Can Japan join the easy money world without triggering a trade war? So far Japan has convinced the world it is not pursuing "beggar-my-neighbor" devaluations. As Japan does not operate a reserve currency like the US it has to win foreign support.
Predicting the outcome of "Abenomics" is hard. Japan thus far got other industrial countries to back its programs at the recent Washington D.C. Group of 20 meeting. Japan avoided causing upset by not doing anything unexpected.
Japan first surprised the world after the Meiji Restoration when its leaders copied western railroads, roads, and department stores, and inaugurated land reform. In the late 19th century Japan modernized its education system, importing teachers, sending smart local students to study abroad. The government took the lead in allocating resources and the public sector created shipyards and factories, often sold off for a pittance to the forerunners of the later conglomerates or keiretsu, ancestors of the Mitsubishi-Mitsui-Sumitomo-Dai Ichi Kangyo-Sanwa which still dominate the Japanese economy.
Japan's modernization was agressive. Its defeat of Russia in 1904 War fed military expansionism, culiminating in the Pearl Harbor atttack against the US and the outbreak of World War II.
Its economic "miracle" during the Occupation and the Korean War turned Japan away from military spending, while its labor costs were still well below US. Japan's agriculture and industry were protected from foreign competition by tariffs, habit, different standards, and a low yen.
This let to an aggressive US exchange rate move in 1971 intended to hurt Japan. Richard Nixon took the US off the gold standard hoping to cheapen US exports to increase American jobs at the expense of its trading partners. It didn't work against Japan.
The Japanese rolled up their sleeves to defeat Nixon's currency ploy. Companies cut costs sharply to maintain exports. Workers in its consensus culture, guaranteed lifetime employment, cooperated with management for Japan's sake and didn't press for wage rises. Japan developed innovative products like the Walkman and electronic goods, optical equipment and cameras, the world's most reliable autos, robotics, and even toys the rest of the world couldn't resist.
The result was that the yen moved up against the dollar. With that nominal GDP per capita swung to a level roughly comparable to the USA. Credit was easy. An asset bubble began in real estate and hit shares. At one point a small area near the Royal Palace in Tokyo was worth more than the State of California. Speculation was rife.
Then came the inevitable bust. For the last 20 years Japan has been stuck in an economic funk. Japan never recovered from the burst bubble despite taking prescribed economic measures in the subsequent two decades: high government deficit-financed spending, quantitative easing, fiscal stimulus, monetization of the debt, all central bank tricks being tried now by the US and being preached also at other countries.
American policy-makers from Ben Bernanke down argue that Japan pulled back too soon. They didn't drop yen bills from a helicopter. Recall that in 1991 when the Japanese bubble bust, nobody really knew how to deal with a collapsed bubble.
Japanese easing caused misallocation of private investment and government spending. Low interest rates led to excessive debt fed by high domestic savings rates. Japan, unlike the US, doesn't borrow from foreign banks or foreign countries. So Japan escaped market discipline over its bad funding habits. It also avoided any need for writing off dud debts. Too many factories with a low rate of investment return were financed by generous bankers to related companies while fewt start-ups and small companies got funding (excep Softbank.) Innovation fell.
Complacent taxpayers let the government build dozens of bridges to nowhere. Facing low domestic demand, Japan depended increasingly on exports. Japanese savers, older conservative people, accepted low returns out of home bias. The celebrated yield seeking Mrs. Watanabe, the housewife managing her family's finances, was hopping from Brazilian to Polish to Turkish bonds. But most of Japanese debt was held inside Japan. .
Today Japan is trying more vigorous fiscal stimulus. Post-tsunami levels of public spending will be kept in place for the next 5 years, at Yen 5.3 trillion/yr. Normally, Japan would have moved to tightening by now. PM Minister Shinzo Abe set a specific 2% inflation target to be reached, as in the US, by open-ended asset purchases. It may be reached by 2014. He aims to raise Japan's debt to 200% of GDP.
Even harder will be the fiscal reconstruction target, halving the budget deficit level from 2010 levels by 2015 and reach a surplus by 2020. Frankly, it cannot be done unless fiscal stimulus plans produce exceptional growth.
Abe's Third Arrow is trade deals like the Trans-Pacific talks announced by Pres. Obama. Abenomics mixes deficit spending with structural reforms: weakening cartels, allowing imports of foreign rice. This may smooth relations with foreign countries, but will be hard to implement.
