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Monday, Jan. 3, 2005


Nightmare scenarios for 2005 -- new year dreams for economists

Japanese tradition makes much of one's first dream of the year. If you dream about things like Mount Fuji and hawks and for some reason aubergine, all is well. If you don't, well better luck next year. There is also some difference of opinion as to which night counts as your first dream night. Is it the night of Jan. 1, or is it that of Jan. 2?

The Kojien, that comprehensive dictionary of Japanese language, diplomatically cites both as eligible.

Whatever the finer points of dream divination, pleasant dreams are clearly nicer than horrible ones. Yet horrible dreams can actually be more helpful than pleasant ones, to the extent that they prepare you for the worst in a virtual kind of way.

For this reason, economists ought to prefer horrible dreams to pleasant ones, for it is the function of an economist to think through horrible situations and warn people about them. Of what use will an economist be who can only say pleasant things that lull people into a sense of security? Thinking of the seemingly unlikely, asking the "What if" question -- dreaming up nightmare scenarios is what economists are trained for. I cannot think of another way we can justify our profession.

So what kind of dream should a good and useful economist have on the first night of 2005? Turmoil in the foreign-exchange markets is one that immediately comes to mind. How far and how quickly is the dollar liable to go down? Exactly when will the 100 yen to the dollar line be breached?

Sooner than later is the economist's dream answer. Since we are in the realm of dreams, it should be further assumed that once that particular barrier has been broken, the distance to the 50 yen to the dollar point is likely to become considerably shorter. Distances, as well we know, are very flexible things in dreams.

A 50 yen to the dollar world does present a lot of dreamlike qualities and indeed does not seem quite real. Yet it is bound to happen sometime. If it happens over a period of 50 years, nobody would bat an eyelid. But it could equally happen tomorrow. In dreamland, most certainly, but so, too, in economicsland. The severing of the dollar's relationship with gold did not happen over half a century -- it happened overnight.

Another kind of economist's nightmare would be plunging bond prices and soaring long-term interest rates in Japan. This is actually a disaster waiting to happen.

The dreamscape is one in which the Bank of Japan's quantitative easing policy is the only thing standing between Japanese government bonds and collapsing prices.

The third and ultimate nightmare is one in which the foregoing two things happen together.

That is more fantasy than dream, critics would say. Economists who dream such dreams would no doubt be accused of not knowing their economics.

That would be justifiable criticism, to the extent that a soaring exchange rate indicates money pouring into the economy. If that money were to find its way into the bond market, bond prices would indeed go up rather than down. But in a nightmare scenario, people would hold onto cash rather than buy bonds that are being issued by an alarmingly heavily indebted government; all the more so if they were not so much buying yen for investment purposes as selling the dollar to avoid getting thoroughly clobbered in a 50 yen to the dollar world.

The one saving grace of nightmares is that you usually wake up just before the ultimate disaster. But what if you don't?

Noriko Hama is an economist and a professor at Doshisha University School of Management.

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