The road to Tokyo

Stocks were up yesterday – 75 on the Dow index – after a battering last week. Gold was down $6.

Where does that leave us? Well, it’s too early to say that the sell-off is over. And it’s too late to say that it hasn’t begun.

Richard Duncan advised us that net liquidity in the markets would begin to evaporate in the third quarter. This, he said, would cause a big increase in volatility. We’re just waiting to see how it plays out.

Long-term readers will remember that for at least ten years we have regarded Japan as a model. 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 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!

Then, Japan Inc got whacked in 1990. It went into what Richard Koo calls a “balance sheet recession”. Businesses had too much debt. They had to cut back spending to rebuild their balance sheets. This caused recession, slump, deflation, and a general economic funk that continues to this day.

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

  1. Demography: people in Japan were getting older, retiring, spending less money.
  2. Stupidity: policy makers went to work with counter-cyclical policies, deficits, QE, ZIRP.

You will notice that we in the US are no strangers to these things either.

The US stock market got whacked about ten years after Japan – in 2000. That was the dotcom bubble popping. But the authorities – with the Japanese example to instruct them – responded more vigorously.

Saving the world had already become popular among economists in the 1990s. Alan Greenspan, Robert Rubin, and Larry Summers had come together to rescue the globe from the Asian crisis, and got their pictures in Time as the ‘Committee to Save the World’.

The rescue team swung into action after the dotcom crisis with their familiar tool – cheap money. This, of course, put the world in worse jeopardy seven years later, as it caused a much bigger bubble in the US, centred on finance and housing.

The crisis of 2008-09 put the US more clearly on the road to Tokyo. Growth rates declined. Birth rates fell below replacement level. Using the policies pioneered by the Japanese – ZIRP, QE, deficits, bailouts – US authorities were able to inflate yet another bubble in equities and debt, but the ‘recovery’ was still the weakest ever recorded, and probably not a recovery at all.

What’s ahead? What now? 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 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 in economics. Abe got together his committee to save Japan. He had the world press behind him and the central bank in his pocket. He pumped billions into the economy, and into the stock market (including putting pension funds into over-priced equities!).

And now, wage growth and household income are dropping. Private sector spending is falling. Stocks are going down. Industrial production is slipping. And the latest estimates show the economy collapsing at a 6.9% rate in the second quarter.

The Japan example is not one we should emulate.

But we will anyway.

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