May 17th, 2003

Thought the following article from the Financial Times of London was interesting and germane. Since I'm a firm believer that all politics are economic (can we say "no duh?"), on a international, or macro-economic level, economics will eventually drive policy.

Fears grow that US economy faces deflation
By Jenny Wiggins in New York, Peronet Despeignes in Washington and David Pilling in Tokyo
Published: May 16 2003 21:37 | Last Updated: May 16 2003 21:37

Fears of deflation in the US rose on Friday as stock prices fell and government bond yields dipped to 45-year lows after a key measure of inflation dropped to its lowest level in 37 years.


The concerns were heightened by reports that Japan's deflation gathered pace in the first quarter with prices down 3.5 per cent from a year ago, their fastest 12-month drop on record.

The fall may fuel concerns that the Japanese economy could be in a deflationary spiral. (Note: Also called a "liquidity trap", Scrute) Japanese prices have been falling since 1995 at an average annual rate of 1 to 2 per cent. The latest figures showed deflation accelerating in the 2002 financial year to 2.2 per cent, a record for a full year.

In the US the yield on 10-year and 30-year US Treasury bonds fell to 3.49 per cent and 4.45 per cent in early trading.

Longer-dated US government bonds have rallied sharply this week, with investors convinced that inflation will remain subdued, having less of an impact on the value of long-term assets.

The Labour Department reported that the 12-month rise in its core consumer price index fell to 1.5 per cent in April, its slowest 12-month rate of increase since January 1966. Strategists said the subsequent fall in bond yields could, however, be positive for the economy. "This is what the Federal Reserve wants," said Dominic Konstam, head of interest rates products research at Credit Suisse First Boston. (Note: the Fed wants the market to do this, but has threatened to buy long term bonds to inject "liquidity" into the financial markets. Normally the Fed works in the short term Treasury debt markets).

Falling yields mean falling borrowing costs, which make it easier for businesses to borrow and homeowners to refinance mortgages and get extra cash - factors that have helped keep the economy afloat. But the sharp slowdown in inflation has inflamed talk of Japanese-style deflation.

Japan's deflation figures were released along with gross domestic product figures showing that growth in the first quarter fell to almost zero, leading some economists to conclude that the economy was on the brink of yet another recession. Nominal growth fell 0.6 per cent in the March quarter, or minus 2.5 per cent on an annualised basis.

Paul Sheard, economist at Lehman Brothers, said: "If you look at the chart it looks horrible. It looks as though deflation is going through the floor." However, the headline figure exaggerated the picture, because the GDP deflator in the first quarter of 2002, when Japan began pulling out of recession, was positive, he noted. "It's something of a statistical fluke, though deflation is deflation and it is not a good sign." Most economists in the US have dismissed deflationary risks as marginal. But the Fed said recently that odds of an "unwelcome substantial" slowdown in inflation were now stronger than that of a rebound. "We continue to believe that inflationary pressures are building," said Brian Wesbury, an economist with Chicago-based, bond-trading firm Griffith Kubik, Stepehens and Thomson, but "it is getting harder and harder to argue against the deflation story".

Concerns have also grown about a global-wide deflation which the US could import, as western Europe flirts with recession and Japan looks more likely to enter a deflationary spiral.

http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1051390103932&p=1012571727088

As we, ah-hmm, "scrutinize" this report, we see some major macro-economic factors which are, IMO, driving, or at least heavily influencing, international policy. Japan's deflation has been a major concern which goes under-reported in the news we normally hear. Japan is fast approaching, IMO, and economic "perfect storm", where demographics, economics, and a rigid, consensus based, political system which can not act decisively, are laying the foundation for a major disruption in that nation, (and potentially a major political shift to extremism within the next 10-15 years.). The Japanese national public debt is somewhere around 140% of annual GDP (compared to approx 67% for the US), indicating governmental leaders have been running their economy on government spending. And since much of this spending consisted of "make work" public works projects of little to no economic value (parks, expensive off-shore airports, land reclamation.. etc), costing them over $1 Trillion since 1992.

