Japan, Argentina, Weimar, or Muddle?

Jim Willie CB

Experts and other purported authorities have made frequent comparisons concerning the US Economy versus Japan. The consensus is that we will not travel the same agonizing path marred by contraction and slow motion destruction. We in the USA have far more similarities than we want to admit with the fading Asian powerhouse. However, critically dangerous differences will prevent the muddle process from occurring smoothly in our economy. We actually compare poorly in differences listed in this article. No, the USA is not as bad as Japan. WE ARE MUCH MORE DANGEROUSLY WORSE. Apply strong Weimar tools within a stubborn Japan quagmire, when addicted to foreign capital, and you risk shock-ridden Argentine outcomes, not a sloppy Muddle.

For over two years American business leaders, financial leaders, brokerage analysts, media pundits, and investors have denied that the United States is gradually entering a Liquidity Trap bearing strong resemblance to the one that has ensnared Japan's economy since 1990. Such denials seem patriotic at best, and obtuse at worse. Prevailing interest rates on USTBill yields might soon be pulled below 1.0% in order to satisfy loud cries and urges emanating from the financial markets. Even car loans, offered at 0% interest now, matching the 0% down payment allowed, have failed to keep sales from sliding. A real estate decline of even moderate proportions would render our groans more completely in rhyme. US banks do not stand as the vulnerable line of defense. The victim on our side of the Pacific Ocean will be primarily Fanny Mae and the Government Sponsored Enterprises, which act much like the Sirens of Greek Mythology, luring sailors to shipwreck. We deny the litany of parallels between 2000-2003 in the USA, and 1980-1985 in Japan. Barrons has responsibly reported numerous comparisons to the Nikkei stock bust and the Nasdaq bust, with only the S&P "other shoe" to drop. Sadly, the United States economy is already in the early throes of a liquidity trap. Eleven ineffective Fed rate cuts stand as testimony, confirmed by a flat GDP, stalled consumer spending, rising household debt, downtrending stocks, and reluctance by business management to expand the capital base in the face of stubborn overcapacity.

Neither Japan nor the USA might stumble in the Land of Muddle much longer.

Some believe Japan can muddle forever, since they have muddled for over a decade. They may finally be succumbing to the Kondratiev Winter forces of liquidation now. Nikkei last month lurched below a multi-year support level, perhaps sensing the US consumer pullback or an imminent rise in the yen versus the dollar. Large Japanese firms are now selling off large tranches of stock in other corporations, fetching poor prices. Distress will likely lead them to repatriate foreign investments at a quicker pace than broadly anticipated. Their largest block of securities is $430 billion in USTBonds, whose sale even in moderate quantity will lead to higher longterm bond yields. Escalating US federal deficits work to ensure at least slightly higher rates. Unless the Fed jumpstarts their next quantum stage of monetization, lapping up Asian supply, longterm US rates would rise to sabotage any hope of economic recovery. Other Asian holders might follow suit. A threat overhangs the US mortgage market, and thus real estate !!!

As our government and financial technicians seek to prevent a painful recession (which would surely feed upon itself), we are implementing much the same levers as the Weimar Republic in the 1920's.

Two decades of bailouts have affirmed the Federal Reserve's role as last resort guarantor of world economic accidents. We are approaching the Keynesian Monetarist end game. A mere 22 cents of new business activity is produced from every new minted dollar (in credit), while 86% of the current GDP is now devoted to debt service. This was precisely the warning issued by the Austrian School of Economics, which has been ignored for decades. The vonMises Institute "students" have warned that late in the debt-based system, the govt will be forced to accelerate the money supply in order to maintain a constant level of economic activity, and ward off a deflationary recession. As Weimar levers are pulled to escape the clutches of the Japan Liquidity Trap, we subject our economy and our financial markets to the extreme risk of foreign capital flight, as seen in Argentina. Unlike domestic bondholders, foreign creditors undergo loss due to currency exposure. They have begun to act upon the Fed's boastful yet menacing signals. If they exit our credit markets in response to unfettered Fed monetization, the Fed action will be vetoed to bring about no change, or even higher interest rates. Severe currency disruptions lie ahead !!!

