Tuesday, January 12, 2010

Something confusing

for a mathematician looking at what economists do.

This is Martin Wolff talking about Japan.

"It is also time to stop the deflation. To achieve this result, the Bank of Japan must co-operate with the government to avoid an excessive strengthening of the exchange rate. The recent strength of the yen should have led to far more aggressive monetary policies. Once Japan has significant inflation at last – 2 per cent is a bare minimum – the country would have the negative real interest rates it still needs."

Now, a signal processing engineer would say that a negative yield is an economic decline because the engineer thinks of the yield curve as a proxy for a Fourier transform. In particular, short term real interest rates being low tells me that domestic retail sales growth is low, Japan should not want that.

The real reason Japan went into decline is that it geared itself to the American consumer through exports. The only way Japan, a resource poor country, can continually export to the US is if their consumers consume less. Japan is caught in a trap in which they have to build consumer products for the energy inefficient USA, products which have less utility for the Japanese consumer.

Now consider this post in which the staff at the Economists cites statistics of Americas abundant natural resources, semi-vacant land, and lack of authoritarian history as the main components of American dominance. Japan does not have that, and the USA has a whole lot less of it today. But Japan is forced to make consumer products appealing to this US consumer blessed with natural resources, products for which Japan should not be consuming without the same endowment.

When short term interest rates are held abnormally low, the consumer cannot balance between savings and consumption. Worse yet, when short term rates are abnormally low, producers tend to borrow from the consumer for speculative bets, which our Fed seems to be encouraging. Economists who want to use interest rates for stimulative purposes tend to favor large investment firms over the consumer.

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