Follow The Bottom Violation
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Jan
9
JAPAN, THE U.S, AND QUANTITATIVE EASING
“When future historians look back on our way of curing inflation, they’ll probably compare it to bloodletting in the Middle Ages.”
– Lee Iacocca
For those of you who don’t know what quantitative easing is, I’ll explain it to you. Central banks, like the U.S. Federal Reserve (the Fed) manipulate the economy through monetary policy. The most common way they do this is by manipulating the rate at which they loan to other banks; when the economy is running too hot, the central bank will raise the rate at which it loans to other banks, thereby discouraging borrowing, and thereby discouraging capital investment. Likewise, if the economy is in the tank, a central bank can lower the rate at which it lends to other banks, thereby encouraging borrowing and capital investment in the economy.
Central banks have other tools at their disposal to encourage or discourage economic activity — like raising and lowering interest rate requirements, or adding or reducing liquidity by buying or selling government bonds. For the most part, however, central banks rely on interest rates. Until recently.
In the late 1980s and early 1990s, Japan hit an economic brick wall. Its central bank lowered rates, and lowered rates, until it finally came to a point where it instituted something called Zero Interest Rate Policy, or ZIRP. This essentially meant the Japanese central bank would hold interest rates at or just above zero long enough to stimulate the economy and get things rolling again. Well it didn’t work; Japanese rates have been atrociously low for two decades.
In the early part of this decade, the Bank of Japan took its next stab at spurring the economy: quantitative easing. What this meant was that the government would print a lot of money, and subsequently do everything it could to get that money into the economy so people and businesses would start spending again. And the Japanese central bank did just that — primarily by using this new excess cash to buy its own government bonds — especially the long-end of the yield curve. The theory was that by purchasing its own bonds, it would inject money into the system at the same time it held those longer-term rates down, thereby inspiring domestic investment.
Guess what. It didn’t work.
Japan has had very little economic growth for nearly two decades. The primary Japanese stock market index, the Nikkei 225, has fall from about 40,000 in 1989, to just over 8000 today. They call it the “lost decade,” but it’s really two lost decades, and it’s tragic.
You’ve been sitting here patiently reading my tirades about how horrible it is that the U.S. government is now printing incomprehensible sums of money, which it intends to use on everything from corporate bailouts, to infrastructure programs, to mortgage bailouts, to possibly even buying the long end of the U.S. Treasury yield curve. Hold it. Isn’t that what Japan has been doing?
Let’s back up. You’ve also been sitting here, patiently reading my tirades about how printing money is inflationary, and the resulting rising prices and interest rates are the results of inflation — not inflation itself. Well, if it’s true that printing money is inflation, and the result means rising prices and interest rates, why hasn’t that happened in Japan? After two decades, shouldn’t they be experiencing hyperinflationary price and interest rate escalations?
The answer is no — at least not domestically — and here’s why. First, try to remember what I’ve been saying for a while: Japan is a creditor nation with a tremendous amount of personal savings. What this means is that the government borrows a lot domestically, from citizens who have a propensity to save, not spend. Still, printing money is inflationary — it is an immutable law of economics — and prices and rates should rise, right? Well they did. Everywhere else in the world. And herein lies the core of my story today.
You’ve heard a lot of talk about the irresponsible policies initiated by Greenspan and Bernanke — lowering interest rates, creating massive mal-investment, and driving asset prices much higher than the market could sustain. Ergo, the bubble, and the explosion. And here we are.
I’m not going to defend Greenspan, Bernanke — nor any other central banker — because I think they’re all evil, and I think they are responsible for the bubble, as well as its ultimate implosion. But what you probably aren’t hearing a lot about is the role Japan played in this catastrophe.
Japan has kept its interest rates low for a long time, which means people could borrow in Japan at extremely favorable rates. They could then take this capital abroad, where seemingly “safe” investments were returning far more than the rate of interest owed on the Japanese debt. So all that money Japan was printing was inflationary, and it was causing rising prices and rising rates — elsewhere.
