Bernankonomics 101

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The currency wars are heating up. Now Japan is in on the act. Yesterday, the Bank of Japan announced it would print another ¥10 trillion, bringing its total asset purchase program to ¥80 trillion by the end of next year.

Of course we have no idea what that means. What’s another ¥10 trillion in the scheme of things? It all amounts to rearranging the chairs on the Titanic. The Financial Times says that the Bank of Japan responded to complaints from the likes of consumer electronics companies Sharp and Panasonic. The strong yen is killing their business…they want a weaker yen.

So the Bank of Japan responded. Everyone wants a weaker currency. It’s the policy weapon of choice in a post bubble economy – steal demand from your trading partners. It’s pretty much the playbook that the International Monetary Fund (IMF) has employed for years.

Whenever a small developing economy got into trouble after Western banks went on a lending spree, the IMF would come in, privatise a whole bunch of assets, bail out the banks and devalue the currency. It effectively transferred wealth from the middle class to the kleptocracy.

In a world of stable economic growth, the currency devaluation usually worked, in that it encouraged exports, discouraged imports and forced the country in question to live within its means.

But currency devaluation doesn’t work when the whole world is struggling for growth. The US tries to steal a little via successive QE’s…Europe and Japan try to steal the demand back by responding with their own attempted devaluations.

This tit-for-tat goes on until you get a major inflation breakout. The theft then transforms itself into something far grander. It’s a systematic theft of wealth from that part of society who are furthest away from the source of the money printing. The further away you are, the more you lose.

So if you’re concerned about not being close enough to the global liquidity tap, buy yourself some physical gold. It’s about the only wealth storage device immune from the idiocy and flawed thinking of the global central banking fraternity.

This flawed thinking is really the product of a flawed financial system. Sharp and Panasonic might be whinging about the strength of the yen, but maybe their business models have now just reached their used by date.

Japan’s post-war economic resurgence was the product of US capital and economic management. With Japan forbidden to have any defence forces, the US fulfilled its defence needs. In return, Japan supplied the US with consumer products. They even financed the US consumer (by financing the US trade deficit) to ensure steady demand for their products.

Japan built its wealth on the innovation and industriousness of its export sector. But that strategy also relied on the US being able to consume well above its ability to pay (in real dollars) year after year after year.

Now here we are, with the US having to resort to a fingers crossed policy of trying to reinflate the burst housing market to encourage consumption demand.

Whichever way you look at it, the financial system as we know it is in the process of breaking down. Just because the stock market looks ‘healthy’ doesn’t mean everything is fine and dandy. The whole system of savers (China, Japan, Europe…yes, Europe as a whole) endlessly financing the debtors (US, UK, Australia) is coming to an end.

Money printing just prolongs the adjustment, and ensures it will be more painful when it happens.

We were talking to Dan Denning about all this money printing business yesterday. All it does is monetise previously created credit. It doesn’t create new credit, which represents new purchasing power in an economy.

All it does is swap a longer term, illiquid asset for a very short term (overnight) asset, i.e. cash. To the extent that banks don’t lend this cash (and create new credit) it sits in the financial system, encouraging speculation and pushing asset prices up.

On the one hand it’s an insanely stupid strategy. On the other it’s the only policy option left for economies weighed down by too much debt and no asset bubbles left to blow…except for gold, which is the last asset bubble central bankers will willingly inflate.

So after sitting back and watching all the major global central banks fire their shots, what weapon will the People’s Bank of China (PBoC) employ?

Maybe they’ll hold off. Yesterday, the Australian Financial Review reported that senior officials at the PBoC would be reluctant to reignite credit growth with further stimulus measures. They see China as going through structural change, not a cyclical slowdown.

While we have been critical of China’s economic management and central planning tendencies, they are not stupid. They know if they continue to perpetuate the investment boom it will lead to even bigger problems down the track.

Unencumbered by three or four year election cycles, China plays a longer term game. The ruling party’s over-riding mentality is social stability. Keep people happy and remain in power. They will have a hard enough time maintaining social stability during the upcoming structural adjustment from investment led growth to consumer led growth. If they reignite the boom now, the eventual adjustment will be very, very painful.

