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Japan
Sock Puppet Kabuki; Nikkei Today Parallels Dot-Com Bust
Posted by Peter Schiff on 06/26/2013 at 7:28 PM
The Japanese stereotype of excessive courtesy is being confirmed by the actions of prime minster Shinzo Abe who is giving the world a free and timely lesson on the dangers of overly accommodative monetary policy. Whether or not we benefit from the tutorial (Japan will surely not) depends on our ability to understand what is currently happening there.

For now most economists still believe that Abe has stumbled upon the magic elixir of economic revitalization. His commitment to pull his country out of the mud by doubling the amount of yen in circulation, and raising the nation's official inflation rate to 2%, had conferred rock star status on the formerly bland career politician. But just one year after his first critical raves arrived, the audience is heading for the exits. As it turns out, the Japanese miracle may be a simple tale of confidence easily gained, and just as rapidly lost. 

In many ways the 75% nine month rally in the Nikkei 225 (that began when Abe was elected prime minister in September 2012), and the subsequent crash that began on May 22, is not all that different from the turbocharged rally, and spectacular crash, that occurred in technology heavy Nasdaq more than a dozen years ago here in the United States.

At the time that Pets.com (the company behind the iconic Sock Puppet) made its IPO, other high flying tech stocks had racked up 1000% gains. While investors scratched their heads, pundits offered reasons why common sense no longer applied to the new economy. We were told that valuations, revenue and profits no longer mattered. And to an extent that now seems absurd, the investing establishment bought into the insanity. But then a funny thing happened, investors woke up and realized that they had nothing but a handful of magic beans that couldn't grow a beanstalk. When the fog lifted, stocks plummeted...Wile E. Coyote style.

This time around investors in the Japanese market were similarly deluded by fairy tales. Leading economists told them that Japan could cheapen its currency to improve trade, use inflation to create real growth, increase prices to encourage spending, and drastically increase inflation without raising interest rates. In short, monetary policy was seen as substitute for an actual economy.

Initially at least the economic data seemed to confirm the success of Abe's program. The leading indicator was the yen itself, which dropped like a stone. Given the widely held view that a weak currency is the key to economic success, the 25% decline in the yen was welcomed as good news. Soon thereafter, the inflation that Abe so eagerly sought began to materialize in various sectors of the economy. When the Nikkei reacted positively to these developments, momentum traders from around began to take notice, thereby creating self-fulfilling prophecy.

But it's no great trick to weaken a currency. Any two bit economy could accomplish that objective. For a nation like Japan that imports nearly all of its raw materials it was inevitable that a drastically cheaper yen would to push up prices. However the rest of the plan, the part about surging exports and growing economic activity, has been much harder to achieve. In fact the data has been downright disheartening. The plunging yen has failed to reverse Japan's weakening trade balance which has declined for 28 straight months. The trend finally sent Japan into an overall trade deficit 10 months ago for the first time in 30 years. The latest data confirms that while the yen value of exports has increased, actual trade volume has fallen.

While the broad economic data failed to impress, economists and investors were nevertheless hopeful that Abenonmics would eventually work its magic. But recently the bottom has fallen out in a way that should have surprised no one, but somehow managed to do just that. Beginning in April Japanese Government bonds began to sell off sharply. Previously, the Japanese government could borrow funds for 10 years at just 36 basis points.

The truth is that the sub 40 basis point yield on Japanese Government bonds was the most important data point for their economy. At those levels, Japan needed to spend 25% of its tax revenue to service its outstanding debt. While that figure is high, most it is manageable given Japan's high savings rate.  However, with a national debt that exceeds 200% of GDP, the Japanese government could quickly become insolvent in the face of higher debt service costs. If rates on 10 year debt were to ever match the 2% of their inflation target, more half of total tax revenue would be needed to service debt payments.  

But the central premise of Abenomics seems to be that the Bank of Japan could push up inflation to 2% without raises the rates on long-term debt. To do this one would have to assume that bond investors would accept negative interest rates, even while a falling yen was eating away at principle and returns on alternative investments would be expected to be more attractive. Such an outcome is not consistent with human behavior. 

As a result, in late May a strong sell off in Japanese government bonds caused yields to nearly triple to almost 100 basis points on 10 year debt. And while one percent doesn't sound like much, it was the rapidity of the ascent that got everyone's attention. This grim, but very simple, reality seems to have hit Japanese stock investors with a panic unseen since Mechagodzilla took aim at Tokyo. Knowing that even moderately higher rates could counteract any economic gains made by stock market or export growth, the faith in Abenomics has seemed to evaporate almost overnight. Sounds a little like the dot-com bubble, doesn't it? 

Any more rapid escalation in Japanese bond yields should tell us that quantitative easing and growth through devaluation is a cul-de-sac that should be avoided. Japan should be our canary in the coal mine. In the meantime, the drama in Japan is diverting attention away from more important shifts in Asia, more of that in our latest newsletter

An expanded version of this commentary will appear in the June Edition of the Europac's Global Investment Newsletter, which will be available for download later today. 

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday! 

And be sure to order a copy of Peter Schiff's recently released NY Times Best Seller, The Real Crash: America's Coming Bankruptcy - How to Save Yourself and Your Country



Tags:  economyinflationJapanNikkei
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The Biggest Loser Wins
Posted by Peter Schiff on 05/23/2013 at 11:08 AM

While the world's economies jockey one another for the lead in the currency devaluation derby, it's worth considering the value of the prize they are seeking. They believe a weak currency opens the door to trade dominance, by allowing manufacturers to undercut foreign rivals, and to economic growth, by fighting deflation. On the other side of the coin, they believe a strong currency is an economic albatross that leads to stagnation. But the demonstrable effects of currency strength and weakness reveal the emptiness of their theory.

A country that attracts investment from abroad (through stable and fair governance, low taxes, a growing economy, and a productive labor force) and produces goods that are in demand on the global stage will generally see a rising currency. In essence, this is the reward for a job well done. Strong currencies then help nations stay strong by conferring greater purchasing power to its citizens and businesses, which keeps input costs low, thereby enhancing international competitiveness. Strong currencies also encourage savings, keep real interest rates low, lower capital costs, and allow for greater productivity and higher real wages.

