Debt Doesn’t Always Mean Inflation: Remember Japan
A lot of goldbugs believe the soaring US deficits mean inflation is inevitable. While I tend to agree, which is why I’m investing in silver and gold, we have to remember that this is not a guarantee. Just look at the Japanese experience.
Many compare the current US economic slowdown to what occured (and is still occuring) in Japan. In the 80’s, a massive real estate boom occurred in Japan. Much like ours, excessive leverage and speculation led to unwarranted real estate values, primarily in the commercial sector. The ensuing bank crisis resulted in a recession and deflation that still occurs to this day. The Nikkei stock index had its all-time high on December 29, 1989, when it was at 38,957.44. Today, the Nikkei index stands at about 9800. You got that right. Over the course of 20 years, it fell 30,000 points, which was about 77%. Yikes!
The Japanese were slow to lower interest rates, but they eventually did so, and interest rates are still near 0% in Japan today. The government also wasted a lot of money via various fiscal policies, building the typical bridges to nowhere. Japan’s debt is now 180% of GDP, though both short and long-term interest rates are near zero and no inflation has occurred.
The big difference between Japan and the United States though may be the Japanese savings rate. While public debt exploded, Japan never had a debt issue in the private sector. Japanese private sector savings simply got swallowed up by the growing government debt. People were happy essentially getting 0% on their money. That turned out to be a better investment than putting the money in the stock market. With the highest corporate tax rate in the world and a mountain of other taxes and regulations, Japanese business has been in a state of lethargy for decades now and there’s no going back.
What does this mean? I am not saying Japan-style deflation is inevitable. In fact, I doubt it will occur. No two disasters are ever exactly alike and the biggest difference between us and Japan is that they have savings and we don’t. Their budget deficits were also the result of one-off governmental fiscal policies moves, whereas our impending disasters are due to structural flaws with our entitlement systems.
This means we cannot count on the bond market to be so benevolent to our long-term bonds. The massive supply glut of US bonds, the potential for structural deficit issues (meaning our deficit consistently surpassed economic growth, even in ‘normal’ times), and the lack of private sector US savings means that bond rates may go up. In this case, if everyone can loan to the US government at 6-7%, the stock market will collapse since people can get solid returns with ‘no risk’ in US treasury bonds, and the cost of borrowing for corporations and individuals will be unbearable.
Many believe that in this case, the Fed will choose to expand its ‘quantitative easing,’ essentially printing money to fund the deficit. Again, this isn’t guaranteed, as the Fed may refuse to do so and force politicians to balance the budget.
Inflation is a potential with our deficits, but it’s not guaranteed. It could be that the government succeeds at simply destroying the economy long-term, much like the Japanese did, in a deflationary moment by gobbling up all of the private sector capital. The Fed may not print that much money.
To make money off of a disaster, you need to not only predict economic doom but also know HOW the doom will occur. That is the problem in this environment. We can point to policymaker mistakes and claim they will make society worse off. But to make money off of this, you need to know exactly IN WHAT WAY society will be worse off.