Dear Diary,
The Dow jumped another 195 points on Friday.
What do you think? Was that because the economy is so healthy? Are stock market investors looking for years of healthy earnings growth ahead? Did buying the Dow at today’s valuations suddenly become a reasonable investment move?
Or could it be because Japan has just done something monumentally absurd?
It is hard to know what attitude to take when talking about Japanese financial policies. Mockery? Pity? Gratitude?
It is easy to mock the Japanese. They have a government debt-to-GDP ratio of 250% – the highest in the world. And year after year – for a quarter of a century – they “stimulate” their economy with QE and deficits.
What do they get for it? Mostly more debt. Stock and housing prices are still just about one-third of what they were 25 years ago. They missed the big dot-com boom of the late 1990s. Then they missed the real estate and finance boom of 2003-07.
Meanwhile, Japan’s celebrated trade surplus is disappearing. And her people are getting old, retiring and dying. Japan has become a huge pension plan headed for bankruptcy.
A Desperate Nation
It is easy to pity the Japanese, too. Most of their wounds may be self-inflicted. Still, they live in tiny houses… with a standard of living the rest of the developed world holds in contempt. And they’ve suffered two and a half decades of on-again off-again deflation.
They’ve tried everything to get out of this slump – stimulus deficits, zero interest rates, quantitative easing. They’ve tried everything, that is, except the one thing that would work!
Not surprisingly, things have gotten worse. In September, real household income fell at a 6% rate. Between 2013 and 2015, it’s expected to fall by almost 10%.
And now the Japanese are desperate.
That is where the gratitude comes in. Americans and Europeans should thank them for having shown us what not to do – for proving, if it needed proving, that you can’t fight a debt crisis with more credit.
More important, they’re showing what happens to Bismarck’s social welfare economy when you run out of young people, growth and credit.
Now, it’s time to double our gratitude. Because now the Japanese are showing us that even a world-class economy can do something worthy of a banana republic.
Already, for every dollar the Japanese government collects in revenue, it spends 40 cents more. Total debt – government and private – is near the highest in the world: at about six times GDP.
Tokyo is running out of time… and money. So, the Bank of Japan finances the government. It buys 70% of the issuance of Japanese government bonds. Last week, it announced that it would buy 85%.
Japan is going to show us that you don’t have to be a Third World kleptocracy – such as Zimbabwe – to undertake extraordinary and disastrous policies.
QE Goes into Hyper-Drive
Thank you, Japan! Let us say a prayer for the Japanese and learn from your example!
Yes, just 48 hours after the end of QE in the US, the Bank of Japan announced the most absurdly audacious QE plan in history. It’s jacking up QE to $750 billion in asset purchases – both bonds and stocks – a year.
Adjusted to the size of the Japanese economy, that’s the equivalent of QE of about $3 trillion a year in the US. Anticipating a flood of new cash, stocks rose around the world.
Coincidence? Lucky timing for Yellen & Co.?
It is almost as though central bankers got together in advance and planned it that way. QE stops in the US; the Japanese put it into hyper-drive. Stocks rise in both countries. All is well.
The Nikkei 225, faithfully recording the hopes and dreams of Japanese investors, leapt 5% on the news. The Dow followed suit.
Foreign investors – no dopes – figured out that there was money to be made in a revival of the old Japanese “carry trade.” They can borrow in Japan – at some of the lowest interest rates ever recorded on the planet.
Then what to do with the money? Hey, why not carry it over to the only world economy still growing at a decent rate: the US?
Regards,
Bill
Is the “Wealth Effect” Real?
The Dow has been extremely volatile over the past four weeks. Hundred-point swings have become commonplace. And the big losses at the start of the month have been followed by a sharp “snap back” rally.
Source: StockCharts.com
You see, central banks have a theory. It’s called the “wealth effect.” And it’s through the “wealth effect” that QE is meant to heal the economy.
QE involves creating money – whether it be yen, dollars or euros. This gives central banks the power to lift financial markets. But so far, QE has been unable to shift economies.
Central bankers believe that when people see their stock market portfolios rise in value they’ll go out and spend that money as though it were extra income.
The problem is that people don’t behave as the theory explains.
That’s because when people look at their broker statements, and they see a big bump in the value of their portfolios, they ask themselves a very sensible question: Is this permanent or temporary?
If they see it as temporary – because it’s being pushed up by central banks and because stocks have been hugely volatile – people won’t see rising prices as new income. Instead, they’ll see it as “easy come, easy go” money. And they won’t go out and spend that new wealth.
Volatility – which measures how much stock prices swing up and down – also causes investors to be more cautious with their investments. That’s because, the more prices bounce around, the greater the chance that traders get stopped out of their positions.
QE contains the seed of its own destruction, in other words. Some QE helps lift markets and dampens volatility. But as QE goes into hyper-drive, as has happened in Japan, it brings with it higher volatility.
And the higher volatility goes, the less effect QE has on spending… and the less investors are willing to take risks in financial markets.
The move by the Bank of Japan misses this point entirely. More QE won’t mean higher consumer spending, as long as it means more portfolio volatility.
Pushing up stock prices is not a means to an end, as planned, but an end in itself.