PM Abe wants Japan to take the lead in developing energy to cut global warming and greenhouse gases, including nuclear (despite Fukushima), wind, geothermal. Abe called for a restart of the Japanese nuclear electricity production in his campaign platform. A national day-care system will be set up so more women can work. Female labor participation rates in Japan are among the lowest for developed countries.
The main economic program means Japanese are being led to spend their money now before it is worth less because of inflation and more expensive imports, boosting consumption. Yields on both short and long term yen deposits are miniscule, controlled by the Bank of Japan to encourage spending. Low yields further weaken the yen which is approaching the 1 US cent level from before the global financial crisis, the standard back in the 1990s. A falling currency helps exports because foreigners can buy more Japanese goods for the same dollar or euro.
Corporations will invest more too if they are convinced growth is on its way and also boost hiring. Now large companies are offering preventive salary increases to their staffers to cover the eventual 2% inflation in advance. As always, smaller and medium-sized enterprises cannot follow.
Export growth feeds corporate profits so Tokyo's stock market is soaring with other assets. So maybe households will be quicker to spend money and Mrs. Watanabe will go shopping.
So far, Abenomics has been successfully presented as like US fiscal policy, undertaken for the good not only of Japan, but for the world. No hostile Nixon-style reaction yet. A yen devaluation is backed by the US which wants Euroland and Latin American central bankers to also adopt US-style quantitative easing and fiscal spending. If enough countries join the dance, there will be no currency war or inflation contagion.
More on Japanese and Asia risks for paid subscribers follows, along with results from The Netherlands and Singapore, and news from Argentina, Canada, Ireland, Brazil, Britain. Cheer up. Monday's blog will be short as I am attending the Europlace events at the NYSE.
Watch That Underscore
Watch out for the underscore. Shortly after Monday's Boston Marathon bombing, a new Twitter account appeared, @_bostonmarathon, which sought funds for victims of the atrocity. The real site for collecting funds is almost the same, @bostonmarathon/ writes the Neue Zuercher Zeitung. Cyber criminals jumped into action almost immediately after the bomb attack, according to Michael Molsner of the Kaspersky Internet Security (of Woburn MA). After signing up on the underscore site you get e-mails with links to YouTube videos. But visitors logging on to the site and staying about a minute wind up with a trojan on their computer, which sends data to servers in The Ukraine, Argentina, and Taiwan. The trojan is PSW.Win32.Tepfer
At underscore Boston Marathon is only one of the 125 domains registered since Monday, among them: 2013bostonbombing.com, 2013bostonbombs.com, and bostonattack.com. The sites are trying to collect money from web surfers who give credit card information to make donations. Don't. These fake sites usually are taken down in a few days, but not before collecting some dough.
Beware also facebook or social network links to a Boston Marathon charity. Once a person's email has been hacked, his or her whole phonebook is easily captured by facebook which is set up to force you to "friend" anyone you ever exchanged emails with.
To protect yourself, to avoid shortened Internet addresses showing up on sites like twitter. Write "Long URL please" before you give in to your charitable impulse. Don't click on shortened addresses to websites in emails even if you know the sender. That is how viruses are spread. (On the interest, you can force revelation of the long URL and you almost instantly see the hidden international address from which the email came.)
Google and search engines are not safe either because their algorithems place sites higher based on the number of clicks achieved. Networked bad guys can generate a lot of clicks and move up in rank. Ranking by clicks means sites visited by recipients of faked emails from friends rise in the ranking.
The next step is often "scareware". When you realize you have been hacked, you are then victimized by free offers to clean up the malware from your system. The least harm is to then charge you for removing an infection you do not have. Real pirates go further, and install a trojan while doing the free search. (Note: Kapsersky also offers a free scan but it may be safe. I have no idea.)
The first Palestinian marathon is planned for April 21 whose destination is Bethlehem. West Bank athletes will compete but Israel is not letting Gazans including former Olympic racer Nadar Al-Masri cross its territory to reach the site. The Palestinian Olympic Committee has asked Jerusalem to reconsider the ban.
More for paid subscribers from Finland, Canada, Brazil, Greece, Switzerland, Britain, and Singapore including a stock sale.
