Investors’ great fear is that America could wind up looking like Japan. But in part because that fear is so strong, the U.S. will head down a different road.
The world is clearly afraid that “Great Depression 2.0” could be at hand. Downturns come and go, but the global economy as a whole hasn’t contracted since the 1930s. Some think it could happen again next year.
We hear less about it in the news, but there is another fear that keeps investors up at night – the off chance that America turns into Japan.
The Nikkei index has made a truly awful round-trip. It’s as if Japanese equities had been transported in a time machine all the way back to 1983.
If U.S. equities were to take a similar trip, we would have to see the Dow fall below 800 – more than a 90% drop from today’s depressed levels.
But there are some powerful arguments as to why this won’t happen. In fact, if things go deeply wrong in 2009, America is more likely to look like Zimbabwe than Japan.
A Vivid Example
For one thing, the powers that be have Japan’s example staring them in the face. In hindsight, we can clearly see many of the things we don’t want to do.
Some of Japan’s key errors leading to the “lost decade” – now lost quarter century – were these:
- Propping up “zombie” companies that should have been allowed to fail.
- Being forever guilty of “too little, too late” in regard to aggressive monetary policy.
- Dropping the hammer too quickly whenever signs of inflation appeared.
- Tolerating the Keiretsu system in which entrenched managements locked arms to block change.
Of those four mistakes, the United States is most in danger of emulating the first.
When government gets into the business of picking winners and losers (or propping up the losers), the invisible hand of markets is stymied. The market relies on an ongoing process of “creative destruction” to channel capital to areas where it is most needed – and to drain it away from areas where it is not.
When we get in the way of that flow, our meddling tends to gum things up. As U.S. policies become ever more hands-on, this danger increases.
Fortunately the long-term risk is lower in this area because the creative destruction tides are stronger. America’s entrepreneurial culture stands in sharp contrast to the old Japanese motto, “the nail that sticks up gets hammered.”
Going for the Gusto
Washington will be sorely tempted to meddle in many unhelpful ways. One mistake the Obama Administration will not make, however, is that of “too little, too late” on the stimulus side.
Larry Summers, one of the key members of the Obama “brain trust,” has clearly stated his view that, in times of crisis, doing too little carries far more danger than doing too much.
It’s like trying to put out a house fire in some respects. If you use too much water, that’s okay – the house might be waterlogged but it will still be saved. Don’t use enough water, however, and the house is in real danger of burning to the ground.
This is why the Obama administration is planning a $700 billion stimulus package for starters, and will have no fear of spending more if the situation calls for it. Britain is thinking along similar lines. No government wants to copy the Japan experience – the risk is too great. In the name of the greater good, fiscal propriety is thus being thrown out the window.
Ben Bernanke is a big fan of going for the gusto too. The Fed is now embarking on an aggressive campaign of “quantitative easing,” much like Japan did earlier on – but with some important differences.
Stephen Jen and Spyros Andreopoulos of Morgan Stanley point out that, for the U.S. Federal Reserve, “quantitative easing” means three broad strokes:
- Telegraphing to markets that interest rates will stay low for a very long time.
- Drastically expanding the Federal Reserve balance sheet – to wit, printing money. (When the Fed buys assets for its balance sheet, the banks that sell those assets get new dollars that circulate into the system.)
- Buying large quantities of U.S. Treasuries outright.
The first two elements are already underway. The third has been all but promised by Ben Bernanke. Part of the reason treasury yields dropped to record lows – and prices soared to record highs – is because Bernanke has openly stated that the Fed may buy treasuries outright, targeting long-term as well as short-term interest rates.
Use It or Lose It
You can think of the Fed’s quantitative easing as a form of friendly blackmail to force savers out of cash and treasuries and back into productive lending and investing activities.
For banks, consumers and businesses alike, the strong temptation is just to hunker down amidst all this turmoil. Safe government bonds and money in the mattress – i.e. three-month Treasury bills and other cash equivalents – are the way to do that.
But if everyone hunkers down, the economy stays in the tank.
So the Fed in effect says, “We are going to penalize all you hunker-downers for holding onto T-bonds and cash. If you keep your money in dollars, you’re going to get burned as we flood the system with dollars. If you try to buy bonds, we’ll be in there buying too... pushing bond prices ridiculously high and long-term yields ridiculously low.”
It’s basically a question of “use it or lose it.” As we have stated before in these pages, inflation is a form of hidden tax. Through aggressive pursuit of inflationary monetary policies, the Fed seeks to tax the daylights out of dead money in order to get things moving again.
Someone’s Gonna Spend It
The main reason America won’t look like Japan is because we know the stakes now. The Fed, the Treasury and the incoming Obama Administration are all focused on the dangers of doing too little, rather than doing too much.
So they will do whatever it takes in that respect – with little to no regard for the inflationary forces that are stirred up. That’s the legacy of Japan’s historic tendency to slam on the brakes at any small sign of inflation. We’ve learned to lay off the brakes and hit the gas instead.
And if you and I don’t get out there and lend and spend, the government will. All the panicked investors buying Treasury bonds hand over fist may have safety on their minds first and foremost, but what they forget is that they are lending to Uncle Sam. And Uncle Sam is not afraid to run wild.
We have already seen the Fed and Treasury “leverage up” to the tune of trillions. If 2009 is as rough as some forecasters fear, then the government’s leveraging up has only just begun. To keep socking away money in cash and treasuries will only encourage the torrent of spending to pour forth.
To sum up, we won’t walk down Japan’s road because we have seen that road, we know where it leads, and we will avoid it by any means necessary. And I do mean any. While Japan embarked on its own path of “quantitative easing,” the measures taken were timid, uncreative and downright puny in comparison to what the U.S. government is prepared to do.
If we err, it will not be on the side of caution. It will be on the side of breathtaking aggression. That’s the monetary policy lesson learned. If nothing else, the implications of this are surprisingly positive for equities.
The Endorsement From Hell
The frightening aspect of all this is what we haven’t learned – and the risks we are taking with our no-holds-barred, win-at-all-costs mindset.
As Marc Faber and others have pointed out, the USA and UK monetary authorities received the endorsement from hell earlier this year – a thumbs up from the Reserve Bank of Zimbabwe.
On Page 9 of the RBZ’s “First Quarter Monetary Policy Statement,” Dr. G. Gono, Governor of the Reserve Bank of Zimbabwe, gives the following praise (bold emphasis his):
Banks, including those in the USA and the UK, are now not just talking of, but also actually implementing flexible and pragmatic central bank support programmes where these are deemed necessary in their National interests.
That is precisely the path that we began over 4 years ago in pursuit of our own national interest and we have not wavered on that critical path despite the untold misunderstanding, vilification and demonization we have endured from across the political divide.
As of July 2008 (the latest month for which figures have been calculated), Zimbabwe’s inflation rate hit 231,000,000%. You read that right: two hundred and thirty-one million percent.
Hard assets anyone?