Should U.S. Investors Fear a Japan Deflation Scenario?
Stock-Markets / Stock Markets 2011 Dec 08, 2010 - 10:07 AM GMTBy: Nilus_Mattive
With Ben Bernanke and the Federal Reserve now into their second round of quantitative easing, a lot of investors are becoming increasingly worried about the U.S. “becoming like Japan.”
In short, they’re starting to wonder whether the entire U.S. economy is entering stagnation so deep that all the money pumping in the world won’t get us out of it — the very same condition that Japan has been suffering with since the early 1990s.
I can see where the fear comes from, especially with Bernanke going on 60 Minutes two nights ago and saying things like,
“We’re not very far from the level where the economy is not self sustaining.”
And …
“It could be four, five years before we are back to a more normal unemployment rate.”
Bernanke even went so far as to suggest that the Fed may expand its current $600-billion program to purchase government bonds!
So today, I’d like to talk a little bit more about “Japan scenarios,” and whether stock investors should be concerned.
Let’s Start With a Little 1990s History …
Japan’s economic malaise began with twin bubbles — first in its stock market, which peaked in 1989, and then in real estate two years later.
Since then, the country’s overall debt levels have skyrocketed to more than twice the country’s GDP … its economic output has been rising less than 1 percent a year on average … and consumer prices have fallen in seven of the last ten years.
And all that has happened in spite of the fact that the Japan’s central bank has kept interest rates at or near zero for nearly a decade!
But what many folks don’t realize is that Japan’s zero-interest-rate policy was spurred on by none other than a group of U.S. academics, including a Princeton professor by the name of Ben Bernanke!
Sure, Japan had already been ratcheting rates down after its crisis began — and by 1996 they were well under 1 percent.
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However, it was Bernanke who said Japanese policymakers were making a major mistake by not committing to keep interest rates at rock bottom for as long as it took for signs of growth to emerge.
Ultimately, officials listened to that advice … along with suggestions that they try other relatively experimental approaches such as “quantitative easing,” in which the central bank openly buys loans, securities and other assets.
For a few years it looked like a turnaround was coming, but those hopes were dashed by the recent global economic meltdown. And today, despite all its efforts, Japan is still waiting for a sustained rebound.
Today, Our Federal Reserve Has Gone from Armchair Quarterback to Throwing Its Own Hail Marys
Ironically, Bernanke and his colleagues now find themselves trying many of the same tactics they once recommended to Japan.
And while there’s no way to know what would have happened without their massive intervention, I don’t think anyone would say they’ve had resounding success yet.
So is that it? Is it the endgame for the U.S. economy? Will deflation take hold?
What’s interesting this time around is that we’re seeing a huge divergence in prices.
Some things, especially commodities, have been rocketing higher and higher … and creating pockets of inflation.
Meanwhile, many other goods and services continue to get cheaper or have stagnated at best.
There are also plenty of other things that are different this time around.
For starters, this battle is far more global in its nature — especially because Europe is wrestling with its own massive problems.
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The U.S. is also much different than Japan in terms of its demographics, trade balance, financial system, savings rate, and position on the global stage.
And even the fact that the Fed remains extremely concerned about the risk of deflation represents a level of commitment that Japan’s policymakers lacked in the first few years after their crisis.
So What Should Stock Investors, and Anyone Else Interested in Income, Make of All This Then?
First and foremost, I don’t think there’s any way to predict exactly how things will go from this particular point in history.
If anything, we simply need to continue watching the Fed’s moves vigilantly, as well as other developments around the globe, and adjusting our strategies accordingly.
But even if you assume that the U.S. economy will tread water for another ten years … that still doesn’t mean there won’t be plenty of money to be made in stocks.
After all, even during Japan’s 20-year market malaise there were individual shares that performed strongly.
Moreover, there were plenty of major market swings for investors to capitalize on with good timing.
Plus, if you started buying after the major implosion, you had a much better chance of making solid profits over the long term.
And if you were collecting dividends along the way, your total returns would have been even better!
All of those same things have held true during the past decade here in the States, where major stock indexes have basically gone nowhere.
So in the end, I continue to believe there are plenty of ways to make money with U.S. shares, whether your goal is long-term income or shorter-term capital gains, and whether the current environment is inflationary or deflationary.
Best wishes,
Nilus
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