It is often argued that a weak currency confers advantages in foreign trade. But the edge only results from putting exports on sale. Any merchant will tell you that it's easy to sell more if you cut prices, but most would prefer charging full retail. However, exports are not an end in themselves, they are a means to pay for imports. The goal of an economy is not to work, but to consume. If citizens in one nation buy goods produced in another, they must pay with exports. When a nation's currency appreciates imports cost less and fewer exports are needed to pay. This means goods and services at home will be cheaper and more plentiful, and citizens won't need to work as hard to buy them. This is the definition of rising living standards.

But when it comes to relative currency valuations, the United States dollar exists in a world of its own. As the international reserve, the dollar is the de-facto beneficiary of any other country's intervention. When countries intervene, they do so specifically against the dollar. In addition, many countries, (China and Taiwan for instance) maintain a pegged relationship to the Greenback. Therefore in a world dominated by interventionist banks, the factors that push the dollar have been inverted.  The dollar falls when fundamentals either improve abroad or deteriorate at home (both cases increase the propensity for intervention). The rest of the world's currencies compete on their own merit. As a result, it is not an accident that over the last decade Australia, New Zealand, and Switzerland, three of the world's strongest economies, have produced strong currencies.

Since 2001, all three have had generally appreciating currencies, accompanied by steadily rising exports, strong economic fundamentals, and low unemployment. From 2001 to 2012, the Kiwi Dollar appreciated by 98% against the U.S. dollar, but its exports in local currency terms increased by 40% (170% in U.S. dollar terms). Over the same time frame, the Aussie dollar appreciated by 103% and exports increased by 102% in local currency (and 305% in U.S. dollar terms). In Switzerland the story was the same, currency up 82%, exports up 53% in local terms and (and 175% in U.S. terms). Where exactly did they encounter export troubles due to their rising currencies?

At the same time, the strengthening currencies made few negative impacts on other aspects of economic performance. At the time when the Swiss bankers caved to international pressure in September 2011 and pegged its previously surging franc to the euro, their economy had shown some of the best economic performance on the Continent. More recently, Australia and New Zealand reported stunning job creation figures. Adjusted for population, the U.S. would have had to create more than 600,000jobs per month to keep pace with Australia, and 900,000 jobs per month to match New Zealand (U.S. job creation has averaged about 169,000 per month over the last year).

These lessons have been wholly lost on the Japanese who are frantically trying (and succeeding) in severely devaluing the yen. Although Japan's export machine had not suffered from the yen's appreciation from 2001-2012 (up 30% in local currency exports and 98% in dollar terms), newly installed prime minister Shinzo Abe and his minions at the Bank of Japan believe a weaker yen is the key to renewed economic strength. But the collapse of the yen has helped push up both the Aussie and Kiwi dollars, which has spurred bankers in Australia and New Zealand into taking unneeded and ultimately self-destructive actions. In April they threw in their lot with the interventionists and cut interest rates to stop the rise of their currencies. But the moves fly in the face of the modern playbook which states that policy should be tightened during periods of full employment, strong growth, and surging real estate prices. The misplaced fear of a strong currency seems to trump all other concerns.

While there is little reason to believe that strong currencies stifle exports, there is ample evidence that they increase domestic purchasing power (which is a real test of economic success). In the United States, oil currently sells for about $97 per barrel, about 16% below the $113 high price seen in April 2011. And so while our economy falters, at least consumers are not saddled with surging energy costs. While the 20% devaluation of the yen since that high in 2011 has made Japan the champion of Keynesian economists, it also means that oil in Japan is currently selling for the highest price since the financial crisis of 2008-2009. And it's not just oil, the Japanese must pay more for everything they import. How this benefits the rank and file has yet to be properly explained.

The latest data confirms that the banzai attack on the yen has not helped Japan's trade position. The weaker currency led to higher import costs, resulting in the 10th month in a row of trade deficits. Although April exports rose 3.8 percent from a year earlier, the trade deficit widened to 879.9 billion yen ($8.6 billion), the worst April since at least 1979. But the falling yen is creating a clear and present danger in Japan's enormous bond market. In less than one month, yields on 10 year Japanese Government Bonds have more than doubled, approaching nearly 1%. While those rates may sound manageable for most countries, Japan has the highest debt to GDP ratio in the developed world. If they had to pay 2% (the same rate as its inflation target), the country would need to devote more than half of its tax revenue just to service its debt! Clearly this possibility is dawning on stock investors who pushed down the Nikkei by more 7% today.

Never in the course of history has a country's economy failed because its currency was too strong. It's a pathology that simply does not exist. On the other hand, the list of those ruined by weak currencies is extensive. The view that a weak currency is desirable is so absurd that it could only have been devised to serve the political agenda of those engineering the descent. And while I don't blame policy makers from spinning self-serving fairy tales (that is their nature), I find extreme fault with those hypnotized members of the media and the financial establishment who have checked their reason at the door.

A currency war is different from any other kind of conventional war in that the object is to kill oneself. The nation that succeeds in inflicting the most damage on its own citizens wins the war. The only real way to win is not to play.

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday! 

And be sure to order a copy of Peter Schiff's recently released NY Times Best Seller, The Real Crash: America's Coming Bankruptcy - How to Save Yourself and Your Country



Tags:  currenciesJapan
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Japan Steps into the Void
Posted by Peter Schiff on 04/19/2013 at 1:36 PM

In the years following the global financial crisis, economists and investors have gotten very comfortable with very high, and seemingly persistent, government debt. The nonchalance may be underpinned by the assumption that globally significant countries that can print their own currencies can't get trapped in a sovereign debt crisis. However, it now appears that Japan is preparing to put this confidence to the ultimate stress test.

For the better part of 20 years, successive Japanese governments and central bankers have been trying, unsuccessfully, to use quantitative easing strategies to pump up a deflated asset bubble. The economy has by and large not responded. The sustained and impressive growth that Japan delivered during the 45 years following the Second World War (which had made the country one of the most successful economic stories in world history), has never returned.  For the last 20 years Japan has offered a "zombie" economy characterized by low growth, stagnation, and exploding government debt. The Japanese government now owes approximately $12 trillion, a figure representing more than 200% of GDP. The IMF expects that this figure will reach 245% by the end of this year. This gives Japan the unenviable title of having the world's highest government debt-to-GDP ratio. But Shinzo Abe, the newly elected Prime Minister of Japan, and Haruhiko Kuroda, his newly-appointed Governor of the Bank of Japan, feel much, much more debt needs to be issued to turn the economy around.

