Financial topics

[John]

Japan's industrial output crashed over 8% in one month, an incredible
plunge. More evidence that the world is grinding to a halt - quite
literally.

> Japan Nov industrial output -8.1 pct mth/mth

> * Reuters, Thursday December 25 2008

> TOKYO, Dec 26 (Reuters) - Japan's industrial output fell 8.1
> percent in November from a month earlier, posting the biggest fall
> on record and a bigger fall than a median market forecast for a
> 6.8 percent drop.

> Manufacturers' output, the core component of production, is
> expected to fall 8.0 percent in December and decrease 2.1 percent
> in January, data from the Ministry of Economy, Trade and Industry
> showed on Friday.

> Industrial output fell 1.3 percent in July-September from the
> previous three months, marking the third straight quarter of
> declines. (Reporting by Hideyuki Sano; Editing by Chris
> Gallagher)

> http://www.guardian.co.uk/business/feedarticle/8168849

John

[freddyv]

...Second, there's a clear visual image of anticipating a tsunami. One
can imagine a tsunami that was launched decades ago (as I like to
say), and one can imagine seeing it coming, even if that's impossible
in real life.

Third, and most important, there's an obvious way to prepare for a
tsunami if you know it's coming - run for higher ground. That
phrase, "run for higher ground," is very appealing, and even
metaphorically makes sense for financial crises. There are no
similarly nice phrases for an earthquake or volcano.

Sincerely,

John

I remember the stories of the recent tsunami about how people went out towards the sea as the water receeded, being attracted by the extremely low tide and not having a clue as to what was coming. That reminds me of how the unsophisticated investor gets sucked into the market in the final upward move because everyone is making money and they don't want to miss out...and then here comes the ocean all at once....

--Fred

[freddyv]

Hi All,

Just read some very interesting info on the 1920s and 1930s titled, "The Greatest Bull Market in History" and have decided to post a few excerpts that I find really add a bit of perspective to our situation some 78 years later. There are several PDF files here:
http://www.geocities.com/cyclepro2/Char ... utlook.htm

...search the page for "The Greatest Bull Market in History".

It is astounding how similar the course of events are to what we are experiencing today. Most of the notes I have posted refer to late 1930 and into 1931, which seems to equate most closely with our current, and perhaps, future conditions. To me, it seems that we have entered the period of currency crisis; as one government makes a move to protect its economy (such as flooding the system with dollars) other countries are left with no choice but to make their own decisions based on self interest.

July 1930 -
"As the second quarter of 1930 came to a
dreadful close the consensus of opinion remained
well divided. Economists were increasingly
pessimistic while many stock
market analysts claimed that the November
low had held on the broad market ignoring
individual exceptions and that the market would turn back up."

This appears to be about the same today. Economists, by definition, would be more accurate since they are not trying to shill stocks. I have noticed these days that those who are calling for market bottoms can give no clear reasons why the market should reverse course and tend to rely on past history (within the past several decades) that does not at all relate to our current economic environment while those who are more pessimistic are much more likely to support their view with hard data.

"Many technicians had recalled the various
other panics which had taken place in 1907
and 1920. In both cases the decline was
approximately 50% from the actual peak in
the market. Here the stock market had
come close to that 50% correction mark.
This led many analysts to believe that the
worst was over and that indeed a new base
would be built during 1930. Some pointed
out that the worst was over back in 1920
within 130 days of the top. The similarities
which were drawn between the 1920 collapse
as well as the collapse in 1907 were in
fact a logical scenario. But then again people
tried to compare the 1929 collapse to
the mid-1970s and again to the 1982 period.
They were wrong in their parallels then as
they were wrong about the parallels in 1930
with those of 1907 and 1920."

