Japan Will Drag The US Down

Excerpts from the UK Telegraph:

Global bear rally will deflate as Japan leads world in sovereign bond crisis

Milton Keynes will be vindicated. Lord Keynes will lose some of his new-found gloss. The Krugman doctrine that we should all spend our way back to health by pushing deficits to the brink of a debt spiral – or beyond the brink – will be seen as dangerous.

By Ambrose Evans-Pritchard, International Business Editor
Published: 6:15AM GMT 04 Jan 2010

The contraction of M3 money in the US and Europe over the last six months will slowly puncture economic recovery as 2010 unfolds, with the time-honoured lag of a year or so. Ben Bernanke will be caught off guard, just as he was in mid-2008 when the Fed drove straight through a red warning light with talk of imminent rate rises – the final error that triggered the implosion of Lehman, AIG, and the Western banking system.

As the great bear rally of 2009 runs into the greater Chinese Wall of excess global capacity, it will become clear that we are in the grip of a 21st Century Depression – more akin to Japan's Lost Decade than the 1840s or 1930s, but nothing like the normal cycles of the post-War era. The surplus regions (China, Japan, Germania, Gulf ) have not increased demand enough to compensate for belt-tightening in the deficit bloc (Anglo-sphere, Club Med, East Europe), and fiscal adrenalin is already fading in Europe. The vast East-West imbalances that caused the credit crisis are no better a year later, and perhaps worse. Household debt as a share of GDP sits near record levels in two-fifths of the world economy. Our long purge has barely begun. That is the elephant in the global tent.

We will be reminded too that the West's fiscal blitz – while vital to halt a self-feeding crash last year – has merely shifted the debt burden onto sovereign shoulders, where it may do more harm in the end if handled with the sort of insouciance now on display in Britain.

Yields on AAA German, French, US, and Canadian bonds will slither back down for a while in a fresh deflation scare. Exit strategies will go back into the deep freeze. Far from ending QE, the Fed will step up bond purchases. Bernanke will get religion again and ram down 10-year Treasury yields, quietly targeting 2.5pc. The funds will try to play the liquidity game yet again, piling into crude, gold, and Russian equities, but this time returns will be meagre. They will learn to respect secular deflation.

Weak sovereigns will buckle. The shocker will be Japan, our Weimar-in-waiting. This is the year when Tokyo finds it can no longer borrow at 1pc from a captive bond market, and when it must foot the bill for all those fiscal packages that seemed such a good idea at the time. Every auction of JGBs will be a news event as the public debt punches above 225pc of GDP. Finance Minister Hirohisa Fujii will become as familiar as a rock star.

Once the dam breaks, debt service costs will tear the budget to pieces. The Bank of Japan will pull the emergency lever on QE. The country will flip from deflation to incipient hyperinflation. The yen will fall out of bed, outdoing China's yuan in the beggar-thy-neighbour race to the bottom. By then China too will be in a quandary. Wild credit growth can mask the weakness of its mercantilist export model for a while, but only at the price of an asset bubble. Beijing must hit the brakes this year, or store up serious trouble. It will make as big a hash of this as Western central banks did in 2007-2008.

The dollar rally will gather pace. America's economy – though sick – will shine within the even sicker OECD club. The British will need the shock of a gilts crisis to shatter their complacency. In time, the Dunkirk spirit will rise again. Mervyn King's pre-emptive QE and timely devaluation will bear fruit this year, sparing us the worst.

By mid to late 2010, we will have lanced the biggest boils of the global system. Only then, amid fear and investor revulsion, will we touch bottom. That will be the buying opportunity of our lives.

Comments:

While I agree with Ambrose Pritchard-Evans that Japan is likely to go down before the US, I do not agree with his conclusion.


The problem with Japan is its massive public debt.  At a projected 225% of GDP it is almost three times higher than the debt of France just before the French revolution.
Like a large corporation, insolvency does not rear its head until long after true insolvency occurs.  The larger the entity, the longer the lag time between actual insolvency and public bankruptcy.


Compounding the problem is the horrible demographics of Japan, a nearly childless, rapidly aging society where there will soon be only 2 workers to support every retired person. 

Further exacerbating the issue is the false premise of Keynesian thinking.
The idea that printing additional currency will "soften" the blow of a recession is madness.  Pushing down interest rates to zero to "revive" the economy is crazy.
After 20 years of little or no growth in Japan, no lesson has been learned.  In fact, the US is now following the Japanese example of zombifying banks and pursuing ZIRP and QE.
While Japan has massive deflationary forces to overcome before severe inflation arrives, we are confident they will eventually succeed.
Then the US  and some other fiat currency nations will follow their lead.
The last time a developed country followed this path we saw the dark forces of National Socialism rise up in the 1930s.
Let's pray our leaders become wiser soon, because they are following the path of John Maynard Keynes, who by current indications seems to be the Economic Antichrist.



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