Japan: Possible Culprit to Drive U.S. Interest Rates Higher

In investing, it’s important to think unconventionally and creatively while at the same time considering risks - no matter how remote or unmanageable they are. I keep thinking: What would drive our interest rates up in the US?

China is the obvious culprit as it’s the largest holder of our fine Treasury obligations. If China’s exports to the US don’t recover to the pre-Great Recession level then, considering its large overcapacity and bad-debt problems, it may quite suddenly find itself unable to buy as many of our bonds/bills. Or even worse, it may start selling them. But this scenario is one I’ve discussed in the past more than once.

Then you start looking down the list of who’s who in the ownership of our government debt, and you find Japan only slightly behind China. Japanese interest rates were circling around zero, but they still failed to stimulate the economy that’s been in a recession for as long as I can remember. The Japanese savings rate was very high, and thus, as government debt ballooned over the last two decades, it was happily absorbed by consumers who were net savers – they had extra funds to invest. However, Japan has one of the oldest populations in the developed world. As people get older they save less; thus the savings rate has been on a decline in Japan. (The fact that their exports fell 36% did not help their savings rate, either. To save you need income).

The appetite for Japanese bonds will decline in tandem with their savings rate. The Japanese government (and corporations) will have to start offering higher yields to entice interest in its bonds. Interest rates in Japan will rise, and this of course will put a significant interest-servicing burden on the already highly leveraged Japanese government. But more importantly (at least from our selfish US perch), Japan will finally become a formidable competitor for borrowing. Our borrowing costs will rise. In addition, Japan may also start buying less or selling US debt, not by choice but out of necessity, putting additional pressure on US interest rates.

Not to appear as an “on the other hand” economist (I’m not one), but the counter-argument to this is, the US consumer may become a net saver and will be able to offset (at least some of the) declining demand from our friends across the Pacific.

P.S. I was interviewed in last week’s Barron’s (you can read full interview on SmartMoney).

Comments

[Dave Wrixon:]

Look, the Credit Crisis came about because the return on capital was not worth the risk. Bernanke "solved" that problem by putting the Fed Rate at Zero, but nobody apart from the Big Banks are getting cheap money from the Fed and they are simply lending it back to where it came from at a healthy profit for doing bugger all.

It is obvious to all but an imbecile that US interest rates need to rise considerably. Don't blame Japan, unless it for setting a bad example with their bubbles and the misguided Zero Interest Rate Policy and Quantitative Easing. It didn't save them and they started in a much healthier position than the US.

Sep 27 12:40 PM

[Buckoux:]

Exactly.

"Making" money involved loaning other peoples money to those who couldn't pay it back and getting a commission on the pass through.


On Sep 27 12:40 PM Dave Wrixon wrote:

> Look, the Credit Crisis came about because the return on capital
> was not worth the risk.

Sep 27 01:44 PM

[chap08:]

Dave, a few points:

1. Anyone who took part in cash 4 clunkers, or receives any other govt. stimulus, gets money even more cheaply than the banks do. If problems persist, expect more people to receive such generous terms.
2. What do you mean by interest rates? If you mean short term rates, then either you are wrong, or I am an imbecile. The Fed can hold short term rates low, needs to do so and has said that it will. Long term rates on the other hand, could start rising. The result would be a steep yield curve.
3. Either way, the nominal rates are only half of the picture. The other half is inflation. Rising inflation (which the Fed has the power to create) would mitigate or eclipse any rate rise. Rising inflation and a steep yield curve is a recipe for increased bank lending (whether or not you think this is a good idea) and economic activity.
4. This picture would be completely different to Japan. The Japanese focused more on fiscal than monetary measures and ended up with a bunch more mal-investment. They never achieved the low, or negative, real interest rates, that inflation allows you to achieve (OK they did, but not for long enough and deflation returned, pushing real rates back up again). That is the key. The Fed are more determined than the BOJ were.


On Sep 27 12:40 PM Dave Wrixon wrote:

> Look, the Credit Crisis came about because the return on capital
> was not worth the risk. Bernanke "solved" that problem by putting
> the Fed Rate at Zero, but nobody apart from the Big Banks are getting
> cheap money from the Fed and they are simply lending it back to where
> it came from at a healthy profit for doing bugger all.
>
> It is obvious to all but an imbecile that US interest rates need
> to rise considerably. Don't blame Japan, unless it for setting a
> bad example with their bubbles and the misguided Zero Interest Rate
> Policy and Quantitative Easing. It didn't save them and they started
> in a much healthier position than the US.