My view is that we should also be careful about comparing our current situation to The Great Depression. There are many similarities and the generational cycle suggests that we are likely to make many of the same mistakes but the differences are that we have a significantly different geopolitical situation. Instead of a world war preceding the financial crisis we defeated our opponent through a cold war. Also, we are now a debtor nation with China being the biggest creditor nation. Our bubbles have been building up over a longer period of time and we seem to have added a final mega-bubble onto the excesses of the late 1990's. Another big factor might be our current demographic situation. We not only have a huge segment of our population reaching retirement age but these people are going to live significantly longer than they would have in the past. They will be taking money out of the stock market and will require tremendous medical expenditures which many expect the government (younger taxpayers) to pay for.

August 1930 -
"In August Roger Ward Babson known by
many as the "Prophet of Doom" since his
correct call of the top in September 1929,
issued his first buy signal."

This next one strikes me as close to where we are at...

January 1931 -
"...as 1930 was coming
to an end, the Fed had lowered the discount
rate for the seventh time since the crash of
1929. Thus, January began with the discount
rate now resting at 2%, the lowest in
history. But the Fed’s action did not spark
any spectacular rally in the Dow Jones Industrials
for year end. Most traders remained
very cautious. The bonds, on the
other hand, rallied sharply from under 93 to
the mid-95 level."

February 1931 -
"The Dow
Jones Industrials rallied sharply during
February as confidence and optimism
seemed to join hands that month. From the
January 1931 low of nearly 161, the industrials
rallied, coming close to 195 in February.
It was a rally during which many
selected stocks actually doubled in value
during the four-week period...The majority of the press and
comments by virtuous people in business
were very bullish."

April 1931 -
"On the world foreign exchange markets,
pressure was building. The U.S. dollar began
to strengthen. In April as the stock
market dropped, the dollar began to rise..."

"Capital, far from contented,
was still afraid of investment. Industries
by and large sought not to expand
but to contract as with this trend demand
for capital declined severely. This is perhaps
evidence in itself that during periods
of economic expansion, demand for capital
rises from the business sector bidding up
the price of money (interest rates) in the
same fashion as increased demand causes
the price of a given stock to rise. Our modern
day perspective that the stock market should rise during periods of declining interest
rates and fall during periods of rising
interest rates cannot be supported when we
review the facts that history has provided."

October 1931 -
"The industrials fell below the 100
level and closed September on the low of
the month. As October entered, the havoc
continued, forcing the industrials down to
nearly 86 which was a far cry from the peak
on the "moratorium rally" which was established
during June of 1931 near the 157
level. This decline came close to a 42%
drop, but the curious thing was that shortselling
had actually been banned. "

"Debt has always been a problem that has
inflicted every society known to man. Even
the great Julius Caesar was forced to deal
with such financial decisions and, indeed, it may have been these decisions which
prompted his assassination. Much of the
political structure of Rome was built on
lavish extravaganzas on the part of politicians
to gain favour and thus votes from the
people."

"The world has therefore gone through the
long-term cycle of debt several times. It was
destroyed by massive overextension, then
abandoned debt and interest payments and
then reverted toward this system. We now
live in a world highly involved in debt and
interdependent payments both on a private
as well as governmental level. The contraction
in world trade was damaged far more
by the default on foreign bonds, the flight
of capital from one nation to another and
the massive contraction in the value of both
debt instruments and tangible assets than
by any other forces during the period."

John, this last one suggests to me that while there are generational dynamics at work there are also larger dynamics at work that may play out over a generation of generations, so to speak. What say you?

--Fred

[John]

-- More ruminations

When you're trying to figure someone out, it always helps to be able
to read what they've written in the past.

And so I was interested when I came across three articles by Richard
Koo in the LA Times in 1997.

Japan Should Focus on Rebuilding Confidence
By Richard C. Koo
December 21, 1997 in print edition D-4
http://articles.latimes.com/1997/dec/21/business/fi-806

S.E. Asia Economy Grew on Borrowed Strength
By Richard C. Koo
October 26, 1997 in print edition D-4
http://articles.latimes.com/1997/oct/26 ... s/fi-46895

Is U.S. Seeing Start of ‘Bubble’ Trouble?
By Richard C. Koo
August 10, 1997 in print edition D-4
http://articles.latimes.com/1997/aug/10 ... s/fi-21086

These articles were being written around the time of the Asian
financial crisis that began in July, 1997. This crisis primarily
affected Indonesia, Thailand and South Korea, but most countries in
southeast Asia were hurt.