The hope that Abe would be a new kind of prime minister with a bold economic formula helped revive the long dead Japanese stock market. Between May and November of 2012, the Nikkei traded within a range of 8200-9400. As Abe's victory began to be expected, the Nikkei started moving up, reaching 10,000 by the time he was sworn in on December 26 of last year. The euphoria continued throughout the spring and by April 2 the Nikkei stood at 12,003 points. Then on April 4, BOJ Governor Kuroda made good on Abe's dovish rhetoric and announced a plan to end years of mildly declining prices by doing whatever necessary to create 2% inflation (in reality these price declines have  been one of the few consolations to Japanese consumers). To achieve its goals, the government is prepared to double the amount of Yen in circulation. Stocks immediately rallied, and in less than a week the Nikkei had breached 13,000 points, taking the index to a 4 1/2-year high. It is rare that any major stock market can achieve a 50% rally in less than a year. But the rally will be costly.

The Japanese government already spends 25% of tax revenue to service outstanding debt (compared to 6% in the US). These costs become even more astonishing when one considers the extremely low rates Japan pays. Ten-year Japanese government bonds now pay less than 0.6%, and five-year yields are now a little more than 0.20%. How much will debt service costs increase if Abe succeeds in pushing inflation to 2.0%? Two percent rates would triple long term borrowing costs. Given the size of its debts, increases of such magnitude could hit Japan with the force of 10 Godzillas.

Japan has an aging demographic and as more time goes by, the pool of potential bond buyers continues to shrink. Unlike the United States, where individual savers are mostly irrelevant in the sovereign debt market, Japanese investors have largely set the market in their own country. There is evidence to suggest that Japanese savers are increasingly considering overseas sources of yield for protection from the inflation that Abe is so determined to create.

As the Nikkei has moved upward, the Japanese Yen has taken the opposite trajectory, falling more than 20% against the U.S. Dollar since the beginning of 2012, and nearly 12% since the beginning of this year (the decline has been even greater in terms of several other currencies). This steep drop, which has taken a huge bite out of the nominal gains in Japanese stocks is unusual in the foreign exchange markets, and has threatened to destabilize an already weak global financial system.

Earlier this year the falling yen issue sparked a full-fledged headline war. On February 16th, participating members of the G20 issued a statement, clearly aimed at Japan, warning against competitive devaluations and currency wars. A day later, Japan's Finance Minister stated flatly that Japan was not attempting to manipulate its currency. After some hesitation, the G20 seemed to accept this statement. For now it seems the international powers have fallen in behind Japan. Both IMF Chief Christine Lagarde and Ben Bernanke have praised Abe's policies. The prevailing opinion seems to be that weakening a currency should not be considered manipulation as long as it's done to revive a domestic economy, not specifically to harm competitors. Such an opinion qualifies as a great moment in rhetorical shamelessness. 

In addition to his plans for inflationary monetary policy, Abe is also attempting to wage war from the fiscal side as well. His Liberal Democratic Party has called for over $2.4 trillion USD worth of public works stimulus over the next 10 years. This spending represents approximately 40% of Japan's current GDP and, adjusted for population, would be the equivalent of nearly $600 billion USD annually in the United States.

It should be obvious to anyone with even half a brain that Japan's prior experiments with ever larger doses of quantitative easing have failed. Leaders in both Japan and the United States, however, are following this path with reckless abandon. According to Abe, the entirety of Japan's economic problems can be blamed on the fact that consumer prices have been declining by one tenth of one percent per year. If only Japanese consumers were forced to pay two percent more per year for the things they need or desire, all would be well. 

Abe's wish may already be coming true. McDonald's announced this morning that, for the first time in 5 years, the price of hamburgers and cheeseburgers in Japan will be rising by 20% and 25% respectively. No doubt the Japanese will be so excited by this development that they'll rush to the stores to consume all the burgers they were planning on eating in 2014 before prices go up again. Of course there is no official concern that low-income Japanese will now have to pay more for low cost food. 

The idea that informs Abe's plan, that rising prices entice consumers to buy before the prices go up, is clearly suspect as economic law dictates that demand increases when prices fall. Any store owner will tell you that cutting prices is the best way to move merchandise. Apart from this problem, how does Abe expect consumers to buy more when their currency is losing purchasing power and more of their incomes will be needed to pay interest on the national debt?    

The boldness of Abe's plans should provide the rest of the world with a crash course in the ability of debt accumulation to jumpstart an economy. The good news is that the effects should not take too long to be seen. I believe that we will be treated with a stark lesson on the limitations of inflation as an economic panacea.

Hopefully, failure of this latest Japanese experiment will help convince leaders in the U.S. and Japan that the only true path to prosperity is free market capitalism. Rather than trying to reflate busted bubbles and micro-manage Keynesian style recoveries, politicians and central bankers should recognize their respective roles in creating the problems and get out of the way.  

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday

And be sure to order a copy of Peter Schiff's recently released NY Times Best Seller, The Real Crash: America's Coming Bankruptcy - How to Save Yourself and Your Country

Tags:  Bank of JapaninflationJapanyen
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The Stimulus Trap
Posted by Peter Schiff on 03/28/2013 at 10:01 PM

For years we have been warned by Keynesian economists to fear the so-called "liquidity trap," an economic cul-de-sac that can suck down an economy like a tar pit swallowing a mastodon. They argue that economies grow because banks lend and consumers spend. But a "liquidity trap," they argue, convinces consumers not to consume and businesses not to borrow. The resulting combination of slack demand and falling prices creates a pernicious cycle that cannot be overcome by the ordinary forces that create growth, like savings or investment. They say that a liquidity trap can even resist the extraordinary force of monetary stimulus by rendering cash injections into useless "string pushing." Some of these economists suggest that its power can only be countered by a world war or other fortunately timed event that leads to otherwise politically unattainable levels of government spending.

