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Crisis & solution: Japan cuts interest rates to zero; Italy & Greece receive stimulus package from China

By WcP.Market.Watch - Posted on 13 October 2010

Italian Premier Silvio Berlusconi, shakes the hand of Chinese Premier Wen Jiabao, right, as they arrive for a joint news conference at Villa Madama in Rome

after nearly two weeks of demonstrations, Greek farmers used their tractors to block border crossings and highways across the country for days, demanding financial help from the government. A farmer hits a riot police officer with his crook at the main port of Piraeus, near Athens, Feb. 2, 2009

Greek Prime Minister Papandreou spoke on Greece's economic plight at the World Economic Forum in Davos.

Low rates in Japan and US have yet to boost economies.


Bank of Japan surprised the world by cutting it's already low-interest rates to effectively zero.

The Japanese central bank is trying to boost its weak economy by making it cheaper for its businesses and citizens to borrow. It also hopes that the low-interest rates will cause the value of its currency, the yen, which has been rising recently, up 12% in the past six months alone, to fall. A weaker yen could boost exports by making Japanese goods cheaper to foreigners.

Low interest rates have for a while now been the accepted policy move to cure weak economies. Ever since the financial crisis, the US, too, has recently been pursuing an ultra-low-interest economy to pull us out of our money mess. And indeed, many forecasters think the US Federal Reserve will soon announce a new program to try to drive down long-term interest rates even farther. The problem is it might not work. Two years since the fall of Lehman sent the US economy into a tailspin, there is a growing amount of evidence that suggests low interest rates may not be the potent economic medicine that many economists think it is. Here's why:

First of all, Japan has tried this before to limited success. The Bank of Japan had its interest rates set near 0% for much of the past decade, and yet its annual GDP growth hovered just about 0%. You could say that without low-interest rates Japan would have been in depression for all of that time, but low to no economic growth is not a sign of a successful policy. Japan's economy did seem to recover in early 2009, but that was only after the country had raised interest rates and then lowered them again.

Second, the recent experience in the US suggests that low-interest rates do not necessarily have the effect economist normally expect. It is thought that low-interest rates because they make it cheaper to borrow will cause companies to borrow money to buy equipment, build plants, boost production or hire more workers. All those activities should boost the economy. In fact, that's not what US companies are doing. They are borrowing money at ultra-low interest rates, but they are not spending that money on plants or equipment, and they are certainly not hiring. Instead they are sitting on the money. Or they are using it to retire old higher interest rate debts. Or they are buying their stock to boost their shares. And none of this appears to be boosting the economy.

Lastly, the focus on low-interest rates, and the high yen, are distracting Japanese policy makers for the real problem with their economy.

The conventional wisdom in Japan is that the country needs a weak yen to help its exporters compete in international markets. But this dependence on exports is an outgrowth of outdated thinking on Japan's economy. There is really no reason Japan should be so reliant on exports. Unlike a small, open economy like Taiwan or Singapore, exports don't account for that much of the economy – in fact, less than 20% of GDP. The problem is that the domestic economy doesn't contribute enough to growth.

Japan, of course, is not alone. The US is using low-interest rates to boost its economy. As it the UK, and the rest of Europe. The problem may be a relative game. If everybody's interest rates are low, at least in the developed world, then lowering your interest rates may not be a boost but just a futile race to the bottom. A growing number of US policy makers are starting to raise questions about the benefits of our low-interest rate policy. Some have called it a dangerous gamble. The biggest problem may be one of signaling. Companies do not build plants or hire workers unless they are confident the economy will improve and people will want to buy their goods. But low-interest rates have the opposite effect, sending a signal that the economy is still weak and will be for some time. How do we get out of this chicken and egg problem? Central bankers, it seems, have yet to figure that one out.

China’s big aid package helps Italy

China’s 4-trillion-yuan ($586 billion) stimulus package and fast economic growth will continue to help Italy crawl out of Europe’s debt woes, Italy’s chief trade commissioner in Beijing told China Daily.

The trade commissioner also said he is confident Premier Wen Jiabao’s official visit to the southern European nation will push bilateral economic relations to a new high.

"Italy has benefited a lot since the financial crisis and is benefiting from China’s stimulus package", as infrastructure projects included in the package have created huge opportunities for Italy’s machinery manufacturers and boosted exports to China, said Antonino Laspina, chief trade commissioner and coordinator in China with the Italian Institute for Foreign Trade.

In 2009, Italian exports to China dropped by only 5.3 percent year-on-year, while Chinese exports to Italy were down about 24 percent. During the past eight months, Italian exports to China grew 28 percent, and exports of machinery contributed about 60 percent of total Italian exports to China, said Laspina.

Italy has been hurt by the ongoing European debt crisis - with the unemployment rate hitting 8.4 percent in July, according to Italian news agency ANSA. And analysts do not expect the rate to go down in the near future. While Italy is still in an economic recession, Laspina said he believes cooperation with China will play a "positive role" in Italy’s economic recovery.

China’s economy grew about 11 percent year-on-year to surpass 17.2 trillion yuan in the first six months, according to the National Bureau of Statistics. Buoyed by strong economic growth, Italian exports to China will continue to surge, not only in machinery but in plastics, luxury, textiles and wine, Laspina said.

While the China-Italy trade volume in 2009 dipped 18 percent amid the crisis to about $31 billion, it bounced back in the first quarter, posting an increase of 34 percent, according to the Ministry of Commerce.

Compared to those from other nations, Italian companies suffered less because of the Chinese market, as many Italian goods target mid- and high-end consumers yet those groups in China were less affected by the financial crisis. "(With) 300 million middle-class, the Chinese market is definitely going to be one of the most important markets for Italian designer clothes, automobiles and other luxury goods," Laspina said, "The growth of China and the growing consumer strength here would help drag Italian economy out of recession."

Besides growing exports, ballooning Chinese investment in Italy is also giving an injection to Italy’s economic recovery. "There is more and more Chinese investment in Italy," he said. According to Invitalia, the Italian official agency for promoting overseas investment and enterprise development, 38 Chinese firms had operations in Italy at the end of last year, mainly in the auto, logistics and machinery sectors.

"Italy’s excellent design expertise, brands, innovation and technology are exactly what Chinese companies lack when they look to go from quantity to quality," he said, "Italy’s strategic position as an important sea gateway to Europe can help Chinese companies further tap the European market after they take hold in Italy."

China pledges: We'll prop up the eurozone and keep Greece afloat

China offered to bail out debt-ridden Greece – and pledged to support the eurozone countries during the global crisis.

Premier Wen Jiabao made the offer at the start of a two-day visit to the crisis-hit country. ‘China is holding Greek bonds and will keep buying bonds that Greece issues,’ said Wen. ‘We will undertake to support eurozone countries and Greece to overcome the crisis.’

Greece needs foreign investment to help it fulfill the terms of a £95 billion bailout from eurozone members and the international monetary Fund that rescued it from bankruptcy in May.

‘I am convinced that with my visit to Greece our bilateral relations and cooperation in all spheres will be further developed,’ Wen told Greek Prime minister George Papandreou. Wen addressed the Greek parliament and left for Brussels, where he will attend an EU-China summit.


Photos courtesy of AP, Toru Hanai / Reuters, and CFP

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