Affairs Department is working on developing a podcast for the Macro Updates.  So…if everything works out correctly the Macro Updates in the future will be available in written and podcast format (if that is the correct terminology to use).  So, you will get to see me jabber on instead of having to read the updates.  Hopefully you will find them useful.

All the best,