Putting aside the dubious proposition that the human desire to strive and succeed can be permanently short-circuited by an economic contraction, and that modest expected price declines can quell our desire to consume, the Keynesians have overlooked a much more dangerous and demonstrable pitfall of their own creation: something that I call "The Stimulus Trap." This condition occurs when an economy becomes addicted to the monetary stimulus provided by a central bank, and as a result fails to restructure itself in a manner that will allow for robust, and sustainable, growth. The trap redirects capital into non-productive sectors and starves those areas of the economy that could lead an economic rebirth. The condition is characterized by anemic growth and deteriorating underlying economic fundamentals which is often masked by inflation or asset price bubbles (I look at how stimulus has impacted the U.S. stock market in the March edition of my newsletter).

Japan has been caught in such a stimulus trap for more than a decade. Following a stock and housing market boom of unsustainable proportions in the 1980s, the Japanese economy spectacularly imploded in 1991. The crash initiated a "lost decade" of de-leveraging and contraction. But beginning in 2001, the Bank of Japan unveiled a series of unconventional policies that it describes as "quantitative easing," which involved pushing interest rates to zero, flooding commercial banks with excess liquidity, and buying unprecedented quantities of government bonds, asset-backed securities, and corporate debt. Although Japan has been technically in recovery ever since, its performance is but a shadow of the roaring growth that typified the 40 years prior to 1991. Recently, conditions in Japan have deteriorated further and the underlying imbalances have gotten progressively worse. Yet despite this, the new government is set to double down on the failed policies of the last decade.

I believe that the United States is now following Japan into the mire. After the crash of 2008, we implemented nearly the same set of policies as did Japan in 2001. In the past two years, despite the surging stock market and apparently declining unemployment rate, the size and scope of these efforts have increased. But as is the case in Japan, we can clearly witness how the stimulus has perpetuated stagnation. (See my analysis of the new plans of the Japanese government).   

In 2008, one of the country's biggest problems was that we had over-leveraged too many non-productive sectors of the economy. For instance, we irresponsibly lent far too much money to people to buy over-priced real estate. Since then, the problem has gotten worse. Currently the process of writing, securitizing, and buying home mortgages has been essentially nationalized. Fannie Mae and Freddie Mac (which are now officially government agencies) write and package the vast majority of new home mortgages, which are then guaranteed (almost exclusively) through the Federal Housing Administration, and then sold to the Federal Reserve. According to a tally by ProPublica, these government entities bought or insured more than nine out of 10 home mortgages originated last year, a $1.3 trillion business. Compare this to 2006, when the government share was only three in 10. As a result of this, our lending is far more irresponsible than it has ever been.

In the fourth quarter of 2012, 44% of all FHA borrowers either had no credit score or a score of 679 or lower. In addition, the overwhelming majority of FHA guaranteed loans are being made at 95% or greater loan-to-value. This means down payments are an afterthought. Under the FHA's Home Affordable Refinance Program (HARP), loans are now even extended to underwater borrowers whose mortgages may be worth far more than their homes. As a result, the FHA could be exposed to enormous losses in the event of future housing market downturns. Such an outcome would be likely if mortgage interest rates were ever to rise even modestly from their current low levels. 

In fact, losses on low-quality mortgages have already left the FHA with $16 billion in losses. To close the gap, it has had to raise the insurance premiums it charges to borrowers. With those premiums expected to rise again next month, many fear that marginal borrowers could be priced out of the market. But rather than learning from its mistakes, the government just announced that Fannie Mae would pick up the slack, lowering its lending standards to match the ones that had led to losses at the FHA. In other words, we haven't solved the problem of bad lending - we have simply made it bigger and nationalized it. 

The overall financial sector is equally addicted to cheap money. Banks have seen strong earnings and rising share prices in recent years. But their businesses have largely focused on the simple process of capturing the spread between the zero percent cost of Fed capital and the 3% yield of long term Treasury debt and government insured mortgage backed securities. As a result, banks are not making productive private sector loans to businesses. Instead, the capital is being used to pump up the already bloated housing and government sectors.

Corporate profits are indeed high at the moment, but much of that success comes from the extremely low borrowing costs and extremely high leverage. Investors chasing any kind of yield they can find are pouring money into companies with dubious prospects. This January, yields on junk rated debt fell below 6% for the first time. Currently they are approaching 5.5%. Consumers are using cheap money to buy on credit. Savings rates are now hitting post-recession lows.

Lastly (but certainly not least), the Federal government is now totally dependent on the Fed's largess.  Without the Fed buying the bulk of Treasury debt, interest rates would likely rise, thereby increasing the cost of servicing the massive national debt.  While Congress and the media have focused on the $85 billion in annual cuts earmarked in the "Sequester," an increase of Treasury yields to 5% (3% higher than current levels) on the $16 trillion in outstanding government debt would translate to $480 billion per year of increased interest payments. Such an increase would force a tough choice between raising taxes, cutting domestic spending or reducing interest payments sent abroad for debt service. If foreign creditors begin to doubt that America has the resolve to make the hard choices, they may refuse to roll-over maturing obligations, forcing the government to actually repay principal.  With trillions maturing each year, actual repayment is mathematically impossible.

But for now most people feel that the transition is underway to a healthy economy. The prevailing debate is when and how the Fed will let the economy fly on its own. Many of the top market analysts have great faith that Ben Bernanke can pull the monetary tablecloth off the table without disturbing the dishes. Those who hold this view fail to understand that the United States is caught in a stimulus trap from which there is no easy exit. How can the Fed wean the economy from stimulus when stimulus IS the economy?  In truth, the trick Bernanke must actually perform is to pull the table out from beneath the cloth, leaving both the cloth and the dishes suspended in air. (Read how Iceland confronted its own crisis while avoiding the stimulus trap).

What would happen to the Treasury market if the Federal Reserve, by far the biggest buyer and largest holder of Treasury bonds, became a net seller? Who will be there to keep the sell off from becoming an interest rate spiking rout? It may sound absurd to those of us who remember the economy before the crash, but our new economy can't tolerate "sky high" rates of four or five percent. What would happen to the housing market and the stock market if interest rates were to return to those traditional levels? The red ink would flow in rivers. With yields rising and asset prices falling, how long would it take before the Fed reverses course and serves up another round of stimulus? Not long at all.

