Wednesday, December 05, 2012

Don't Cry for Me Argentina

Or, Japan, Inflation and the Carry Trade.

Japan is in a somewhat peculiar position. It has an enormous national debt (230% of GDP, compared to basket case Greece with about 160%), but its citizens are tremendous savers. Most of the Japanese debt is owed, in fact, to those very savers, who put their money in the Japanese Postal Savings bank. That means that the Japanese people collectively are simultaneously on the hook for 230% of their GDP and equipped with large personal savings.

Japan's problem, as I noted elsewhere, is that its economy is in the doldrums. Ultimately a country's ability to provide for its citizens depends on its economic output, though, and big numbers in your savings passbook won't help if your country can't produce and nobody else wants your money because you have nothing valuable to sell for it. The policy of running a the economy at a small inflationary rate is an idea to try to rev up the economy. The theory of how it works and when (when you are against a zero interest rate bound on conventional monetary policy)is that inflation makes save money less valuable, and hence encourages spending, on the one hand, and borrowed money less onerous, because you are going to pay it back with less valuable future money.

WB was kind enough to point our that the carry trade poses a complication or two. The idea behind carry trades is to borrow money at a low interest rate in one currency and invest it at a higher interest rate in another. Of course the relevant interests are the real interest rates, so any inflation in one currency or the other needs to be taken into account - which is where carry traders lose their shirts.

The obvious carry play is also stimulative, since money borrowed in Japan and traded for dollars or euros puts yen in the hands of those who can only really spend it in Japan. Of course inflation might push Japanese savers to start sending their money overseas but that's also stimulative for the same reason.