Dave Wrixon's  Instablog

Japan after twenty years of failure has suddenly changed direction. They are now talking a strong Yen. The common wisdom of the Monetarist, supported by the Keynesians is that low interest raises borrowing and consumption and drives the economy. But Japan has had low interest rates for two decades and nothing has changed. The blame has been put on Zombie Banks and High Government Debt, but as time has elapsed this argument has become less convincing, although clearly they would not have helped. At the same time comparisons are made with the 1930s which may also be misleading as the flow of capital of around the globe was highly restricted then compared with today's standards. Suddenly, the new regime is talking a strong Yen which implies higher interest rates. Can higher interest rates really get an economy out of trouble?

Well, maybe the answer is yes. The UK has had consistently higher interest rates than Europe and America during periods when its economic progress was not only solid, but compared with the preceding mess very impressive indeed. What is noticeable about the UK economy is the huge amount of inward investment it has received from abroad and the way it has to a large degree retained its own financial resources for reinvestment. If you compare this with Japan which has been the centre of "Carry Trade" for the best part of two decades the contrast is stark. OK, others may prefer to make comparisons with the US, whose GDP rise was also impressive, but as one of the main beneficiaries of inward capital flows the US has produced investment returns through consumer credit and consumption, which has hollowed out its industries and destroyed its wealth generating base. It is now about to replace Japan as the centre of the "Carry Trade", and already it is clear that capital is starting to abandon the US, which will almost certainly make the long-term prognosis dire.

Unless, the US introduces capital controls which is going to be very tricky when you a massive net debtor and also have the World's Reserve Currency, then the only solution appears to be a Thatcher style period of austerity with high interest rates, which may be the only reason there still is a UK economy. The problem is of course that thing have to get a lot worse before they actually get better, but that is perhaps a lot better than thing getting progressively worse over an extended time frame.

The question therefore has to be whether a race to the bottom is the correct strategy to get out of the mire and win the economic race. Perhaps, a rethink is required. Could it be that the example to follow is Switzerland.