Service notice: Tomorrow's blog will be short because I am invited to the Europlace Financial Forum at the NYSE, a lousy venue for events because of security. But you can't talk the French out of holding events at the Bourse. I leave next Weds. night for Spain and Portugal where I will be doing field work on the soft underbelly of Europe and attending an Oxford Reunion in Madrid. I then will hit London for a conference.
This Time Is Different
The K-Street consensus against deficit spending arose to deal with emerging market crises, adopted by the experts of the World Bank and the International Monetary Fund (IMF). The consensus was that when deficit spending continued following a financial crisis, it would inevitably hurt the countries doing it. The K-Streeters said debt causes recession and imposed austerity with abandon on Asian countries in during the "Asian contagion" when a Cuban-born American economist named Carmen Reinhart and Kenneth Rogoff were on its staff.
K-Street was why nasty medicine, drastic cuts in government spending, was forced on developing countries by the IMF in recent crises. Deficit spending, above all by the US, was adopted by developed countries in the wake of the global financial crisis (GFC) in 2008-9. Then Keynesian critics of the K-Street view of the world pointed out that policy makers could change their spots depending on whether their home country or some bedraggled outpost of empire was the deficit-spender.
In fact, during the GFC, the cost of sovereign debt has been extremely low because the government turns out to be the only borrower, with corporations and households gun-shy about debt.
But no one questioned the theory that there is an inevitable link between soaring deficits and slow growth. In fact, the K-Street consensus made a comeback, thanks to a treatise against state debt written by Reinhard and Rogoff, now both Harvard professors, late in 2009 during the height of the GFC, "This Time Is Different: Eight Centuries of Financial Folly" (TTID).
TTID wrote that history proved that a country's government debt once over 90% of gross output (Gross Domestic Product or GDP) would eliminate growth and lead to an actual decline of output in subsequent years. The outcome was the same whether the deficit-spending country was developed or developing. This was called a "debt trap."
The RR argument covering industrialized countries had an impact on current economic policy. TTID also led to slow or reluctant deficit spending in Britain and western Europe in the wake of the GFC. The IMF actually published studies based on the R&R thesis last year.
"This Time Is Different", the most dangerous words in the English language, became a shibboleth of opponents of quantitative easing and increased government debt. The term is ironic reflecting the R&R Harvard prof authors' conclusion that the current crisis is not different at all.
Now the K-Street apologists have been attacked not by Keynesian activists supporting central bank activism, but by close examination of the statistics the Harvard profs used to justify their conclusions. The negative impact of deficits turns out to be based on bad statistics according to a group of researchers at the very non-Ivy League University of Massachusetts at Amherst. In fact, 90% deficit countries achieved an average 2.2% positive growth rate, according to the UMass re-examination.
The Reinhard-Rogoff numbers were fiddled with "selective exclusions" and "unconventional weighting" as well as plain coding errors. As a result, the Harvard economists produced "serious errors that inaccurately represent the relationship between public debt and GDP growth."
"The average real GDP growth rate for countries carrying a public debt-to-GDP raio of over 90% is actually [plus] 2.2%, not [minus] -0.1%," wrote Thomas Herndon, Michael Ash, and Robert Pollin.
The real reason to worry about activist deficit spending and quantitative easing is that when they come to an end (as they must eventually), the impact on economies and markets can be severe. That is all the more reason not to hold back for fear of deficits when they are necessary.
Typically mining stocks rose before metal price did in previous gold price recoveries. This Time Is Different, because there are now so many owners of gold exchange-traded funds, not available when gold last fell sharply from its 1979 peak. Some ETFs are bought on margin and have to be sold. ETF sales feed directly into the price of bullion rather than to gold mining share prices.
Central bank bullion buying may help gold this time if CB's decide to reconstitute their suddenly lower gold reserves while gold is cheap and borrowing costs low. The last time gold plummeted interest rates were prohibitive as Fed chief Paul Volcker was squeezing inflation out of the system with high cost money.
More for paid subscribers from Panama, Hong Kong, Britain, Israel, Canada, Ireland, Mongolia, Myanmar, Belgium
The Boston Marathon has been held on Patriots Day, the 3rd Monday of April, since 1897. The event, the oldest and most prestigious US race, starts in Hopkinton west of the city and runs through Newton where my son and his family live and yesterday cheered on the runners. It ends at Boston’s Copley Square and attracts some half-million spectators and about 20,000 racers every year. Two bombs exploded on Boylston Street near the finish line some 3 hours after the fastest runners had long since left the area. The bomb victims were dogged amateurs and the families and friends who cheered them on.