That means any talk of an exit strategy is just that, talk.  Not only can the Fed not exit, but it will have to delve further into the stimulus abyss.  While doing so, the Fed will continuously insist that the exit lies just behind an ever moving horizon. It will repeat this mantra until a currency crisis finally forces a painful exit.

Unfortunately, the longer the Fed waits to exit, the more painful the exit will be. But trading long-term pain for short-term gain is the Fed's specialty. In the meantime, Wall Street watches in uncomprehending stupor as the economy settles deeper and deeper into the stimulus trap. 

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, John Browne, and other Euro Pacific commentators delivered to your inbox every Monday! 

And be sure to order a copy of Peter Schiff's recently released NY Times Best Seller, The Real Crash: America's Coming Bankruptcy - How to Save Yourself and Your Country

Tags:  federal reserveFedsJapanSequester
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Treasury's Last Pillar Crumbles
Posted by Peter Schiff on 01/03/2013 at 7:20 AM
With the return of Shinzo Abe and his Liberal Democratic Party to power in Japan, the market for US Treasuries may be losing its last external pillar of support. Re-elected on September 26th, Abe has quickly set a course for limitless inflation, saying Japan must "free itself from deflation and the strong yen." This is significant to the global economy as Japan is the largest foreign power left with a strong appetite for US Treasuries. If this demand falters, the Fed may be the only remaining buyer of new Treasury issuance.
 
Abe's Plan
 
This election marks Abe's second turn in the premier's seat. He first held the position from 2006 to 2007, when he abruptly resigned as the first of a string of unpopular one-year premierships. Notably, in the intervening time, the LDP lost its lower house majority to an opposition party for the first time since its formation in 1955. The victors, the Democratic Party of Japan, had been formed in 1998 on a platform of reducing corruption and making Japan more progressive.
 
Unfortunately, as we know from our past century of experience in America, progressivism is not the cure for an ailing economy. The DPJ was predictably unsuccessful at reining in the bureaucracy, but did manage to push through a damaging doubling of the national sales tax and additional entitlement spending.
 
Similarly to President Obama's 2008 election, the Japanese people were sold a lot of rhetoric about hope and change and, lacking any sincere alternatives, decided to give the new guys a shot. The results were equally disappointing on both sides of the Pacific. 
 
While American voters decided to throw good votes after bad in 2012, the Japanese preferred to return to the devil they know. The only problem is, he's still a devil.
 
Abe has essentially promised to return to the failed but feel-good policies of LDP government for the last 3 decades; namely, he will prop up failing industrial giants and attempt to print his way out of an economic slump.
 
Saving Grace or Pain in the $%&?
 
The yen hit a post-war high against the US dollar in 2011 and has remained strong. For sound-money enthusiasts, this has been cause for celebration. But for Keynesian demand-siders, it's a crisis.
 
Rather than attribute decades of sluggish growth to an interventionist industrial policy, Abe and his cadres are blaming the strong yen. In response, Abe has called for the Bank of Japan to target at least 3% inflation.
 
For some time, the only saving grace for Japanese citizens who are unable to find jobs or secure financing has been that prices have been stable or falling. Abe intends to rob them of that salve while doing nothing to address the underlying infection.
 
While some Americans may feel a self-interested sense of relief that one of the major dollar-alternatives is being undermined from within, they are misunderstanding the knock-on consequences of this move.
 
The Last Major Pillar
 
For the Treasury to continuing having successful auctions at current rock-bottom interest rates, someone has to be purchasing. A lot. 
 
Before 2008, most of the demand came from foreign central banks - especially China. Since the financial crisis began, China and many emerging market banks have dramatically reduced their purchases and even become net sellers. 
 
The deficit has been made up by the Federal Reserve, domestic personal and institutional investors, and a few foreign holdouts led by Japan. In fact, Japan is about to overtake China as the largest foreign holder of US government debt.
 
This is significant in that the other two sources of funding - Fed and US domestic - are essentially intertwined. The more Treasuries the Fed purchases, the higher inflation becomes, which harms the US economy even further, which leaves domestic funds less wealth to invest in Treasuries. In my view, the foreign influx of capital has been the key third pillar that has kept this vicious domestic cycle from playing out in full.
 
How It Crumbles
 
Prime Minister Abe's plan to devalue the yen could thus be disastrous for both US and Japanese government finances. As the yen devalues, Japanese domestic investors - who make up the bulk of owners of Japanese Government Bonds (JGBs) - will be under intense pressure to sell out and find higher yields elsewhere. 
 
This flight of capital will threaten Tokyo with default, so the likelihood is that the Bank of Japan will begin directly buying JGBs on an even larger scale (as our Fed has done since the financial crisis) instead of buying US Treasuries. They may even become net sellers of Treasuries in order to finance their bailout of Tokyo while controlling inflation.
 
This will, in turn, put tremendous pressure on US Treasury investors. As the outflows mount, the Fed will no doubt announce another program to buy Treasuries under the guise of promoting economic stability. If the Fed becomes the permanent crutch of the Treasury, we can expect inflation to get higher and higher - driving more and more investors out of Treasuries.
 
Decoupling Continues
 
It is clear that Washington and Tokyo are but two sides of the same coin. Japan's debt-to-GDP is about 212%, while the US has just crossed 100%. Both are highly dependent on domestic investor interest in government debt to keep the charade going, and neither have prospects of paying their debts without real write-downs for investors. 
 
Unfortunately, neither government is using the time before this real crash strikes to even attempt to shore up their positions. The platform of Shinzo Abe seems poised to undermine Japan's ability to continue subsidizing US government debt. Left without any significant external supports, Treasuries will be in an extremely weak position when attention shifts from the EU sovereign debt crisis to the our own tattered finances.
 
Fortunately, there are ways for investors to escape Abe and Obama's tandem cliff-dive. Recent data shows that China continues to build a viable alternative. The South Korean won and Taiwan dollar are now significantly more correlated to the movements of the yuan than the yen or the US dollar. These booming economies will sustain demand for commodities as they build real wealth. With the old statesmen of sovereign debt compromised, I expect the up-and-comers to continue to turn to gold and silver in droves.

