Wouldn't it seem unreal if I said that people are paying interest on investing their own money somewhere? Yes right? Well, people in Japan are dealing with a similar kind of situation, and it was unreal until 2009 but now it has become factual. Let us know why.
After the Global Financial Crisis in 2008, the world economy wasn't progressing. It was under a threat of deflation. Deflation occurs when there is an ample supply of products but no demand in the market. ( demand<supply) Therefore, a little inflation was necessary for the world to grow.
We have been taught that inflation isn't good for a country but what we haven't been taught is that it isn't completely bad either. Inflation arises when the demand for products is more than the supply of goods in the market. (demand>supply).
This provides the businesses a growing opportunity and as they produce more, they sell more (because the demand for the product is more) and make more profits and ultimately the income levels of people rise. Inflation is good until the increase rate of inflation (say 5%p.a.) is less than the increase rate of income (say 7% p.a.).
It turns bad when the numbers get interchanged i.e. inflation goes up to 7% pa. and income rate is 5%; which is the exact ongoing situation in India and many other countries of the world, but we will come to that part later in some other blog.
For a better understanding, let's dig a little deep into how the financial system of a country works. The financial system consists of a central bank, commercial and government banks, and the general public. The central bank is the regulator of all the commercial banks of a country. Commercial banks lend money to the people and charges interest on them. When a commercial bank deposits the money of people, it uses the interest charged on borrowings to pay people interest on deposits. This is how a bank earns and if either of the processes does not happen, the banking system would collapse.
This is looked at by the central bank of a country. A central bank saves a commercial bank from getting bankrupt by lending it money and charging interest on it known as repo rate. And if a situation arises when commercial banks have excessive cash with them, they park the cash with the central bank, and the central bank pays an interest known as reverse repo rate.
After the global financial crisis, many countries were struggling with their economy. To bring the economy back on its feet, the USA, for the first time introduced the concept of Quantitative Easing, or what we say in layman terms, printing money so that the central bank buys government bonds(long-term securities) leading to an increase in the money supply in the economy. This increase in cash liquidity was done so that people create a demand for products and the economy starts moving up a little i.e. make the economic environment inflationary.
Other countries also started quantitative easing to protect their economy from the threat of deflation. But the money doesn't get dissolved in an economy sometimes, there are other factors too. USA's money would also flow into Sweden or any other country as well (investors invest internationally too).
Sweden was itself into increasing the money supply, hence in 2009, Sweden introduced the policy of negative rate of interests. This means the central bank would charge interest on the commercial banks for parking their cash with them. This would discourage the commercial banks to deposit their cash with central banks, give out more loans to people, and hence economy would grow.
Inspired by this, Shinzo Abe, the to-be prime minister of Japan in 2012-13 stated that to protect Japan from deflation, he would allow the central bank to print money into oblivion till the inflation arises at a rate of 2% in the country. This policy introduced by Shinzo Abe was named after him which is called Abenomics.
Google defines Abenomics as the nickname for economic policies set out for Japan in 2012 when PM Shinzo Abe came into power for the second time. It involves the nation's money supply, boosting government spending, and enacting reforms to make the Japanese economy more competitive.
The money supply was increasing in Japan. What would a commercial bank or any other financial institution that holds a large amount of capital does? Two things can be done:
First, parking the cash with the central bank.
Second, investing in government bonds.
These two are the only safest options for any financial institution.
The central bank had, however, refused to park any cash with it (otherwise what would be the use of creating liquidity in the market). Hence the only option was to invest in government bonds.
But Japan had introduced the concept of negative bond yield (return generated on investing in bonds) in 2012 so that investors (here investors mean big financial institutions or people who have a net worth of more than $ 500 million) don't invest and spend the money somewhere, creating demand and diminish deflation. But these investors preferred investing in government bonds because although they had to pay bond yield themselves, their capital would be safe for longer-term.
Today, Investors are also assuming that the yen (Japanese currency ) would appreciate in the coming years because the demand for bonds is increasing. and hence, more people are converting other currencies say dollars into yen thus increasing the demand for yen, decreasing the demand for dollars. Therefore, depreciation (decrease in value) of the dollar in terms of yen.
In simple terms, the yen's value would increase (appreciate) in terms of other currencies.
But what is increasing the demand of Japan government's bond exactly? The answer is Shinzo Abe's commitment to increase the money supply until inflation rises and goes up to 2%. Investors are assuming that demand for the bonds would keep on increasing thus, the price would increase, and the yen would appreciate in the coming years which means the bond yield would fall more (because the price of bond and bond yield are inversely related). However, the investors would have a net profit overall.
This means investors are going to invest until they do not see any chance of profits anymore i.e. if the bond yield to be paid falls and becomes more than the net profit earned. So, we can say that investors aren't contributing to controlling deflation but have found a way to earn a considerable amount of profits.
Every crisis indeed brings in opportunities to gain major wealth if understood wisely and also lead to major losses if humans become a slave of their emotions.
The result is yet to be seen. No one knows whether this would actually increase inflation in the country or would be just another bubble to the world. But it would be worth observing for you as well as for me. Till then, happy reading :)
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