United States, the next Japan? The Taste of Deflation

Is Japan's current economy a sign of things to come for the United States? In the 80's, Japan's financial markets and real estate market created a bubble much like our bursted bubble today. Although we are not having to issue 100 year bonds and US citizens are not acquiring foreign skyscrapers and other forms of real estate around the world, at our real estate apex much like Japan's, real estate values were over-valued creating their bubble, where trillions were wiped out. Sound familiar? Although we have not lost trillions(yet), we have not fully felt the repercussions of the easy credit which we are feeling in our residential real estate, but not quite yet in our commercial sectors, which means our bubble is still half full. Whenever there is easy credit, there is increased risk taking and an increase in the likelihood for default. Furthermore, with increasing bank regulations, loan officers and the investment community are having a hard time finding profitable investments and consumers are starting to increase their savings at a time when the economy really needs their old spending habits. As these savings rates increase and people fear the safety of their banks, who already give little incentive to save with the bank with low interest rates, compared to burying a can in the backyard or under the mattress, the government started to subsidize those failing banks and businesses. Sound like AIG, Citi, BOA, Merrill or familiar? Yes, well this was Japan back then. Alarming? It should be because they called this period of time "the lost decade". The Nikkei bottomed out around 7600, we hit a bottom of 7000. Furthermore, we are stuck at the moment when Japan started their unsuccessful quantitative easing policy creating their "lost decade", where they tried to artificially create inflation. In addition, this is what the news is talking about when they are talking about the United States being the next carry trade. Furthermore, Japan is still stuck in deflation or stagflationary economy, where the Nikkei 225 is stuck at half its peak value. The main reasons for this deflated "lost decade" are bubbles in equities and real estate.

During the "lost decade", the banks continued to lend to companies and individuals that continued to invest in real estate, when the values dropped, these loans went unpaid and banks delayed the decision to collect on the collateral in hopes that asset prices would improve, escalating deflation. In addition, these banks were unable to lend more money until their cash reserves were built up to cover potential bad loans. This is where TARP was helpful for us to some degree. TARP was designed to reduce the quantity of these bad loans and to increase the funds available for economic growth, kind of like grease for the economy. In fear of insolvent banks, Japanese citizens were afraid of bank failures increasing their holdings in gold and real estate. Interestingly, sounds all too familiar and Japan's economy is still in a rut.

Now, Japan has a dilemma with it's demographic shift, much like our "Greying of America" compounded with a decreasing birth rate and decreasing wages, exacerbating deflation. Decreasing wages caused by retiring, top pay scale, baby boomers being replaced with lower pay, contract hire, and part time employees decreasing salaries close to 10 percent in the last decade.

TBC