I first went to Japan on Pearl Harbor Day, 1979 — on a Fulbright fellowship to study the Japanese economy and Japanese culture for my doctoral thesis.
I went to find the answer to precisely the same urgent question that confronts us today: Is there a good chance the U.S. economy will follow a path similar to Japan’s?
I can assure you it’s no simple question. I spent two full years in Japan. I visited dozens of banks, insurers and technology companies. I interviewed scores of decision makers. To get an insider’s view, I even joined a major Japanese brokerage firm for over a year. Since then, I have been back three times, including a visit to Japan earlier this year, just when the country was near a nadir in its 13-year on-again-off-again depression.
My research is broad and complex. But my answer for you today is quite simple: YES! Despite differences, the UNITED STATES IS FOLLOWING A PATH SIMILAR TO JAPAN’S, and with this inaugural gala issue of “Martin on Monday,†I’ll show you where, how, and what to do about it.
It is absolutely urgent that you fully understand this. Without this unique comparative perspective, you risk getting caught in SERIOUS DECEPTIONS — regarding the 7.2% estimate for GDP last week … regarding the optimistic-sounding jobless figures announced on Friday … and about additional good economic news that’s bound to be announced in the days ahead.
You risk getting trapped and financially raped. You risk getting hooked on the same kind of bliss and euphoria that repeatedly lured millions of Japanese investors to their financial Armageddon throughout the 1990s.
Let me take you back a few years to a historically accurate fictional scenario, and you’ll see what I mean …
THE BUBBLE ECONOMY
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.
Indeed, Mr. Mieno uses a different term — “ba-buru keizai†— the bubble economy. For months now, he has been watching with growing alarm as wild speculation has overtaken the Japanese stock market, the real estate market and the entire economy … driving 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 stock average, once lower than our Dow Jones Industrials, but now approaching 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 many American cities. He voices “VERY SERIOUS CONCERNS†about “roureika†— the aging of the Japanese population, a demographic time bomb that will explode before the end of the decade.
We leave his office wondering what he’s going to do about the bubble economy. Sure enough, a few days later, he decides Japan can’t risk it any more. 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 — “just enough,†he says, “to cool things down a bit.â€
But his action is tantamount to looking for a gas leak with a lighted match: The whole bubble blows up in his face.
To his utter shock, the Nikkei crashes by over half — to below 15,000 by 1992. And to the utter dismay of every Bank of Japan governor since, it NEVER recovers, despite many rally attempts.
FIVE GLORIOUS STOCK MARKET RALLIES
This brings us back to the present, and by this time, you’re probably aware of Japan’s plight. You’ve probably heard about Japan’s decade-long, protracted decline — the on-again-off-again recessions … the largest bank failures in all history … their greatest mass lay-offs since the Great Depression … and more recently, their many years of outright DEFLATION — falling prices on everything from homes to hamburgers.
What you may NOT be aware of, however, are the “great GDP growth spurts,†the “miracle bouts of job creation,†and the “glorious stock market rallies†that took place during the 1990s.
Indeed, between 1992 and today, I count five major recoveries and stock market rallies in Japan, with the last of the five taking place right now.
Some of the rallies were truly impressive — while they lasted.
Between 1995 and 1996, for example, the Nikkei Index rallied for 13 months, gaining a whopping 59.4% from its lows and recovering a full third of its previous decline.
Between 1998 and early 2000, it did even better. Its rally lasted 18 months, and the average rose 63.7%, recouping 37% of its earlier decline.
But all these gains were wiped out in subsequent crashes, and recessions. And finally, in late 2000, after five years of a broad, massive sideways chop, the Nikkei plummeted below the lowest lows of the 1990s, busting clear below the 10,000 mark.
Think about this for a moment: Each of these giant rallies spanned almost a year or more, much like ours has in 2003.
Each rally created another “mini-bubble†in the stock market, driving the prices on many stocks back up to pre-bust valuations, much like we’ve seen in the S&P in 2003. (More details on this in a moment.)
And each rally was the result of massive government stimulus to the economy, much like we have seen here in the United States.
The similarities in the realm of government policy are even more striking:
They dropped their interest rates to record lows. So have we.
They pumped up their money supply. So have we.
