Tuesday, February 1, 2011


Please review the Bloomberg story - http://www.bloomberg.com/news/2011-01-13/japan-exporting-deflation-reveals-meaning-of-bernanke-s-economic-nightmare.html

In the last post titled Economic Warfare - Inflation Bombs (Part 1) -  I outlined how the US leadership was attempting to create asset price inflation (stock markets up) in an attempt to change perception and create a state of "feeling better" which actually changes reality so that the economy's participants act in ways that spur improvement and thus makes the economy "better".

The mechanism of this "feel better" cocktail is the use of QE or Quantitative Easing which is simply where the Fed and Treasury "print" electronic dollars and buy US Treasuries from the open market.  Essentially the hope is that this exchange of dollars floods banks and other investors with cash.  In the case of banks, the hope is that they will lend money to borrowers that will then do projects that stimulate the economy and create jobs.  Investors are "encouraged" to buy other things like stocks with their treasury proceeds.    The tidal wave of new dollars has done exactly what the Fed has desired in that the purchases of stocks and other assets have increased substantially in value since the low of March 2009.

As I covered, those same dollars haven't just bought stocks, they bought commodities like gold, silver, oil, wheat, cotton, sugar, cocoa, copper, and every other hard and soft asset.  The by-product of this has been a surge in prices for these commodities.  Read my article for more on the impact of those price increases.

So, to summarize and get to the point of this post, the Fed gambit has succeeded so far in getting stocks up and the economy moving forward.  As Ben Bernanke has highlighted many times, deflation is the ultimate enemy, it was the cause of the Great Depression and some say it was the cause for WWII as well.  Since he is an expert in that economic period, he has vowed to defeat it at any cost.  The cost literally has been in the trillions to accomplish this feat.

There is also one other thing going on in the back ground.  Our government (Bush and Obama) attempted their own fixes in concert with the Fed.  These fiscal  approaches included massive government spending to counter act the decline in personal consumption and spending.  Of course the US government didn't have all the money for the additional trillions it was spewing out, so it created massive deficits and that trend continues today.  What is important to note here is that this massive outflow of government spending and surge in debt now must be paid for in the form of treasury obligations.  So, not only is the Fed buying US government debt for the sake of sparking an asset rally, it is also purchasing the debt of the US due to significant cost over runs.  The amount we owe is so large that we are now sensitive to any increase in interest rates that come from an erosion of the quality of creditworthiness.  Here is the money shot - The US Fed now really has this dual policy mandate (that is unspoken) - 1)  Keep the markets up so the recovery can be sustained   2)  For goodness sake don't let interest rates rise cause we can't pay the cost of interest on our borrowed principle.

So after that very long introduction we know that there is a WAR ON DEFLATION.  So what is the problem with deflation?  What happens to consumers in a deflationary environment?  Let's examine the story about Japan's experience to see what scares Bernanke so much.

  • "Their advantage may be Japan’s disadvantage. Prices in Japan as measured by the gross domestic product deflator have declined almost without interruption since 1994. That has muted the effect of falling wages and provides a cautionary tale for Federal Reserve Chairman Ben S. Bernanke, who has been lecturing on deflation’s perils as a central banker since 2002. "
Ok, so since 1994 prices have declined in Japan for everything from shirts to hamburgers.  Anything bad there?  Let's read on to see. 
  • “Retailers like Uniqlo were able to ride the wave of deflation and grow,” said Yoshimasa Maruyama, a senior economist at Itochu Corp. in Tokyo. “To win these pricing wars at home, companies had to keep cutting workers’ pay, and that’s spiraled down with prices falling and then falling some more, with deflation never ending.”

The article's point here is that the company did cut wages to attempt to compete in the environment.  Therefore, if my wages are cut it must be terrible right?  Actually, if my wages are cut, but all the things I buy are less then I don't really feel it as much.  It seems like Martin Shulz agees.

  • “Everyone knew deflation was bad for jobs and bad for the economy, but gradually, households and companies just got used to it,” said Martin Schulz, a former Bank of Japan researcher and now senior economist in Tokyo at Fujitsu Research Institute. “The risk is that it takes hold in the U.S. as well.”
Admittedly there are negatives.  Companies just don't cut prices, they cut headcount to complete.  But where does the notion come from that deflation is bad in the article? 

  • ‘Unavoidable Endgame’

    Deflation will steadily sap nominal growth, depriving the government of revenue, until one day Japan will no longer be able to finance its borrowing, Jerram said. The country will either default on a debt of about twice the size of the economy or debase its currency to reduce the real value of liabilities.