In their next panic, the Greenspan-led hacks running our Fed will plant the seeds of hyper-inflation, whose germination will be dictated by China.

In November of 2002, the new Fed Governor Bernanke crowed that the Federal Reserve would avoid the unfortunate Japanese outcome by putting their high-tech printing press to work, early and often. In recent weeks, Dept of Inflation Chairman Alan Greenspan denied his shortage of ammunition, citing numerous monetization options, along with reserve requirement relaxations, all of which would assist in providing liquidity. A common economist error is to apply tools that work during expansion, and expect their usage to succeed during contraction (of corporate profits, sales revenue, and asset values, while debt default spreads.) We flaunt tools of monetization, which carry great risk of a Weimar hyper-inflation consequence in time. The tools we brandish might resemble a guillotine poised over our financial body, with the USDollar currency the exposed head. When, not if China revalues their yuan currency upward, the entire non-Japan Asian Rim will follow suit, inducing the seeds of US price inflation to sprout. China will likely shift gears when their central bank has a desired quantity of reserve assets, led by gold to gird their currency. At that time, China emerges front and center as a world power !!!

"Liquidity" is nothing but a deceptive euphemism for more "Credit."

When abused, credit leads to massive inflationary, then deflationary outcomes. We live now during a time of bankruptcy in economic thought and balance sheets. The public is now told that our sickly economy needs more liquidity, when excessive credit has actually caused the current extreme stagnation. So why would more credit remedy the pervasive malaise? More infusions of heavy liquidity doses will surely lead to a more challenging problem later. In full gallop, debt default and debt retirement are now overtaking herculean federal attempts to reflate the economy. The most recent St. Louis Fed data on MZM indicates the money supply is currently in decline !!!

Disturbing parallels are slowly emerging in the geopolitical and financial fronts between the United States and Europe, with Iraq the new Weimar Republic, and the USDollar the new ReichMark.

German debts were owed to the angry vengeful British and French in the punitive counter-productive resolution imposed by the victors following World War I, signed as the Versailles Treaty. Fast forward to today. American debts now are owed to overridden Europeans, infuriated Arabs, bewildered Japanese, and upstart Chinese. A more immediate and politically volatile $80B debt is owed by the Baath Nazis of Iraq to Europe. Together, the American-Iraq debts make for a strange partnership reminiscent of Versailles. Creditors are slowly growing in their anger. If not from emerging geopolitical differences, or irreconcilable religious differences, or terrorist resentment, then the basis of anger might come from simple market decline in the underlying currency. The entire Iraq War was paid on the USGovt Credit Card. Will this queer alliance founded in debt desperation and resource deprivation motivate a similar power land grab such as Hitler's with Poland, France, Belgium, and North Africa? I say yes, it has already begun. I believe we are witnessing the beginning of World War IV, not Arab Democracy. The parallels of deep debt, angry creditors, economic stagnation, resource shortage, and international tension seem clear, but are lost on the public, whose reaction better resembles one to a football game. New alliances are forming, even as NATO and the UN each appear effectively null and void. Was NATO trampled in pursuit of oil, or defense of the dollar, perhaps both !?!

The Federal Reserve is notorious for overshooting, and owns a track record to prove it.

Recall the planned slowdown in 1992, when the Fed pulled back on money supply for two full years, killing both Bush Sr's presidential bid and the economy's attempt to overcome the Gulf War energy price shock. Recall the panicky increase in Fed Funds rate targets in 1994-95, when the long bond rose over 2% in shock. Recall after the Asian Meltdown in 1997 and the consequent Russian Default in 1998, when the charioteer Greenspan identified irrational exuberance, he loosened the monetary reins when at most he should have held fixed. This error was compounded in late 1999, when he went full throttle on liquidity in anticipation of worldwide Y2K snafus that never surfaced. The Fed tightened in overkill from late 1999 into mid-2000, fabricating the "Soft Landing" illusion, only to produce a worldwide bust. Then suddenly another panicky move to ease monetary pressure in January 2001 that has yet to end. Money supply has expanded more rapidly since early 2001 than at any time in modern history, taking on Weimar proportions. The world is awash in dollars. I believe the Fed is now finally perplexed, if not frightened. For the first time in the Fed's history, its chairman admitted to being in the dark. The unprecedented admission came at the last FOMC meeting. Expect an overshoot as the Fed struggles against a mighty global deflation foe, with no option but to sacrifice the bloated dollar and allow an explosion in gold !!!

