Rodney Johnson | Monday, February 11, 2013 >>
In the 1988 vice presidential debate, Dan Quayle was going back and forth with Lloyd Bentsen. At one point Quayle’s age and experience was questioned in the context of him becoming president if something happened to George H.W. Bush.
This issue had been tossed around in the press before the debate, so everyone knew it was coming. Quayle responded by talking about how his age and experience compared with that of JFK when Kennedy was elected president.
When asked for a rebuttal, Bentsen pounced. Using an obviously scripted line, Bentsen retorted, “I knew Jack Kennedy. Jack Kennedy was a friend of mine. Senator, you’re no Jack Kennedy!”
Well I have an equally scripted rebuttal for the Japanese government’s pledge to devalue the yen…
“Yen, you’re no Jack Kennedy!”
The Japanese government’s pledge to devalue the yen is an effort to break their trend of deflation. The country wants to create inflation by any means possible, hoping it will lead to cheaper exports (it will), as well as increased domestic consumer spending (it won’t).
However, many people around the world are pointing out that a dramatic drop in the yen could be the start of a crisis for the entire Japanese financial system. The dominoes would be a falling yen… which leads to rising interest rates as investors required more return to compensate for a drop in the currency value… which would lead to government debt interest rising… thereby making the debt of the country unsustainable.
The end result?
A financial catastrophe that starts with a falling currency but is ultimately about too much debt.
As the yen loses value – it is down 20% versus the dollar over the last four months – bond markets around the world are anxiously awaiting any signs that the country’s interest rates are ticking up.
At the same time, market participants nervously watch the U.S., pointing out the $85 billion that the Fed is printing every month on top of the $2 trillion already printed, and the annual deficits of $1 trillion-plus of the U.S. government.
In the meantime, interest rates have crept up ever so slightly in the U.S. with the 10-year Treasury bond bumping up against 2% while the 30-year Treasury bond is now back over 3%.
Could the U.S. dollar be on the same glide path as the yen?
Could this be the beginning of the end of the U.S. currency and our financial system?
Senator Quayle and JFK might have been in similar positions, with similar experience and age, but no one in the room thought of them in the same way.
In exactly the same way, the yen and U.S. dollar may be in similar positions, but it would be a mistake to think of them as the same.
Just look beyond the last five years, and beyond simple measures like the current exchange rate and interest rate environment…
The Japanese population is old and getting older. They don’t have a huge, young generation to help bring them out of economic malaise.
Japanese work rules largely favor older workers who refuse to leave their comfy jobs, with their good pay and great benefits.
As the population has aged, they bought Japanese government bonds to provide themselves with some level of safety. Prices were falling all around them during two decades of deflation. They didn’t have to earn any interest to come out ahead, they just had to get their money back in retirement.
With the young set not able to buy and the older set not interested in spending all their money, Japanese companies sold more and more to foreigners through exports. The government did all it could to stimulate economic growth, but to no avail. No matter what it spent on infrastructure and stimulus programs, the people of Japan refused to budge.
But all that spending did have one big effect: it put the country into debt by over 230% of GDP! No. “Put” isn’t the right word. It buried the country under a mountain of IOUs.
Now the retirees want their money back and are net sellers of Japanese government bonds. And Japan must continue to sell bonds to finance its deficit spending. So the interest rates are set to march higher.
The financial implosion is all but written on the wall.
Now compare this to the U.S…
Sure, we have unsustainable entitlement programs.
And yes, our government has done its best to push down the value of our currency to help exporters… and so spur growth.
However, the actions of the Fed have kept inflation above zero. While this steals from savers, it does produce nominal growth in the economy.
Also our nation is much younger than Japan’s, so we have a working generation of boomers that might not be spending as much, but they are not retired yet either.
Plus we have a large population of young people, the Echo Boomers, who will form families, have children and grow their own spending, which will be a huge boon to the U.S. economy in the next decade.
As for debt, ours is growing at an alarming rate, obviously, but it is less than half that of Japan in terms of GDP.
But all of these points are mere sideshows to the overwhelming factor that keeps the U.S. from following the yen and the Japanese economy down the tubes.
It isn’t age… it isn’t the balancing act of inflation versus deflation…
The overriding factor is that the U.S. dollar is the reserve currency of the world.
We are the backbone of international transactions. We account for 85% of all foreign currency exchanges on the planet.
People do business in dollars, and accordingly they use U.S. Treasury bonds – our debt – as a parking place for funds.
This huge demand for U.S. dollars and U.S. debt keeps our currency and our country in a solid position that Japan – and every other currency-issuing country – can only dream about.
How long can we keep this “exorbitant privilege,” as it was called by General de Gaulle? That is a subject worthy of its own article… for another day.
Ahead of the Curve with Adam O’Dell
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