News That’s Fit To Punt – 06/Aug/2011

Turning Japanese As A Headline

Last week, the Economist ran with the headline ‘Turning Japanese‘. The gist of it is that the very model for the current behaviour of both the EU and US governments in propping up the economy with stimulus spending while racking up debt is essentially what Japan did after the property bubble.

In the early days of the economic crisis the West’s leaders did a reasonable job of clearing up a mess that was only partly of their making. Now the politicians have become the problem. In both America and Europe, they are exhibiting the sort of behaviour that could turn a downturn into stagnation. The West’s leaders are not willing to make tough choices; and everybody—the markets, the leaders of the emerging world, the banks, even the voters—knows it. It is a mark of how low expectations have sunk that the euro zone’s half-rescue of Greece on July 21st was greeted with relief. As The Economist went to press, it still was not clear on what terms America’s debt limit would be raised, and for how long. Even if the current crises abate or are averted, the real danger persists: that the West’s political system cannot take the difficult decisions needed to recover from a crisis and prosper in the years ahead.

The world has seen this before. Two decades ago, Japan’s economic bubble popped; since then its leaders have procrastinated and postured. The years of political paralysis have done Japan more harm than the economic excesses of the 1980s. Its economy has barely grown and its regional influence has withered. As a proportion of GDP, its gross public debt is the highest in the world, twice America’s and nearly twice Italy’s. If something similar were to happen to its fellow democracies in Europe and America, the consequences would be far larger. No wonder China’s autocrats, flush with cash and an (only partly deserved) reputation for getting things done, feel as if the future is on their side.

That just about sums up the observation and the rest of the article is a discursive chat about government debt and the inability of politicians to find a way to reduce debt.

Except right now might be the moment of truth for all these people who both hold debt and are indebted. To be honest it is a terrible time to be in debt or to be a lender because it all hinges on whether the mountain of debt can be repaid at all. If it can’t, then all bets are off.

Here’s yesterday’s SMH:

Broadly there seem to be two options on the policy menu. One is the deflation option: let market forces take over, let the defaults begin and provide a social safety net.

The other is the inflation option: keep splashing the cash to reduce the debts to zero. This is clearly the favoured Wall Street option. Wall Street’s proxies in Washington may duly deliver more stimulus: stimulus the public can ill afford – stimulus that could bring about another Weimar Republic – but stimulus that will diminish the size of the debt.

Which is of course what I’ve been seeing articles in  Japan about Japan’s debt. Now, the politicians can’t readily opt for the former option because this would mean everybody’s houses will have to lose value and lots of people will be kicked out of their houses and mortgages. There’s really no way either side of politics can bite the bullet and survive such an adjustment in the extreme. Neither side of politics could proscribe this as a solution and stay in office. But that might be the devil you know.

The politicians cannot openly opt for the latter because it means it’s going to burn down everybody’s retirement savings as well as term deposits and cash. People will rightfully leap toward gold and silver – and other precious metals but not commodities as a whole – in that post-apocalyptic kind of scenario where everybody would be running to the hills with their guns or joining the fascists or communists just to feel safety in numbers (which is what happened in the Weimar Republic. It would be like the fall of Rome if it happened across the USA and Europe. That’s the devil you don’t know; or maybe it’s the Deep Blue Sea.

In the twenty years since the Bubble burst in Japan, no politician has come close to proposing a way out of this situation. In fact Heizo Takenaka who was an economics professor before becoming Koizumi’s Finance Minister was looking to opt for the latter with the assumption that even if things get terrible in Japan, the people of Japan would still have a high governability. In other words he was willing to burn down savings in order to get out of debt through inflating the currency. I’m just trying to imagine Obama or Merkel or Gillard or Swan having that kind of gumption with their own people. Needless to say, he’s not in office now.

Anyway, I think we’re only beginning to see the unraveling of the highly distorted financial system that’s been built up over a century and a half.

Inflation Figures Not Adding Up For You?

Long time readers here would know that for some time I’ve been a big sceptic of the CPI. It turns out that the CPI might have been biased upwards in the last few years.

In a post-mortem of the previous cycle of CPI data, which ran from 2000 to 2005, the bureau found that its methodology over time created an ”upward bias” in the CPI figures. The methodology assumes that consumers keep buying the same basket of goods and services, regardless of their price. And over time, that increases the relative weighting of items whose prices are rising rapidly, and reduces the weighting of those whose prices are falling or relatively stable.

Over time, the basket of goods and services that comprises the CPI becomes increasingly unrepresentative of the real world of consumer purchasing, because it assumes that consumers pay no heed to price signals. Without correct weightings for each of the 90 categories in its basket, the CPI figures are inaccurate, and so are their derivatives, such as measures of underlying inflation.

This is serious. There is a flaw in the inflation data that we should have known about, but didn’t. And it almost cost us dearly.

The bureau’s post-mortem estimated that between 2000 and 2005, this upward bias had overstated the level of inflation by a cumulative 1.2 percentage points. In the year to June 2005 alone, inflation was overstated by 0.4 percentage points. That was the fifth and final year of the cycle. Inflation was reported as 2.5 per cent, but when the bureau surveyed what households were actually buying it found the true inflation rate was 2.1 per cent.

All f this is to say that one can’t be certain about inflation based on one’s own life circumstance. My own view is that regionally speaking, inflation has run higher in Sydney than elsewhere in NSW and if anything the raise in interest rates might be appropriate for Sydney but of course it can’t be done like that. Even that is by the by. The important message seems to be that the interest rates are actually too high given the CPI the RBA has been using has had an upward bias, and so interest rates should be lower.

I would like to add into the mix that unemployment figures are not what they used to be. In the old days they’d simply count up the people on the dole. These days they work hard to push and nudge and coax and intimidate and irritate people off the dole queue so there are quite a number of people who are part-time employed with 1-4 hours of work a week but are not considered unemployed. Yet if unemployment figures are to be believed, we’re close to maximum employment. So if the RBA is working off “garbage in” figures like that,  no wonder there are people who think the interest rates they are putting up are “garbage out”.

It is quite reasonable to argue the interest rates are in fact already too high for the RBA’s own stated purpose. Unless of course they want people to voluntarily de-leverage and are concocting an environment for that to happen.



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