The second of the above three articles says that the reason that
these countries' economies had done so well up to that point is
because of trade with Japan:

S.E. Asia Economy Grew on Borrowed Strength
By Richard C. Koo, October 26, 1997. ...

Those economies were the primary beneficiaries of the strong yen
between 1985 and 1995. The strong yen prompted Japanese companies
to increase both their imports from the rest of Asia and their
direct investment in the region. Those two factors boosted
Southeast Asian economies in a major way. Indeed, a large
proportion of the phenomenal growth observed in these economies
during that time resulted from the activities of Japanese
companies. ...

Put another way, the economies in Southeast Asia had an
artificial boost from 1985 to 1995, but now the currencies have
since returned to levels that reflect the true fundamentals of
their respective economies.
http://articles.latimes.com/1997/oct/26 ... s/fi-46895

Koo's purpose in that article was to lecture the various Southeast
Asia countries, but what's most interesting is what it reveals about
Japan. If these other countries had been doing so well, thanks to
trade with Japan, even following the Nikkei crash of 1990, then it
follows that Japan must also have had robust international trade at
that time -- not only with these countries, but also with the
bubble-ridden US and China.

When I wrote my web log article the other day, I included one of
Koo's slides:



Richard Koo's presentation, exhibit 6, shows Japan's GDP kept
growing during the 1990s.

This slide was crucial to Koo's argument, but frankly it puzzled me.
Koo's point is that massive fiscal stimulus causes GDP to increase,
and this graph shows GDP increasing. The problem is that the massive
fiscal stimulus began in 1998, but this graph shows GDP increasing
throughout the entire period. So it's very hard to conclude, from
this presentation, that the increasing GDP is somehow correlated to
the fiscal stimulus.

Japan seems to have escaped the worst effects of the 1990 Nikkei
crash (massive homelessness, bankruptcies, etc.), and it seems that
exports have always been a big part of that escape. Here's one
recent summary:

In the case of Japan, domestic observers feel little confidence
that such measures will boost the economy. ZIRP and QE [zero
interest rate policy and quantitative easing] were not able to
reverse deflation in the past, and it was exports that dragged
Japan out of its recession from 2002 onwards, pushing the country
to its longest post-war expansion (although at a modest annual
rate of 2%).
http://www.financeasia.com/article.aspx?CIaNID=91437

What I keep seeing, as I research this subject, is that Japan has
depended heavily on exports since 1990. There's every reason to
believe that Japan's increasing GDP over these 18 years was caused by
its export business, rather than by fiscal stimulus.

And now we see, in my posting a few messages back, that Japan's
economy may be in serious trouble today, because Japan's export
business is crashing.

Another thing that puzzled me about Koo's presentation was the reason
he gave why military expenditures have a greater impact than
infrastructure projects -- because the military produces "useless
products."

Unless you assume that Koo is being deeply ideological -- something
that I never felt in his presentation -- then this is truly a weird
statement.

As I understand it, the issue is the following: You want each dollar
of fiscal stimulus to have the greatest impact possible. Spending
dollars on either tax rebates or social programs has the least
impact, since the money simply gets used to pay down debt.
Infrastructure projects, on the other hand, generate jobs and GDP,
and have a knock-on effect of creating more jobs for suppliers. Thus
each dollar has greater impact.

Well then, what's the point about "useless products"? I guess it
must be that if you manufacture one tank, then you just have to go on
and manufacture another tank. But if you build a bridge, then once
the bridge is finished, then you can't build it again. But you can
build another bridge somewhere else, can't you?

Here's one description:

Government spending can break the cycle. Not tax cuts, which will
only go to pay down debt or are saved into a banking system that
isn't working, but actual bricks and mortar. Think the New Deal's
Works Progress Administration super-sized or Japan building
highways and bridges over seemingly every river, stream and
rivulet.

