Rezepte fürs Land der deflationierenden Sonne, von Maudlin (Auszug)

verfasst von André, 28.09.2002, 20:36

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Knocking at Deflation's Door
Even the Pros have Trouble
Land of the Deflating Sun
Competitive Currency Devaluations
Dollar Devaluation Party
Absolute Returns

By John Mauldin

Today we are going to examine a war going on in the central banks of
the world. The central banks of the world continue to do what is
necessary to make their respective nation's products attractive to
the American consumer, doing the best they can to make their
currencies cheap. There are increasing calls for the US to let the
dollar fall as a weapon in the war against deflation. Both can't
happen at the same time. You don't want to let your investments get
caught in the crossfire. There will be casualties.

The investment climate and the rules associated with them have
changed. If you are still investing under the old investment rules,
you are having trouble.


To get an insight into the changes, let's first go to Japan. I will
need to quickly review the scene for new readers, but we will get to
the point shortly.

Land of the Deflating Sun

Japan is in a decades long recession/depression and is currently in
a deflationary spiral. Excess capacity means lower prices means less
profits means fewer jobs means less consumption which leads to lower
prices because of excess capacity and so on. It is a vicious
spiral. Japanese exports to the US fell again this month, and any
thoughts of a recovery are only in the dreams of politicians.

Japan is in a liquidity trap. That is a condition when interest
rates are as low as they can go, but since deflation is even lower,
the real cost of money is high. It leaves a central bank powerless,
as they cannot lower rates to stimulate spending.

It has been well known for some time that Japanese banks are
essentially bankrupt. Their bad loans far exceed their capital. In
my opinion, the principal reason for the Japanese economic crisis is
their refusal to force banks to deal with bad loans. They simply
would not force much of their elite to"take their medicine" and
thus the average Japanese citizen has been badly hurt.

I have stated many times that the Japanese central bank, along with
the government, is the only management team which could make Xerox
management look competent. They do a dance that Greg Weldon calls
"the Ostrich," as they continually stick their head in the sand to
avoid facing reality. Only now, reality is beginning to really get
scary.

At the recent Jackson Hole Federal Reserve conference where Alan
Greenspan gave the speech declaring the bubble was not his fault,
there was another academic paper presented. This one seriously
suggested a"fool-proof" method for the Japanese to escape from the
current deflationary liquidity trap in which it finds itself. It
called for setting price levels, depreciating the currency below any
conceivable equilibrium level, and then setting a fixed exchange
rate to guarantee the lower level. This should boost economic
activity and prices, and once things were moving along, the central
bank could abandon the price targets and once again target
inflation.

BCA Research tells us the representative from the Bank of Japan did
not endorse this, but admitted that extraordinary measures were
needed, such as the direct buying of real estate or stocks.

Let me translate the above economic language. The presenter
seriously suggested that Japan consciously destroy its currency and
its buying power, create enough inflation to insure a period of
sustained rising prices, and then induce a recession to control the
inflation. There are several important things to note from this.

First, this was presented in the context of a Federal Reserve
sponsored forum. It makes one wonder whether the Fed was sending yet
another message. Second, this was not some minor adjustment that was
suggested. It is major economic medicine, and if you are an average
Japanese citizen is not what you want to hear. If there was a
message, it was that Japan is in serious trouble and that only
drastic medicine can save it. Think chemotherapy. The patient may
live, but it is certainly anything but pleasant. Doctors, and
central banks, do not suggest such measures unless the patient is
otherwise terminal.

Japan is the world's second largest economy. It is the chief source
of deflation in the world, and the Fed is telling them they need to
do something before they drag the world down with them.

Then this week the Bank of Japan, after 10 years of sitting on its
hands, says it will start buying stocks directly from banks. Think
about that for a moment. If Greenspan were to announce the Fed was
going to buy stocks in order to shore up the economy, there would be
a huge outcry. It would be a mistake of the largest magnitude for
the Federal Reserve to buy stocks.

Let's look at what the Bank of Japan will likely do. Japanese banks
do not mark the stocks in their portfolios to market price. They are
kept on the books at the value at which they are bought. Since the
Japanese stock market is down 75% from its high (not counting actual
bankruptcies and mergers), many of the stocks in the portfolios of
banks are carried at losses. The banks have also many stocks they
have held for decades which are still showing a profit. But if they
started to do any serious selling, they would drive the stock market
down much further.

The banks desperately need cash to be able to write off bad loans. I
have seen serious estimates that banks will need at least four years
worth of earnings to be able to handle their bad loan portfolios.
But to go for four years showing no profits would depress and
further weaken an already devastated banking sector.

There is evidently no appetite in Japan for the government to do as
we did in the Savings and Loan crisis -- simply taking over banks,
letting the taxpayer foot the bill and selling the profitable
portions to solvent banks. That hurts shareholders, of course, but
it puts the banks in the hands of new management.

Japan will do what it must to make sure the elite save face and also
save their personal bank accounts. The Bank of Japan will do what it
can to save the current management and the large shareholders.

