Devotees of the Bank of Japan

(for MediaCorp 938LIVE’s Money Talks on 19 July 2007)

It was reported last week that Madam Lim Ah Hiang, who runs a hawker stall in Bedok selling fish soup, raised her price by 10%, from $3.00 to $3.30 a bowl. The rising costs of raw materials gave her no choice.

If Madam Lim were in the African country of Zimbabwe, rising costs would force her to raise the price by 300% every month.

That is because the official inflation rate in Zimbabwe is 3,700% a year. So a bowl of fish soup should rise from $3.00 to $9.00 in the first month. Twelve months later, it would be more than $100.00 a bowl.

This is Zimbabwe today, with its acute shortages and high jobless rates.

But it hasn’t always been like this. As recently as 1997, the Zimbabwean economy was an African success story. Things took a nose dive from year 2000 after a disastrous land reform, and the evaporation of international aid.

With no money to pay salaries, Zimbabwe’s central bank resorted to printing money as a stop-gap measure. But it soon became the main solution, leading to hyperinflation today.

In recent years, major central banks have also been printing money through their low interest rate policies. They were responding to the dot com bust in year 2000 and the World Trade Centre attack in 2001. While the global economies have revived, global asset inflation is now an issue.

Realising the harm, central banks reversed their policies recently. The exception is the Bank of Japan or BoJ. The yen’s interest rate remains at a very low 0.5%.

At such a low interest rate, global investors find it profitable to borrow the yen to invest in higher-yielding assets. This is the “yen carry” trade. No one really knows how large it is. It could be in the billions or trillions of dollars.

It is this huge size that is a potential flash point for global markets. The day BoJ starts to raise interest rates continuously will be the day yen borrowers rush to repay their loans. But first, there will be a massive selling of assets. Such a global financial storm, which could be worse than the Asian financial crisis, has been predicted by doomsayers.

The puzzling question is why BoJ officials do not realize that they are pushing the world closer to this storm? From BoJ’s viewpoint, their policy is right because, firstly, a weak yen is good for Japanese exports. And secondly, they believe their policy requires more time to revive the domestic economy.

Many have tried, unsuccessfully, to persuade BoJ and its devotees to do otherwise. We must remember that in economic policies, there is no black and white. Just as in any religious belief, economic devotees can be blinded by their own mantra.

If and when BoJ devotees finally realize that their beliefs are based on a fake relic, rotten eggs will land on many faces. BoJ will then have to raise interest rates.

One of two things can happen. The doomsayers could be wrong. The yen’s impact on global inflation and liquidity could have been grossly overestimated. In that case, a global financial storm will not take place.

If the doomsayers are right, the storm will break out. In the end, if Madam Lim wants to retain her customers, she would have no choice but to cut the price of her fish soup to less than $3.00 a bowl.