“It was the fiscal stimulus that actually helped end the Great
Depression, not the monetary policy,” said Richard Koo,
Tokyo-based chief economist at Nomura Research Institute and
author of The Holy Grail of Macroeconomics: Lessons from Japan's
Great Recession.

“I don't think it will be over quickly. I am recommending at
least three to five years seamless medium-term fiscal stimulus
measures to give enough time for the private sector to repair its
balance sheet.”

The interesting phrase is: building "bridges over seemingly every
river, stream and rivulet." Those bridges are not totally useless.
So what's wrong with that?

Even more important, what are people supposed to eat? If the
greatest impact of fiscal stimulus is useless products, then there
won't be much food. Why not fiscal stimulus to pay to grow more
food, package it, and distribute it to consumers? At least, people
then won't starve.

Once again one gets the feeling that there's more to Japan's story
since 1990. It can't be just fiscal stimulus and huge gaggles of
bridges that explain how Japan remained relatively unscathed.
It seems clear that the export business is the real reason.

And, of course, America's will not have many countries to export to
in a worldwide financial crisis.

(Incidentally, history appears to be repeating itself.
Japan's previous crash occurred in 1919, but its export business was
shut down by America's 1931 Smoot-Hawley Act.

As a related matter, a web site reader has referred me to this
article that provides data on Asian countries that had financial
crises in the early 1920s -- just as the same Asian countries had
financial crises 70 years later, in the late 1990s.
http://www.gold-eagle.com/editorials_02 ... 402pv.html )

As we approach January 20, what really bothers me is the totally
undisciplined fantasy-type world people seem to be living in, and how
the expectation is that Barack Obama will cure everything with
massive, unbridled spending.

Subprime mortgages are a good thing, if they aren't abused. Hedge
funds are a good thing, if they aren't abused. Auction rate
securities are a good thing, if they aren't abused.

But they were all massively abused in the last 5 years. Thanks to the
lethal combination of nihilistic, greedy Gen-Xers, combined with
stupid, greedy Boomers, there were no limits to the use of these
instruments, resulting in the current disaster.

Well, that's the same thing that's happening now. Fiscal stimulus is
a good thing, provided that it isn't abused. But it's obvious that
the same nihilistic, greedy Gen-Xers, combined with stupid, greedy
Boomers, are setting no limits whatsoever on the use of fiscal
stimulus.

And now they have Koo's analysis that tells these people, who have
never shown any responsibility in the past, that there's NO COST to
this fiscal stimulus, since it will be paid for by macroeconomic
savings.

It seems that everything new that comes along provides more and more
justification for unbridled financial debauchery. People who are
stupid, nihilistic and greedy will have no discipline, and will push
every idea out to the breaking point.

This has got to be a recipe for an ever-growing disaster, even bigger
than any disaster contemplated so far.

Sincerely,

John

[abs]

Hi John -

Thanks for finding that video of Koo's speech - it really helped fill in the blanks of the presentation I had posted. I agree with your conclusions that international trade surely must have helped buoy Japan's economy since its crash in the early 90's. I also concur with your analysis that we may be heading off the cliff. However, let's assume that Koo's core idea is correct, that government spending which is exactly equal to the debt payments and increase in savings can maintain GDP and in effect stabilize the economy by increasing both money supply and the velocity of money (since GDP=money supply x velocity). And, let's also imagine that the vast majority of developed nations all take these actions. In that scenario, isn't it possible we might have an economy about as bad as Japan's has been for the last 12-15 years instead of a complete collapse? If not why not?

I imagine that Koo might argue, as does Roubini, that the government needs to become the lender and consumer of last resort. In a sense, they are both saying the same thing although in different ways. So, put another way, if the US government begins to consume exports from Japan (instead of the US public consuming them), isn't the net change to Japan's exports zero? Now obviously I realize that this is not a perfect solution because the US government is not going to start buying all kinds of consumer electronics exported by Japan, but perhaps the US could start buying some very high tech military equipment manufactured in Japan resulting in a net change of zero in total exports from Japan to the US. Now imagine this happening on a global scale . . .

