Core Viewpoint
The reversal of interest rates between China and Japan has led global capital to favor the low-interest-rate environment in China. This is because, in addition to interest rates, exchange rates also influence capital flows. Japan is experiencing &#34;bad&#34; inflation, with rising interest rates but a depreciating currency; China, on the other hand, is facing &#34;good&#34; inflation, characterized by relatively low interest rates and a strong currency.
The true implication of the interest rate reversal between China and Japan is that the global supply chain has already been and continues to be profoundly reshaped. Most countries (including Japan) are suffering from imported inflation after a prolonged hollowing out of their manufacturing sectors.
Caught between the two major powers of China and the United States, Japan's future path in technology and re-industrialization is not easy. Japan's interest rates, like its inflation, will completely bid farewell to the old era.
China's relatively low inflation is a price reconstruction in the transition between old and new driving forces. With a complete industrial system, energy independence, and food security, China is one of the few countries that can sever the chain after the real estate crisis, breaking the cycle of &#34;falling housing prices -&gt; capital outflow -&gt; currency depreciation -&gt; imported inflation.&#34; With its technological and manufacturing advantages, China will ultimately emerge from low inflation and enter a new cycle.
Summary
The gears of the interest rate system reversal between China and Japan will begin to turn in 2024. Intuitively, high interest rates correspond to high growth, while low interest rates correspond to low growth, leading to a transposition of the interest rate matrix between China and Japan. According to the simple theory of interest rate parity, capital should flow from low-interest-rate countries to high-interest-rate countries. Does the reversal of interest rates between China and Japan mean that capital will flow from China to Japan?
Once we clarify the inflation behind the interest rates and identify the underlying economic logic reflected by inflation, we can deeply understand the interest rate reversal between China and Japan. The future will follow a counterintuitive conclusion: capital will not flow from low-interest-rate countries to high-interest-rate countries, but rather from Japan, where interest rates cannot be suppressed, to China, which has a complete industrial system and strategic security in energy and food, even though China's current interest rates are not high.
Why is this so counterintuitive?
<h2>We first observe that the reversal of the interest rate matrix between China and Japan is a rare historical phenomenon.</h2>
In 2024, Japan's 30-year government bond yield officially surpassed that of China, and this trend quickly spread to the short end, with Japan's 10-year government bond yield expected to officially surpass China's in 2025, and the 1-year government bond yield also showing signs of overtaking China's.
Beneath the surface of interest rate inversion lies a dual misalignment of the monetary policy cycles and inflation cycles of the two countries.
From the perspective of monetary policy, the People's Bank of China, under the tone of &#34;taking the lead,&#34; has been in a loose cycle of interest rate cuts and reserve requirement ratio reductions to counteract the downward trend in the real estate cycle and insufficient domestic demand; meanwhile, the Bank of Japan has been forced to bid farewell to a decade-long quantitative easing in this round of global inflation, exiting from yield curve control and negative interest rate policies, and entering a rate hike phase.
From the essence of inflation, China's current low-interest-rate environment reflects the low-level operation of CPI and PPI, indicating a price reconstruction during the transition between old and new driving forces; in contrast, the surge in Japan's interest rates is due to its emergence from the &#34;lost thirty years,&#34; with a systematic upward shift in the inflation center.
<h2>Does Japan's high interest rate and high inflation signify economic prosperity? Quite the opposite; it is a testament to the Latin Americanization of the Japanese economy.</h2>
The market often holds an optimistic fantasy of &#34;economic recovery&#34; regarding Japan's exit from deflation, but a deep analysis of the causes of the current inflation in Japan reveals a dangerous &#34;Latin Americanization&#34; characteristic—namely, a type of stagflation caused by &#34;imported inflation + supply-side constraints,&#34; rather than healthy demand-driven growth.
The reversal of inflation in Japan is primarily driven by three forces, all of which carry the color of negative supply shocks.
First, the hollowing out of the manufacturing sector has made Japan very sensitive to imported inflation. Since China joined the WTO in 2001, Japan has accelerated its &#34;foreign investment nation-building&#34; strategy, leading to a large-scale exodus of domestic manufacturing, leaving a significant supply gap domestically. This has changed the sensitivity function of the Japanese economy to exchange rates: Japan has transformed from a &#34;beneficiary of currency depreciation&#34; to a &#34;victim.&#34; Due to the lack of domestic capacity replacement, when global commodity prices rise, Japan cannot stabilize prices by increasing domestic supply and can only rigidly endure the harvesting of imported inflation. The relocation of manufacturing abroad is just one channel of Japan's manufacturing hollowing out; the real reason for Japan's manufacturing hollowing out lies in its limited scale, which cannot maintain the entire industrial system. The rise of China as a manufacturing powerhouse makes manufacturing hollowing out an inevitable trend for Japan.
Second, the long-term loose monetary policy has become an &#34;amplifier&#34; of imported inflation. The Bank of Japan's long-standing financial repression faced backlash during the global interest rate hike wave in 2022. To maintain artificially low interest rates, Japan formed an unprecedented policy divergence with mainstream global central banks, leading to a collapse-like depreciation of the yen. This currency depreciation triggered by monetary policy divergence resonates with the hollowing out of the manufacturing sector, greatly amplifying the import costs of energy and raw materials, making financial repression a catalyst for soaring inflation.