    “That’s the unavoidable endgame,” said Jerram, who has analyzed the Japanese economy since 1987. “As long as it’s in the future, everybody can pretend it’s someone else’s problem.”
I laugh when I read that text.  Yes, the unavoidable endgame is that the government defaults or devalues IF they continue to have stupid government spending on useless building projects (bridges to nowhere), entitlements, and stimulus spending that achieves nothing!  Sound familiar?  Japan is the future of Amerika!  The endgame is unavoidable if governments continue to have huge fiscal deficits and don't control themselves.  This is where we see the sheer terror of Bernanke and other government leaders.  Delfation is a killer if you have an out of control government that doesn't manage spending appropriately.  How many times have we heard that governments will actually downsize and cut costs?  NEVER!  In fact, the US government builds in annual increases into the budget that do not need to be approved.  So every department's budget grows automatically every year.  That includes salaries and base expenditures!  No wonder we cannot control the power and cost creep of the government!

The takeaway here is that deflation is bad if you are a government official.  Otherwise you'll see that Japan's style of deflation isn't quite as horrible as it is cracked up to be.    Consumers (normal people) actually feel fine with deflation.

  • The success of the companies in Japan has helped consumers adjust to deflation. The average household owns 1.4 cars and 2.4 color televisions, about a quarter more than in 1990, a Cabinet Office survey shows. The proportion of people content with their standard of living was 63.9 percent last year, compared with 63.1 percent in 1989, a government report said.
Contrast the information above with the choice that your federal government and Federal Reserve is making.  They would rather declare war on the retired and poorest US citizens by invoking the spirit of inflation.  Bernanke demands rising prices in gasoline, oil, clothing, and food and those costs become a larger portion of the poorest income --- just to survive!  The middle class are squeezed to death in the spiral of surging prices.  The Fed claims that wages will increase and jobs will be created, but where is the data to support this?  Where are the rising wages?  Where are the jobs?   I've highlight again the statement from above -
  • The country will either default on a debt of about twice the size of the economy or debase its currency to reduce the real value of liabilities.
The reality is that the government and the Fed has chosen not to cut the size of our government and it's entitlements, but has chosen to debase our currency.  The debasement of the currency amounts to the crushing of our poor and also the poor of the world through price inflation (because commodities are priced in dollars).  I wonder how long the Amerikan poor and middle class will put up with these attacks.  When will the rioting of Egypt and Tunisia come to the streets of our cities?  If you think the trend of higher prices in food is going to abate you are absolutely wrong.  If you think we won't see $4 gas this summer you are nuts!  Good or bad, Amerikans are soft and don't have the heart to stand up to these overt attacks by government elites.  Where is the America I grew up in?

Would you rather choose starving to death, being on the government foodstamp roles, and losing your independence and dignity or choose this?

  • “It’s amazing what you can buy with 100 yen now, we didn’t have 100-yen stores before,” said Sachiko Enokida, 80, who lives on her bimonthly pension checks from the government and has witnessed inflation’s ups and downs since the 1940s. “After the war, we all thought this was going to be the last year before we starved. Then things really boomed and people were buying apartments like crazy and you saw wealth everywhere. I would hate for things to get expensive again.”
    With almost one fourth of the population over 65 years old, Japan chose to stay in deflation, said Feldman. That turned cash into an investment, as money left in bank deposits gained in purchasing power the longer it stayed there. Today, Japanese households keep 56 percent of their financial assets in cash, compared with 14 percent in the U.S.

    “The factors that produced and permitted deflationary policy seem likely to persist,” Feldman said in a report.
    Meanwhile, consumers continue to enjoy lower prices. Golfers pay 26,800 yen to play on the weekend with a caddy at Oak Hills Country Club, a course 90 minutes’ drive from central Tokyo designed by Robert Trent Jones Jr. Twenty years ago, the fee was about 40,000 yen, said Katsutoshi Ohira, acting manager.

    “I don’t think I can expect any meaningfully big pay raises going ahead,” said Satoshi Miyazaki, 34, who works for an advertising company in Tokyo. “Since I’m paying for things out of my limited salary, lower prices have been a great help.”

There is going to be a collapse in Japan too, don't get me wrong.  Both countries have pursued poor policies that didn't include government cuts.  Both countries continued to borrow and live in the moment rather than in a mode of planning for the future.  My point here is simply that Bernanke and the Fed have picked the option that benefits the US government, banks, and elites rather than the US citizen.  They have picked themselves over the us.




    1. Very nice post, thank you

    2. Let's take a look on global economic crisis right now. Where to build great economy? Western countries are dominated with powers but not totally in economy because of the growing recessions that hits them thoroughly. As we can see, Asian economic giants like China, South Korea, Thailand, Singapore, Hong Kong, Taiwan, and Japan are aggressively booming their economy.

    3. High Risk -
      I share your excitement about those emerging countries, but we must remember that inflationary crack ups can be just as destructive as the deflationary style blow ups we had in the US.
      I do like China, South Korea, and Singapore, India, and Chile too, but that doesn't mean that their stock markets in the next 24 months will outperform anywhere. Longer term, those are homerun plays as you know from reading many posts. In the short run though, you could seriously suffer 25% or 30% drawdowns in those areas as they are forced to attempt to stamp out inflation.
      Remember, good economy does not always = Good stock performance in the near term.
      Great point though, but temper that idea a bit because when things are booming we don't often see central banks able to let the air out with out a following bust (just like the US in 2000 and 2008).


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