By then Ethiopia’s Lelisa Desisa and Kenya’s Rita Jeptoo had long since won the men’s and women’s events respectively. The number of dead and injured is growing and it now appears that there were ball bearings mixed amidst the explosives which went off.
My Boston grandchildren now have to be told about evil people, hardest on Jules, 5.
Was this Al Qaeda? Boston was where one of the 9/11 hijacked flights originated. A marathon features runners in what Islamists would consider immodest dress, particularly for women. Like the former World Trade Center here, Boston's marathon symbolizes American openness to the world. Hitting it could be viewed a blow to US pride and illusions of security.
But it might also have been an Oklahoma City-style home-grown US nut. We should pray for healing for the wounded in body and spirit, and in memory of the dead.
But I am also a financial reporter with a beat. So with embarrassment, here is my guess: gold and defense shares will go up today particularly if there is any hint that the horror was planned from abroad.
Citigroup which is in the depositary receipts business published a note by an expert on the Swedish financial transaction tax experiment. The FTT would make hedging costlier and increase asset price gaps. Trades that require central clearing would become more costly, so would shift back to being done by banks. Raising money would move from bond markets to bank finance, making banks vulnerable to unsecured funding. Corporate credit would become more expensive because of liquidity premia, and peripheral government debt would be harder to raise.
More for paid subscribers follows from Brazil, Spain, France, Canada, Australia, Britain, Singapore, Israel, Belgium, Ireland, and Denmark.
Not so precious metals
The gold price drop has picked up momentum over the weekend and in overseas markets today. Then bad numbers on US retail sales and homebuyers' confidence plus slower Chinese growth weighed in. I tend to be skeptical of trend investing, particularly over gold, in many ways a fashion item, not just jewelry and glitter, but also the mode of commodity-themed exchange-traded funds. These ETFs went into fashion and out of in the past few months. The gold price is now below $1400/ounce.
For the record (again) the end of Fed quantitative easing will not mark an end to gold's appeal as an inflation hedge. The US will exit QE if and when employment figures improve, but this stage probably will be marked by inflationary wage pressures.
And you don't even have to wait from unemployment to fall. In Japan, large companies are volunteering to raise wages to match the government 2% inflation target, part of Tokyo's own version of QE.
INK Research, a Canada tracker, is reported in today's Globe & Mail to have reported for Toronto-listed gold and precious metals stocks, there were 7x as many with insider buying as selling. This kind of imbalance is usually a mark of a turning point in markets. The number of buyers to sellers was half as high, at 3x, at the start of this year.
The last time there was such a huge lopsided move to buying by gold and silver mining insiders in Canada, it was at the peak of the 2008-9 financial crisis. Insiders tend to be contrarian, buying when they think their companies' stocks are undervalued. Insiders are also prone to being early, followed by the market overall with a 3 to 6 month lag.
While he is not a precious metals insider, Bill Gross of Pimco today tweeted that he "would still buy gold here" this morning, citing "world reflating". Of course Mr. Gross famously also recommends buying bonds which would suffer in renewed inflation, so maybe he wants to offset the risk.
Your editor got hauled over the coals for calling the Colombian rebel movements' bombing of pipelines "political risk". According to my critic, political risk is not guerilla actions but only "tax changes from the government." He adds: "Political risk is not present in Colombia." Presumably the 2006 surprise government decision to tax investment corporations does count as political risk, in politically "safe" Canada. Under the rules of the Overseas Private Investment Corp., an "independent" US government body which insures foreign investment, war and terrorism count as political risk.
Capriles did far better than pollsters and the press predicted in grief-stricken Venezuela, and Nicolas Maduro's 50.6% victory may be subject to a recount, presumably complete with hanging chads.
More on Colombia from our Cali-born reporter Frida as well as on Chile, and more on gold, Ireland, Italy, India, Israel, Sweden, and Britain.
I have just posted the performance tables for www.global-investing.com which you can view on the website. Pre-subscribers may look at the closed-positions table; paid subscribers can view the current stock, bond, and closed-end and exchange-traded funds. Click for a "printer-friendly" view of the spreadsheets even if you don't want to print them.
