01/15/10 Baltimore, Maryland – No unarmed profession has done as much harm as economists.
Recently, Yukio Hatoyama, the new Japanese Prime Minister, proved it again…revealing a budget deficit that must have made Paul Krugman drool. The Japanese government will spend 92.3 trillion yen next year, about 1 trillion dollars. Tax receipts will be enough to cover only half that amount, leaving the nation with the biggest shortfall since WWII.
It is obvious to everyone but an economist that spending twice as much as you earn is not a formula for real prosperity. And it is obvious to anyone but investors that buying Japanese debt is asking for a kick in the pants. But these are the same economists who mistook the bubble world of 2003-2007 for genuine prosperity and the same investors who bought dotcoms in ’99 and mortgage finance companies in ’07.
Mr. Hatoyama portrayed his spending spree in humanitarian terms. It was aimed at “saving people’s lives,” he offered. This is a big change, he explained; previous spending initiatives have been intended to channel rivers and create parking places. So bountiful were these public works projects that, in the ’90s, Japan poured more concrete than any country on earth, prompting one commentator to refer to Japan’s stimulus efforts as “state-sponsored vandalism.”
Effacing the landscape did little to bestir the economy. The concrete hardened, but the markets gave way. More wealth was lost than in any other country at any time in history. Commercial real estate dropped 87%. Banks lost $1 trillion as they wrote off bad loans in the property sector. Golf club membership prices dropped 95%. Stocks ebbed down for 20 years and then hit a new low in March of 2009. After 20 years of bear market, they were back to 1982 levels. In the real estate and stock markets alone, $15 trillion was wiped out, an amount equal to three times the GDP of the entire country. By way of comparison, during America’s Great Depression, between ’29 and ’33, only 1 times GDP was erased.
“Everyone was bankrupt,” concludes Nomura Securities’ chief economist, Richard Koo.
The trouble, according to most economists, was that what was good for individuals wasn’t good for the whole economy. As businesses and consumers paid down debt the money went into banks and didn’t come out again. How could it? No one wanted to borrow; they wanted to save. Sales fell. Then prices fell, prompting consumers to save even more. The more the private citizen repaired his finances; the more the finances of the nation fell apart. This is known in economics as the ‘fallacy of composition,’ which is to say, the whole is not the same as the parts. You may have all the parts of a cow in your freezer; but don’t expect it to moo.
Richard Koo believes Japanese economists pulled off a great triumph. Monetary policy didn’t work; consumers wouldn’t borrow and banks wouldn’t lend. But huge dollops of fiscal stimulus kept the wheels turning. The private sector cut spending; the public sector put it back. As a result, GDP never fell below its 1989 high…and unemployment never rose above 6%.
It’s too bad the world is not a simpler place. If it were, the fallacy of composition might make sense…prosperity might be as easy as maintaining positive GDP growth…and economists such as Koo and Krugman might be worth a damn.
But the fallacy of composition is a fallacy…at least as applied by modern economists. There comes a time when a man should sober up, even though the hangover is unpleasant. But while Japanese households were drinking strong coffee, Japan’s economists refused to allow GDP to fall; they put zombie companies on life support; and they kept the doors on the banks open. This not only prevented a new economy from arising, it cost money. As the citizens paid off debt, the government borrowed in their names. While households repaired their private balance sheets, government destroyed the balance sheet of the entire nation.
Now, after 20 years, the private sector has had time to pay down its debts. Corporate debt-to-GDP levels are back to 1956 levels. Japanese households have more net savings than any others in the world. But instead of tapering off its deficits, they grow larger and larger. Why? Because deficits no longer stimulate the economy; they ARE the economy. The Japanese tried to cure an alcoholic with heroin. Now, they’re addicted to it. Take away the stimulus now, says Koo, and the economy gets the shakes, tax revenues fall and deficits actually grow larger.
Asked ‘what is the most effective form of fiscal stimulus,’ Mr. Koo replied: “military spending…because it increases demand without increasing supply.”
Only an economist or a fool could believe such an obvious fraud. The Japanese fought the downturn by adding to the supply of bridge abutments. They might just as well have bought aircraft carriers. The taxpayer now has concrete up the kazoo, and a public debt that’s headed to 300% of GDP…or to Hell…whichever comes first.
Bill Bonner
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill’s daily reckonings from more than a decade: 1999-2010.
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We’re in the same boat. All this talk about how the government is going to stop buying MBS in March is ridiculous. Most economist think this would result in mortgage rates going up 50 bps. I think it would be more like 500 bps.
The FED is our entire mortgage market now. If they effectively stop loaning, who is going to make loans? I sure wouldn’t loan someone money to buy a house and only collect 5% interest. I would want at least 10% before even considering it. Maybe if they put 50% down, I would take 8%.
Also, there’s no way the FED is raising rates in 2010. No chance. All it would do is crash the dow. It would undo the big con the governments been running all year.
Personally, I think it is far more exciting when Japan builds aircraft carriers rather than concrete abutments.
Is it possible that artificially low interest rates and quantitative easing CAUSE deflation? Some possible results of that approach:
1.] Governments borrow more money to spend but the money is spent in an unproductive way, distorting the economy.
2.] Private investors in government bonds receive less money investing in their country, leaving less money to invest in their country in a productive fashion.
3.] The low interest rates lead to many loans, but the money is invested in other countries, not the host country, because the host country is following bad economic policy and no one in there right mind would invest there. [ carry trade]
4.] The host country gets nothing for their low interest rates and quantitative easing, the countries that end up with the borrowed money get market bubbles and some real growth.
Is this too simple? Cheers.
Literally, a dollar worth of goods or commodity produced, a dollar note can be printed. That is simplified form of saying as regard to the term commodity money or paper money.
The greenback is internationally circulated, an international legal tender and many a major currency is pegged to it.
Chinese factories are on full swing production. Anywhere to work out a solution, where a dollar worth of Chinese goods produced and a dollar note will be printed to ‘absord the commodity’ ?
If this is workable, the FEB has plenty of room to print tons and tons of greenback. hei ! hei !!!
Like Bill has always said…everyone eventually gets what they really deserve. Americans will always be wreckless spenders… Not even God Almighty can change that. There is allways a fool waiting to be parted from his money.
H.H. – It is always too simple, but then what you described seems to lead to no effect in the host country (which means deflation during economic busts) and inflation in the booming countries.
I wonder what Japan looks like in twenty years. I can’t imagine a civil war or even civil unrest in such a disciplined society. Perhaps they are going to vote for communism. That would give them the chance to expand like China in the longer run.
Hi all:
Perhaps the whole World should just declare bankruptcy. This of course would be welcome by the New World Order where they could quit rubbing their greedy hands together long enough to buy the firms at 5 cents on the dollar. Why did Warren Buffet buy BN now? He rubs shoulders with the Bilderbergers, perhaps he could have picked up BN for 5 cents on the dollar by waiting a bit!
*Barry: I’m with you on this – let’s start on a fresh note.Every country and *everyone* too. Let’s forget the realities and technicalities – they just complicate things:-)
Now, everyone starts with the same exact sum of bank balance, regardless of what he had (or owed) before. Countries too. Those now successful won’t like it, of course… China, most Opec countries, Bill Gates.. But we’re going ahead anyway – Everything on a clean slate after this `Great Re-Alignment’.