Tapering Toward Tragedy

Martin D. Weiss in Kyoto, Japan, 1980

When governments create gigantic monetary bubbles, what happens when they try to reverse the process?

What happens when they begin to tighten credit in some way — be it by raising interest rates or by slowing down the money printing presses (“tapering”)?

For some answers, I suggest we revisit the recent history of Japan.

The Greatest Monetary

Bubble of the 20th Century

I first went to Japan in 1979 — on a Fulbright fellowship to study the Japanese economy and culture for my doctoral thesis.

I spent two years in Tokyo. I visited dozens of banks, insurers and technology companies. I interviewed scores of decision makers. And to get an insider’s view, I even joined the international department of a major Japanese brokerage firm.

Since then, I’ve been back many times, often at critical turning points — when Japan was at the peak of its real estate bubble, when it was near the nadir of its 23-year depression, and last year, when it was still struggling to recover.

My research on Japan is complex. But my answer for you today is simple: Bubbles, especially monetary bubbles like ours, always end badly.

I feel it is essential that you understand this. Without this unique comparative perspective, you risk getting caught in serious deceptions — regarding the federal deficit, the Fed’s money printing presses, and its recent first steps to slow them down. You risk getting hooked on the same kind of bliss that repeatedly lured millions to their financial Armageddon for decades.

Let me take you back a few years to a historically accurate fictional scenario, and you’ll see what I mean …

The Bubble Economy

Bank of Japan, Tokyo

The time is early January 1990; the place, Tokyo.

We are visiting the relatively Spartan offices of the Bank of Japan, and we are ushered in for a brief visit with the 26th governor, Yasushi Mieno.

Mr. Mieno knows nothing of the expression “irrational exuberance” — the words his counterpart in America, Fed Chairman Greenspan, won’t make famous until later in the decade. But he certainly understands what it’s all about.

Mieno uses a different term — “baburu keizai” — the bubble economy. For months now, he has been watching with growing alarm, as wild speculation has overtaken the Japanese stock market, real estate market and the entire economy … driving asset prices through the roof, growing wilder by the day.

The governor’s manner is mild, but his words are not. He speaks with a mixture of pride and fear about the Nikkei 225 Average, once lower than our Dow Jones Industrials, but now close to 39,000.

He laments that a square inch of land in the fashionable Ginza district of Tokyo costs more than all the real estate in a square mile of good land in the U.S.

He voices “very serious concerns” about roreika — the aging of the Japanese population, a demographic time bomb that’s expected to explode before the end of the decade.

He does not tell us what he’s going to do about it. But sure enough, a few days later, he decides Japan can’t risk it anymore. It’s too dangerous for the long-term health of the entire nation. It’s a threat to national security.

So he raises interest rates by a small notch — not enough to cause any disruptions; just enough, he believes, to cool things down a bit.

But his action is tantamount to looking for a gas leak with a lighted match: Japan’s entire bubble economy blows up.

To his surprise, the Nikkei crashes nearly 50 percent within two years. And to the utter dismay of every Bank of Japan governor since, it never recovers.

Glorious Stock Market Rallies

This brings us back to the present, and by this time, you’re probably well aware of Japan’s plight.

You know about Japan’s 20-year depression, its massive government debts and never-ending struggles to support an aging population.

And you may also know that, even today, after the most muscular government stimulus in decades, the Nikkei is barely over 14,000, still down by over 24,700 points from its all-time high of 24 years and two months ago.

What you may not be aware of, however, are all the “glorious” stock market rallies that have taken place since the decline began in 1990: I count at least seven, with the last of the seven taking place right now.

And some of those rallies were truly impressive — while they lasted.

Between 1995 and 1996, for example, the Nikkei Index rallied for 13 months, gaining 59.4 percent from its lows and recovering a full third of its early-1990s decline.

Between 1998 and early 2000, it did even better. Its rally lasted 18 months, and the average rose 63.7 percent, recouping 37 percent of its prior decline since 1990.

The biggest rally of all began in 2003. The Nikkei rose by a whopping 136 percent, from a low of 7,700 to a high of 18,157 over the course of 51 long, glorious months — only to come crashing down again to brand new lows in the global debt crisis. (By comparison, the Nikkei’s most recent rally, which began in 2012, is not nearly as impressive.)

But think about this for a moment:

Each of these giant rallies spanned long periods of time.

Each created another “mini-bubble” in the stock market, driving the prices on many stocks back up to pre-bust valuations.

And each was the result of massive stimulus to the economy, much like we have seen in the United States.

The similarities in the realm of government policy are even more striking:

* Japan’s central bank crushed their key interest rates to zero percent and kept them there for years. So did we.

* As a result, Japan’s citizens greatly reduced their rate of savings, shifting decisively toward a society of conspicuous consumption. So did ours.

* Later, when years of zero interest rates were not enough, they resorted to outright money printing in a big way. So did we.

* Plus, Japan bailed out their failed banks, leaving giant zombies in their midst … embarked on wild deficit spending, running up a massive national debt … and bought up corporate paper, creating giant speculative bubbles. So did we.

At times, some of their government programs seemed to work; and so did ours.

Each time, their stock market rallied, their GDP enjoyed a growth spurt, and their job market seemed to came to life. It always looked promising. But each and every time, their experiments with economic meddling ultimately ended in failure.

I’m afraid ours will, too.

What was Japan’s solution when their economy and stock market were in the dumps? To create more debt! But to their great consternation, they eventually discovered one fundamental truth:

Debt Is Not Wealth

What is our solution in America when we face similar tough times? Unfortunately, it is very similar. The only critical difference: Our leaders have not yet discovered that one fundamental truth.

Are there important cultural and structural differences between Japan and the United States? Of course!

In the Japan of the 1990s, the fiscal weapon of choice was massive public works projects — more super highways to rural areas that already had abundant infrastructure … huge municipal centers in relatively smaller towns that really didn’t need any to begin with … massive sports arenas, despite the absence of any local pro teams … and much more.

Japan’s ruling Liberal Democratic Party was (and is) very close to Japan’s big construction companies. Plus, they figured they had a good cause — to “save” Japan.

The government and the construction companies — along with the banks that dished out most of the debt financing — came together to form an “economic rescue machine.”

Periodically, whenever the clouds of doom were darkening, they’d just crank up this machine to create “miracle” recoveries right in the middle of a two-decade-long depression.

In the U.S., the government’s “rescue machine” is built a bit differently. Our construction lobby isn’t anywhere near as powerful as Japan’s.

Moreover, since American consumers are such big spenders, our politicians have long-ago figured out that the easiest way to get money into the economy is simply to get banks to loan it cheap to consumers and get them to spend it.

But regardless of the specific weapon each government uses, the battle strategy is very similar: The politicians see the enemy — a sinking economy and a falling stock market. They bring out their big guns. They shoot fresh new money into the economy in unprecedented quantities. And then, sure enough, the stock market and economy bounce back, sometimes just for a year or two, sometimes for much longer.

But shoving funny money into the economy is one thing. Creating lasting prosperity is another.

To pave the way for sustainable growth, we will first have to clear away the bad debt and other garbage left over from the previous economic boom.

We haven’t done that. Quite to the contrary, as I demonstrated here three weeks ago, we’re piling on more and more. (See The Consequence of Complacency Is Catastrophe.)

That’s why it’s so hard for the Fed to back off from its monetary bubble; and why the consequences of even the gentlest bubble-puncture can be so severe.

What are the consequences for 2014? What should you do about it?

Stay tuned for our best answers.

Good luck and God bless!

Martin