Will Japan's interest rate hike trigger a financial earthquake? You're not overthinking it, you're thinking wrong.

Recently, there has been much discussion about Japan's interest rate hike. If I’m not mistaken, the video from that so-called 'economist' who couldn’t even distinguish between need and demand should have the biggest impact, being broadcast everywhere, suggesting that Japan’s interest rate hike won’t trigger an 'earthquake', yet he still wants to create the momentum for an 'earthquake'. The logic of this 'economist' is roughly as follows: Japan has long been in a zero or negative interest rate policy, leading to a long-standing arbitrage trade between the yen and the dollar, and the scale of this trade is substantial, reaching several trillion dollars.

Therefore, when the yen suddenly starts to raise interest rates while the dollar is simultaneously lowered, it will inevitably lead to the unwinding of arbitrage positions. A large amount of dollars will withdraw from various markets, including the stock market, exchange rates, commodities, and the cryptocurrency market, leading to a rapid collapse of major markets, followed by international capital bottom-fishing, staging another round of financial games. This script is familiar to everyone, right? The expected time for Japan's interest rate hike is tomorrow (December 19). Recently, global stock markets have indeed been fluctuating slightly, seemingly validating this 'economist's' prediction as astute. However, is the phenomenon and the logic behind it really as he claims?

Many of us only know that Japan has had zero or negative interest rates for the past two decades, but we do not understand what this zero or negative interest rate really means, and how the mechanism operates. It is important to know that the so-called zero or negative interest rate refers to the interest rate at which the Bank of Japan lends money to commercial financial institutions, not the actual commercial bank interest rate. A simple common sense is that if commercial banks also had zero or negative interest rates, ordinary people would not deposit money; how would banks lend externally, and how would the financial system operate?

The Bank of Japan lends to commercial financial institutions at zero or negative interest rates, which then attract deposits and lend at a certain interest rate; this is the truth. The purpose of this is to lower financial costs, promote enterprise investment and financing activities, and boost economic activity. We certainly cannot rule out that the interest rate differential between the yen and the dollar can lead to arbitrage, but the arbitrage space is not as exaggerated as that 'economist' claims. The dollar interest rate indeed once reached as high as 5%, but the comprehensive interest rate of Japanese commercial banks is usually around 3%, not the huge differential he mentioned between 0% and 5% or -N% and 5%. Of course, even a 2% interest rate differential would obviously lead to the existence of arbitrage trades, especially when accompanied by a continuous depreciation of the yen against the dollar.

A comprehensive analysis shows that the financial arbitrage trading between Japan and the dollar exists in both directions. Some borrow yen to buy dollars and deposit them in American banks to take advantage of the interest rate differential, while others use dollars to buy yen and rush to the Japanese stock market to buy, such as Buffett. The decisive factor here is mainly the fluctuation of exchange rates; it is not solely due to the interest rate differential. The yen is now going to raise interest rates; of course, it will have an impact, but to correctly understand this impact, we must analyze it from the reasons behind the interest rate hike. We must understand that the bank benchmark interest rate is actually influenced by the interbank overnight lending rate, which is in turn influenced by government bond rates.

Japan's sudden interest rate hike is not because the Bank of Japan is out of its mind, trying to create financial turmoil or a strong yen, but because Japanese government bond rates have begun to soar. Why have Japanese government bond rates started to soar? The fundamental reason is that Japanese government bonds are not selling well. Because they are not selling well, it is necessary to raise the interest rate level; this reasoning is quite simple, right? The reason for the past zero or negative interest rates by the Bank of Japan was that government bonds sold well at extremely low rates. Now that low rates are not selling, they have to raise rates; it is that simple. Now, you should understand the true reason or root of the event. The question to ponder is why Japanese government bonds are not selling well; this is the key issue. The failure of government bonds to sell is certainly due to the capital market's lack of confidence in the Japanese economy, losing faith in the Japanese government's ability to repay debt, right?

Some say that the economic situation in Japan is booming, with an unemployment rate close to zero, indicating an overheating economy, so interest rates should be lowered, yet they avoid discussing changes in Japanese government bond rates. This is clearly avoiding the main issue. Whether the economic situation is good or not cannot be judged solely by the employment rate; we must look at broader economic indicators. The reasoning is very simple; in a planned economy, there is no unemployment problem, right? If people are maintained by continuously printing money, then naturally there is no unemployment problem. The Japanese economy has stagnated for decades, supported all along by zero or negative interest rates.

In today’s global economic situation, can this model still work? We should see that first, American government bonds are not selling, and then Japanese government bonds are not selling. When American government bonds stop selling, Trump forces the Federal Reserve to buy government bonds. Everyone only notices that the U.S. is lowering interest rates, but ignores another crucial piece of information that the Federal Reserve has started printing money again. A landmark event is that at the same time as announcing the interest rate cut, they announced the start of the balance sheet expansion program and began large-scale purchases of U.S. government bonds. The simultaneous lowering of interest rates and expansion of the balance sheet in the U.S. means what? I don’t need to explain it, right?

Financial turmoil in the U.S. is certain, and even financial collapse is inevitable; I have been saying this and firmly believe it. However, the current actions of the Federal Reserve are aimed at saving the collapse, attempting to navigate through monetary easing, especially with the AI bubble possibly bursting at any time. At this moment, at least in the short term, the effect will certainly be to push the prices of the U.S. stock market and commodity markets to continue rising; how can there be a collapse in prices across various markets? Therefore, the basic conclusion is that Japan's interest rate hike may cause shocks to the Japanese market, including financial turmoil, but for the U.S. and global markets, it is likely to stage a short-term further rise rather than the opposite.

Do not overestimate the impact of the yen on the U.S. and global economies, and do not create panic emotions without reason. Tomorrow is the day of Japan's interest rate hike; we will wait to see whether the global financial market will indeed experience a major financial earthquake as that 'economist' said. My view is the opposite; everyone just wait and see the facts. Note that even if there are coincidences in phenomena, the underlying logic stated by that 'economist' is still incorrect.