The US Economy may soon be severely tested by a series of shocks.

Instead of muddling through, I consign to the outlook laid out by Doug Noland of Prudent Bear. He believes we are careening perilously toward the Argentine outcome, with numerous shocks and sudden disruptions emerging from currency, credit, and banking distress, trumpeted by foreign flight. The interventionist action so far by the federal govt has only kept retail spending levitated in an economy that is 70% dependent on consumers. Monetary action encouraged by the Federal Reserve has only drawn households deeper into debt, even raiding their stable equity source in residential homes. Despite Greenspan's claim that household and corporate balance sheets have made a remarkable adjustment, the exact contradiction is the reality. Is he stupid or senile or lying? My guess he is "lying" so as to condone his own failure. The US Economy is in a more perilous position than it was in the summer of 2000, when danger was first sniffed in the stock market. Now a real estate bubble is steadfastly denied. We may have begun the second phase of the New Paradigm Recession, triggered by a housing decline. As said in Alcoholics Anonymous, if the family repeatedly wonders aloud whether Uncle Sammy could be an alcoholic, then he most certainly is. Why else would we wonder so regularly? Recession straight ahead !!!

The prescription for an Argentine implosion shock is a combination of debt failures, weak export competitiveness, and sudden departure of foreign capital.

The US economy has suffered the debt duress for over two years. Our gaping trade imbalance is now an annualized 6% of national GDP. We are primed and vulnerable for some degree of foreign abandonment. Owing to our deteriorating condition of extraordinary import dependence (both capital and finished products), our economy might stand alone among industrialized nations in a return encounter with price inflation. The avenue may be built from imported products priced higher after a dollar decline, atop a foundation of rising commodity and energy prices. New factors have entered the mix, as Europe and the Middle East are showing hostility toward us. The appeal of EuroBonds now eclipses our USTBonds. Arabs experiment with pricing crude oil shipments denominated in euros. Islamics launch their gold-backed Dinar currency this summer. Forces are aligned to create an international bandwagon leaving New York City and our financial markets, taking hot money out of town. Such is the Argentine airpocket missing, at least for now. Foreign capital exodus, dead ahead !!!

Differences between USA and Japan are very unfavorable, relating to currency valuation, bankruptcy ease, saving propensity, foreigner debt ownership, financial engineering, monetization techniques, basic integrity, and intervention willingness :

a) unlike Japan, US Economy cannot tolerate a declining USDollar
A declining USDollar is anathema for our economy, since imports would open the door to price inflation. Asia operates as our subservient manufacturing base. If Asian currencies rise, in particular the pace-setter Chinese yuan, then prices across our entire retail sector will rise. Even the absurdly indexed CPI will register a rise. A declining dollar imports inflation, reversing the 1990 decade-long trend. Higher longterm interest rates would immediately be reflected. The real estate sector, providing easy capital for sustaining consumption, would suffer a prick to its seemingly unending bubble. A recession would ensue. A falling dollar brings higher commodity and energy costs. Higher production and living costs would smother the economy, pinching corporate earnings and consumer spending. The stock market would naturally see considerable foreign and domestic selling, which feeds back into a weaker economy. It is all bad.

Japan is sustained from reduced currency, since it is an exporting nation. The Bank of Japan acted as accomplice in the hyper-growth of credit in the 1980 decade. Devastating debt management at the national level corroded the strong trade surplus effect to the yen currency. More importantly, the BoJ worked in concert with the foreign exchange markets in punishing the yen for irresponsible credit policy. While their economy slowly has died (let's call a spade a spade), export pricing was kept competitive by means of chronic yen currency debasement. The exact opposite is true of the United States, where price inflation, reduced consumption, and economic recession would follow a currency devaluation. The flight of foreign investor capital may soon occur.

