Thanks To Japan We Know How Central Banks Can Control Inflation

by: Gary A

I recently wrote an article about how the Fed is in a box regarding the hollowing out of America due to the process of seeking good collateral and keeping interest rates low. In developed societies we can see how interest rates are kept low by looking at the curious case of Japan.

Japan seems to defy gravity or the exclamations of economists, as interest rates stay low in the midst of huge deficits and total debt exceeding 200 percent of GDP.

The Central banks are, in a traditional mode of thought, losing their ability to contain inflation. They are, so the thinking goes, giving up their ability to raise interest rates to cut off any future inflation. The gold bugs and others see that inflation around the corner, well, maybe around the next corner, and the next corner.

But the Fed doesn't see inflation, and certainly is walking a fine line. Yet, Japan doesn't see any inflation and that is the key to managing its economic system.

Interest rates are kept low, 1 percent, and yet, the Bank of Japan manages inflation by simply allowing less money to invade MainStreet Japan. Japanese savings is way down, to 2 percent. Remember, in the pre-bubble Japan, the savings rate was massive, 44 percent of wages.

So, Japan is somewhat like the United States could be in the future. And Japan is managing with an aging population and in a mature economic cycle. Yet Japan has no fear of inflation, and the necessity for greater yield on bonds is not really there.

Kyle Bass and others have shorted Japanese Treasury Bonds and will probably not live long enough to collect on that bet. Japan has discovered oil shale, and will likely have less dependence on foreign energy, and that really helps the country.

So, if we use the Japanese model to show what would happen in the U.S., I don't think that Ben Bernanke worries about inflation. I don't think he will allow MainStreet to be flooded with money. And certainly, while this will hurt the people, it will keep the system going for a long, long time. American debt is denominated in dollars, so that the appreciation or depreciation of other currencies has no effect on U.S. debt.

Japan is like the U.S., in that Japan won't run out of money. And those who fear hyperinflation in the U.S. can look at Japan and think no hyperinflation.

Buying gold to hedge against inflation is almost a scam under this scenario. Gold is pretty. Gold is collateral, not quite perfect. But as a hedge against inflation, it isn't needed!

Am I saying the people in the nations should be happy with this scenario? We have the BOJ forcing insurance companies and pension funds to buy bonds, and we have pension funds and insurance companies here, in the U.S., taking bad collateral off the books of the banks.

It all seems so dirty and rotten. Look at the Libor scandal and the rehypothecation of what little good collateral there is. It is dirty and rotten, but it beats chaos. Ben keeps the economy functioning but probably has to take a shower every day to feel clean inside.

So, under this scenario of a low interest rate regime, probably the only practical investments are those that assume the system continues as is. Shorting our treasuries could be a fatal financial mistake.

As far as real estate is concerned, there will be more bubbles, which is what may differentiate the U.S. from Japan. Real estate could be a good investment, but the real estate sector remains volatile.

I have noticed in bubble areas, rentals have become commonplace. The abundance of these rentals could force rents to decline. If that happens, and in some cases it already is, house prices could be under pressure after this current run up.

Highly levered mortgages are not appropriate for the investor in these areas. As for Los Angeles, it has been a city prone to massive real estate speculation. And there could be legs in that rally.

So, remember, even though the Fed is printing a boat load of money, it is actually working to raise the cost of living, and is making it more difficult and expensive for MainStreet. This printing is not making its way to the real economy nor will it in the future. It is making its way to speculators in all manner of markets.

Either the Fed makes it difficult for MainStreet, or inflation and interest rates could become a big problem, and it could get a lot worse for us as a nation. The banks and pension funds and insurance companies are keeping stocks going up. If those crash it won't work against U.S. bonds.

I don't lightly forget that the Fed allowed the housing bubble. The Fed allowed deregulation of markets and Greenspan was in on the housing bubble, as he said you could get a "better deal" by using an adjustable mortgage in February 2004. He knew the housing sector could not grow without folks who could not actually afford mortgages being allowed to get them!

That model was devised after the payday loan model, where if you can't afford it, banks make a mint.

So, the Fed, and the international banking cabal, has done some really bad things. But when it comes to interest rates, I caution people against fighting this cabal. It is simply too powerful to fight.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.