Yet, because of the prodigious saving habits of the Japanese people (an estimated $12 Trillion) over the past 20-30 years, they have been able to finance this debt, despite almost zero percent interest returns on savings. But of course, as prices have declined, the purchasing power of these cash hoard has increased. However, given that an estimated 25% of the Japanese population will hit retirement age over the next 5-10 years, these people are loath to spend or consume, since few really have much faith in the corporate pension system. That's 1 in 4 Japanese workers who will be quitting their jobs, withdrawing retirement funds, and trying to scrape by. But that also means the Japanese income tax base will decline commensurately, depleting tax revenues and either forcing spending cuts or tax hikes to maintain their ability to pay the national debt. And that suggest interest rates will be forced higher as the quality of Japanese national debt becomes more dubious. And devaluing

Some have opined that Japan will be forced to import labor into its primarily homogenous workforce in order to maintain that tax base. Some have argued that Japan should devalue the yen in order to spur consumer spending (as people opt to spend their money rather than see it lose purchasing power through induced inflation). However, it would prove political suicide to suddenly cut the value of cash savings for all of those aging pensioners. Personally, I find such a shock to their social and economic fabric could lead to a return of extremist, perhaps militant, forces within Japanese politics.

And why the above article is pertinent to the US is that some economists and analysts are fearful that what's happening in Japan may happen in the US. A liquidity trap where interest rates are forced so low that effectively savers are paying banks to hold their money, and loans bear little to no cost to the borrower. But is the situation in the US the same as in Japan? There are similarities, a stock market bubble, followed by dramatic crash in equity values (with a commensurate drop in interest rates and booming bond market since bonds paying 5-8% become more valuable than newly issued Treasury bills). And the declining interest rates have led to a dramatic increases in real estate valuations in many areas (especially here in DC). And while we've avoided negative economic growth thus far, without some major change in the economic confidence and performance, there's the distinct possibility we may decline further, or at best, remain stagnant.

We've recently heard about the 40% decline in the value of the US dollar against the Euro in recent months. But it must be recalled that the Euro is still valued less than it was at its inception. That means the US dollar had appreciated that much, effectively setting up a protectionist barrier to US goods being sold in Europe. It would seem the Bush administration and Fed have decided that it was not good policy to subsidize the European and Japanese economies with a strong dollar policy. And one of the pre-requisites for decreasing the value of the dollar, imo, was to bring about a decrease in oil prices worldwide for the next several years (oil transactions are currently priced in USD). And while I'm not even willing to suggest that the recent war in Iraq was solely fought for oil (maybe I'll address the mid-east in a couple of days), it certainly would increase the odds of a US economic recovery, if not a global one.

Unfortunately, it likely will mean the possibility of an economic recession in Europe. And that can only exacerbate the double digit unemployment in many European nations.

Well... Enough for now... I'll leave it on that note.

TheCentralScrutinizer

May 16th, 2003

Well, I've finally done it. Plunging into unknown territory as the net's newest Blogger. As some can obviously see, I'm a Zappa fan (as are many others who merely refuse to admit that a dirty mind is a terrible thing to waste)... ;0)

But this blog is not about music. It's about what really fascinates me; International Politics and the influences that drive these interactions between nations, states, and individuals. This site will provide me a ready repository for any number of articles I come across independently, or through my participation via other discussion forums on Silicon Investor (My handle there is Hawkmoon).

With my previous experience as a military and private investigator, my philosophy on world politics, and pretty much anything else, resides upon answering two seemingly simple, but broad and elusive, questions:

1.) What's the angle? IOW, what is the agenda of the party in question? Is it political, economic, or merely personal?

2.) Who's making money off the deal?... (follow da' money).. Money can be cash, property, or any other number of financial instruments. Follow the money trail and you'll ultimately find the root of international policymaking.

Governments are not monolithic entities. In fact, they are run by a relatively small percentage of the total population. And these people have immense power, whether the governmental system is democratic, authoritarian, or totalitarian.

However, all that being said, I do believe that ideals can, and do, drive many politicians. And while they generally have a financial basis (since we seldom do that which only makes us poorer), those ideals can facilitate wealth creation for a large percentage of a society. I don't subscribe to wealth creation being a zero-sum game of winners and losers. Some will just win more than others... :0)

I also am a firm believer in taking criticism well. I do not pretend to know all the answers. But I'm open to having my opinion influences by facts and documented evidence, depending on their significance to answering the questions above.

So as I get my feet under me with this blog posting, hopefully I'll provide a different and informative perspective that, even if you disagree with me, will cause you to pause and reflect on why you hold the particular beliefs that you do.

Stay tuned!!

TheCentralScrutinizer