Saturday, August 16, 2014

This Is The Worst Nightmare For the United States & The West

I've always said Americans should watch Japan's train wreck of an economy, because we are on the same trajectory as theirs--but with a few years' time lag.  And our Keynesian experiment of debt monetization will be more catastrophic because the US holds the global reserve currency.  Everybody will be dumping dollars once confidence in the bond and currency markets collapses.
We heard the “surprising” news last week that the Japanese economy shrank at an alarming 6.8 percent annualized rate in the three months through June, its biggest quarterly contraction since the 2011 earth quake and tsunami. This proves that Japan’s greatest national disaster, Abenomics, has failed and the Japanese economy has fallen victim to the scam called Keynesian economics -- the belief that a country can tax, spend, devalue, and inflate its way to prosperity....

Since the popping of the BOJ- induced bubble in 1989, Japan has been the most faithful adherent of Keynesian principles. At the onset of the crisis they immediately began on their misguided path with large doses of deficit spending. Instead of allowing the economy to rid itself of bad investments and heal, they continued to prop up failed business models -- creating zombie banks and an equally zombie-like economy.

As one lost decade turned into two, in the year 2000 they coupled their fruitless spending efforts with massive amounts of money printing.  And despite two decades of low growth, the nation stubbornly held on to the popular Keynesian excuse of “if only”: If only our stimulus was larger, if only we weakened our currency more, if only we kept interest rates lower for longer; economic Nirvana would be achieved.  Keynesians love to use this counterfactual argument because they believe it cannot be proven wrong -- that is, until now.

In 2012 Prime Minister Abe had a master plan to pull the world's third-biggest economy out of its stagnation. His plan was to deploy, in massive and unprecedented fashion, the strategies of central bank credit creation, currency destruction, and debt accumulation.  The Japanese doubled down on the great Keynesian experiment. As if Paul Krugman himself was running the economy, they placed the economy on Keynesian steroids.  Now we are beginning to see what an economy looks like when the Keynesian playbook is used to its fullest extent.

Household consumption plummeted at an annualized pace of 19.2 percent from the previous quarter, while private investment sank 9.7 percent. And because of the Japanese battle against deflation, real wages dropped 3.8 percent year on year in May. Those mismanaging the Japanese economy believe that consumption will surge if they can achieve a substantial increase in the CPI. The misguided logic is that Japanese consumers will spend only if they are running in perpetual fear of rising prices.

One of the cornerstones of Abenomics was destroying your currency with the hopes of boosting exports. Ironically, last week the central bank warned over a worsening export and factory output picture.  In fact, June showed the worst trade deficit ever in Japan, and a 57 percent rise in the trade deficit for the first half of the year.

And today with a near 250 percent debt-to-GDP ratio, it’s difficult to argue that Japan didn’t engage in enough deficit spending.  Over the past three years interest rates on the Japanese government bond 10-year note went from 1.5 percent to 0.52 percent.  Under its own brand of quantitative easing policy put in place last April, the Bank of Japan now buys 70 percent of all new government bonds issued in markets, as well as other more risky assets.  With the JGB market on virtual life support courtesy of the BOJ, it is impossible to argue that rates aren’t low enough or that the BOJ hasn’t monetized enough. They spent, they printed, they taxed; but the Japanese economy is out of gas, and the Keynesians who own this plan are now out of excuses.

The United States should heed Japan’s economic woes as a warning sign and a reason to change course while we still have a chance. With U.S. debt to GDP at 105 percent and household debt at more than 80 percent, the aggregate amount of our nation’s debt is at an all-time high. But unlike Japan we have the overwhelming privilege and responsibility of holding the world’s reserve currency.

Obliging other nations to trade and hold U.S. dollars is not written anywhere in the Bible. For the time being other nations decided to maintain a holding equal to 50 percent of our publicly traded Treasury debt. Losing their confidence in our credit and currency would be devastating to our economy. Japan has no such worries about keeping foreign investors happy because that country finances 90 percent of its debt internally.

We have become a country that over-consumes and under-produces. Debt levels have skyrocketed while our demographic and labor force participation conditions are quickly approaching critical mass.

We have to abandon these failed Keynesian policies while there is still time. We must boost our employment-to-population ratio, deregulate the economy, simplify the tax code, balance the budget by cutting expenses, end the Fed’s runaway printing press, and allow the free market to set interest rates and asset prices. Only by doing this do we stand a chance of not falling further into Japan’s stagflationary nightmare. But if we persist in following the Keynesian counterfactual, our fate will be worse than that of Japan, as the deluge of debt being dumped by our foreign creditors causes the dollar to be dethroned, interest rates to soar, and inflation to skyrocket.

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