Peter Schiff is CEO of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known bullion coins and bars at competitive prices. 

Click here for a free subscription to Peter Schiff's Gold Letter, a monthly newsletter featuring the latest gold and silver market analysis from Peter Schiff, Casey Research, and other leading experts. 

And now, investors can stay up-to-the-minute on precious metals news and Peter's latest thoughts by visiting Peter Schiff's Official Gold Blog.


Tags:  ChinadollarinflationJapantreasuriesyen
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END GAME
Posted by Peter Schiff on 06/14/2011 at 9:19 AM

Economic data over the past weeks, punctuated by last week's dismal employment reports, confirm the diminishing impact of the stimulus efforts orchestrated by the Obama Administration and the Federal Reserve. In what must be a huge disappointment to Keynesian enthusiasts, the record doses of both monetary and fiscal narcotics did not produce the desired results. In fact, the size and scope of the "recovery" of the past two years was weaker than would have been expected in a typical business cycle recovery without any stimulus whatsoever. Indeed our current recovery is the weakest on record, despite the biggest jolt of government stimulus ever administered.

 

But despite the gathering gloom Austan Goolsbee, the Chairman of the President's Council of Economic Advisors, argued over the weekend that the economy is on the right track and that the recent salvo of horrific economic reports were not significant. The poor numbers, he said, resulted from external factors like the Japanese earthquake and the downgrade of European sovereign debt. I don't know if he really expects anyone to buy his story, but admitting you have a problem is the first step toward recovery.

 

In a sign that Mr. Goolsbee may have been getting increasingly uncomfortable with his job of economic propagandist, he abruptly resigned this week. He will be returning to academia where I'm sure he is hoping to avoid blame for the coming economic train wreck.

 

Although I have made these comparisons before, the parallel between drug addiction and the reliance on economic stimulus is just too strong to ignore. And as with drug addition, an economy builds up a tolerance. Each time the government successively stimulates with printed money or deficit spending, ever larger doses are needed to achieve the same result. Lest we forget, coming into the Crash of 2008, the economy had been on the receiving end of years of over stimulus. President Bush and Alan Greenspan never fully weaned the economy of their shock treatments that followed the dot.com crash and the shock of September 11th.

 

This time around, the stimulus-fueled recovery is so mild that the economy is already relapsing into recession before the Fed has even begun to tighten. This puts Bernanke in a very difficult position. He either follows through on his loudly trumpeted plans to end quantitative easing this summer, or abandon those plans in favor of more stimulus. Both choices are unappealing.



Tags:  Austan GoolsbeebubblecrashGreenspanJapan
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Pentonomics - The Inflation Knuckleball
Posted by Michael Pento on 03/29/2011 at 9:57 AM

By its very definition, fiat money is something created out of thin air: the word "fiat" is Latin for "let it be done" (as in, by decree). But the convenience that such a currency system offers central bankers is paid at the expense of savers. With nothing of real or lasting value on which to anchor, the value of fiat currencies can always blow away like ashes on a windy day. 

For the past 40 years or so, every country on the planet has relied on fiat money. To a very large extent, this means that the national economies are far more exposed to the whims of their central bankers than they have been in the past. So, if central bankers go off their meds, the danger to the currency becomes profound. Unfortunately, at America's Federal Reserve, it seems the inmates are now running the asylum.

We are being led to believe that falling prices are evil, and that only an increase in inflation can save our economy. From the moment the financial crisis took hold in 2008, Fed Chairman Ben Bernanke has looked to lower the dollar's value and cause asset prices to rise - especially in real estate. But his pitch is wildly off the mark. The Fed can't control the exact rate of inflation, nor can it direct where inflation will be distributed across the economy. In other words, inflation is like a knuckleball: once you let it loose, you're never really sure where it's going to go. And Bernanke's pitches are so wild it would make Tim Wakefield jealous.

Thus, we are seeing rising prices everywhere except where Bernanke really wants them - real estate. Data released last week shows that the median price of existing homes declined 5.2% in February compared to the previous year, to $156,100. New home prices fared even worse; the median sales price dropped to $202,100 in February, from $221,900 a year earlier - a tumble of some 9%!

However, commodity prices provide the arena in which the the Fed's lack of inflation control becomes most apparent. So far this year, gold is up over 4% and the CRB Index is up 8%.

Meanwhile, over the same period, the dollar has dropped over 4% against other fiat currencies, according to the Dollar Index. This has occurred despite global economic developments that would normally benefit a currency that has "reserve" status: Japan, the world's third largest economy, has been taken off-line due to a catastrophic earthquake; the EU is facing another massive bailout bill as Portugal failed to pass austerity measures; and, a sandstorm of destabilizing revolutions is sweeping through the Middle East. Yet, instead of providing a safe haven for skittish capital, the dollar has recoiled. 

It's really no wonder that faith is waning. As the dangers of inflation become increasingly apparent, there is still no prospect for a change in policy any time soon. By all reasonable accounts, commodity prices will continue to surge as real interest rates continue to fall. Right now, the yield on the one year T-bill is .23%, while the YoY increase in inflation is 2.1%. And this is using the government's twisted figures! I estimate real interest rates are somewhere close to -8.75%. Therefore, investors are being thrust into the arms of precious metals and away from dollar-based assets. There really isn't much choice.

However, since the real estate market was in a prolonged and lofty bubble, it will be the last asset class to respond to the Fed's dollar debasement strategy. Although Bernanke is noted for his Great Depression scholarship, it should be obvious by now that he never spent much time studying asset bubbles. If he did, he would have learned that gold took decades to recover from its crash in 1981. The NASDAQ is still 45% below its all-time nominal high set over a decade ago. And, unlike housing prices, these markets were allowed to clear themselves after their respective crashes. Prices dipped more than 70% before turning north in earnest. In contrast, home prices are being kept in a rump bubble by Fed stimulus. Amazingly, since 40% of the core CPI is owner's equivalent rent, Bernanke will continue to miss the mark about the true level of the inflation he has created.

The aftershock of the real estate bubble has sent millions of homes into foreclosure, left 11% of homes vacant, and caused 23% of mortgage holders to be without any equity in the home. Unless the Fed starts to create credit to buy houses directly off the market, it will be very difficult to get real estate values to move higher.

