There was an op—ed article in the Wall Street Journal on November 14 entitled “Who’s Afraid of a Little Deflation?” by John H. Cochrane. The big fear today in Europe is that they’re on the edge of 0% inflation and could easily slip into mild deflation.
Economists there from Christine Lagarde (IMF Director) to Mario Draghi of the ECB are warning that deflation could send Europe into a downward spiral. Lagarde called it an “ogre” that could “prove disastrous for the recovery.”
Cochrane argues that these fears are overplayed as this is not the 1920s or 1930s when the last great debt and financial bubble emerged and burst, as back then central banks were not willing to step in and provide endless liquidity to keep a spiral of bank and business failures from creating such a sharp downward spiral.
He rightly uses the example of Japan that, on average, has had zero inflation for two decades and on—and—off minor deflation. They haven’t had massive bank failures or bank runs.
But I would argue that Japan has been experiencing a very difficult situation…
They’re economy has been in a coma economy since 1997 when they started to run their printing presses and created such flood of money. Their goal was to offset the deflationary spiral that would have occurred naturally much like in the 1930s.
I would argue that Japan has had to keep accelerating the level of money printing and fiscal deficits – as with any drug – to keep the economy from falling into deeper deflation. This isn’t a good sign and never ends well.
Japan’s stocks have never come anywhere near their late 1989 highs when the Nikkei neared 40,000. They have continued to fall to new lows on each global downturn. Stocks were down 80% at their lowest point in early 2009 and are still down 60% today.
Japan’s real estate fell 60% and it’s still down that much today… 23 years after its peak in 1991!
Japan has had zero average GDP growth for the last two decades. They are indeed in a coma! Does that sound OK? No pain, no gain is what I see from Japan’s history.
I strongly believe that Japan will never come out of its coma in the long run if it continues these policies that don’t allow the economy, its debts and financial leverage/speculation to rebalance.
So, yes, Japan’s endless quantitative easing (QE) may have prevented a massive bank and business meltdown as in the 1930s.
In the case of our country, that sharp purge quickly flushed debt and financial speculation and leverage out of the U.S. economy. Yes, we had the greatest crisis in U.S. history but we came screaming out of it and not just for years, but for decades.
Japan has not come screaming out of its crisis that started in 1990—1992 and I was the only one that predicted that crash back in 1988 – 1989. Why? I was looking at Japan’s massive real estate and stock bubbles against the sharp decline in their demographic numbers.
Quantitative Easing on the Continent
Germany and much of Europe is heading into an even sharper demographic downturn in the next several years, with many countries heading down for decades. Demographic trends for the U.S. head lower into 2020 – 2022 and the healthiest affluent sector will follow Homer Simpson’s peak at age 46 in 2007 with a peak at age 53 in 2014.
Central banks have had to continue running massive QE for 6 years now with mediocre results. Just as the Fed finally tapered off in the U.S., Europe stepped in strongly again and Japan continues to up its QE. That’s why stock markets are still going up even in the U.S.
It’s a global market and this “funny” money has to go somewhere and it’s not going into loans or productive investment. It’s going into speculation.
What central banks should most fear is not inflation from excess money printing but the very bubble they have now created artificially bursting from its own excesses.
Cochrane states: “Nowhere, ever, has an economy such as ours or Europe’s, with fiat money, an interest rate target, massive excess bank reserves and outstanding government debt, experienced the dreaded deflation spiral.”
But I argue that this is the first time we have faced a major crisis with such endless money printing and liquidity. We don’t know how it works out in the end. I just know from observing everything else in life, especially addictions, that it works out worse rather than better even though you put off hitting bottom and then the initial detox by taking more of the drug.
I agree with Cochrane that because of these new and unprecedented policies of long term QE, rather than short term liquidity injections to prevent short term crises, there is a temporary new normal. The result will either be near zero inflation and a coma economy like Japan for decades, or mild deflation at worst rather than the sharp and violent deflation we saw in the early 1930s…
Until something goes wrong!
I see the most likely scenario being that a series of global events – from Germany continuing to fall into recession, the China bubble bursting, Putin moving into Ukraine when he gets the right shot, to a second demographic cliff for the affluent in the U.S. – will cause an even sharper downturn and it will ignite such a deflationary spiral that central banks won’t be able to react fast enough.
The subprime crisis came out of nowhere and we had the worst recession and stock crash since the 1930s and the banks didn’t see it coming and were completely unable to catch up. But how do central banks have the credibility to come back and print even more money when such unprecedented stimulus failed?
I don’t know exactly how the next crisis will occur but every major indicator I have says it is coming, sooner rather than later… and I’m looking at between now and early 2020.
If we can get something for nothing and central banks have found the new “ark of the covenant” then I will have to change my outlook and I’m not planning on doing that.