Japan Is Back, So Beware.

Byline: Peter Tasker (TASKER is a founding partner of Arcus Investment, a money management firm in Tokyo.)

It's been a long time coming--about 15 years, in fact. The Japanese central bank has just embarked on its first real monetary tightening since Japan's bubble economy imploded in the early '90s. Since then there has been only one direction for Japanese interest rates to go--south. Now, the Bank of Japan's decision last week to stop "quantitative easing"--pumping money into banks--heralds the end of free money in Japan.

For most of this period Japan has been stuck in a kind of alternate financial universe. While the rest of the G7 boomed, Japan slid into deflation--a crippling condition in which prices, wages and corporate revenues fall and debts grow more burdensome. The Nikkei index of stock prices plummeted from 39,000 to below 8,000. Real-estate prices slumped for 14 years in a row, for a total decline of 60 percent. And interest rates kept heading lower; by 2003, 30-year government bonds were yielding less than 1 percent. In bond-market terms, this is craziness on the scale of the dot-com boom. Bank deposits offered the princely return of 0.07 percent, so the yen equivalent of a million-dollar deposit produced post-tax income of about $600 a year. In Japan's high-cost economy, that's barely enough to finance a daily cup of coffee.

If a bizarre phenomenon goes on long enough, it starts to look normal. And the fact that the world's second largest economy abolished interest rates is a truly bizarre phenomenon. Not even in America's Great Depression did bond yields fall as low as in postbubble Japan. On the evidence of Sidney Homer's classic, "The History of Interest Rates," the Japanese government was borrowing money at the lowest cost since financial transactions were first recorded in ancient Babylon.

The Bank of Japan has been justly criticized for paralysis in the face of the 1990s market meltdown. Another blunder would probably cost the bank its independence. So with the politicians watching like hawks, it is planning to proceed very gently. Several months will pass before it drains off the liquidity injected into the money markets under the quantitative-easing regime, and policy rates will not be hiked until the second half of the year, at the earliest. By then, the BOJ will probably have accepted some ...