Japanese Banks May Get Loans Interest Free

Having already started to give money away to consumers, Japan now seems intent on offering interest-free money to banks as well.

Heading where no nation has been before, Japan’s central bank said this week that it will let a key bank interest rate fall to zero if necessary. The overarching goal: to beat some life into the dead horse that is Japan’s economy.

“This is uncharted territory,” said Matthew Poggi, economist with Lehman Bros. Japan. “It’s never been done any time, anywhere.”

Japan’s already minuscule interest rates, combined with a bit of jawboning and Washington’s continued economic strength, help explain a more than 5% decline this week in the yen, which fell nearly two points Friday to 121.5 to the dollar in New York.

The good news is that the weaker yen is less dangerous to the rest of Asia than it was even six months ago because of the region’s greater economic strength. At this weekend’s meeting of the Group of 7 industrial nations in Bonn, Treasury Secretary Robert E. Rubin and other ministers of finance are expected to bless the weaker yen policy.

Japan’s latest stimulus scheme of lowering interest rates until there’s no more room to go follows a string of policy initiatives that have all fallen flat. These have included massive public spending programs, record tax cuts and even free shopping coupons for consumers.

Japan’s Nikkei stock average closed Friday at 14,098.04, down 48.75 points, its third consecutive daily decline.

“The market’s reaction to these [Bank of Japan] policies is not very positive,” said Junji Ohta, analyst with Okasan Research Institute. “It seems that all the policies you can think of have already been used.”

Critics, meanwhile, fear the central bank’s apparent policy direction could undermine the institution’s independence, do more harm than good and signal yet another desperate attempt by Tokyo to delay the inevitable: a badly needed restructuring of an outdated economy.

“Japan has many structural problems,” said Tetsuro Sugiura, chief economist with Fuji Research Institute. “For the economy to pick up quickly, these must be resolved.”

All the hand-wringing was sparked by the central bank’s move this week to reduce the rate that banks pay for short-term loans to 0.15% from 0.25%. It subsequently signaled it could go all the way. Rates subsequently fell as low as 0.08%.

Disappointment With Interest Rates

To put this in perspective, a pensioner hoping to live on $16,000 in interest a year from a 0.8% savings account would have to keep $2 million on deposit, said Charles Lambert, market analyst with Jardine Fleming Securities (Asia), “and that’s before taxes.”

“I’ve been very disappointed with the current interest rates, but if they went to zero that would be beyond belief,” said Yosuke Konishi, a 46-year old businessman in Tokyo’s business district. “I’ll have to become a more aggressive investor if this goes on.”

Another danger of zero interest, some say, is that liquidity could dry up because it will not be worth it for lenders to make loans. Newspaper reports suggest this chill has already started to happen.

At broader policy levels, meanwhile, the markets seem at least as concerned about what the central bank might do as what it has done.

A basic fear is that the Bank of Japan is starting to bow to politicians’ calls to print more money. Such a move would undermine the institution’s independence and reputation.

Politicians everywhere tend to be addicted to spending, with responsible central banks acting as a brake on their excesses. In an often-cozy Japanese business world, however, the Bank of Japan is under particular pressure.

Japan has already spent more than $890 billion to stimulate its economy in recent years, not counting bank bailout packages and other initiatives. It now struggles to finance this mountain of debt.

The central bank’s recent steps “show the [Bank of Japan] can be swayed by political pressure,” said Ron Bevacqua, economist with Merrill Lynch. “It’s quite a disaster.”

A related concern is that the central bank is now on the path toward “monetizing,” or directly purchasing, its own government’s debt to finance more spending. This happened immediately after World War II in Japan and Germany and led to hyper-inflation, when desperate shoppers needed wheelbarrows of cash to buy loaves of bread.

Some Argue for Controversial Policy

While the Bank of Japan denies that it will purchase its own debt, some even encourage the policy, arguing that Japan now suffers from deflation, not inflation, which supposedly makes hyper-inflation unlikely.

For others, however, the mere suggestion that Japan will monetize its debt signals the nation’s desperation to avoid restructuring and to preserve an increasingly archaic economic system of inefficient shopkeepers and debt-drenched real estate holders.

Japan’s real problem, these economists argue, is overcapacity, which is as high as 40% in the construction industry and 20% in many manufacturing sectors. About 2 million people are clinging to seat-warmer jobs, Fuji Research estimates.

If they were laid off, Japan would see an unheard-of 7.3% unemployment rate rather than the current 4.3%. While restructuring is painful, this camp argues, Japan has no other credible choice.

“A move toward monetization or any massive reflationary effort tells me structural reform is not even on the radar screen,” Bevacqua noted.

That said, Japan lacks a Western-style social safety net or adequate pension system.

Furthermore, the social compact between workers and companies makes rapid-fire, American-style layoffs unpalatable and unacceptable.

A final concern with the Bank of Japan move, critics say, is that near-zero interest rates and a feared shift in the bank’s policy that would target money supply over interest rates could be ineffective.

That follows because, no matter how much cheap money you throw at a country, you can’t manufacture a demand for money where it doesn’t exist.

The analogy, economists say, is of trying to push on a string.

Still, some analysts believe that all the hoopla is overblown. The bank has only lowered interest rates, not yet monetized debt, said Alexander Kinmont, Japan strategist with Morgan Stanley.

“It is important to realize this is an unusual circumstance,” said Kyoji Okada, senior economist with Daiwa Research Institute. “This is an emergency.”

Etsuko Kawase in The Times’ Tokyo Bureau contributed to this report.