b) unlike Japan, US Economy permits bankruptcies as a regular course of business
Our economy is undergoing an acceleration in bankruptcy filings, both corporate and personal, as waning sales revenue has stressed high debt levels across the entire economy. The job of a recession is to cull unproductive, irresponsible, and excessive debt. However, the entire United States economy is a debt experiment gone amok. Debt levels are many quantum levels higher than those seen in 1930. Debts from federal, state, corporate, city, municipal, and household are all under stress. The stress at the state level is acute. California flirts with bankruptcy. Some contractor bills are now being paid with California coupons, a precursor to new "state currency." Will these coupons act as legal tender to pay grocery bills? Nevada has announced intentions to mint silver coins, certain to be challenged in court. A revolution in state currency is about to occur. Fiscal duress at the local level threatens school function. Their main recourse is to raise property taxes, thereby pressuring real estate further. Pension funding now competes for scarce capital in the service of corporate debt. Rolling over the longterm debt is not the routine exercise it once was, as lenders have become more reluctant to extend credit to marginal customers. The bankruptcy path feeds upon itself. Money supply is reduced via capital burning. Money velocity is reduced, slowing the entire system. Even lower interest rates contribute to the slowing of the economy in a contracting environment, contrary to popular inept economist beliefs.

Japan blocks bankruptcy at every corner. Engrained within their culture is an intense reluctance to declare insolvency and deal with the liquidation process. Numerous examples are on record where chief executives commit suicide in the shadow of shame. Banks do not account for non-performing loans in the same manner as American banks, marking them down in stages, providing loan loss reserves. Instead, they mark them to their original price and value, an utterly moronic accounting technique. It is estimated that $1.6 trillion in soured loans still sit on the books of major Japanese banks. Sickly medium-sized corporations and banks continue to survive and operate with the help of conglomerates, known as keiretsus. The parent keiretsus provide the necessary capital to avoid bankruptcy at all costs, literally. They routinely resort to coercion of member banks within the conglomerate, which relent in funding the zombie firms. This is a Japanese phenomenon, and even has been given the name "Vampirism." Japan muddles along from inefficient capital recycling and release. The exact opposite is true of the United States, where bankruptcy and liquidation might get out of control. The flight of foreign investor capital may soon occur.

c) unlike Japan, US Economy depends upon consumption & spending
Our nation is comprised of countless citizens who spend compulsively, and live for today. They borrow heavily in order to maintain a standard of living. Many regard our standard as their entitlement. The saving rate went from its historical 6-7% to negative levels late in the 1990 decade. The "go-go" generation has unlearned the vast benefits of savings, which build engines of wealth. Our financial leaders go so far as to encourage our citizens to consume, raid home equity, all in some patriotic duty. Cheap credit is readily available, for furniture, cars, and houses. The first few months of payments are now offered in order to keep inventory moving. The entire US Economy is based upon a free flow of debt, which is possibly seeing its limitations. Many eroding factors are taking a toll on consumer spending -- job loss, high debt levels, saturated demand.

Japanese citizens are the most prolific savers on the planet, with an astonishing 20% savings rate. They fund their own colossal federal debt, now at 160% of GDP. It is estimated that Japanese household savings total more than $12 trillion. This energetic nation finances sovereign debt across the entire industrial world. Their economy can benefit from unleashing their savings and foment a riot of consumption that would assist in lifting their economy. Many challenges remain, such as an insolvent banking system and sick keiretsus, but at least they are in a position to force fund their survival. The exact opposite is true of the United States, where a stall in consumption will threaten the entire system. The flight of foreign investor capital may soon occur.

d) unlike Japan, much US debt is owned by foreigners, with a trade gap widening
Foreign investors own a dangerous amount of debt all across our financial system, with federal govt securities the most widely held, and agency debt picking up speed fast. Corporate debt is also prevalent in foreign portfolios. So close is this relationship that the Federal Reserve holds perhaps 20% of the USTBonds in New York City foreign accounts. The actual percentage of the $6.5 trillion federal debt is in debate, but believed to be approximately 45%. The Bible warns that a debtor is a slave to his creditor master. It also warns that money will become "moth-eaten." On the other hand, our culture almost revels in its belief that if a debt is large enough, a partner is created. The US trade gap and federal debt perpetuate and exacerbate the strain. Our economy requires roughly $3 billion per day of foreign capital, just to keep operating, just to maintain a standard of living. With dependence comes lost control of our fate. A correction to the imbalance is overdue.

