Morgan Stanley Global: Collision Course

September 28, 2004

The Bank of England was the first of the major central banks to
raise interest rates. As we know, the U.S. Federal Reserve
followed suit. Rates are also rising in countries like Canada. In
general, central banks around the globe are raising interest rates.

This could be perceived as good news because the confidence
central bankers display in raising rates sends a layman's
message that economies are improving. However, higher rates
have a severe, negative impact on people, companies, and
institutions that are heavily in debt.

Japan is a case in point. Japan is the second largest economy in
the world after the U.S. Right through the three recessions the
country encountered since 1991, the Japanese government
decided to spend "like crazy" to get its economy going. Japan's
federal government debt is now 145% of gross domestic
product.

Japan's debt is the largest in the industrialized world. And
higher interest rates will make that debt more difficult to
manage. It's no wonder Moody's has cut Japan's debt rating
six times since 1988 to the lowest among the Group of Seven
industrialized countries.

The yield on a Japanese 10-year government bond is now about
1.95%, the highest level in four years and up almost 1.5% since
the 10-year government bond's record yield low set in June
2003. If rates rise only slightly more in Japan, the country will
be facing another crisis, as it craters under its huge debt burden.

A rate hike of one percentage point didn't mean much back in
the 1980s or 1990s. Remember when borrowing rates were
above 15% in the early 1980s? A one-percentage-point move
did not make much of a difference to the economy at all.