They embarked on wild deficit spending. So have we.
Their government stimulus programs SEEMED to “work.†So has ours.
Each time, their stock market rallied sharply. Their GDP enjoyed a growth spurt. Their job market suddenly came to life. Everything looked VERY promising. But each and every time, their experiments with economic meddling ended in failure.
I’m afraid ours will, too.
Like their stocks at the various rally peaks, our stock market valuations are again sky high. Historically, our average stocks cost about 17 or 19 times earnings. But right now, the stocks in the S&P 500 are trading at 27 times earnings. The overpricing of the stocks in the Nasdaq 100 Index is even worse — about 72 times earnings.
DEBT IS NOT WEALTH!
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 simple reality: Debt is not wealth.
What is our solution in America when we face similar tough times? Unfortunately, it is exactly the same. The only difference: We have NOT YET discovered that one simple reality.
Are there important cultural and structural differences between Japan and 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 tight with 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 “instant recovery machine.â€
Periodically, whenever the clouds of doom were darkening, they’d just crank up this machine to create “miracle†recoveries smack in the middle of a decade-long depression.
In the U.S., the government’s “recovery machine†is built a bit differently. Our construction lobby isn’t anywhere near as powerful as Japan’s. (Our defense lobby comes somewhat closer, but defense spending doesn’t create as many jobs.)
Moreover, since American consumers are such big spenders, our politicians have long-ago figured out that the best way to get money into the economy is simply to GIVE it away to consumers and let THEM spend it. (In Japan, they tried a similar gimmick, but it bombed. Instead of spending the free money, most Japanese consumers salted it away in savings accounts.)
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 crashing 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 for a half year or so, sometimes for a year or more.
Soon, you hear the shouts of “kampai†or “cheers†with Champaign bottles popping or hot sake pouring. “Look, it’s working!†they rant. “Look, we’re geniuses!†they rave.
But shoving new money into the economy is one thing. Creating a real, lasting prosperity is another.
To pave the way for lasting growth, you 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, we’re piling on more and more.
So … when will our political and financial leaders learn that one simple lesson that the Japanese didn’t figure out until it was too late? When will they learn that DEBT IS NOT WEALTH? Don’t hold your breath. It may take quite a while.
And the longer it takes, the more ups and downs we’ll have to endure, and the longer we’ll have to wait for a real bull market and recovery.
Right now, American consumers are more deeply in debt than any other population in the history of mankind. But instead of helping people find a way to dig themselves out of debt, our government is perpetually looking for new ways to get them to borrow, spend and speculate more.
The public sector debt is even worse. With record federal deficits, record state deficits and record trade deficits, the government debt pile-up in the U.S. is now larger than Japan’s ever was.
JAPAN AND THE U.S. ARE MORE ALIKE THAN DIFFERENT
Are there some big factors that make Japan fundamentally weaker than the U.S.?
Yes. Their banks have more bad debt and less capital. Their construction industry, despite their political pull, is a mess. Their job market is still relatively inflexible.
But there are EQUALLY big factors that make the United States weaker than Japan: Our consumers have less savings and more debt. Most of our tech and telecom industry are still a mess. Our export capacity is shot, even with a weaker dollar.
Plus, there are many MORE factors that we have in common with Japan: Widespread corruption in key financial sectors … the demographic time bomb … and HUGE DEBT BUBBLES!
How do countries EVER cut their debt bubbles down to size? Typically it happens in a deep recession. That’s when the excesses are cleaned out, paving the way for a real recovery down the road. But our recent mini-recession in 2001 was so brief and so shallow, it didn’t even make a dent in the debt pile … which leaves us with one urgent question still unanswered:
WHO’S GOING TO PAY THE BILL?
Who’s going to get stuck with all the debt when it comes due?
A few months ago, I was chatting with an old brokerage firm friend over sushi in Tokyo, and I asked him that same question.
His answer: “When I was a young man, we used to say that ‘future generations’ will have to pay dearly for our folly. Well, now the future has arrived, and we are all very surprised to find out that WE are the so-called ‘future generation.’â€
You won’t have long to wait before the debts come due.
THE FIRST DAY OF RECKONING FOR THE ENTIRE ECONOMY
Nearly all debts — whether old debts that were previously issued or new ones being issued every day — are bought and sold in the DEBT MARKETS.