Here's what they will do. They will first buy stocks in which the
banks have a profit. This will allow the banks to sell stocks in
which they have a loss to the public. The profits and losses match,
showing no loss to the bank. They then have cash to write off bad
loans. This also has the"advantage" of injecting significant
liquidity into the economy. While not as direct as the Fed paper
suggestions, if aggressively applied, it will achieve the same
outcome.

It is not the correct thing to do. But Dennis Gartman cogently
argues that given the Japanese unwillingness to do the right thing,
it is better than nothing. From the standpoint of an American (or
for that matter, anyone but a Japanese citizen), and given my stake
in seeing the world economy avoid a deflationary implosion because
of Japanese intransigence, I would have to reluctantly agree.
However, it is indefensible to allow those responsible for the
problems to not only escape responsibility, but to profit from them.
If I were a Japanese voter, I would be in the streets, manning the
barricades. I guess that's just the 60's Flower Child coming out in
me.

However, this is not the troubling aspect of the issue. I am firmly
persuaded the Japanese care not one whit what the Federal Reserve or
any other government or central bank thinks. The"solution" proposed
by Fed academic clearly shows the serious level of concern at the
highest levels of our government. This concern is shared in many
quarters, both liberal and conservative, and in many countries.

That the Japanese are actually planning to do something shows that
the concern is not misplaced. If they have come to the point where
things are getting so bad they will be forced to do something, then
it is serious.

One last important point, which we will re-visit later, is that the
means suggested by the Fed and evidently agreed with by the Bank of
Japan is that to combat a deflationary spiral you need to devalue
you currency. Factor in that the Prime Minister of Japan also wants
to see the currency drop against the dollar, as do the major
exporting businesses, and it seems clear the direction of the yen is
headed down. Then why has the yen gotten stronger of late? We will
come back to this question, as it holds one of the keys to the new
investment rules.

Competitive Currency Devaluations

Stephen Roach of Morgan Stanley points out that the US consumer was
responsible for 64% of the growth in the world's economy from 1995-
2001, roughly twice what our share of world output was during the
same period. The world economy is dependent upon the US consumer. As
the US economy has slowed down, the world is slowing even more.

The problem is that there is no other engine for growth. I have
chronicled Japan's crisis. Germany, the third largest economy, is on
the brink of a recession and is close to deflation. Europe may slip
into recession before we do. South America is in shambles. China and
India are working hard to stimulate a consumer economy, but both are
years away from being a major force for growth in the world economy

Like a drug addict who needs his fix, it seems most countries want
to keep the value of their currencies low so they can continue to
sell products to the American consumer. Rather than going cold
turkey and trying to boost their own consumption and letting their
currencies rise, they keep returning to the"fix" of devaluation --
anything to keep the American consumer spending dollars.

During the 90's, the entire world, and especially Asia, spent huge
amounts on factories to build products for America. There is now too
much production capacity for current demand. The businesses of each
country hope to keep their factories producing, and sell their
products at ever cheaper prices. But rather than lower their prices
in terms of their local currency, they urge their governments to
lower the price of the currency. That way they can continue to pay
their workers in a depreciated currency, passing their problems to
the employees. Of course, the local currency buys less on the world
markets, but the factories are busy. This is a"last man standing"
business plan, and has its own set of problems, which are not the
concern of this letter today.

The point is, as one country after another, especially in Asia, lets
their currency drop, other countries feel forced to lower the value
of their currency to stay competitive. This is of course price
deflationary in terms of the US economy. It also means our competing
companies cannot raise prices, and hurts profits.

The US is now at a trade deficit of 5%. At our current"progress,"
the world will soon be lending us $2 billion per day to finance our
spending. There has never been a currency that did not drop when
trade deficit levels have risen to the heights that the US trade
deficit is currently approaching. But the dollar, after dropping
for the first part of the year, is now down only 3% against a basket
of world currencies. This is hardly the stuff of a serious currency
correction.

Knock, Knock, Knocking at Deflation's Door

And now we come to the heart of the matter. I have been writing and
warning about deflation for four years. There weren't many of us in
1998. Now it is standard fare.

I have maintained in this column that while I think we will
experience deflation, the most likely scenario is that it will be
mild. The Fed has clearly let the world know they will expand the
money supply as much as necessary to keep deflation from becoming
serious. The dollar (because of the huge trade deficit) should drop
in concert with this policy, thus letting us avoid the worst aspects
of deflation.

The important word in that last sentence is"should." There are some
reasons to be concerned that this might not be the case.

Martin Barnes of BCA Research is one of the most highly respected
economists in the world. He is read everywhere. He is not noted for
overstatement or hyperbole, as he is aware of how serious his words
are taken. Thus it is with some disquiet I read his recent letter.

He makes the argument that deflation is now at our door, and he
expects that we will see mild deflation soon. His argument is that
because growth in the US is so low, and because inflation is already
so low, that deflation is inevitable, barring a growth recovery not
currently on the horizons.

