Last August, it was reported that deflation in Japan had reached a new record. Prices were dropping at the fastest pace 38 years. By November, it was duration, rather than depth, that got the press’s attention. Prices had been going down for 10 months in a row. Then, last week an update:
“Japan Deflation Hits a Record Pace,” reported the BBC. Prices in Japan were falling faster than they ever had since they began keeping track in 1970. The tide has gone out so far; beachcombers can’t remember when there was so much beach to comb. But what follows is not offered as a prediction, but only out of curiosity. We don’t know how this will turn out. Could it end in hyperinflation? Maybe.
Prices fall in Japan. The yen rises. And the government uses every trick in the book – and some as yet unpublished – to knock it down. If you are in a position to borrow money from the central bank, the bankers will give it to you at practically zero interest. And if your neighborhood wants a bridge or a community center, that too will be forthcoming from the Japanese government. No government has ever been so generous. At least, not without going broke. For every yen the government squeezes from its taxpayers, it returns more than 2 yen in public spending.
Investors must think the trend is eternal. Or perhaps they don’t think at all. They lend money to the world’s most spendthrift major government for 10 years in exchange for a yield of only 1.310%.
The drama of this story is an old and familiar one. Deeply flawed heroes at the world’s central banks and treasury departments think they can do a better job of guiding the economy than the markets themselves. It is they who set the price for short-term money, for example, not willing borrowers and lenders. They are the ones who fight the correction every inch of the way. They are also the ones you don’t want to stand behind; every shot they take backfires.
In France, the savings rate, as percentage of revenue, has gone up for the last 16 months, to 17% – the highest rate in 27 years. This comes as the Sarkozy government follows the lead of the US and Japan, with a deficit of about 8%…compared to 10% in the US and even higher in Japan. This is not the first time this has happened in France. The previous savings rate peak came when the Mitterrand government was trying to stimulate the economy out of the slump of the early ’80s. The more the government tries to stimulate spending by running deficits, the more people try to protect themselves by saving.
While the drama continues throughout the world, the story is most advanced in Japan. Which is to say, the central bankers have gotten themselves into deeper trouble. Martin Wolf of The Financial Times and Richard Koo of Nomura Securities applaud their performance. But by trying to suppress a correction in the private sector, Japan’s central bankers have stretched out a slump over two decades and set up the nation for a bigger crisis in the public sector. And there is nothing they can do about it. Their fiscal stimulus no longer stimulates. Their monetary inflation no longer inflates. And every quack cure they offer brings the patient closer to the grave. You might think they’d give up. Instead, they increase the dosage. Fiscal stimulus hits a new record, right along with deflation.
But it’s the final act that interests us. With public debt at nearly 200% of GDP and 700% of tax revenues, we shouldn’t have to wait much longer. Given the track record, we have to assume that it will be the exact opposite of what central bankers expect. They are aiming for the whimper of newborn growth. More likely, they will get the bang of hyperinflation.
The Japanese were recently among the champion savers of the world. Directly or indirectly, these savings financed the government’s stimulus efforts. Banks, pension plans, insurance companies – all bought government bonds as a safe way to store wealth. The government then drew upon this stored up wealth to finance its bridges to nowhere and its other boondoggles. The result is a misunderstanding on its way to becoming a disaster. The typical Japanese person looks forward to his retirement with a mountain of savings in his backyard. He believes he still has his cake. The government, however, has eaten it.
Higher savings rates typically produce lower prices, for a while. Currencies rise. Even in Weimar Germany, there was a period in 1920 when the mark rose. Falling prices would seem to be proof that the money is still there. But the real money is gone. Then, suddenly, people notice that their savings are nothing but paper. The tide turns. Confidence disappears. The big wave of accumulated savings hits the marketplace like a tsunami. Desperate people try to get rid of paper. They want something solid to hold onto. Long-term bonds, the most vulnerable to inflation, are exchanged for cash. Cash and government securities flood the market. Prices soar. Middle-class savers drown. Meek debtors, relieved of their burdens in the flood, inherit the world. So do the arrogant debtors in the government. And the shrewd speculators. And then central bankers return to their desks and come up with a new plan.
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