The difference between Japan’s attempt at quantitative easing and recent U.S. monetary policy changes are obvious:
1. As Japanese interest rates hovered near zero, the global economy was exploding. There was no shortage of people eager to take advantage of low-cost funds in Japan and invest them around the world. Today, the opposite is true; while U.S. rates might be at historic lows, I don’t believe there will be nearly as much demand to borrow in the U.S. and invest elsewhere. In case you haven’t noticed, we’re in a severe global recession.
2. The U.S. is a debtor nation. In fact, the Chinese and the Japanese are the two biggest holders of our debt. If they, or any of several other major foreign players, decide to stop loaning money to the U.S., rates will go higher. A lot higher. Further, with U.S. long-term bond prices at historic highs, there may be some incentive for foreign holders of those Treasuries to liquidate, in order to spur their own domestic growth. And that brings me to the next point…
3. Japan and China are huge exporters to the United States. But the U.S. economy has buckled, and that means we’re going to be importing much less. And that, in turn, probably means that countries like China are going to have far less cash to buy our Treasuries. On top of all that, countries like China are slowing domestically along with everyone else. They’re going to have to tighten their budgets just like everyone else.
4. Finally, I think Japan has been given one big giant reprieve over the last two decades. They implemented ZIRP and quantitative easing at a time when they would be effectively sheltered from the damaging inflationary effects of printing gobs of currency. But the party is over, and I think they’re going to get hit in the face with their irresponsible policies — probably even harder than the rest of the world.
No matter how you look at it, higher interest rates and prices are coming. But most people who agree with me are focusing on the United States. In my view, however, the problem is going to be much, much worse.
I think Japan is in a lot of trouble.
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Disclosures: Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.
You can buy his novel Discipline wherever books are sold.
3 Comments so far
Partners
Sorry, Chairman Ben S. Bernanke, But Quantitative Easing Won’t Work.
In a Liquidity Trap although Saving (S) is abnormally high investment (I) is next to 0.
Hence, the Keynesian paradigm I = S is not verified.
The purpose of Quantitative Easing being to lower the yield on long-term savings and increase liquidity it doesn’t create $1 of investment.
In a Liquidity Trap the last thing the Market needs is liquidity.
Quantitative Easing does diminish the yield on long-term US Treasury debt but lowers marginally, if at all, the asked yield on long-term savings.
Those purchases maintain the demand for long-term asset in an unstable equilibrium.
When this desequilibrium resolves the Market turns chaotic.
This and other issues are explored in my tract:
A Specific Application of Employment, Interest and Money
Plea for a New World Economic Order
Abstract:
This tract makes a critical analysis of credit based, free market economy, Capitalism, and proves that its dysfunctions are the result of the existence of credit.
It shows that income / wealth disparity, cause and consequence of credit and of the level of long-term interest-rates, is the first order hidden variable, possibly the only one, of economic development.
It solves most of the puzzles of macro economy: among which Unemployment, Business Cycles, Under Development, Trade Deficits, International Division of Labour, Stagflation, Greenspan Conundrum, Deflation and Keynes’ Liquidity Trap…
It shows that no fiscal or monetary policy, including the barbaric Quantitative Easing will get us out of depression.
A Credit Free, Free Market Economy will correct all of those dysfunctions.
The alternative would be, on the long run, to wait for the physical destruction (through war or rust) of most of our productive assets. It will be at a cost none of us can afford to pay.
In This Age of Turbulence People Want an Exit Strategy Out of Credit,
An Adventure in a New World Economic Order.
A Specific Application of Employment, Interest and Money [For Economists].
http://edsk.org/interest.html
Press release of my open letter to Chairman Ben S. Bernanke:
Sorry, Chairman Ben S. Bernanke, But Quantitative Easing Won’t Work.
http://www.prlog.org/10162465.html
Yours Sincerely,
Shalom P. Hamou AKA ‘MC Shalom’
Chief Economist – Master Conductor
1776 – Annuit Cœptis.
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