Japan has never appealed to foreigners for supplying credit, since they are the greatest savers even seen in history. They supply credit through their vast savings. Outside underwater mortgages, Japan does not have deep debts at the household level. The debts at the corporate and federal level are self-contained, owned by Japanese investors. So this island nation is not at the mercy of foreigners and their whims of shifting preferences. Japan's trade surplus runs annually at a high level. The bilateral surplus with the United States amounts to 2.5% of its GDP. It runs almost as high with the European Union. Japan may be in deep financial trouble, with great uphill struggles ahead, but it has the means to be in control of its own fate. The exact opposite is true of the United States, where a foreign dependence may someday lead to an exodus of hot money capital, departing our economy for any of several reasons, causing serious airpockets, leading to declines in asset prices, to increases in interest rates, and to rising debt defaults. The flight of foreign investor capital may soon occur.

e) unlike Japan, US Structured Finance has created a megalith monster
Since 1990, our ingenious Structured Finance systems have acted as centrifuge fountains of capital to supply the residential real estate sector. Commercial property appeals typically to commercial banks, yoked by shorter terms of amortized loans. Fanny Mae, Freddy Mac, and other GSE's appeal to investors with the murky promise of federal guarantees. Now Japan and China have become major investors of agency debt. Originators of loans assemble loan portfolios, with diminishing concern for either properly valued collateral property, creditworthy borrowers, or viable loan-to-value ratios. They package their loans, sell them to Fanny Mae, then recycle the replenished capital to repeat the process, thus socializing home ownership. As mortgage rates fall, the refinance process leads to reinvestment of the prematurely retired bonds into government treasury securities. In the process a feedback loop is created, which serves to reduce interest rates further. A new round of refinances ensues with more enticing mortgage rates. This is one mechanism for the marketplace to force interest rates toward zero, as occurred in Japan. Govt policy joins the deadly dance to zero. A rampaging monster has been created, one which operates outside regulatory oversight. Fanny Mae recently discovered a method to account for their growing derivative book using expected future value instead of marked-to-market value. Earnings showed a nice improvement. The FNM stock is up almost 30% since early March, despite a real threat to its financial foundations, echoed by a warning from St. Louis Fed Governor Poole.

The Japanese have no equivalent in financial structures. Banks own their underwater mortgages tied to residential real estate. Although their govt pension system is not a structure, one might identify it as a supporting extortion. Workers are forced by law to contribute into dead-end 1% federal bond instruments (Japanese Govt Bonds), which by comparison lack any dynamism of growth, and certainly fail to spin out capital. The govt pension system manages to keep their credit market stable but comatose with nil interest rates. The exact opposite is true of the United States, where our structured finance apparatus is inherently unstable, threatening mortgage finance, housing asset prices, thus the entire economy. The flight of foreign investor capital may soon occur.

f) unlike Japan, US Federal Reserve is a monetization machine on steroids
Our Federal Reserve has raised the monetization to new levels of efficiency, harnessing technology of the printing press and computerization. Not only is this unconstitutional agency willing to use tools broadly, but it boasts about its arsenal, all the while blind to its destructive path and history. The Fed has failed in its charter to manage a stable currency. The Fed overrides the credit market based upon equilibrium, which has led to greater swings in expansion (booms) and contractions (busts). A great danger exists from supplying money and credit to great excess. Gresham's Law states that bad money drives out good money. Fiat currency and low quality debt displace sound money and real capital, a concept widely misunderstood by our bungling economists. In fact, the US Govt is at war with sound money. Seeds are now being planted for hyper-inflation in the near future. The inhibiting force of the Chinese export trade could possibly encourage the Fed to feel no boundary and print dollars without control. A revaluation upward of their yuan currency is certain in the next couple years, to finally honor the World Trade Organization agreement. At that time the malignant seeds of price inflation will sprout.

