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Monday, Feb. 20, 2006

JAPANESE PERSPECTIVES

Japan's falling savings rate reflects a global competition for funds


The national savings rate dropped to as low as 2.8 percent in 2004, according to a report released by the Cabinet Office last month. This is incredibly low, given the figure had been above 10 percent until as recently as 1999.

When Japan's huge trade surplus was a politically sensitive issue, the frequent criticism from abroad was that the Japanese were saving too much and should be trying to spend more and import more instead.

The savings figure tells us how much of a person's disposable income (after taxes are deducted) is being put aside for the future. Naturally, things like falling income, rising tax and social security burdens and expanding consumption will push down the savings ratio.

The rate, which was 10.2 percent in 1999, has fallen sharply: It was 7.6 percent in 2000, 5.1 percent in 2001, 4.5 percent in 2002, and 2.8 percent in 2004. There are two major reasons for this decline.

One is that income continues to face downward pressure from burdensome scandals and intensifying competition with cheap overseas labor that began entering the market after the end of the Cold War.

This April's tax hikes will likely draw down savings even further, but another strong factor is the building safety scandal, which has revealed that several condominiums were built to false earthquake-resistance specifications. People will likely tap their savings as they scrounge up additional funds to buy new houses.

The second reason is that people are finding it difficult to tone down inflated spending habits that were formed during the bubble years. If they want to maintain their current level of consumption in a tough income situation, they will inevitably tap their savings.

The savings rate in 2004 represented a drop of 1.34 percentage points from the previous year, with the consumption factor accounting for 0.98 points and the income factor the rest.

While the economy is attempting to make a turnaround now that one of its engines -- investment -- has finally revved up, the other engine -- consumption -- has eaten into many people's savings.

Japan will be hit by these two factors simultaneously as it braces for the impact of its rapidly graying population.

Needless to say, people save for a rainy day, or for emergencies and retirement, and they will naturally tap their savings when they begin to rely solely on pension benefits. And while it is often said that young people accustomed to credit cards don't tend to save as much as prior generations, it is the elderly population in fact that contributing more to the drop in the national savings rate.

One issue that merits attention is that the Bank of Japan's zero-interest-rate policy has prompted people to shift their savings from bank deposits to more risky financial tools that offer higher returns, including stocks, foreign currency deposits and foreign currency-denominated securities.

This changing pattern of savings management has also resulted in less money being put into government bonds, thereby pushing up JGB yields.

Further efforts must be made to cut public expenditures to make a smaller, more efficient government. Allowing the continuation of bid-rigging practices that waste taxpayer money is out of the question.

The growing stream of money flowing into foreign-currency-denominated investment tools means Japanese people are refusing to manage their funds at home -- creating something of an exodus of funds out of the country. WHILE Japan still maintains a current account surplus and more and more foreign investors are pouring money into Japanese stocks, the yen's current weakness shows yen-denominated funds are flowing out of Japan at a faster pace.

And the favorite destination for such funds is the United States -- a country known for its low savings rate.

Since last year, the U.S. savings rate has been in negative territory -- meaning that American consumers are spending more than they earn. If Americans' savings run dry, investment and consumption will shrink and they will have to rely on savings from outside the U.S. This is why the U.S. government, despite its huge trade deficit, is unable to give up its pursuit of a strong dollar.

But America is not alone. Emerging economic powers like China and India are fundamentally in a state of low savings, and what has ensued is a worldwide competition for savings. The U.S. can still rely on funds from overseas, but once those funds start flowing out, interest rates will rise and the dollar could fall rapidly.

Depreciation of the dollar will result in lower values for dollar-denominated assets, or a decline in savings.

Diversification of fund management is essential in an era of globalization, and foreign-currency-denominated investment tools are a viable option. But one must be fully aware of the foreign-exchange risk. If the dollar falls by 1 yen each month, it will result in a 10 percent loss over one year -- a drop that cannot possibly be offset by interest rate gaps.

Teruhiko Mano is a professor at Seigakuin University Graduate School.


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