Note that Russell Jones whom I quoted last week is not with Westpac, the Australian bank, any longer. He has joined John Llewellyn at www. llewellyn-consulting.com, the macro-economic think tank in London, as a partner. Apologies to both men.
The Turn To Come
The turn of the road is still some ways off but it is getting closer.
What will lead to the eventual resumption of inflation and/or the end of easing policies by the Fed and its fellow central bankers is the return of wage rises, writes Russell Jones, the econmist at Westpac, an Australian bank. For the past 5 years during the post-crisis, he argues, wage inflation has virtually disappeared in developed economies. This allowed quantitate easing policies to be improvised without wages taking off by over c2%/yr. The days of low US wage pressure may be ending already according to some data from small businesses, but some of this trend is the result, he says, of bad data.
"Real wages remain more or less stagnant, suggesting that inflation-busting pay deals remain rare. Market and survey measures of inflation expectations remain broadly stable and subdued. And [even at] 7.6% US unemployement rate remains far above most estimates of the 'full employment' [ joblessness level which is] 5.5-6%."
That's now. But he warns "labor market developments bear close watching. Were the postive trend in average earnings growth to be mirrored in other indications, core inflation could begin to move back upwards."
He points out that the same risk doesn't yet arise in Europe where the data are "distinctly downbeat":
"The annual rate of labor cost growth dropped to a mere 1.3% in Q4  from 1.8% in the prior quarter. The is the 2nd lowest figure on record. Moreover, if Germany's 2.9% wage inflation outturn is stripped out, the picture is softer still. Indeed, wages are actually falling in the perifery, with Spain suffering particularly large declines."
Mr Jones concludes that "the implications of falling wages for demand and recovery are disturbing. Without recovery, there can be no sustained solution to Europe's deep-seated malaise." "Core consumer inflation is set to fall further from its already low level of 1.4%" and "pull the headline rate toward a similar level from an already sub-target 1.7%."
Which leads Mr. Jones to conclude that further European Central Bank easing is likelier than continued easing by the Fed. He worries that because of political constraints like the need to get formal member government approvals, Mario Draghi may not be able to act with decisiveness. Being able to only take marginal steps means the ECB may wind up doing "little or nothing to arrest the burgeoning disinflation."
Mr. Jones did not mention Australian or Asian policy.
Friday the 13th comes on Saturday this week, but the market didn't notice today. More bad news from Latin America, Canada, and India today, but at least there is one ray of sunshine from Britain for our subscribers. Join them to enhance the value of your portfolios.
BRICs are sooo out
Your editor met Ruchir Sharma, emerging markets guru at Morgan Stanley, at the Carnegie Council where he was promoting his new book, Breakout Nations. Mr. Sharma oversees the Morgan Stanley Institutional Frontier Emerging Markets Fund, MFMIX, which your editor used to tip, and which she still owns. (It was a closed-end fund but converted into a mutual fund, a sector this newsletter doesn't cover, MFMIX invests in equities from frontier countries, ones which haven't yet emerged.)
Mr. Sharma was scathing the emerging markets BRIC concept invented by Jim O'Neill of Goldman Sachs a dozen years ago. He tore into the BRICs one by one.
In Brazil his stay was grossly overpriced by NY standards, having to pay $1000 per night. The doubling of the valuation of the real makes any Brazilian exports except raw material uncompetitive. A T-shirt which cost too much shrunk the first time it was washed. Read more »
For Rich and Poor
On this 75th anniversary of The Bronx High School of Science, which I attended, I am delighted that another alumnus, Leonard Lauder, son of Estee Lauder, has donated a billion dollar collection of Picassos and early 20th century works to the Metropolitan Museum of Art. Both are venerable New York City institutions which serve rich and poor alike.
Bend it like Beckham. The battle of the titans over Herbalife took a sour turn yesterday after KPMG withdrew its HLF audit reports for 2010-2012 and fired its auditor for selling insider information. A senior partners of the auditor firm is under FBI investigation for selling for cash non-public information about HLF and another company, Skechers, to a "West Coast" fund manager and stock trader. KPMG's partner personally sponsored Los Angeles Galaxy, UK heartthrob David Beckham's soccer team, whose players wear uniforms advertising the team's sponsor, Herbalife.