Sep 27 03:46 PM

[JohnnyJunk:]

Nice article Vitaliy. The interview in SmartMoney was also enjoyable.

Sep 27 10:48 PM

[Denis Gould:]

The unconventional question is to ask what will drive bond yields down. If you accept that interest rates are going to be at zero for years to come because the priority is to get fiscal policy back on track then bond yields of 2.5, 3 whatever become attractive. We will see 2%yields on 10 year Treasuries within the next two years.

And who is going to buy them to push them there? Banks.

Sep 28 02:02 AM

[Dave Wrixon:]

The Fed does not decide interest rates the market does, although the Fed can probably buck the trend for a very short period but dollar collapse will force its hand. You can run but you cannot hide.


On Sep 27 03:46 PM chap08 wrote:

> Dave, a few points:
>
> 1. Anyone who took part in cash 4 clunkers, or receives any other
> govt. stimulus, gets money even more cheaply than the banks do. If
> problems persist, expect more people to receive such generous terms.
>
> 2. What do you mean by interest rates? If you mean short term rates,
> then either you are wrong, or I am an imbecile. The Fed can hold
> short term rates low, needs to do so and has said that it will. Long
> term rates on the other hand, could start rising. The result would
> be a steep yield curve.
> 3. Either way, the nominal rates are only half of the picture. The
> other half is inflation. Rising inflation (which the Fed has the
> power to create) would mitigate or eclipse any rate rise. Rising
> inflation and a steep yield curve is a recipe for increased bank
> lending (whether or not you think this is a good idea) and economic
> activity.
> 4. This picture would be completely different to Japan. The Japanese
> focused more on fiscal than monetary measures and ended up with a
> bunch more mal-investment. They never achieved the low, or negative,
> real interest rates, that inflation allows you to achieve (OK they
> did, but not for long enough and deflation returned, pushing real
> rates back up again). That is the key. The Fed are more determined
> than the BOJ were.

Sep 28 04:44 AM

[chap08:]

That's where you are wrong Dave.

1. The Fed can still set the short term rate where it wants to. That's why it's now so low.
2. Any form of "dollar collapse" implies inflation and low or negative real interest rates. This is totally different to Japan's experience.


On Sep 28 04:44 AM Dave Wrixon wrote:

> The Fed does not decide interest rates the market does, although
> the Fed can probably buck the trend for a very short period but dollar
> collapse will force its hand. You can run but you cannot hide.<br/>

Sep 28 06:14 AM

[GregZw:]

The U.S savings rate will have difficulty keeping up with the increase in federal state and local taxes.

As the FED moves from buying to selling Treasuries, and the Treasury continues to increase their selling of bonds to finance the deficit, I think we will see a bubble bursting in Treasuries.

Sep 28 08:40 AM

[GregZw:]

You assume Bernanke can continue to control interest rates. The first hint that he can't will blow up the bond market.


On Sep 28 08:42 AM From Harvard wrote:

> This bull market simply cannot be stopped with interest rates still
> soooo low. Despite booming projected GDP growth and stock market
> up 53% from lows, Bernanke has given no hint of raising them.
>
> good articles: tinyurl.com/n854tt
>
> this is still a dip buy market

Sep 28 08:45 AM

[GregZw:]

Only a fool would tie up money for 10 years at 2% until the FED shows it can remove the excess liquidity it created without killing the economy.


On Sep 28 02:02 AM Does nobody understand what long term actually means? wrote:

> The unconventional question is to ask what will drive bond yields
> down. If you accept that interest rates are going to be at zero for
> years to come because the priority is to get fiscal policy back on
> track then bond yields of 2.5, 3 whatever become attractive. We will
> see 2%yields on 10 year Treasuries within the next two years. <br/>
>
> And who is going to buy them to push them there? Banks.