It is clear that by trying to channel his inflation into just one asset class, Bernanke has placed the entire US economy in severe danger. He now faces a serious conundrum. Does he raise interest rates significantly to fight inflation at the cost of a second housing market collapse, or does he sit idly by and watch the broader economy become as unaffordable as a resetting Option-ARM mortgage? Neither choice is pleasant, but one thing's for sure: if the bond vigilantes start to raise interest rates for him, we'll know his knuckleball missed the strike zone.



Tags:  Ben Bernankefederal reserveinflationJapan
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Quake Response Puts Yen on the Line
Posted by Peter Schiff on 03/18/2011 at 11:41 AM
One of the immediate financial consequences of the catastrophic Japanese earthquake is that Japan needs to call on its huge cache of foreign exchange reserves to rebuild its shattered infrastructure. To pay for domestic projects, Japan will require yen - not dollars, euros or Swiss francs. As a result of these conversions, the yen rallied considerably after the quake struck.

But a surging yen runs counter to the macro-economic currency plans favored by most global economists. In order to maintain Japan's position as a net-exporter of manufactured goods and net-buyer of US debt, the yen needs to stay down. So, the G-7 group of the world's leading economies has intervened in the foreign exchange market by selling yen holdings, thereby pushing the currency down. In the short-term, their efforts appear to have been "successful," with the yen dropping sharply today.

Theoretically, this action is being taken to preserve export earnings, but this is only a secondary effect. Primarily, in making this move, the G7 is saying that the key to rebuilding Japan's earthquake-ravaged economy is to raise the price of everything it needs to buy.
  
After all, absolute purchasing power is far more important than nominal export earnings. When the yen gains in strength, Japan earns more dollars from its exports, which could now be used to purchase the raw materials necessary to rebuild its infrastructure. However, by weakening the yen, Japan earns fewer dollars for its exports, increasing the economic burden of reconstruction.

Conventional wisdom is that a weakening currency is a boon for economic growth and exports; however, history does not support this view. 

For example, during the 20-year period from 1971 to 1991 - often referred to now as an economic miracle - the Japanese yen tripled in value against the dollar, an average appreciation rate of about 10% per year. This increasing purchasing power enabled the Japanese to enjoy steady economic growth and rising living standards. Over that time, Japan's GDP grew at an average rate of 4.5% and net exports increased fivefold. Government debt as a percentage of GDP fell slightly to about 20%. 

Over the following 20 years, from 1991 - 2011, the Japanese economy has been dead in the water. Yen appreciation slowed considerably, with the currency rising by approximately 50% against the dollar, or about 2.5% per year. However, over that time, the Japanese economy and net export growth essentially stagnated, with GDP growing by less than 1% per annum and government debt exploding to over 120% of GDP. 

The real problem for Japan is that in the aftermath of the bursting of the stock and real estate bubbles, the Japanese government refused to allow market forces to repair the damage. Instead, it based its foolish approach on restricting the rise in its currency to maintain exports to the United States.  In this cart-before-the-horse worldview, Japan assumed its economic growth was a function of its exports. In reality, exports flow from economic growth.

So, in order to engineer an export-led recovery, Japan embarked on an era of central government planning, Keynesian style pump-priming, and nearly endless quantitative easing. The result was disaster. The only bright spot was that the underlying strength of the Japanese economy kept a lid on consumer prices despite all the inflation deliberately created by the Bank of Japan. So even while good jobs have become harder to find, ordinary consumers have had the benefit of falling prices. It is ironic that Japan's "deflation" is cited as the primary cause of its malaise. If Japan's economy had been less efficient, its 20-year malaise would have been accompanied by increasing consumer prices, a.k.a. stagflation. This would have caused much more suffering to the Japanese people.

Still, as a result of its enormous economic policy errors, much of Japan's efforts over the past 20 years have benefitted Americans rather than its own citizens. A tremendous share of their purchasing power was transferred across the Pacific, helping to inflate a bubble economy in the United States. Of course, as the Japanese economy struggled beneath the weight of this massive American subsidy, it gradually passed the baton to China, which for the same foolish reasons was happy to run with it.

The unfortunate reality is that the Japanese government is doing more economic damage to Japan than the earthquake and tsunami did. This new round of inflation will overwhelm the ability of the Japanese economy to offset upward pressure on consumer prices. Combine that with the lost output associated with the quake and the expense of reconstruction, and it becomes evident that inflation will soon become a major threat to Japan. As this realization forces interest rates higher, the cost to Japan of servicing its massive government debt will be crushing. 

There is still time for Japan to rethink its self-destructive monetary policy, let its currency rise, and allow its economy to recover. If they do, the US will experience its own disaster as the dollar tanks.


Tags:  Japanyen
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Japanese Fallout May Hit Treasuries
Posted by Peter Schiff on 03/18/2011 at 9:50 AM

Japan is facing two meltdowns in the wake of its devastating earthquake. The first, and more critical, is the meltdown at the Fukushima I Nuclear Plant, 150 miles north of Tokyo. Surely, this is the greater near-term threat. But long-term, another threat looms, having to do with the Japanese government's response to the former.

As the fourth largest economy in the world, behind the EU, US, and China, any major setback in Japan likely will have widespread repercussions. Japan is also the third largest holder of US Treasuries, behind the United States and China. While it is too early even to assess the Japanese damage accurately - let alone to forecast the full implications - it is possible to see the potential for a meltdown of the US Treasury market and international monetary system.

Current estimates hold that the Japanese disaster has already lowered world economic growth by a full percentage point for the year.

Leaving aside massive international aid, a complete nuclear meltdown, or other escalations, Japan already will have to spend a massive amount of money to cope with the current disaster. This raises the question: from where will such an enormous amount of money come?

Japan could borrow. However, with a debt-to-GDP ratio of some 200 percent, or twice as bad as that of the United States, and with the main credit rating agencies exercising more scrutiny than before the Credit Crunch, raising funds will be difficult at an economic rate of interest. Moreover, Japan will likely be spending a large chunk of its foreign exchange reserves to buy oil to replace its lost nuclear power generating capacity - diminishing its collateral in the eyes of creditors.