Either way it will be painful for Australia. We’ve been saying it for a while now. But apparently news is only news when someone important says it is so. Today’s Australian Financial Review quotes ubiquitous economist Ross Garnaut as saying, ‘I think we’re going to have a very difficult time adapting to the decline in living standards that’s going to be a necessary part to the adjustment to the end of phase one and two of the boom.’

Another way of saying the end of phase one and two of the boom is the beginning of phase one and two of the bust. You’ve already seen the impact on commodity prices and producers. Mining services companies are feeling several phases of the bust all at once.

But China optimists think the worst is over. Iron ore prices are now back around US$110 per tonne, well off the Fortescue-killing lows reached a few weeks ago. But we reckon it’s a dead-cat bounce.

Once the realisation that China is in the midst of a long structural change sinks in, bulk commodity prices will head lower again.

That’s unless investment banks can develop a market for coal and iron ore futures – or paper iron ore and coal. That way central banking money printing can find its way into more and more derivatives of real products, make people feel wealthy via rising paper values, and get them spending. Spending creates demand which creates investment and jobs. It’s Bernanke economics 101. It couldn’t be easier!

By the way, if you want a Western insider’s view on what is going on in China right now, check out this article. It doesn’t inspire much confidence. In fact, it’s an on-the-ground view of what happens to an economy that has just gone through an historic credit boom.

Even if this viewpoint is half-right, Australia’s leaders and so-called China experts may have woefully mis-read the situation.

Regards,

Greg Canavan
for The Daily Reckoning Australia

From the Archives…

Be Very, Very Scared
14-09-2012 – Greg Canavan

How QE Favours the Rich
13-09-2012 – Bill Bonner

To the Barricades!
12-09-2012 – Dan Denning

The Power of Pork
11-09-2012 – Dan Denning

Waiting on Beijing
10-09-2012 – Dan Denning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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7 Comments on "Bernankonomics 101"

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Ross
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bottom line is that lack of demand is driving this … Thursday, September 20, 2012 Cancellations of American Airlines (AA) flights have climbed this week – it had scrapped nearly 250 flights by Wednesday – as it plans flight reductions. American spokesman Bruce Hicks said the carrier will reduce its schedule for the rest of September and through October by one to two per cent (equal to 17 to 34 flights). “It’s an attempt to pre-plan and better accommodate our passengers by cancelling in advance and changing the schedule to re-accommodate people to give them plenty of notice before they… Read more »
annie
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Gold looks the only way to go. Just worried about the Australian government down the track enacting Part IV of the Banking Act which allows for confiscation of personal gold. It happens in the States in the 30s, you had to hand in all your gold.

Lachlan
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You would be compensated in dollars Annie as those in the States were. If it does happen though then the chances of a subsequent devaluation will be high so I would be looking to switch the dollars for something tangible. A low percentage of privately owned gold was actually handed in either in the States.

annie
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I don’t know if you had to register your gold in the 30s. Do you have to register a purchase of gold in australia now? If so it would be hard to get around it. Also the price set by the RBA for that gold may not be the going price. Accounts differ as to how much was handed in during the 30s. I don’t trust governments at all when the shtf.

shortchanged
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Yes you do Annie, but not only that, other government departments such as Centrelink, the tax office (ATO) drivers license, department of foreign affairs, (passport), tax file number and Austrac, google it, plus your bank account. This department, Austrac is ostensibly to keep track of money laundering, as if any self respecting terrorist could not find a better way. But its so that they, the government, keep track of what you have in your bank. But the killer is that when you sell the gold, you pay tax on the profit. Here in the old dart, none of the above… Read more »
annie
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Yep Orwell’s world was a walk in the park compared to what’s going on now.

Jim Black
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I have some dumb questions. The AMP listed a number of years ago, flew for a few weeks. I foolishly in hindsight kept my shares They then fell down a big hole. Never seems to have risen. Seems to have done nothing for years Is there something involved, that if it earns more than x the profits flow to advisers or something, and in effect the post co-operative entity has its performance capped? Whats with Boral? Is it deeply mired in USA? Then also Origin Energy. They were talking $au20.00, now only half that. Aren’t Australians paying their power bills.… Read more »
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