A NEW SPOTLIGHT ON JAPANESE STYLE DEFLATION
In a scholarly paper that was released today James Bullard, President of the Federal Reserve Bank of St. Louis, stated, “The U.S. is closer to a Japanese-style outcome than at any time in recent history”. As everyone knows, the Japanese economy has undergone a period of extremely slow growth with periodic recessions combined with price deflation over the past 20 years. Its stock market is still about 70% below the 1989 peak while property values are still depressed despite ultra-low interest rates and massive government spending. While the paper concluded that this was not the most likely outcome, the release caused an immediate intra-day drop in the stock market that was partially reversed later in the session. Bullard’s prescription for avoiding this highly undesirable outcome was to advocate more reliance on additional quantitative easing (QE) rather than extremely low interest rates.
Bullard’s paper is the latest of a recent realization that deflation is a major threat and that the U.S. could follow Japan into its own lost decade (or two?). However, Comstock pointed this out over a year ago in a “special comment” dated May 21, 2009, titled “Deleveraging—-U.S. vs. Japan”. In that comment we wrote– referring to Japan, “Now nearly 20 years later, both the stock and commercial real estate markets remain more than 70% off their peaks, while residential land prices are more than 40% below their peak. Although the optimistic view is that the various stimulative plans by the new administration, together with the massive easing by the Fed, will help the U.S. avoid the same deleveraging result as Japan, it is exceedingly difficult to see how that will happen”.
Although Bullard was expressing his personal opinion rather than that of the FOMC’s, we think it is important. He is a voting member of the FOMC and, more importantly, he is regarded as one its more hawkish members. For a hawkish Fed governor to come out for additional substantial QE could be a turning point in how the investing public looks at the longer-term outlook for the economy.
In our view the case for deflation is a strong one as most of the classic symptoms are present in the U.S. today. Record historic debt is already in the process of deleveraging, and there is still a long way to go. Consumer demand is restrained. There is an excess of labor supply with five people available for every open job. Capacity utilization rates are historically low. Household net worth is far below peak levels. Credit is available only to the most highly qualified borrowers. Money supply has been flat or decreasing despite massive stimulus. All of this is a classic recipe for deflation.
We also believe that there is little the Fed can do to avoid the outcome. Japan kept both short and long-term interest rates exceedingly low for many years and ran massive budget deficits with little to show for it, although they did prevent a complete collapse of their economic and financial system. While there is a difference between the U.S. and Japan, two major differences were in favor of Japan rather than the U.S. During most of Japan’s two-decade malaise the global economy was quite strong and Japan was able to support its economy with a substantial amount of exports. Furthermore, Japan started with a 12% household savings rate and was able to run it down, thereby providing some support for consumer spending.
So far, the stock market has been resistant to a downturn. The consensus believes that the economic recovery is on track, the Fed can avoid deflation, the U.S. is not like Japan, the European crisis is over, the market is cheap, and China has curbed its real estate bubble. For reasons pointed out in past comments, we disagree on all counts and investors are making the same mistake they made in early 2000 and late 2007 when they overlooked key negative factors that should have been recognized at the time.
11 Comments
Bullard’s paper is the realization that we have a gov’t filled with economists that know nothing about either economics or history.
Amen to that. I get more of a feeling that they are little more than Druids slaughter some poor animal in attempt to divine the future.
bullard is guest host on CNBC this morning.
US population demographics may help us stay away from long term japanese-maliase…………without getting into the negatives of more people on this rock
while i agree the short n intermediate problem is deflation, you cannot convince me that the FED will stick that “747-landing-on-a-postage-stamp” QE back-off………inflation and bond vigilantes are down the road, tho it will be years.
i’m just glad i’m here to muse about it…….just buried my old surfing buddy after his life of choking down heaters…..at least he went in his sleep, IN BANKING, but believe me 61 ain’t as old as it used to sound.
I hear ya boatman, trust me. Besides, here in NYC a pack now costs $15+….now its just a huge waste of money.
On a lighter note, I did put on a fairly nicely sized short position at the start of this week and have been unwilling to cover at a 50% profit twice thus far just to watch it erode away. Kinda sick of the cheerleaders saying the data is “mixed” – it’s blatantly bad, end of story. And even the market is prepping for it – it just may not look this way. I was hoping for a nice gain on this trade (my first since the “flash crash”) but I’ve started to convince myself that it could net me some nice coin.
Latest weekly leading index, -10.5 percent, the worst since May 2009.
I read that every single time single time this indicator has slipped into double-digit a recession has followed. ????
At least Japan had/has a solid manufacturing machine churning out trade surpluses and a populace committed to high savings. I don’t think we match up well in that department.
As for the ECRI comment above, I believe the number released today was -10.7%, a change of -0.2% from last week.
To quote myself (ahem) “Doing the same thing and expecting different results is the definition of insanity”
Obama, Geithner and Bernanke have been following the Japanese playbook exactly. Political pork spending, zero interest rates, QE, massive debt, forced taxpayer bailouts of failed companies that have good political connections
Japan has been doing this fraudulent “stimulus” nonsense for 20 years, and they have nothing to show for it but the largest debt in the G7.
Since the US is following the exact same failed policies, of course we are going to get the same failed results
You would have to be stupid or an economist to expect anything else.
If you read his article, it says more about the Taylor Rule (setting Fed rate to control inflation) than anything. Due to a quirk the curved Taylor rule intersects the flat line Fisher int rate line twice at about 1.5% and close to zero. Each point is considered in equilibrium or steady-state. If plotted US is at 1.5% area and Japan at 0%.
He argues that keeping Fed rates at 0% could force US to same equilibrium as Japan, better to raise Fed rate to 1.5% and use QE for stimulus. Another aspect he doesn’t mention – all the boomers in cash and bonds would then have more interest income to spend increasing demand.
There seem to be equal forces at play between inflation and deflation at the moment. Population growth would help, if only unemployment was not as high as it is now. There aren’t enough jobs to absorb a lot of new people coming in – unless they come with capital and new business of course.
Bullard is right in the Japan comparison and wrong on the solution. Look no further than KOO KOO’s endless infatuation with QE. It has accomplished nothing for Japan. The answer is lies in letting the broke companies and individuals go broke and default. Quit kicking the can down the road. It’s the only way new and sustainable investments will come into the market.
There is one huge difference between the US and Japan. The Japanese real estate bubble was larger. Much, much, much larger. We don’t have anywhere near as much deleveraging to do in order to return to normalcy. Maybe 3-5 more years of forclosures will clear out all the bad loans, and allow US real estate to be used as good collateral again.