Liberal Japan

None of the following is true … at least I should hope not.

Imagine a world, where countries create money by merely printing it on paper. This money represents nothing, it’s not backed by gold or sliver or even rice. It’s worth nothing in any tangible sense. But people want this money, and the reason is this, they need it to pay taxes. Each government that prints their own variety of this money, forces its citizens to pay some of this money to them. If you don’t have any of it when the government comes calling, instead of taking this paper money, they’ll seize your real assets. So it’s your choice, either get a hold of some of this paper money and pay the government its demanded due or face the physical seizure of your assets.

In this situation, even though the printed money isn’t backed by any physical asset like gold or silver, everyone wants it so they can protect their own assets from being seized by the government.

Some people even begin to hold this paper money as a sort of investment.

Of course, it’s a pretty dicey deal to hold onto this money, because as I’ve said, the government can create it merely by printing some more of it. The more there is of this paper stuff, the less value it has. So if the government wants to, they can devalue the money just by printing it. If you’d had a lot of this money saved up, the value of your savings then goes down.

This gets pretty complicated, when you consider, it’s not just one country printing their own paper money, but many. And they don’t just print the money, they lend it out to banks at rates of their own choosing. As there are more than one kind of money — dollars, yen, francs, euros and so on — we would presumably want the money that is the strongest. So all these money printers are at least sort of in competition with each other. Depending on how well any particular government manages their money, and depending on how well their economy is doing, and depending on many other issues, the value of the printed money will either go up or down. Paradoxically, some countries might even want a weak currency, if they feel it will help their economy.

Now, I don’t know how accurate the above is, but I think it does at least give one a sense for what passes as money in this world today.

Recently the yen has been rising in value. Why?

Obviously the reasons are so complex as to boggle the mind, however we’ve heard a lot of talk about subprime loans having something to do with the price of tea in china [ahem], I mean the price of the yen in Japan. How could this be?

Well, for various reasons Japan has wanted a weak currency. They’ve kept their interest rates low to encourage people to borrow money so that the economy will grow. They’ve also worked in other ways to keep the value of the yen low, so that the prices of Japanese good overseas will be cheap and people will buy more of them.

If the value of the yen is low, then that means a Toyota car made in Japan will be relatively cheaper than a GM car made in America. While both Toyota and GM build cars in other places, the point still stands. A weaker yen encourages people to buy more Japanese products overseas. So the policy of Japan has been to keep the yen weak to help the Japanese economy.

Yet because of the weak yen, some other things have been happening. People realized that they could borrow money in Japan cheap and then lend it to people in America at expensive rates. (America had high rates because money printers there were pursuing goals different than the money printers in Japan.)

In America there had been a boom in the housing market, prices seemed to go up and up and there was no stopping it. Of course, no one buys a house directly, everyone borrows money to buy a house. Usually bankers are quite conservative and careful when they lend money to someone who wants to buy a house. However, with housing prices going up and up, loaning money became an almost sure bet. In fact, many banks began to engage in something called subprime loans. This is when a bank loans money to someone who can’t afford to pay it back at interest rates that continuously increase.

One would think that lending money to someone who couldn’t pay it back at interest rates that continuously increase would be a bad idea. You would think. But, so long as housing prices continue to go up, the loan doesn’t have to be repaid. If the house is worth more than it was before, a new loan can be made to pay for the old loan. So you never have to pay for the old loan, just make a new loan. This will work so long as the house continues to increase in value. So what if the value of houses starts to decline. Well, that can’t happen, can it? All the banks have to do is lend even more money to keep people buying houses, and that will drive the prices of houses up even higher. Loan more, buy more, loan more, buy more, and we can all get filthy rich? I mean the more we do it, the more we get, right? Well, not exactly. Sooner or later the chickens come home to roost.

That’s what’s happening in America now. No one knows how much, but a lot of Japanese yen has been borrowed to loan money to Americans. After all, I could borrow Japanese money cheaply, and then lend it out in America for big profits. This was a neat way to make some nice money. It’s called a carry trade.

But, now that the chickens have come home to roost, and reality is setting in, people are realizing the credit market is collapsing (or at least shrinking), and those who get out first are going to be the only winners. Those who get out last … well they won’t get out … they’ll go down with the ship.

So how do you get out? You sell your loans and buy yen and pay back the money you borrowed. So suddenly there is rush to exit, and the price of the exit ticket is in yen. No wonder everyone needs yen.

Yet with everyone buying yen, the price of the exit ticket keeps getting higher and higher, meaning even more people want to get out because if they wait too long, the price of the ticket will be more than they can afford. This drives the price up even higher.

Now, of course, government policy and government goals can all affect the value of the currency. However, only to a limited extent. The government cannot really control the market and even influencing it is more of an art than a science. Moreover, the government is constrained by reaction of other governments and reaction of people to having their savings accounts artificially weakened to bail out speculative investments. Many governments wouldn’t mind seeing a higher yen.

In any event, it does look like, at least for now, that the yen is on a trajectory for 110 or lower. (This is the yen to dollar rate, thus the lower it goes, the stronger the yen is.) Now, if it hits 110, the Japanese government will almost certainly react. They’ll perhaps print some money and buy up some dollars from America. Or something like that. But will this be too little, too late? Could the yen strengthen further? I’m sure we’d all like to know …

Whatever happens, how many people will question the value of having a currency that is backed only by the government’s ability to seize your physical assets?

Other links of interst:
The big question: buy or sell?
CNN: Yen may strengthen further as unwinding of carry trades accelerate
Fed’s Unexpected Move to Soothe Battered Local Stock Market
Ron Paul: The End of Dollar Hegemony