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by Bill Bonner

Evaporating Liquidity?

The Dow rose 75 points on Monday, after its battering last week. Gold fell $6 an ounce. Where does that leave us? It's too early to say that the sell-off that started last week is over. And it's too late to say that it hasn't already begun.

You'll recall that economist Richard Duncan advised us that "excess liquidity" - the gap between what governments absorb when they borrow and what central banks emit by way of QE and reinvestment of foreign-exchange reserves - would begin to evaporate in the third quarter.

This, he said, would cause a big increase in market volatility. We're waiting to see how it plays out…

japan

(Photo via olympic.ca)

The Road to Tokyo

Longtime readers will remember that for at least 10 years we have regarded Japan as a useful model to help determine how the bursting of the US credit bubble in 2008 would play out. It is not where we want to go… but we are condemned by the gods to follow in Japan's footsteps. Why?

We don't really know. But we do know Japan had its financial glory days in the 1980s. Everybody wanted to be Japanese back then. Japan, Inc. had the world's most dynamic industries… and central planning that worked!

But Japan, Inc. went bust in 1990. It went into what Nomura Research Institute economist, Richard Koo, calls a "balance sheet recession." Businesses had too much debt. They had to pay down debt to rebuild their balance sheets. As individuals and businesses cut spending and investment, this caused recession… slump… deflation… and an economic funk that continues to this day.

The downward move in the credit cycle was aggravated by two things:

  1. Demographics: People in Japan were getting older… retiring… and spending less money.
  2. Stupidity: Policy makers went to work with countercyclical policies… deficits… QE… and ZIRP.

Saving the World

We in the US are no strangers to these things, either. In 2000 - about 10 years after the Japanese market headed south - the US stock market got whacked. That was the dot-com bubble popping.

But the US feds - with the Japanese example to instruct them - responded even more vigorously than the Japanese.

Saving the world had already become popular among economists in the 1990s. In 1999, Fed chairman Alan Greenspan, secretary of the Treasury Robert Rubin and deputy secretary of the Treasury Larry Summers came together to rescue the globe from the rapid spiral of defaults that became known as the Asian Contagion.

And TIME magazine put their mugs on its cover under the headline "The Committee to Save the World."

276-0201105447-Time_Committee_to_Save_the_WorldThe "Three Marketeers" swung into action with familiar tools: bailouts and cheap credit. This put the world in worse jeopardy seven years later, as it caused a much bigger bubble in the US, centered in finance and housing.

The crisis of 2008 put the US more clearly on the road to Tokyo. Asset prices plunged. So did economic growth rates. Meanwhile, the birth rate was falling below replacement level.

Using the policies pioneered by the Japanese - ZIRP, QE, deficit spending and bailouts - the US feds were able to inflate yet another asset-price bubble (this time mainly in stocks and bonds). But the economic "recovery" was still the weakest ever recorded… and probably not a recovery at all.

Simulate Until You Stimulate!

What's ahead? We look to Japan to find out. Giveth the moment… cometh the leader. After 24 years of punky, funky economic performance, the Japanese were ready to do something really stupid.

"What option does Japan have?" asked incoming prime minister Shinzo Abe. What was Abe's new policy? More cheap money, of course! Simulate until you stimulate. Fake it, until you make it.

That may work in some areas of life, but not economics. Inspired by Greenspan, Rubin and Summers, Abe put together a committee to save Japan. And just like the Three Marketeers had in the 1990s, Abe had the world press behind him and the central bank in his pocket.

He pumped trillions of yen into the Japanese bond market… devalued the yen… and even got Japan's famously risk-averse $1.16 trillion national pension fund to increase its exposure to Japanese stocks.

Now, Japanese wage growth and household incomes are dropping. Private sector spending is falling. The Nikkei is falling. Industrial production is slipping. And the consensus estimate is for the Japanese economy to shrink at an annualized rate of 7.1% in the second quarter.

The Japan example is not one we should emulate. But we will anyway.

(click to enlarge)

Japan's gross public debt as a percentage of GDP - all that's left after 30 years of stimulus spending is a huge debt burden - via St. Louis Federal Reserve Research

The above article is from Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc. in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.

Source: Uh Oh... Look What's Happening To Japan