Thursday, April 4, 2013

Land of the Setting Sun

It's sad and pathetic what is happening to Japan, but it's a cautionary tale for any aging society that would rather repeat the same failed policies for twenty years straight than to face reality.

Last night (and again tonight), the Nikkei went parabolic, gaining 4% when the Bank of Japan revealed its latest "shock and awe" monetary easing campaign. Monetary easing hasn't worked for the past 20 years, but I am sure it will fix the economy any day now...

This (below) would be a lot more impressive (2 year view):

If it were not for this (25 year view):

Expanding The Money Supply Doesn't Fix a Broken Economy
At best, monetary policy brings low interest rates and allows various economic constituents to borrow their way into oblivion. However, once that trick is used up, then the entire economy is saddled with debt and deflation sets in.  Once the maximum debt threshold is reached, further debt accumulation is not possible and supply capacity exceeds demand by virtue of the fact that demand had been artificially magnified during the debt accumulation phase and yet after-the-fact demand is now suppressed by ongoing debt service (interest) costs. This rosy scenario of course all assumes there are no untimely asset crashes in the meantime, given the fact that an economy saddled with debt is massively leveraged and has no margin of error for any investors to lose their confidence. That's what makes Japan unique among nations. Its debt is largely issued by the government and held by Japanese pensioners. Therefore, there is a greatly diminished likelihood of a "hot money" crash, since foreigners tend not to buy debt that earns 0%. If anything it's the opposite - until Bernankenstein's 0% regime, the Japanese Yen was the funding currency of choice for carry trades, which meant flight-to-safety episodes strengthened the Yen. All of that is well and good, except now the Japanese sovereign debt load is the highest in the entire world - north of 200% of GDP. Economists tell us that's not a problem, because it's money they owe themselves.  Really?  So, if I borrow money from my 401k retirement plan and spend it, that's ok, because I owe myself? What if I don't like the prospect of eating dog food in retirement, is that still ok? The bottom line is that the Japanese spent their savings and issued IOUs to themselves which in the fullness of time will be totally worthless. 

A Cautionary Tale
For better or for worse, the rest of the world cannot emulate Japan's strategy of borrowing itself into oblivion and then some. The rest of the world requires external capital flows which are dependent upon borrower solvency. The concept of Ponzi borrowing, Japanese style, is generally frowned upon by most creditors. Therefore, the real lesson at hand is that the option to continue using more and more monetary stimulus to "fix" the economy, doesn't work. Here in the U.S., zero interest rates and now QE have been applied for four years straight and big surprise, like Japan are not working. The same thing applies for Europe where the ECB's mere threat of QE ("OMT") sparked the mother of all carry trades last year and otherwise put a massively leveraged bid under the Spain and Italian bond markets. Again, a strategy that works until it doesn't. Therefore, all we are doing now is waiting for Minsky to show up and teach the morons running the global economy a geography lesson, starting with the fact that Spain and Italy are not Japan.