Japan primarily employs the basic "plain vanilla" currency debasement game, issuing yen and purchasing USTBonds to drive down its yen currency. The Bank of Japan is the agent perpetrator in overnight trading. The tactic lacks the sophistication of American ingenuity. Japan enjoys the shorterm result of keeping their export prices competitively low. American consumers enjoy the end result as well. The BoJ thereby preserves the status quo within an export economy, maintaining a moribund equilibrium. The exact opposite is true of the United States, where accelerating monetary expansion undermines our foreign creditors, setting up the potential for a dollar freefall and all its horrendous consequences to our economy. The flight of foreign investor capital may soon occur.

g) unlike Japan, US institutions harbor widespread corruption Glaring evidence in the last two years indicates an institutionalized fabric of corruption engrained throughout the entire US financial landscape. Corporate accounting, brokerage analysis, executive self-compensation, Congressional lobby to block reform, foot dragging on prosecution, use of off-shore banks and agents, collusion between govt ministries and financial centers, media bias catering to advertisers, all this has changed little in the last two years since Enron made headlines. While public awareness has grown, reform and indictments are pathetically slow and shallow. While Americans believe a movement has begun in our country toward remedy, foreigners see the status quo as deeply entrenched.

Japanese have far more honesty in their institutions, but not without an isolated rare episode themselves. A few years ago, we heard of a palladium price fixing case. Bribery occasionally surfaces among govt officials. But by and large, the Japanese are a relatively honest bunch. One area where we share extensive common ground is with subsidized pork projects. Our pork is just staggering, with Trent Lott's abandoned Carnival Cruise Liner project in Mzippi costing taxpayers over $800 million. Tokyo is replete with roads to nowhere, along with price supports for $6 peaches. Honesty is commonplace in Japan, contrasted with a basic pursuit of honor. The exact opposite is true in the United States, where corruption is commonplace, contrasted with a widespread moral breakdown. The flight of foreign investor capital may soon occur.

h) unlike Japan, US maintains a pervasive interventionist attitude
Simply put, we are an arrogant confrontational meddling bully nation internationally. We confront makers of unconventional weapons, while our conventional weapons deliver 1000:1 kill rates on the battlefield. We coerce exporting nations to finance our federal debt, or else face a closed marketplace. We erect trade barriers even against our most friendly trade partners, like Canada and Europe. We abuse our advantage of spinning off dollars that work as a world reserve currency. We use our economic strength and control of trade routes to dictate to smaller nations, even installing puppet govt leaders. We dole out foreign aid, expecting heavy influence in return. We employ hypocritical international bylaws with our friendly neighbors in the community of nations. In response, we have seen numerous cases of retaliation. Criticism and vengeful attack have been routine for decades. We have suffered extreme hardship from embargoes, such as the infamous revenge by OPEC in 1973 after our support of Israel. We have been the target of dumping in chips, steel, and other industries. We have been victimized with terrorist attacks. Most pernicious though, where we interfere, we usually witness what the CIA terms "blowback" a few years later as new tyrants brutalize their people and their neighbors using weapons we supplied. See VietNam, Iran, Iraq, Afghanistan.

The Japanese are notoriously meek, wielding no military high-profile presence. They just do not engage in confrontations and battles. They may upset foreign inventors, coming to market more quickly with products patented outside Japan. But speed in development is not illegal, only frustrating. Japan hands out remarkably little foreign aid, but one can argue that their financial creditor role for numerous sovereign nations satisfies criteria for altruism. They exhibit an incredibly low profile. Their most ubiquitous foreign emissaries scattered across the globe travel in the form of 1000's of Toyota pickup trucks planted in the Islamic world, South America, and elsewhere. The exact opposite is true of the United States, where empire building and colonialism invite retaliation. We seem to "walk loudly and carry a big stick bought on credit." The flight of foreign investor capital may soon occur.

May 13, 2003

THE BIO:

Jim Willie CB works as a statistical analyst for a private consulting firm engaged in marketing research, for at least the next three weeks until his job is terminated, saving his firm the overhead cost.  He holds a Ph.D. in Statistics, which has led to staff positions offered first to layoff.  His career has stretched over 22 years.  He aspires to one day join the financial editor world, unencumbered by the limitations of economic credentials.  Visit his free website to find articles from topflight authors at  www.GoldenJackass.com  .

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