Third, the declining population has led to the successful transformation of imported inflation into a &#34;wage-price spiral.&#34; If the first two factors triggered inflation, then the population issue has made inflation stubborn. The labor supply gap caused by aging has been thoroughly exposed after the pandemic, and the severe &#34;labor shortage&#34; in the service industry has forced companies to passively raise wages significantly. This &#34;defensive wage increase,&#34; which does not stem from productivity improvements but from supply shortages, directly leads to a high growth rate of wages maintaining above 5% in 2024-2025, transforming external imported pressure into internal long-term inflation stickiness.
In summary, Japan is experiencing a predicament similar to that of Latin American countries, where industrial hollowing out leads to a lack of supply elasticity, currency depreciation directly translates into inflation, and labor shortages lock in the price floor. This is a painful &#34;bad inflation&#34; that forces the central bank to raise interest rates against a backdrop of economic weakness.
<h2>Does China's low interest rates and low inflation mean a deep economic recession? A more accurate understanding is that China is undergoing a price reconstruction under the transformation of new and old driving forces.</h2>
In stark contrast to Japan's &#34;bad inflation,&#34; China's current low inflation environment should not be simply defined as &#34;deflation&#34;; it resembles a price reconstruction amid a fierce clash of new and old driving forces.
The structural differentiation of inflation data precisely outlines this picture.
On one hand, the retreat of old momentum has brought deflationary pressure on the demand side. With the end of the &#34;golden era&#34; of real estate, the real estate chain is facing deep destocking, and the negative wealth effect caused by falling housing prices has suppressed residents' willingness to consume discretionary goods, which is the core drag on the current CPI and PPI total index.
On the other hand, the rise of new momentum has brought &#34;technical price reductions&#34; on the supply side. In fields such as non-ferrous metals, power equipment, and new energy vehicles, the price decline is not due to a collapse in demand, but rather stems from the strong cost reduction and efficiency enhancement capabilities of Chinese manufacturing. Chinese companies have driven down the prices of high-tech products like electric vehicles and consumer electronics through extreme supply chain efficiency.
Therefore, China's low inflation is a composite product: it involves both the painful clearing brought about by the real estate bubble deflation and the benign cost reductions resulting from industrial upgrades.
This is a price performance in a process of &#34;creative destruction,&#34; rather than a fate of long-term recession. As the new productive forces gradually overshadow the old momentum in the economy, this structural low inflation will transform into higher quality growth.
<h2>Understanding the profound implications of the reversal of interest rates between China and Japan</h2>
Low inflation and low interest rates reflect the stage limitations encountered in China's economic development, but they more deeply reflect China's supply advantages.
Looking back at global economic history, the bursting of real estate bubbles is often a prelude to malignant stagflation, rather than a smooth path of low inflation. China's ability to maintain price stability during a deep adjustment period in real estate is precisely a side confirmation of the advantages of a large country with a complete industrial system and monetary sovereignty.
The lessons of history are painful. In the 1990s, Mexico, the UK, and Sweden all suffered from currency collapses after their real estate bubbles burst. Due to a weak domestic manufacturing base or high dependence on foreign markets, capital flight led to a sharp depreciation of the local currency, which in turn caused uncontrolled prices of imported goods, plunging the economy into &#34;asset price collapse + soaring living costs&#34; stagflation.
China's exception stems from its hard power on the supply side.
First is the completeness of the industrial chain. As the only country in the world with a full range of industrial categories, China is a producer of goods rather than merely a consumer. Strong domestic manufacturing capabilities ensure that even during currency fluctuations, the vast majority of industrial and consumer goods can maintain ample supply and price stability, forming the first line of defense against inflation.
Second is the security barrier of energy and food. Although crude oil relies on imports, China's energy is primarily coal-based, and it is vigorously developing new energy alternatives; in terms of food, the high self-sufficiency of staple grains means that fluctuations in international grain prices cannot directly impact domestic prices.
Now let's look at Japan's recent post-pandemic inflation.
Japan's post-pandemic experience is not a pleasant inflation, but rather a result of its manufacturing sector's long-term hollowing out, making it difficult to absorb imported inflation. We can confirm the essence of Japanese inflation through the depreciation of the yen.
It is precisely because the underlying logic of inflation in China and Japan is different that the flow of funds under the misalignment of inflation and interest rates does not entirely follow intuitive expectations. Funds flow from low-interest-rate China to high-interest-rate Japan, where the most critical variable hindering this flow is the exchange rate
On the contrary, Japan's inflation, exchange rates, and interest rates describe the fact that Japan is experiencing stagflation, while the situation in China is quite different. The relatively low interest rates in China showcase a strong supply advantage. Funds are flowing from Japan to China instead.
Main Text
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The reversal of interest rates between China and Japan has triggered changes in global capital flows. Japan is facing "bad" inflation, with rising interest rates but a depreciating currency; China, on the other hand, is experiencing "good" inflation, with low interest rates and a strong currency. This phenomenon reflects the reshaping of global supply chains, as many countries face imported inflation. Japan's path to technology and re-industrialization is challenging, while China, with its complete industrial system and energy and food security, is expected to emerge from low inflation and enter a new cycle. In 2024, the interest rate system of Chinese and Japanese government bonds will reverse, and capital will flow from Japan to China

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