Repeating the folly of Japan... and then some

Bill Bonner - Thu 12 Nov, 2009

Recessionary Japan and the US Governments Debt

Buenos Aires , Argentina

The Dow rose again yesterday – up 44 points. Gold went up too – to a new record of $1,114.

Can anything stop stocks and gold?

Trees do not grow to the sky, dear reader. And for every bounce there is a bust.

“It’s amazing, the US is doing everything that Japan did wrong,” said a friend yesterday.

Let’s see… in the 1980s Japan’s corporate leaders thought they were going to take over the world. Investors thought so too. They expanded. They wheeled. They dealed. Prices shot up and they all thought they were geniuses.

In the ‘80s, everyone wanted to be Japanese. Management consultants used Japanese words to describe commonplace insights.

For example, instead of saying that businesses always need to try to do things better, they referred to “kaizen” as if it were the secret of success.

And US economists urged the Reagan Administration to have an “industrial policy” – because that was what Japan had.

Japanese businesses were the envy of the world. Japan was the world’s second largest economy. But in growth and stock prices it was Numero Uno.

It turned out, as it always does, that Japan did not have the secret to everlasting success. Instead, what it had was what comes before a fall.

The stock market crashed in Tokyo in 1989. The Japanese economy entered a recession.

At first, the experts believed it was temporary. They urged investors to take advantage of the opportunity to buy into Japan, Inc. at record low prices.

They thought Japanese industry was unstoppable... unbeatable. It would recover in no time, they said.

But Japan, Inc. didn’t recover. Instead, it went into a long, drawn-out recession that lasted year after year... with on-again, off-again deflation... and several stock market rallies.

Each time stocks rallied, they fell again. Each time the economy began to grow... along came another setback. This continued for the next 20 years... until March of this year... when Tokyo stocks hit their lowest point for the whole bear market.

A generation of investors had been nearly wiped out. Over two generations they had made nothing. Trillions worth of wealth had been erased.

What did the Japanese authorities do during these last two decades? They fought the correction every step of the way, with the boldest attempt at fiscal and monetary stimulus ever undertaken up to that point.

Interest rates, in effect, came down to zero. And government spending soared, creating the largest deficits in Japanese history.

Now, Japan’s national debt approaches 200% of GDP – a peacetime record. If it continues to grow at this rate, it will hit 300% of GDP in just a few more years.

Sound familiar? It should. The key US interest rate is now, in effect, zero. The Fed says it will leave it there for “as long as it takes”. And deficits have reached staggering levels – 13% of GDP.

At this rate, the US debt/GDP ratio will hit 100% in just a few years. And if it continues, US debt/GDP will reach 200% not long after – as recession-reduced tax revenues meet stimulus-increased outlays.

But wait... the feds say they won’t let it happen. They’ll turn this thing around. The economy will begin to grow. Tax revenues will rise. Prices will go up.

Hey... that’s just what the Japanese said!

So far, the US is doing almost exactly what the Japanese did... propping up zombie companies and stimulating the economy as best it can.

But if it does the same thing the Japanese did, won’t the US get the same results the Japanese got?

Here is where it gets interesting. Because the US economy is not exactly like the Japanese economy. Japan had high savings... and a positive trade balance.

It could run up huge government debts and ‘owe it to itself’. It could finance its government debts with the savings of its own people, in other words. It never had to worry about foreigners refusing to buy its bonds... or selling them suddenly.

America ’s government debt is different. The US doesn’t save enough to finance its own deficits. So it depends on the kindness of strangers.

If those strangers ever lose faith in America’s ability or willingness to repay its debts, they’ll drop the dollar like an annoying girlfriend.

And when they do, the whole global monetary system will come crashing down.

But suppose savings rates go up in America – to, say, 10% of GDP, like they were before the bubble years. That would make $1.4 trillion of savings available to finance the feds’ deficits.

And suppose the slump continues... as we think it will, with another big scare in the investment markets. People will seek safety in... yes, you guessed it... US bonds.

This will take the pressure off the dollar and permit the US to finance its countercyclical spending without depending heavily on foreigners.

The recession/depression will be annoying... but not insufferable. And Bernanke will figure he has more to lose by undermining the dollar than to gain from it. In that case, the Japan-like slump could go on for many years – just as it has in Japan!

More thoughts after this important reminder from our staff in London ...

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And back to Bill with more thoughts ...

*** “You go ahead. I’ll take care of the baby.”

You editor is visiting his son and grandson in Buenos Aires. Last night, granddad agreed to babysit so the young parents could go out to dinner.

After a pizza and some horsing around, the little boy – 18 months old – began to have doubts about granddad. It was late. He was getting tired. He looked around and asked for “mama”.

No stranger to parenting, your editor knew just what to do. He put the boy in a stroller, took him out on the street and began a long walk.

We were in Palermo Soho, a thriving and trendy neighborhood of Buenos Aires. The buildings are only two or three stories high. Streets are made of cobblestones, with sycamore trees on each side. And everywhere you look, there are restaurants, cafes and boutique shops.

By day, it is a nice area... but a visitor sees derelict buildings as well as spiffy renovated ones. At night, the run-down properties disappear in the shadows.

In the Plaza Serano, a man on stilts walked the streets. He must have been looking for tips from the cars that passed. Little Liam, our grandson, looked up at him in alarm. The world must be a strange and wonderful place to a small child; he must have wondered how the man got so tall.

In the centre of the square, a small woman sang tango songs, accompanied by a guitarist and an accordion player.

We walked along. People looked at Liam in his stroller and smiled. He smiled back. Then, they looked at your editor with curiosity, wondering if he was the father or the grandfather.

Couples walked arm in arm. Some embraced on street corners. One couple sat on a bench, kissing each other so enthusiastically they clearly needed a hotel room.

Several cafes had tables out on the sidewalks. Waiters carried trays of beer and wine. Girls in blue jeans looked at the fashions in a shop.

Within two blocks, Liam was fast asleep. The jostling of the paving stones didn’t seem to bother him. Neither did the wail of an ambulance or the murmur of couples in conversation. Or the bright lights of the restaurants.

But by then, we were fascinated. There were so many young people on the street. So many fashionable shops. So many renovated houses – many with innovative and interesting designs.

So many bars. So many cafes and restaurants... each with its own theme. One promised a traditional ‘parrilla’... another advertised ‘Italian cooking’... still another was cloaked in red, promising diners an amorous encounter.

We wandered for blocks. Then we realised we were lost. No matter. We just kept walking... looking in the restaurants... studying the shoes and dresses in the shop windows... and smiling at the passers-by.

There are many cities with lively sections. Many offer interesting nightlife. But we can’t recall one where the nightlife seemed so relaxed and friendly that we could walk along with an infant in a stroller and have such a good time.

Maybe it’s because we never tried.

Until tomorrow,

Bill Bonner,
For The Daily Reckoning