How to dance the tango

Two days ago, we promised a look, not at where we are going, but at where we are supposed to be. Japan, that is.

First, a quick look at the markets: the Dow down 109 yesterday; gold up a few bucks. What’s ahead?

“Tokyo now, Buenos Aires later” is still our best guess.

“America will follow Japan’s lead”, we predicted as the crisis began in 2007. Japan doesn’t have a runaway stock market, you will protest. True, but America doesn’t have a 200% to GDP government debt either. Or girls who wear those ‘wicked witch of the west’ stockings and pigtails. So, the comparison is hardly exact.

But the important thing is that Japan has a slumpy economy. So does the US. And they have them for the same reason: in both countries, the consumer is reluctant to borrow. And without borrowing, he has no way to increase his consumption.

Households have been cutting back for three reasons. One, they are getting older. Two, their real incomes are stagnant or falling. And three, they already have too much debt.

This makes the downturn in both Japan and America similar. Both are led by households eager to repair their balance sheets. Out goes the debt. In come the savings.

In the US, for the last six years, government and corporate debt have soared. Student debt too. Corporate debt is now larger than mortgage-backed debt.

Here’s Bloomberg on what happens to that money: “The $1 trillion M&A [mergers and acquisitions] quarter, not seen since before the global financial crisis, is back.

“Global deal volume this quarter is $992 billion, according to data compiled by Bloomberg that includes pending, completed and proposed transactions. That number puts this three-month period on pace to be the biggest for M&A since the third quarter of 2007 — the best year ever for deals — before Lehman Brothers Holdings Inc.’s 2008 bankruptcy gave it a near-death experience.”

Party like it was 2007! But you already know what is going on in America.

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Here’s the latest on Japan from The Telegraph: “There are no one-way bets in global finance, but Japan’s stock market comes close. The authorities are about to funnel large sums into Japanese stocks openly and deliberately under the next phase of Abenomics, both by regulatory fiat and by purchasing the Nikkei index directly with printed money.

“Prime minister Shinzo Abe is unshackling the world’s biggest stash of savings, the $1.3 trillion Government Pension Investment Fund (GPIF). Officials say the ceiling on equity holdings will rise from 12pc to around 20pc as soon as August, opening the way for a $100bn buying blitz.”

Yes, dear reader, after watching the US, enviously, for the last 24 years, Japan has decided to join the fun. It is going to goose up its own share market, just as US authorities have done by hook or by crook.

The hook takes the form of regulatory changes that encourage pension funds to put their money directly into the stock market. The crook is more subtle. To understand it, we have to go back to 1990. That was when Japan, Inc went broke. Stocks crashed. Real estate too. It was what economist Richard Koo calls a “balance sheet recession”.

Household and businesses had to cut back on spending in order to reduce their debt levels. Any reduction in spending is abhorrent to modern economists – whether they speak Japanese or English – so almost immediately, the government got to work to stop the process.

First result: a quarter century of relative stagnation. All the while, the government intervened – borrowing the money that households wanted to save and spending it on bridges that weren’t needed and roads that didn’t go anywhere you wanted to go.

Second result: the nation’s savings were consumed and wasted, leaving Japan with a record level of government debt. At 240% of GDP, it’s the highest in the world, and takes nearly a quarter of tax revenues to stay up with the interest payments.

And now we approach the final phase of this zany story. Now, Tokyo goes to Buenos Aires! For nearly a quarter century, Japan’s diligent savers have funded its government deficits. Now, the savers are retiring. They need their money back. At the same time, Japan’s trade surplus is disappearing. Where will the money come to keep the lights on?

Nowhere. Already, there are days when scarcely a single buyer steps up to buy Japanese bonds. The central bank of Japan takes up the slack. And as people get older (spending their savings rather than adding to them) and as the country’s current account surplus disappears (Japan is not the export powerhouse it once was), more slack appears.

The Bank of Japan will come to the rescue, of course. It will print the money to buy bonds and fund the government. The yen will fall. Prices will rise. Interest rates will go up too. And the Japanese will learn to tango.

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