Re: Summa Contra Curmudgeons

["Charles Jannuzi" <jannuzi@xxxxxxxxxxxxxxxxxxxxxxxxx>]

RE: Andrew Smithers: American anxiety is bubbling under
07 April 2002

There is a pretty good article--as far as investment analyst pieces go--on
Japan at the Smithers site, too. The American piece summarizes something
that was posted either on this list or LBO-T a little while back.


Next to comment about one bit of the article:

>>The case against allowing asset bubbles is that there can be no
satisfactory resolution to their demise. Once assets get out of line with
incomes, the return to normality needs either a large fall in nominal asset
prices or a large rise in nominal incomes. The former gives rise to
bankruptcies and risks setting off a liquidity trap. The latter can only
occur if inflation reaches heights that central bankers are dedicated to
avoiding.<<

About that last point, it would seem central bankers are not so dedicated to
avoiding asset inflation that causes it all in the first place.

In Japan, as consumer prices have gone down, purchasing power of those still
employed has gone up. Still, with interest rates and investment returns flat
or negative as asset values depreciate, I can't say incomes (including
capital gains) have gone up. I think GDP at PPP values of currencies reveals
an economy more like about 35-40% the size of the US's, not the 1/2 you
might expect of 127 million people. Certainly not the threat to western
capitalism and civilization the Republicans and Democrats strategized about
for the past 15 years.

I think the term 'liquidity trap' is a bit misleading, especially for a
country like the US. If the last decade of Japanese economic history is any
indication of what happens after a bubble is burst, deflation is the better
term.

Deflation makes business plans come a cropper on profits, and it makes built
up debt all but impossible to pay off (due to lack of profits but also the
loans becoming more expensive). The government provides lots of liquidity
but if you use increasingly expensive loans to refinance loans you couldn't
pay in the first place you are just getting yourself closer to the reckoning
where you can not pay.

Factors for deflation hitting the US:

high productivity (or so they say, though the US seems obsessed with 'labor
productivity')

overproduction, or an ability to import it

an ability to import cheaply, both in commodities and manufactured items

a strong dollar (though the dollar is undervalued against the yen)

As for the Americans consoling themselves that this appears to be a short
and mild recession--over almost before its existence was confirmed-- this is
where it's best to remember that economists and analysts paid to pump up the
market are not impartial nor are they historians.

What happened in Japan is the yen continued to gain value against the dollar
while the stock market CRASHED.

Government deficit spending plans (already in the works before anyone had
said recession--the results of the US-Japan 'structural impediment' talks )
kicked in and the economy limped along, matching the US in GDP growth for
almost a decade. Given the more long term view that most Japanese companies
do have, it seemed everyone was biding time, thinking they've seen cycles
like this before. A lot of companies did some very radical things about 5
years into the slump, but since profits didn't return, the typical western
analyst took this to mean they hadn't really done anything at all.

However, a lot made this cycle turn into flatliners:

--an overvalued yen (which could be called a strategically overvalued yen,
since this is what the US and the EU wanted) which made exports unprofitable
if not altogether impossible against competition from China, S. Korea and
Taiwan

--an Asian financial crisis in 1997 that messed up Japanese companies'
investment in infrastructure (i.e. relocation of manufacturing to E. and SE
Asia) as it messed up Japanese financial investments and loans in the region

--an inability to find the next big thing to dominate and make profits from
(caused, foe example, by trade protection in the 1980s that kept the
Japanese out of processor chips and OSes for desktop and notebook computers)

--increased competition in the domestic market in Japan. This is subjective
but it would seem that companies like Toyota and Sony got more serious about
taking over the already competitive and less profitable markets in Japan
when they saw their profits overseas dry up.

Moreover, Chinese goods became very popular, in clothing, but even in
consumer electronics, and these were marketed by companies quite willing to
by-pass the traditional distribution system. The increased competition in
retail even added to the deflation, since retailers cut prices to try and
win customers.

To conclude, the stock markets stayed mostly down, property values continued
to go down, banking and retail underwent considerable deregulation and
restructuring, interest rates and other investment returns were flat or even
negative, and the cleaning up of loans also seemed to go with a lot of
declared bankruptcies.

If the stock market crashes and property owners see their values go down,
I'd say something quite similar is possible for the US, but the US economy
would seem to be less vulnerable to shocks than Japan's. It has more power
over international finance, it has a resource-rich hinterland, and it has an
adjacent trading bloc. However, if the stock markets crash--money goes out
of the Dow and key companies on the NASDAQ--and if the US finds that
financing its twin-deficit empire just got much dearer, then...well, we
won't be seeing Dow 36,000 in my lifetime. And you won't be talking V-shape
or double bottom bounce but flatliners.

This is why US capital, the capital that goes with wielding power, is
looking for a breakout and working the political brinksmanship for the
bottom line like never before.

Charles Jannuzi