Japan Warning: Don’t Step in a Bear Trap!

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July 31, 2016
Steak House Update: August 3, 2016
August 3, 2016

Imagine you see a friend step into a bear trap.  Wham!   The trap springs closed, he cries out in fear as his leg is painfully wedged in the teeth and jaws.  He screams a warning to you:Stay away! Don’t follow me! Avoid the trap!”

The U.S. is getting just this warning from Nobuchika Mori.   He’s telling us to how to avoid a financial bear trap.


Why You Should Care:  Well, once again, it’s important to stay informed.   This will help.


Taking Action:  Read away!


The BLOG:  Mr. Mori is a very important man in Japan.  Today, as commissioner of the powerful Financial Services Agency, Mr. Mori is the country’s top financial regulator.   In Japan, the FSA could be compared to a combination of the SEC, our national banking supervision, and the Comptroller of the Currency.

In the 1990s, Mr. Mori explains, “Japan experienced the collapse of real estate bubble … and was plagued with the ensuing non-performing loan problems. The crisis can be divided into two phases.

In the first phase of the crisis, real estate prices slumped, followed by the failure of such businesses as real estate and construction. Then in the second stage, the drop of asset prices turned into the deflation in the real economy. Under the deflationary environment, not only real estate-related industry but wider range of businesses including distributors and manufacturers saw drop in their earnings.”

Sound familiar?   Sure, the cause of the US Great Recession of 2008 was different, but we experienced a similar outcome.   First home prices fell…then all property prices.   Then the entire US economy deflated.   Ugly.

To fight the deflation, central banks of the top economies injected massive liquidity into their respective economies.   How did they do that?

Called quantitative easing (QE), each of these central banks ‘traded’ cash – which is 100% liquid – in exchange for securities – which are ‘held for investment.’  Central banks create ‘cash’ electronically.   With the press of a button, they used this newly created cash to purchase sovereign and quasi-government securities.  (Recently, the ECB has begun buying corporate securities.)

Their collective objective?   They were two-fold.  One, each country sought to prevent deflation within their borders.   Two, they sought to maintain the approximate foreign exchange/currency relationships that existed before the QE.   In most respects, both were accomplished.

But the changes to each country’s balance sheet is, well, a bit frightening.    Check out the central bank balance sheet increases in these countries, representing the many of the largest economies on the planet:

Central Banks

This is one image you’ll want to click on to enlarge.   Notice that right around 2008, the size of the balance sheet of every country increased anywhere from 2X to 4X.  Collectively, globally, trillions of dollars (and Euros, SF, Pounds, Yen, etc.) began to slosh around the world.

At any other time in history, this massive injection of liquidity would have triggered global inflation.  Not this time.  Why?

Experts suggest the liquidity injected between 2008 and today simply replaced that lost by the Great Recession.  Those same experts believe that without the new liquidity, the world would have suffered massive and persistent deflation.  We’ll never know because this is one bear trap we avoided.

We grabbed the proverbially bull by the horns, wrote off/down bad loans, fixed the banking and financial systems, passed and implemented the Dodd-Frank Wall Street Reform and Consumer Protection Act (signed into law in 2010), and as a result, since 2009 the US economy has been expanding.  Slowly, but expanding.    All is fixed.   All is good.   Or is it?

About 2,300 pages in length,

dodd

Yes, those are pretty big letters…which I felt were appropriate for a pretty big law of over 2,300 pages.

There is no doubt the Great Recession necessitated change and revised regulation.  But was Dodd-Frank the best choice?

In speeches and editorials since he took office, Mr. Mori has regularly cautioned his Western counterparts about over-regulation.   In a keynote address in Tokyo on June 6, entitled “Revitalization after the banking crisis,” Mr. More made these comments:

“Japan had long been plagued with deflation against the background of the decline of working-age population and the progress of aging. Such a phenomenon is not just an issue of Japan but also a common challenge for developed countries.

As a result of drawn-out deflation, interest rates remain low, yield curves are flattened, and earnings of commercial banks appear structurally repressed around the world.

It is an urgent issue in Japan to increase productivity of companies, especially of the service industry, given that a labor shortage is becoming conspicuous due to the decrease in the working-age population.

The Japanese industry structure is in the midst of shift from the manufacturing to the service industry. Such a change in industrial structure tends to give rise to income inequality, but if the middle-income class could be sustained through the improved productivity and consequential stable wage growth, that should also lead to social and political stability.

Amazingly, he could almost be talking about the United States.   Hmmm….

In a recent interview with the Wall Street Journal, Mr. Mori suggested, “Looking back from today’s vantage point, we wonder if we should have done things differently, paying more attention to economic growth.”   Interesting.

And he finished with this:   “The more we rely on regulation, the more such distortion and inefficiency become prominent,” Mr. Mori said.

Mr. Mori makes these observations after over 20 years experiencing the same challenges the US and other developed nations are facing today.

Perhaps we should listen carefully to Mr. Mori.   Very carefully.

  • Terry Liebman

1 Comment

  1. […] work energetically to reduce red-tape, embodying the thoughts and words of Mr. Mori, (review:  https://terryliebman.wordpress.com/2016/08/03/japan-warning-dont-step-in-a-bear-trap/) ushering in the potential for greater GDP growth.   Increased growth means an increase in […]