Let me quote:"The Fed will not back away from an easy monetary
stance for the foreseeable future. This argues against a major sell-
off in bonds, and warns that the dollar is vulnerable on the
downside. With regard to the latter, the saving grace is that the
rest of the world is also on shaky economic ground and the dollar is
still regarded as a safe haven. However, if the U.S. edges closer to
a liquidity trap, the authorities will not hesitate to push the
dollar lower."

He makes a second point,"While the mixture of deflation and high
debt levels poses a threat for the U.S., disaster will be avoided if
the real estate market does not suffer a meltdown."

Part of his prescription is for the"authorities" to allow, or
encourage, the dollar to drop. This is echoed by Stephen Roach and
numerous other thoughtful economists.

Dollar Devaluation Party

OK, let's review. We are getting ready to enter a period of outright
deflation. The Federal Reserve recently published a paper outlining
what policies could be enacted to prevent serious deflation.
Basically it involves allowing the dollar to drop, more fiscal
stimulus in the form of budget deficits and tax cuts and expanding
the money supply. If this seems like a prescription for inflation,
that is because it is.

As I have argued in the past, the Fed has made it plain they intend
to keep us out of serious deflation. The logic seems to be that it
is better to have the devil of inflation with which we (the Fed)
know how to deal, than a devil we can't do anything about. It seems
to be a choice between the stagflation of the 70's or the
deflationary depression of the 30's.

Now, of course, the Fed and other leaders think they can induce only
mild inflation and engineer a new growth economy. I sincerely wish
them all the best. I like a growing economy.

But what if they throw a dollar devaluation party and no one comes?

Let me explain it this way: if every consumer in America decided it
was in his best interest to start saving an extra 5%, the US economy
would tilt into recession quite quickly. What would be a good policy
for each individual would have negative collective consequences for
the economy.

The same applies on an international level. If the drug addicts of
the world do not stop the competitive devaluation of their
currencies in an effort to keep the American consumer buying their
products, then it will be difficult for the"authorities" to lower
the value of the US dollar in the fight against deflation.

It will take away one of the major deflation fighting tools in the
hand of the Fed, just at the time when it will be most needed.

The problem is that everyone cannot lower their currency at the same
time. This means that if deflation becomes an issue, it may be
"necessary" for more aggressive easing and monetary expansion in
order to stem the deflationary tide. This will create more
imbalances that will have to be worked through. Ultimately,
aggressive monetary expansion will mean inflation that will not be
mild.

Now, before you start heading for the storm shelter, let me point
out that none of this is going to happen in the next quarter or
probably even begin next year. These things take time to work out.
It is quite possible we will continue to Muddle Through for quite
some time.

But some of the Fed governors are clearly concerned, or we would not
be seeing two governors not vote with Greenspan. The recent economic
papers coming from the Fed tells us there is concern about
deflation.

The bond market is telling us deflation is coming. Slow growth and a
dollar that stays too high in a low inflation environment tell us
deflation is coming. Richard Russell stated it well recently when he
said his head told him bonds are too high, but his pocketbook made
him buy some more municipal bonds.

It is tough to want to buy bonds when every historical indicator is
saying they are way overbought. Gartman makes the analogy that when
the temperature approaches absolute zero, the laws of physics
change. As we approach the absolute zero of outright deflation, the
normal historical relationships in the investment world are changing
as well. If you are using investment models based upon an
inflationary world, you are not going to succeed.

What does this mean in the near future? The Fed is going to cut
rates again and again. It will not be to stimulate the economy.
Cutting rates for that purpose is pointless at the low levels we see
today. The Fed will be looking to combat deflation and help lower
the dollar. They should have cut at this week's meeting. They will
at the next post-election meeting.

If mortgage rates were to go back up, the US housing market would be
seriously hurt, and that is the one thing with which the world
cannot cope. Fortunately, it appears likely that mortgage rates are
going lower. I rashly predicted a 5% 30-year mortgage in 1998. Now
it does not look so rash. It may happen by next spring. If someone
is willing to lend me money for 30 years at 5%, I shall oblige them
to the fullest extent possible.

Deflation also means that corporations will have no pricing power,
and thus earnings are not going to rebound at anywhere near the rate
analysts predict. That means more stock market upheaval; more bear
market rallies and more ultimate disappointment.

But we will get tax cuts, deficits, lower rates and easy money. All
this stimulus means we will likely continue to Muddle Through for
the year, albeit at a slow pace. Will it eventually catch up with
us? Will we have a Year of Reckoning? In the long run, of course we
will. But it could be a very long run. And let me remind you that
the world does not come to an end in recessions or even with
deflation. The vast majority of us will still have jobs and business
will go on as usual. Europe seems to be stumbling along with 9%
unemployment and no one is in a bread line.

Absolute Returns

I am not expecting a repeat of the 30's. I do expect that assets
will be re-valued, and that we will have to adjust. That is why
absolute return investment strategies are so important.


John Mauldin
John@2000wave.com

Copyright 2002 John Mauldin. All Rights Reserved

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gesamter Thread:

• Rezepte fürs Land der deflationierenden Sonne, von Maudlin (Auszug) - André, 28.09.2002, 20:36
  • Re: Danke André und Frage? - R.Deutsch, 29.09.2002, 08:37