Japan could follow the US example and "paper over" its problems. But without the benefits of being the international reserve currency, the Japanese would immediately feel the effects of domestic inflation. The Bank of Japan has already pumped out ¥8 trillion ($98 billion) in the wake of the earthquake, but it is unlikely to try to match the Fed's $600 billion printing spree this quarter.

So, if Japan is limited in its ability to borrow or print money, it may have to sell part of its vast holdings of US Treasuries.

At the end of last month, the US Treasury had outstanding debt worth some $14.19 trillion. This represents 96.8 percent of the total $14.66 trillion value of business generated within the United States for the entire year of 2010. It is just short of the $14.294 trillion debt limit set in 2010 by a profligate Democrat Congress. To put it in perspective, the US government now owes $91,400 for every working American. However, this represents only some 22 percent of Washington's $62 trillion of unfunded obligations, which include Social Security, Medicare, housing, and other guarantees.

Japan is the third largest holder of US Treasuries ($877 billion), behind China ($896 billion) and the Fed ($1.108 trillion). Should Japan start selling Treasuries in large amounts to fund the repair of its economy, it could have a serious effect on US interest rates and the market value of Treasuries the world over. US bonds are widely held by central banks, international banks, and insurance companies, which already are concerned about their funding of loss claims arising from the damage in Japan.

Thus, a Japanese selloff could trigger a liquidity crisis like the one following the collapse of Lehman Bros. and AIG. Large institutions may not be willing or able to bear with US bonds through a steep correction.

Western economies are on thin ice as it is, even without a shock in their presumed "safe" asset.

Stock markets in the EU and US are weakening, destroying large amounts of private wealth and potential consumer confidence.

Further, the EU is facing the reality that the financial rescue programs it organized to save some of its members are not working. China and Japan offered to help. Now Japan may not be able to fulfill its promises. This could reignite further speculative downward pressure on the euro.

It seems that while we are all concerned about the effects of nuclear meltdown on the residents of Japan, we should also be aware that the fallout could spread further in the financial markets than it does in the atmosphere. Just as Californians are stocking up on iodide pills as a precautionary measure, investors should be stocking up on hard assets. After health, it's vital to guard your wealth - especially in emergency times like these.



Tags:  Japantreasuries
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Japan Intervenes to Bail Out America.com
Posted by Peter Schiff on 09/17/2010 at 4:21 PM

This week, after the Japanese yen had surged to a fifteen-year high against the US dollar, the Japanese government decided to intervene in the foreign exchange market. To great fanfare, the Bank of Japan initiated a vigorous campaign to buy US dollars, thereby stemming the rise of the yen and pulling up the greenback. The effects were immediate, with the yen falling an astonishing 3% on the day of the announcement. At a time when American politicians are growing increasingly vocal about China’s currency manipulations, Washington was strangely silent on the Japanese move. This was completely overlooked by the hawkeyed media.

While missing this blatant irony, the media spin doctors cast the Japanese decision as an attempt by the island state to prop up its own fragile economy. More accurately, the intervention was done to help American consumers buy more cars and electronics from Japan. In truth, although more American purchases would nominally benefit some Japanese exporters, a weaker currency is a detriment to the overall Japanese economy.

The politics of currency intervention are actually quite simple. Japan’s economy is dominated by large manufacturers that export lots of goods to Americans. The problem is that Americans can’t really afford to buy in the quantities that they did just a few years ago. So, instead of looking for new customers with more money to spend, either in their own country or in other productive economies, Japanese manufacturers use their political clout to lobby their government to bailout their traditional U.S. customers. The bailout takes the form of a direct transfer of purchasing power from Japanese savers to American consumers, so that Americans can continue buying products they couldn’t otherwise afford. In short, pushing up the dollar allows Japanese exporters to postpone a necessary, but costly, restructuring.

The tendency for governments to sacrifice the needs of the general population in favor of entrenched corporate interests is not unique to Japan. In the United States, we have taken similar measures on behalf of our dominant industries. However, instead of manufacturers and exporters, whose political clout has waned along with their economic prospects, Washington has moved to protect the profits of the financial, retail, and real estate industries– the true heavyweights of the American corporate world. These industries profit when Americans borrow money to buy things they can’t afford. To keep this behavior going, the government must make it possible for consumers to take on more debt; but, in so doing, these policies have left us with an ailing economy in need of deep and drastic restructuring.

In a way, what the Japanese government is doing for American consumers is very similar to what our government is doing for American homebuyers. Rather than let home prices fall, the US government subsidizes homebuyers so they can continue overpaying for houses they cannot actually afford. The beneficiaries of these moves are those selling, building, and financing overpriced homes. Unfortunately, the last thing we need as a nation is to build, buy, or finance more homes. Our economy would improve if the resources devoted to the real estate market could be devoted to other, more needed industries. 

Japan should allow the dollar to fall, which would force their manufacturers to adapt to a changing global market where Americans consume less, and those in emerging markets consume more. Instead, it is vainly trying to preserve the status quo and appease entrenched political factions.

Just like here in the US, Japanese politicians take cover by falsely claiming that the intervention “saves jobs.”  However, the jobs that are saved come at the expense of more productive jobs that are either lost or not created. If Americans cannot afford to buy Japanese products, it makes no sense for the Japanese to continue selling them to us. Rather they should devote their time, effort, savings and resources to selling products to customers who can actually afford to pay.

Japan’s bailout of American consumers is nothing more than international vendor financing. This is the same technique used by telecom companies during the Internet boom of the late ‘90s. In order to pump up short-term profits, manufacturers of communications gear loaned money to cash-strapped Internet startups so they could buy switches and routers. Of course, when the dot-coms went bankrupt, all those phony sales were written off; then, the stocks of those companies doing the financing, like Cisco, Lucent, and Nortel, collapsed as well (though they did not collapse to zero like the dot-com companies). Although their performance would have lagged during the boom, the equipment manufactures would have been in far better shape fundamentally if the phony sales had never been made.

The same fate awaits the US and Japan. In this analogy, Japan is Cisco and the United States is Pets.com. Sooner rather than later, both Japan and China will realize that they have been hoodwinked by a fast-talking sock puppet without a credible plan to pay them back. When that happens, they will take the write down and let us fend for ourselves.



Tags:  dollarJapanyen
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