TOKYO -- The trade war between the U.S. and China risks substantially disrupting the international financial system, Princeton University economist Nobuhiro Kiyotaki says, cautioning that the repercussions of tariff-induced inflation would ripple through the currency and equities markets.
The impact "may spread to the financial system," Kiyotaki told Nikkei in an interview. If both sides continue with tit-for-tat tariffs, "the inflation would lead to further increases in interest rates and give rise to disturbances in the currency market and a stock market slump," he argued.
The global financial crisis of 2008 led to such safeguards as the Dodd-Frank reform legislation in the U.S. "Regulations were strengthened, and big banks have become safer than before the crisis," Kiyotaki said.
But "I'm concerned about the risks in areas outside the reach of regulations," he said, citing the trade war itself as an example.
The Turkish lira's plunge indicates the level of uncertainty surrounding emerging markets. "The falling exchange rate for an emerging country will have domestic factors, but it will also include the U.S. effect," Kiyotaki said. He touched on the concern that the trade war will increase inflation and so compel rate hikes by the Federal Reserve, possibly accelerating capital flight from emerging nations.
Recognized for his research on financial crises, Kiyotaki has advised Japan's cabinet-level Council on Economic and Fiscal Policy and the Fed.
Kiyotaki sees the debt-ridden national budget as one of the biggest risks facing Japan. The problem as it stands now "is considerably perilous," he said.
"They need to create a contingency plan against a financial collapse," Kiyotaki argued. He said such a plan would include spending cuts, increased tax revenues and a reduction in the value of Japanese government bonds through inflation.
He did not give a timeline for the collapse but warned that one can come relatively quickly. "If foreigners start purchasing large volumes of Japanese government bonds, it will likely trigger it," Kiyotaki predicted.
In this scenario, a lower Japanese savings rate creates an environment where JGBs can no longer be refinanced solely at home. Then, with the requirements stemming from international investors, interest rates would surge.
To avoid that fate, "the Japanese government has no choice but to make long-term budgetary commitments," Kiyotaki said. This would include raising the 8% consumption tax to 10% in October 2019 as scheduled, he explained.
Kiyotaki painted a rosier picture of Japan's overall economic landscape. "Prices and nominal wages have secured positive growth rates, and deflation has already halted," he said. On the Bank of Japan's inflation target, "there is no need to give up, but it's not necessary to be rigidly fixated on 2%, either," he said.
Kiyotaki sees the BOJ's negative-rate policy as soon outliving its usefulness. "Not only are financial institutions experiencing pressure on earnings, distortions in resource allocation are emerging," he said. One major side effect, according to Kiyotaki, is the excessive financing on apartment construction. This activity has been driven by wealthy people seeking to avoid the inheritance tax.
Kiyotaki advises the Japanese government as a member of the policy commentator forum of the Council on Economic and Fiscal Policy. He is also regarded as a potential candidate for the Nobel Prize in Economics.