Are we at the end of the line?

Posted by Ray on March 16, 2011 under Main | Be the First to Comment

I rarely wear my beliefs on my sleeve and I do not mean to start doing so now, but I have been doing a lot of thinking and praying for the people in Japan. The images we are seeing and the reports we are bombarded with are horrifying to say the least. It also proves that we are all interconnected and what happens abroad does indeed impact us here in the US, even earthquakes and tsunamis. I hope that all who read this will take a minute to at least think a few kind thoughts of well being for the people if not outright say a prayer, donations to the Red Cross would not hurt either.

With all that said it is shameful for many of the pundits to hop in the TV and talk about how good this tragedy is for the Japanese economy. It is not a good thing and it will not bring prosperity to anyone let alone to the US. First and foremost, Japan likes to keep its business local so I can assure you Caterpillar will not win out on contracts versus its local competitors. Over and above that this horrible event will create a huge drag on global GDP as the number 3 player is out of the game and who knows how the nuclear situation will turn out. That means Apple should have saved its $200 on its press release announcing its plans on postponing the launch of the iPad 2 in Japan since everyone knew that already and, frankly, who really cares about the iPad launch in Japan when the locals are being exposed to radiation.

With the number 3 player out of the game the economy in the US, China and the world will slow, I am sure of this. It also means QE 3 is a given and the next one will be a fairly sizable easing program. I am so sure about more QE because the Japanese will have to sell treasuries at some point to cover the rebuilding effort. Their central bank have added an astounding 55 trillion Yen, $700B USD, of extra liquidity, but not even the Japanese can print their way out of this thing. They will have to sell and there is no one to pick up the slack for US treasuries right now, to the level of selling that will come. On top of that I believe Japan selling may be the trigger for China to unload some holdings as well, we will see about that. The Fed is the only one around to pick up the slack and give the US Treasury interest free loans, since earnings must be repaid to the treasury department.

Even before this tragedy I was perplexed about the Fed’s QE 2 program. It was not needed, in my opinion, as rates were low already and capital was flowing again. The only reason I could see QE 2 being needed for was to prop up the stock market and by Bernanke’s own admission that is what it did since bond yields have only gone north since the start of the program, the opposite of what Ben wanted to happen. Besides the markets needing a boost the only other reason I could think of for this type of easing program was that the end of the line was here. What I mean is that the Fed may have known that the market was going to want higher interest rates from the US since we have piled on the debt in the last few years.

Basic mathematics tells you that the US cannot handle higher debt servicing costs which is why the treasury rolled out over 50% of our debt to mature in less than 7 years. On top of that every 1% increase in debt servicing costs adds about $120B a year to the budget which is also known as the debt death spiral. However, with QE 2 the Fed can jump in and buy up this higher yielding paper and kick back 95% of the interest back to the treasury department, almost an interest free loan, which explains why the Fed is monetizing, sorry, buying just issued higher yielding paper. This signals to me that the US government may have reached a breaking point in its debt load.

I am not saying the US cannot issue more debt, not at all, what I am saying is people will want higher rates to hold the paper. No one believes that there is no inflation out there and the only time we see any interest is when things really hit the fan like right now. Think back a couple of weeks ago when the Middle East was revolting treasuries sis nothing and the dollar sank. Compare that to now treasuries are going up but only on the short end of the curve and the dollar, what you really should be watching, is not doing well at all. It is very odd because as treasuries rally the dollar should be seeing some decent strength and here we are sitting below 77 on the DXY still.

This all signals trouble to me as we have seen many revolutions combined with a major economy stopped due to a tragedy and the only thing going up is the short end of the treasury curve. The dollar is not the safe haven it once was and I am not sure what is anymore. I believe gold and silver offer a better alternative than the dollar at this point, but there is volatility there as well. At the end of the day though, precious metals are still the place I would rather be as I see no end in sight for easing and I see higher inflation. I believe this is the end of the line and the Fed has no choice but to monetize more debt. The sad thing about all this is that rates will continue to climb anyhow because it is just too risky to loan money to the US government at this stage of the game.

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To fight deflation, abolish cash. Could Japan make reality of ‘science fiction’?

Posted by Ray on July 5, 2009 under Main | Be the First to Comment

Courtesy of the Timesonline.co.uk. We are heading into a similar situation with one huge exception, out economy did not have the strength that the Japanese had when their troubles began 20 years ago. We started out strapped for cash when we embarked on the ludicrous Keynesianism rampage of government stimulus. The Japanese have attempted to continually prime and stimulate their economy for 20 years with disastrous consequences and a lot of debt. We are doing the same thing, but with an already massive amount of debt.

June 19, 2009
Leo Lewis Asia Business Correspondent

With recovery elusive, a population doddering into old age and perhaps a decade of deflation in prospect, Japan may start mulling the most radical monetary policy of all — the abolition of cash.

Unorthodox, untried and, said one Bank of Tokyo Mitsubishi strategist, “in the realms of economic science fiction”, the recommendation has nevertheless begun floating around Tokyo’s corridors of power and economists have described Japan as particularly suitable as a testing ground.

The search for more outré economic policies continues, despite the recent surge in the Nikkei 225 index.The market may be reflecting soaring Chinese investment, rising consumer confidence and other cheerful data but economists see few long-term beacons of hope for Japan.

Other extreme ideas mooted by the financial authorities include a tax on physical currency or introducing one to operate alongside the yen. All three ideas are based on a theory concerning interest rates and the concept that a nominal rate of zero — as Japan has now lived with for much of the past decade — may be too high. In Japan’s case, the theory would suggest that nominal rates of -4 per cent might be closer to what is required to rescue the economy from another deflationary spiral. Having agreed that this might be necessary, the next question is how it could be imposed.

Several MPs in the ruling Liberal Democratic Party believe the abolition of cash, though politically radioactive, might be technically feasible. Richard Jerram, a senior economist with Macquarie bank, told investors that “the proposal has become practical with the broad penetration of electronic money and credit cards in Japan”.

He said that all the proposals were radical but worth consideration for Japan. Without physical cash, a central bank can set rates exactly where it likes, runs the argument. Mr Jerram said: “At the heart of the problem of achieving negative nominal interest rates is the idea that physical currency is an anonymous bearer bond with a nominal interest rate of zero.” While a central bank can impose positive or negative rates on non-physical assets, transmitting those rates to physical currency is a huge challenge. By permanently removing cash from a system, he added, policymakers are robbed of the excuse that zero is the lowest that nominal rates can go as a deflation-fighting tool.

In theory, many Japanese could easily make the leap into a cashless world. The country has six main competing cashless payment systems, many of them embedded into mobile phones. Including Oyster-type cards issued by public transport companies, industry sources estimate that there are about 120 million cashless payment chips sitting in Japan’s wallets and handbags, waiting to be swiped.

Nevertheless, the country remains a wholeheartedly cash-based consumer society. Currency in circulation is about 16 per cent of its GDP, compared with the levels of 2 to 3 per cent in most developed countries. Reducing that 16 per cent to zero would be a wrench but would come with considerable benefits, Mr Jerram said.

But just as Japan’s cultural attachment to cash may prove hard to dislodge, some economists believe that the same may be true of deflation. The country’s growing population of elderly people mainly hold cash or cash equivalents and, compared with its US and European counterparts, the Bank of Japan has come under virtually no political pressure to be more belligerent in its war on deflation. It is unlikely, added Mr Jerram, to brook anything as radical as abolishing cash.

Story here: http://business.timesonline.co.uk

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