Thoughts?

Andrew

[browner55]

-
And now they have Koo's analysis that tells these people, who have
never shown any responsibility in the past, that there's NO COST to
this fiscal stimulus, since it will be paid for by macroeconomic
savings.

Even if the stimulus is paid for via macroeconomic savings (savers buying treasuries) this just puts off the inevitable, as the government must pay back the loans. My largest source of confusion stems from the recent Fed announcement that they will buy long term treasuries (is this monetizing the debt?). Additionally their desire to issue their own bonds really has my head spinning.

[John]

< http://www.ft.com/cms/s/0/b2247e62-d02f ... 07658.html >

[abs]

John -

Not to go too far into a tangent, but you may be aware that the Old Testament has something called the "Jubilee Year" which was supposed to occur at regular intervals every 50 years. When the Jubilee year occurred, land (and related leases on the land) would be closed and the land returned to the original owner(s). Also in the years leading up to the Jubilee year lease costs for land were supposed to be decreased. I am now beginning to wonder if our forefathers understood something about generational dynamics or cycles and correlation with "economic bubbles". It seems to me that if life expectancies were shorter at that time, that the 4 generational cycle might have been completed within 50 years versus the 70-80 years we have now. Also, I'm now thinking that some of the regulations put in place could have had the benefit of avoiding real-estate/land bubbles. Of course, religious scholars have found all kinds of alternate rationale for the Jubilee Year although I'd have to say that avoiding economic catastrophe seems far more compelling. Your thoughts?

Andrew

[jwfid]

Hi John,

I liked your analysis of Dr. Koo's recent comments. I would like to add that while we might have narrowly avoided a "balance sheet recession" during the 2001 to 2003 period (thanks to Bernanke and Greenspan), we certainly have a likely depression today. I doubt the Japanese banks and insurance companies during the 1990's required capital injection of the scale our banks have needed in the last couple of months just to keep them out of bankruptcy, let alone begin to lend money again.

By the way, did you catch the part of his presentation where he discusses the difference between mortgages here in the USA and elsewhere? He makes a point that this could lead to a much bigger problem if real estate prices fall much further because borrowers could just decide to "return the key".

I believe Dr. Koo has correctly identified the balance sheet recession (which would have begun in 2001) and the fix, but I believe our situation is no longer repairable. Bernanke, Greenspan, and generational dynamics made sure of that.

Joe

[John]

Dear Fred,

> My view is that we should also be careful about comparing our
> current situation to The Great Depression. There are many
> similarities and the generational cycle suggests that we are
> likely to make many of the same mistakes but the differences are
> that we have a significantly different geopolitical situation.
> Instead of a world war preceding the financial crisis we defeated
> our opponent through a cold war. Also, we are now a debtor nation
> with China being the biggest creditor nation. Our bubbles have
> been building up over a longer period of time and we seem to have
> added a final mega-bubble onto the excesses of the late 1990's.
> Another big factor might be our current demographic situation. We
> not only have a huge segment of our population reaching retirement
> age but these people are going to live significantly longer than
> they would have in the past. They will be taking money out of the
> stock market and will require tremendous medical expenditures
> which many expect the government (younger taxpayers) to pay for.

Thanks for doing this research and extracting those quotes. It's
always amazing how people are saying and doing the same things today
that they were doing in 1929, and yet politicians, journalists,
analysts and pundits learn absolutely nothing from history.

It's certainly the case that there are differences -- especially in
the order in which things have occurred -- but the fundamental
generational attitudes and behaviors are the same. That's also true
if you look back at the major previous international financial
crises, back to Tulipomania and the South Sea bubble, you see the
same essential similarities, especially the securitization of debt
and a huge credit bubble.

Also, don't expect those "tremendous medical expenditures" to be
actually paid -- things like pensions, social security and medicaid
will be repudiated during the financial and war crisis.

Sincerely,

John