Taken from an Editorial by:
Aubie Baltin CFP. CTA, CFA, Phd. (retired)
The Pivot Point
We are now at or close to the topping out point, which is the point at which consumers can not or will not take on any more debt and/or Mortgage corporations and Banks are unwilling or unable to extend more credit. We now seem to be hitting those topping points simultaneously in many areas: jobs, housing, consumer spending, and credit expansion.
The poor investments of the must have-it-now, generation is about to be unwound. We are where we are because Central Banks have printed ever expanding amounts of money to prevent the normal business cycles from working, to satisfy politicians wanting to get re-elected. Remember "it's the economy stupid". But the only thing the Central Banks have accomplished is to putt off the inevitable deflationary credit crunch while making sure it will be a lot worse in the end. They have definitely NOT eliminated the business cycle.
There are many that think true deflation (decrease in money supply) can not happen under a fiat money system but perhaps the point is moot. Money supply itself actually never contracted in Japan. Instead, it grew very slowly for a long time as bank credit contracted for more than five years consecutive years. Clearly there was a credit contraction so how did money supply still manage to grow? Fiscal deficits were ramped up to dizzying heights, Island Airports and roads to everywhere were built, and the Bank of Japan monetized all of it. I don't think the Government and the FED could get away with that here in the USA, especially since unlike Japan, where they have a 40% savings rate our savings rate is close to zero plus the fact that Japan's Gov. Debt is owned by the Japanese, unlike the USA that owes the rest of the world over $3 Trillion. A financial crisis that brings about massive debt repudiation would cause a massive shrinkage of the money supply (the true definition of deflation) In addition, the velocity of money plummeted in Japan. The net effect of the credit contraction on prices was clearly "deflationary". Prices across a broad range of assets, goods and services fell. Indeed, practically everything fell in price except government bonds.
People were amazed at the alleged "bond bubble" as well as the Zero Interest Rate Policies of the BOJ. However, a 1% interest rate on a 10-year bond makes sense when prices are falling 2.5% annually, the real yield becomes 3.5% (1% interest rate + 2.5% deflation) which is obviously far higher than 1% stated rate. Perhaps a practical way to think of deflation under a FIAT system is the destruction of credit/debt that exceeds the growth of the money supply.
Regardless of social, economic and political differences I expect the USA to attempt to follow in the footsteps of Japan even though the circumstances are vastly different. Although a central bank might be able to sustain a certain amount of inflation by resorting to extreme measures, like "dropping money out of helicopters" it can not stop the inevitable credit contraction. Nor will the FED bail out consumers at their own or other creditors expense. The Fed like the BOJ will stop short of destroying themselves and their power. At some point, most likely due to the Real Estate Bubble implosion, consumers will be unable to take on more debt and/or because banks will refuse to extend consumers additional credit as the value of their assets collateralizing their loans tumble; consumer bankruptcies will soar as the various credit bubbles implode. Furthermore, in a world awash in overcapacity there will be no need for corporations to borrow to make investments when they are awash in over capacity. That is why the Bank of Japan failed to defeat deflation and that is why Bernanke will fail as well.