Sep 28 08:50 AM

[Mike from NYC:]

Why anyone would want to buy US debt is beyond me except to continue our purchasing their exported goods, most notably China. How can any purchaser expect the US to make good on all its debt when the US accounts receivable is far smaller than accounts payable - this wasn't always the case but has been for almost 30 years and it's gotten worse since China became a manufacturing giant. China, Japan and others were our dealers to support our addiction to money and in return for their drugs (money) we gave them IOUs. Am I in my ignorance missing something?

Sep 28 08:53 AM

[GregZw:]

The first major player to dump their long term treasuries will start a collapse and be able to buy them back at 10 cents on the dollar whether its China, Japan, or the FED. The rest of the players will likely lose.

Sep 28 09:10 AM

[Dave Wrixon:]

No that where you are wrong. The Fed will at some point have to intervene to prevent a complete melt down of the dollar, which will result in higher interest rates which will almost certainly throw the US back into a deep recession.

The dollar can probably stand being devalued by 5-10% per annum but when that start to morph toward 100% per week then even he is going to have to start behaving a little more responsibly.


On Sep 28 06:14 AM chap08 wrote:

> That's where you are wrong Dave.
>
> 1. The Fed can still set the short term rate where it wants to. That's
> why it's now so low.
> 2. Any form of "dollar collapse" implies inflation and low or negative
> real interest rates. This is totally different to Japan's experience.
>

Sep 28 09:13 AM

[rennert:]

All sounds good but the economy will not ever recover until Grandma and her Garden Club friends all over America will get a decent return on their CD's. They are not blinded by all that economic talk. They walk into the grocery store and see with horror how their food and vet and doctor bills have explode to the upside. They are smart and persistent. Toilette paper and a few nibbles is all they buy. The economy will go into free fall if their CD's stay this impoverished.

Sep 28 10:19 AM

[battman:]

100% inflation per week??? Wow, I think that's a slight exaggeration.

Until someone can step in and replace the US consumer, the dollar should be okay. It will go down, but not to any extreme of 100% inflation (not weekly, monthly or even annually).


On Sep 28 09:13 AM Dave Wrixon wrote:

> No that where you are wrong. The Fed will at some point have to intervene
> to prevent a complete melt down of the dollar, which will result
> in higher interest rates which will almost certainly throw the US
> back into a deep recession.
>
> The dollar can probably stand being devalued by 5-10% per annum but
> when that start to morph toward 100% per week then even he is going
> to have to start behaving a little more responsibly.

Sep 28 11:16 AM

[Steve in TN:]

George Archer:
"The author should go back to Jimmy Carter era--the Rothchild's Federial Reserve Bank, made sure the interest rates were about 17% over nite. Why? To oust Carter because he supported Palestine.
FYI: the low interest rates were to stuper the general public not to question the two invasions and CIA; MOSSAD 911 attacks."

George, your arguments lost all credibility with those two sentences.
You should seek mental help immediately.

Sep 28 11:22 AM

[Old Trader:]

I follow the author's logic, but how far down the road are we talking? To me, it sounds like this would be a fairly slowly evolving problem.

Sep 28 11:28 AM

[Jimbo:]

George Archer: So it was Mossad that pulled off 9-11? Wow! Those Jews are pretty clever, They managed to talk 19 Saudis to perpetrate the deed. I bet the current administration has their eye on you for an important appointment.

Sep 28 12:25 PM

[Dorlan H. F...:]

Why do you refer to these countries as "culprits"? You should be grateful to them for taking on what the Americans refuse to do. The key to savings is CASH VALUE life insurance. You Americans look on this with scorn. On the advice of people who peddle soft solusions like Dave Ramsey, Suze Orman, Clark Howard and all the other advocates of TERM LIFE INSURANCE Americans have been saving less and less. The little that is saved is placed in Hedge Funds and Mutual Funds. These institutions believe that the return on Treasury Bills are too small. So they rather speculate in oil. Driving up the price of oil while driving people out of work - GM, Chrysler and airline workers.