There’s a debt market for mortgages, a debt market for government securities, a debt market for corporate loans and bonds — not to mention multiple debt markets for short-term debts.
So … when there is too much old debt sloshing around in the economy … and there are too many governments or companies rushing to issue new debts … where do you think we see the consequences? Where do you think we’re going to see the first day of reckoning for the entire economy?
In the debt markets, of course.
What happens? Simple: There’s just too much darn debt — old and new. So naturally, the market VALUE of those debts goes DOWN. In two words … BONDS CRASH.
And if you thought crashing stocks made a sickening sound, wait till you hear the thunderous roar of crashing bonds.
It already started this past summer — the worst bond crash since 1987.
And in the past 10 days, in the bond trading rooms of major Wall Street banks and brokerage firms, it has started again: While Washington and most of Wall Street were busy celebrating the good news on the economy, those guys were busy SELLING!
That’s why Treasury bond prices have just fallen again. That’s also why bond prices are, at this very moment, right ON THE VERGE of breaking down to brand new lows for the year. It’s also why long-term interest rates, the reciprocal of long-term bond prices, are on the verge of brand new highs.
“So what?†you ask.
Hah! The bond market is no sideshow in the financial arena. It’s the center, the core. The bond market is what’s driving interest rates, which in turn, is what drives the supply of credit for our entire credit-addicted economy.
So when you hear the thunder of bond prices falling … or when you feel the gust of interest rates surging … if you don’t wake up and pay close attention, you could be in for the shock of your life.
I showed you a moment ago how, in Japan, all the stock market rallies of the 1990s — no matter how glorious while they lasted — sooner or later petered out and died.
Now let me tell you what typically marked the beginning of their end: It was the periodic breakdown in the Japanese bond market.
At the time, most market experts in Japan didn’t recognize its importance, or just didn’t understand it. But in retrospect, it makes absolute sense:
BY BORROWING AND SPENDING ENOUGH, THE GOVERNMENT CAN ALMOST ALWAYS GET A GOOD RISE OUT OF THE ECONOMY AND THE STOCK MARKET. BUT THAT EXTRA BORROWING AND SPENDING HAS PRECISELY THE OPPOSITE AFFECT ON THE BOND MARKET.
Bond investors don’t like big government defects because they know it means the government will have to issue big supplies of new bonds, depressing the value of ALL bonds, including the old ones they have in their portfolio.
So bond investors get very, very nervous when governments run huge deficits. But they usually hold their fire as long as they can be assured that the economy is still weak and future inflation won’t wipe away the value of their bonds.
THEN … just as soon as the economy enjoys a bounce, and the foul smell of future inflation begins to reach their nostrils — THAT’S when the bond investors recoil in horror and start selling.
At first, it’s just a trickle of selling, and Wall Street pays little attention. Then, the trickle becomes a flood, and all hell breaks loose in the bond markets. Free-market interest rates — the ones the Fed cannot control — explode.
The Fed tries to hold a tight lid on its official rates for a while, but inevitably, it MUST cave in, and jack up the official rates, too.
That’s what the Bank of England did this week. But they weren’t the first — Australia beat them by few days. Nor will they be the last.
Bottom line: No matter how you slice it, sharply higher interest rates is the scenario you are facing in the months ahead.
So be careful! If you own long-term bonds, you could get hurt. If you must, lock in today’s low interest rates, you may not have another chance later.
And if you’re counting on the latest economic news to be just the beginning of great times ahead, be sure to do one more thing: Remember the Japan syndrome.
Good luck and God bless!
Martin
P.S. One last word: There IS a bright future for our economy and our country. But it’s not here and it’s not now. It’s going to take a lot more hard work and sacrifice before that day can truly come.
Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com
The information included in this electronic newsletter is subject to the terms and conditions located at http://www.safemoneyreport.com/subs/terms_of_use.asp.
View our Privacy Policy. Or, if you’d like to make a suggestion that you believe will enhance this service, please visit the “Make A Wish” section of the Safe Money Report website. Thank you!
http://www.safemoneyreport.com/contact/WishList.asp
© 2003. Weiss Research, Inc. All rights reserved.