Herbalife was a short target of hedge-fund manager Bill Ackman of Pershing Square Capital Management who called it a "pyramid scheme". Ackman was opposed by a defender of Herbalife, Carl Icahn, another mogul manager, who bought more shares of the firm in January after going on TV to attack Ackman.
There is one good thing about the KPMG audit recall. The bent auditor shared his insider info out of LA but both Icahn and Ackman operate from New York City. Whenever people tell me foreign stocks are too risky for their portfolios I recall stories like this. There is disagreement, there is ego, and, yes Virginia, there is corruption on Wall Street. KPMG is also being sued for misinformation during the Global Financial Crisis, the only major auditor to be targeted.
John Llewellyn asked me about feedback from his article yesterday about measuring an alcove when rulers go individualistic. One reader comment so far, from IA of NY: she suggested building a shelf smaller than the space and putting blocks of wood at either end to stop things falling off it. She thinks turning this concept into a guide for benchmarking investments might involve using a normalized rate of return on short-term government bills covering several years.
More from Canada, Spain, Britain, Finland, Brazil, Mongolia, India, Thailand, and Colombia.
The Measurement Issue
London economist John Llewellyn of www.Llewellyn-consulting.com writes in his latest Global Letter:
Investors are accustomed, courtesy of modern valuation theory, to us[e] the yield on sovereign [debt]as the benchmark measure of the risk-free rate of return, and thereby as the reference value, or numeraire, for other (riskier) assets. But today, QE and more unorthodox monetary policies, as well as new financial regulations and unusually high risk aversion, are causing yields on developed-economy sovereigns to be ‘artificially’ low, even if the risk inherent in the sovereign has not changed, which in practice it may well have.
All this makes thinking very difficult. Arguing by analogy may not appeal; but here goes.
Imagine that one Saturday you measure an alcove into which you intend to fit a wooden shelf that you will make by cutting a piece of wood to fit. When you awake on Sunday, however, you hear on the news that scientists are saying that, for a reason not understood, some rulers apparently have shrunk overnight.
You look at your ruler. It looks the same [but] perhaps a bit shorter. But maybe your memory is playing tricks on you? What is clear is that, regardless of whether the scientists are right, you cannot now cut your piece of wood to the length that you measured yesterday, for if your ruler has indeed shrunk, you will cut the shelf too short for the space. You will have to re-measure the alcove.
That would work when you were doing both the measuring and the cutting provided that you used only your ruler, [if] it did not change length again between your measuring and your cutting the wood. However, there would be no continuity with the past or with other [rulers]. You would not be able confidently to order a pre-cut shelf from a supplier’s catalogue, because your [measures] could differ. To safely order a pre-cut shelf you would have to know how much your ruler had shrunk relative to the ruler your supplier used when he produced his catalogue.
While you are pondering all this, you hear on the news that now some scientists are claiming that not only are some rulers changing length but so are the foundations of buildings. The only way to be sure, they say, would be to check how both your ruler and your foundations against the “standard metre” in the National Physical Laboratory (if you could gain access to it.)
The analogy highlight[s] three issues:
1. To the extent that bond yields, the numeraire against which the prices of equities and other assets have typically been assessed, are artificially low, how are we to measure the risk premium of other assets (the dimensions of the alcove)?
2. If assessments of true sovereign risk differ from analyst to analyst (different suppliers’ rulers changing by different amounts) how are investors to compare risk (order from a catalogue)?
3. If underlying sovereign risk is changing (the foundations changing size), how are we to identify that (gain access to the ‘standard metre’)
The problem for households, companies, and investors is that they have to take decisions. And, with the pricing of assets becoming problematic, these decisions have become more complicated. Two possible responses:
Move into real assets--equities, commodities, and property, [as] seems to be happening;
Be cautious about expenditure; and this is certainly happening. [At] the limit, the risk is of rising asset prices, maybe even to the point of bubbles, yet without these serving to support aggregate expenditure.
Your editor thinks the problem John highlights also explains the Bitcoin phenomenon, and the expanded taste for dollars (mostly US ones) in Euroland. More for paid subscribers follows from Israeli biotech stocks, analyst assessments of our Canadian shares, and news from Singapore, Israel, Britain, Switzerland, and Brazil.