As deflation has been feared in the last two years since the financial crisis, central banks have pulled out the stops to try to prevent and counter it. "Quantitative Easing (QE)" has been the name of the game. It basically involves buying up loads of debt, including direct purchases of government debt, by throwing on the printing presses to flood the market with cash. Normally when more and more currency chases the same amount of goods, prices should rise. Under the extraordinary conditions of the past two years, however, this has not been the case. Deflation has thus far been mostly avoided in the rich world outside of Japan, which has suffered inflation on and off for the past 20 years since its financial crisis in the early 1990s.
Japan has coupled QE with fiscal stimulus on and off for two decades, and yet still suffers deflation. There are also worries that Japan's capacity to stimulate with government spending may soon approach limits, though bond yields as of yet show no sign of this (Japan's debt is the highest in the rich world by far, but it is almost exclusively domestically held). Must Japan simply surrender itself to deflation, its economy a soufflé in a prematurely opened oven? Perhaps not. Japan has a few options. One would be more dedicated and aggressive QE. But there is also something else, something never tried before: negative interest rates.
Strictly speaking, there is no reason a central bank (or any bank, for that matter) could not offer negative interest rates. The problem is that many normal instruments of monetary policy would cease to function properly if this were done.
The problem with deflation is that people know that prices will be lower the longer they wait to purchase things. It also means that even small returns on investments are good ones because even stuffing money under the mattress makes you richer if prices constantly fall. This means riskier investments are unnecessary. All this means that people save and stay on the safe side, rather than borrow, spend, and engage in entrepreneurial activities. This devastates an economy, which requires some risk-taking and spending to keep it alive.
If a bank offers you a loan at an interest rate below inflation, that is an extremely strong incentive. It means it is cheaper for you to borrow the money, buy something today, and pay later than it would be to wait. That is why negative "real" (i.e. below inflation) interest rates give such a boost to an economy (and can normally spark strong inflation if overused).
If inflation is negative, however, this becomes problematic. A bank could, in theory, offer you a loan at -3% interest with an inflation rate of -2%. You could still buy a car at a lower price with the loan than without, and the car dealer would get to sell the car at a higher price now than it would later. The problem is: the bank would pay the difference. Why should it do that? True, it might receive loans from the central bank at -4% interest, earning a spread of just 1%, but that's a profit, right? The problem is: the bank would earn a 4% profit if it just left the money in the vault, didn't lend to anyone, and gave it back to the central bank (or rolled over the loan, taking on more). In short, the bank still has every incentive NOT to loan out the money at a negative rate, never mind a negative real rate.
Negative interest rates could help reduce government debt and allow a government to spend more. It is therefore possible that they might work. They would also help banks to re-capitalize and absorb debts, allowing them to then offer very low interest-rate loans, at perhaps even 1%, something not achievable in normal times. These measures might be enough. If negative interest rates needed to reach consumers, however, because deflation had become so entrenched and the currency continued to appreciate instead of inflation rising, the central bank would have to get even bolder. It would have to start lending to businesses and maybe even consumers directly. Absolute insanity? Perhaps, but if all else fails, this is something that would surely work to drive up inflation. If not done carefully, it could also spark huge investor panic. Desperate times?
Showing posts with label Japan. Show all posts
Showing posts with label Japan. Show all posts
Saturday, September 18, 2010
Wednesday, May 19, 2010
The Japanese-American Military Relationship: Call the Divorce Lawyer?
At the end of the Second World War, Japan was disarmed. Non-aggression clauses were even written into its constitution. Japan had no need of a large military because the United States vowed to protect it. At that time, the US was probably also the only force that would have been capable of attacking Japan in East Asia. Today, things look a bit different. Although China is rising and has been increasing military spending, Japan nonetheless remains a military lightweight, assured by security guarantees from the United States, much as Western Europe has been since the end of WWII.
Recently, however, there have been squabbles over American military bases in Japan, particularly in Okinawa. The previous government told the Americans the base could expand in size. Local residents, however, would rather see the base disappear altogether. Japan's new government at first agreed to review the case, putting off the Americans (though it has now reneged on this promise and plans to keep the base as previously planned). Is this a sign of further tensions down the road and the erosion of the Japanese-American security arrangement? In short: probably not. The Japanese know that the Americans insure not only their security, but the stability of the entire region. They are unlikely to kick them out any time soon, as evidenced by their eventual decision to let them stay, albeit possibly at a more remote location on the island. Even China has reason to wish for a US presence there. The strategic relationship is likely to recover and to remain at least as strong for the next two decades at a minimum. Whether the arrangement itself will be enough to stop an arms build-up and further tensions in the region, however, is in the stars.
America's presence in the Japanese archipelago is a central element in the area's security, part of the architecture of the modern "Pax Americana." Not only does it serve to protect Japan from outside attack, it also obviates Japan's need to build up its own defenses, which in turn makes other states in the region (notably both Koreas and China) feel less insecure and therefore less inclined toward military buildup themselves. South Korea's shipping lanes pass close to or through Japanese territorial waters and it is reliant on its trade links to the rest of the world.
