Putting the Japan to U.S. Economic Comparison to Rest

One of the most common questions I hear these days: “Is the U.S. headed in the same direction of the Japan economy of 1990s?” The big fear is that we are headed to 10 years of deflation, as Japan experienced in its “lost decade.”

Yes, there many similarities between the Japan of the 1990s and the U.S. of the 2000s. Japan’s real estate market and stock market both peaked in euphoria and collapsed, just like they’ve done here.

Today, the yields on government bonds in the U.S. have collapsed as investors run to safety (I find the concept that people find security in U.S. T-bills ironic). A two-year U.S T-bill pays about 0.20% today. In Japan, two-year government bonds pay 0.15%—U.S. government bonds are close to matching the yield on Japanese government bonds for the first time in 20 years.

But there are two big differences between Japan and the U.S., after their economic crashes. The difference leads me to believe that we will not follow the path of Japan. In fact, we will take a different path and face inflation, not deflation. Here’s why.

About 95% of Japanese government bonds are bought by domestic investors. In the U.S., we have the opposite. About 50% of our bonds are bought by foreign investors.

This goes back to the question: at what point will foreign investors tire of the devaluation of the greenback, and the increasing U.S. deficit and national debt, and thus demand higher interest rates from U.S. Treasuries? That point, in my opinion, is not far off.

The next big difference between Japan and the U.S. has to do with each country’s respective action after their real estate market and stock market crashes.

Yes, both Japan and the U.S. are based on fiat currency systems, but the response from the central bank of each country post-economic crash has been very different.

After the Japanese economy collapsed, Japan’s central bank failed to do the one thing necessary to kick-start its economy: increase the money supply. In the 12 months following April 1992, when Japan was officially recognized as being in a severe recession, the broad money supply in Japan did not change. And only 10 years after the recession started did Japan begin any type of central bank quantitative easing (“QE”).

The Federal Reserve did the opposite. Once we were recognized to be in a recession in December of 2007, the Fed flooded the system with money. The Fed cranked up the printing presses and significantly increased the broad money supply. The Fed has already gone through two sets of QE and might be getting ready for QE3.

Two countries: Japan and the U.S.; both experienced the same crashes, a real estate market crash and a stock market crash. Japan’s central bank chose not to increase the broad money supply and the result was that Japan went into years of deflation.

The U.S. central bank has done the opposite following the crashes of its real estate market and stock market. The Fed has flooded the economic system with cash. It has greatly increased the broad money supply. Is stands ready to unleash another round of QE if necessary.

There is a tremendous, actually unprecedented, amount of liquidity in the U.S. economy thanks to the Fed. And that’s why I believe we will get the opposite of what Japan got. We won’t get years of deflation; we’ll get years of inflation, which is what the rise in the price of gold bullion has been yelling about.

What He Said:

“When property prices start coming down in North America, it won’t be a pretty sight, because consumers are too leveraged. When consumers have over-borrowed so much that they have no more room in their credit lines to borrow more, when institutions start to get tight on lending, demand for housing will decline and so will prices. It’s only a matter of logic, reality and time.” Michael Lombardi in PROFIT CONFIDENTIAL, June 23, 2005. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.

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