Japan and China have to come in where Americans fail to thred. Americans money must chase high yields while some other idiot must provide the savings to fund job growth and Your Government activities. Japan is now second to China in the purchase of Treasury Bills not because their people are getting old, which they are, but they are savings less because America's assinine idea of buying TERM LIFE INSURANCE has found its way to Japan. Up to 1994 only 8% of policy sold in Japan was Term. Last year 16% was Term. A 100% increase in the sale of Term. As Term sale increase, savings rate falls. Just as it did in the US. In 1981 the US was creditor to the world. Then 23% of policy sold was Term. The US is now the largest debtor nation in history. Last year 41% (mind boggling #) of policies sold was Term and their savings rate was negative. Writers like you should be less focus on how to satisify greed and try and find out how a country could be a net creditor in 1981 and by 2009 is the worlds largest debtor. You can star by reading my book LIFE INSURANCE - The Cause Of Economic Prosperity by Dorlan H. Francis available at xlibris and most online bookstores. You may also see my blog:
dhfken-lifeinsuranceco...

Sep 28 01:24 PM

[kebu77:]

Correctamundo!

Without a deadline - when the Japanese behavoirs will occur, the article is unhelpful. Descriptive, not predictive.


On Sep 28 11:28 AM Old Trader wrote:

> I follow the author's logic, but how far down the road are we talking?
> To me, it sounds like this would be a fairly slowly evolving problem.

Sep 28 01:32 PM

[mna:]

Another bad article. Where to start? Sensationalist title with little substance (I wouldn't call your bankers "Culprits" when they decide to pull financing from you).

The entire article is summed by stating the obvious, and adds no value beyond simple logic. Japan is getting old. Old people save less. AHA! oh my god they are gonna start spending and take away all our financing that we truly deserve because we are Americans, and we deserve living beyond our means. Nevermind that we wouldn't have needed the financing to start with if we reined in spending.

Honestly, I'd stop with the shameless self promotion and start with articles that are a little more thought-provoking. This is almost as bad as the article where you accused China of making up their GDP numbers, when in truth you just messed up simple arithmetic.

Sep 28 02:55 PM

[Living4Divi...:]

I agree with GregZw - except that 10 year rates are at 3.3020% not at 2%. Still, your argument holds true.


On Sep 28 08:50 AM GregZw wrote:

> Only a fool would tie up money for 10 years at 2% until the FED shows
> it can remove the excess liquidity it created without killing the
> economy.

Sep 28 04:22 PM

[Moon Kil Woong:]

It is not other countries driving inflation and rates up. It is 100% US primarily the Federal Reserve as usual. The author is correct that US savings will start to offset a decreasing foreign appitite for our bonds. That means rather than our savings going to improving our economy it will be sucked back into relatively unproductive government spending which is the other root of inflationary pressure.

Inevitably our long term bond rates will rise yet again even if we stay at zirp which bankers are playing like an ajustable rate mortgage. Like Japan, they are already addicted to free money. Getting off this boat will likely be as painful as Japan trying to get off QE.

Sep 28 08:36 PM

[Roman Sagdiyev:]

Good article

Sep 29 09:51 AM

[James Lewis:]

The FED can buy all the treasury notes it needs to if Japan/China stop buying. Financing is not the issue, the effect on the dollar is. As things stand so much wealth worldwide was destroyed that deflation is still a threat. Especially if we get a double-dip in the price of assets and all the associated selling that will occur due to solvency/tier capital requirements. I think from here no one is going to make any sudden moves in the interntional debt markets. Except the FED, US consumer will slowly but surely through direct/indirect means take over the role of financier to the US government.

Some have argued this will mis-allocate capital away from productive means. But this is not true, as a lot of this capital was used to buy useless goods from China and help swell their trade surplus. Of course the USA made money on the recycling of this money as it re-entered the USA by the export nations by selling manufactured financial products (with pretty good profit margins). But keeping the money in savings and by association helping the US to finance its government spending does not have to be a total waste. After all the government could do the smart thing and subsidise more industry to develop manufacturing at home. Which in turn could help ease the employment problem. So there is a lot of good that can be done by the increased savings going into treasuries.

Those that think the dollar is going to weaken/gold is going to rise are in for a big surpise. The USA is not in the weak position everyone seems to think. The USA has gone through re-structuring many times and will find it no problem to adjust its policies. It's all relative, all that needs to happen is an emerging market blowup and the dollar will become the central banks darling again.

Why - there is no alternative. Regardles what the gold bugs keep telling you as they try to sell you gold at 1000.

Sep 29 12:39 PM