It is not competition between Japan and South Korea, however, that is most worrisome. The elephant in the room is China. If the US were to depart from Japanese shores, is there any real doubt that the Japanese would start to feel nervous about their much larger neighbor to the west? The logical reaction to this insecurity would be a military buildup, of which Japan is certainly capable: it has the population (127 million), technology, and economic power. Japan's pursuit of security, however defensive its nature, would serve to make other countries in the region, namely China, but also both Koreas, feel less secure. Further insecurity in North Korea would make South Korea nervous. It is easy to see the chain reaction that would likely ensue.
Taiwan also relies almost exclusively on the United States to ensure that any change in its current status (in limbo between an independent state and a province of China) is not determined solely by the mainland Chinese. If Taiwan were to be wholly incorporated into the mainland, whether peaceably or not, this would extend China's reach into Japanese territorial waters near Okinawa (which in our extended scenario is no longer shielded by American forces). Leaving aside for a moment the worry that a democratic and open Taiwan might become an autocratic and oppressive Chinese province, this would be a serious destabilizing factor for the entire region.
Last but not least, China itself would not necessarily benefit from a US withdrawal. Although the Chinese would almost certainly rejoice if America removed its airbase from Taiwan and stopped supplying it with weapons, China, too, benefits from the Pax Americana. China would be faced with heightened diplomatic and military challenges if the region destabilized and Japan and the Koreas began building up their militaries. It would have to be very cautious not to drive on an arms race by becoming anxious and building its military might as well. The prospects for this restraint are not good. The security dilemma means tensions and even war would be hard to avoid in the absence of America's stabilizing power.
For all these reasons and more (habit, history, and cultural aspects), the Japanese-American connection is likely to remain strong as long as there are no truly severe (and foolish) diplomatic screw-ups. The only question then is: as America's (and Japan's) relative power declines in relation to China (assuming things continue to go well for China), how long will America's security guarantee remain credible? How long can America prevent a buildup and destabilization of East Asia? The continuation of strategic ties to the region may only delay the inevitable. The Pax Americana, like other paces before it (Britannica, Romana), will not last forever. The real issue is: what will replace it? Pax or bellum?
Recently, however, there have been squabbles over American military bases in Japan, particularly in Okinawa. The previous government told the Americans the base could expand in size. Local residents, however, would rather see the base disappear altogether. Japan's new government at first agreed to review the case, putting off the Americans (though it has now reneged on this promise and plans to keep the base as previously planned). Is this a sign of further tensions down the road and the erosion of the Japanese-American security arrangement? In short: probably not. The Japanese know that the Americans insure not only their security, but the stability of the entire region. They are unlikely to kick them out any time soon, as evidenced by their eventual decision to let them stay, albeit possibly at a more remote location on the island. Even China has reason to wish for a US presence there. The strategic relationship is likely to recover and to remain at least as strong for the next two decades at a minimum. Whether the arrangement itself will be enough to stop an arms build-up and further tensions in the region, however, is in the stars.
America's presence in the Japanese archipelago is a central element in the area's security, part of the architecture of the modern "Pax Americana." Not only does it serve to protect Japan from outside attack, it also obviates Japan's need to build up its own defenses, which in turn makes other states in the region (notably both Koreas and China) feel less insecure and therefore less inclined toward military buildup themselves. South Korea's shipping lanes pass close to or through Japanese territorial waters and it is reliant on its trade links to the rest of the world.
It is not competition between Japan and South Korea, however, that is most worrisome. The elephant in the room is China. If the US were to depart from Japanese shores, is there any real doubt that the Japanese would start to feel nervous about their much larger neighbor to the west? The logical reaction to this insecurity would be a military buildup, of which Japan is certainly capable: it has the population (127 million), technology, and economic power. Japan's pursuit of security, however defensive its nature, would serve to make other countries in the region, namely China, but also both Koreas, feel less secure. Further insecurity in North Korea would make South Korea nervous. It is easy to see the chain reaction that would likely ensue.
Taiwan also relies almost exclusively on the United States to ensure that any change in its current status (in limbo between an independent state and a province of China) is not determined solely by the mainland Chinese. If Taiwan were to be wholly incorporated into the mainland, whether peaceably or not, this would extend China's reach into Japanese territorial waters near Okinawa (which in our extended scenario is no longer shielded by American forces). Leaving aside for a moment the worry that a democratic and open Taiwan might become an autocratic and oppressive Chinese province, this would be a serious destabilizing factor for the entire region.
Last but not least, China itself would not necessarily benefit from a US withdrawal. Although the Chinese would almost certainly rejoice if America removed its airbase from Taiwan and stopped supplying it with weapons, China, too, benefits from the Pax Americana. China would be faced with heightened diplomatic and military challenges if the region destabilized and Japan and the Koreas began building up their militaries. It would have to be very cautious not to drive on an arms race by becoming anxious and building its military might as well. The prospects for this restraint are not good. The security dilemma means tensions and even war would be hard to avoid in the absence of America's stabilizing power.
For all these reasons and more (habit, history, and cultural aspects), the Japanese-American connection is likely to remain strong as long as there are no truly severe (and foolish) diplomatic screw-ups. The only question then is: as America's (and Japan's) relative power declines in relation to China (assuming things continue to go well for China), how long will America's security guarantee remain credible? How long can America prevent a buildup and destabilization of East Asia? The continuation of strategic ties to the region may only delay the inevitable. The Pax Americana, like other paces before it (Britannica, Romana), will not last forever. The real issue is: what will replace it? Pax or bellum?
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