Warning Signs of a Modern Depression: See 1990 Japan

by: David Roskoph March 17, 2008 | about stocks: DIA / QQQQ / SPY    
David Roskoph

David Roskoph

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Oil at $110 and an ever falling dollar seem to make stagflation a probability and hyperinflation a real threat. I believe these alarming conditions are merely an inflationary blow off that punctuates the desperate actions of an irrelevant Federal Reserve; like a star going nova before imploding. Although the Federal Reserve has changed the bearings and switched to 100 octane on the printing presses, it is not enough to stem the incipient deflation from the collapsing real estate bubble and its attendant economic shock wave.

We have entered 2008 in much the same way the seemingly invincible Japanese entered 1990, teetering on bankruptcy. Japan’s banking system was an accident waiting to happen by allowing sub-prime, and even defunct business, loans to be held as good receivables. Their Central Bank oversaw such practices and no doubt assumed the bad debt would be consumed by future growth. Sound familiar? Our Federal Reserve presided over substantially the same delusion during our real estate bubble by allowing banks to sell loans at AAA rates to sub-prime borrowers. The good debt was then wrapped into tidy little institutional packages and sold as AAA paper, because it was mortgage backed. When the credit quality of all that “good debt” is finally market to market, money simply evaporates and the shock wave resonates far past ground zero. Bear Stearns’ (BSC) epitaph is being written with sub prime ink. If the #5 investment bank is on life support, how healthy are those beneath them?

The exceptionally aggressive and a-historic action from our government is just getting started; at least it sounds better than “panic has set in”. The procession of interest rate cuts and emergency actions is in response to the scent of deflation now permeating the Washington D.C. muster stations. The first stimulus plan will roll off the press in May to resuscitate a drowning consumer but it’s far too little to have any meaningful effect. As well, deficit spending might otherwise restore sanity, as it did during WWII, if our economy wasn’t the voracious credit-hungry fiat monster that it has become. In our case, there is no surplus from which to draw these rebates - only recycled debt; and our deficit is becoming an almost meaningless number. The most that rebates or more deficit spending can do now is calm the public on the way down. As J.M. Keynes might put it, we lack enough real money to support aggregate demand in a functioning economy and more debt just won’t do. Credit can be free but it will only further indenture a country already drowning in debt.

Although the S&P estimate of 300 billion may in near the mark in terms of the actual failed debt, the cause of the binge remains - an absence of organic growth. Artificially inflating our entire residential real estate market and then financing the margin with bad debt is evidence of desperation, not creativity. Our capacity to foster organic growth has been waning as we lose share to more competitive nations or simply outsource our domestic capacity away. We accepted the economic growth from our past bubbles as organic, and we pledged that as collateral to borrow our standard of living. Now we find out that it was mostly financial engineering. Each bubble’s pop replaced lost money with debt and we agreed to the notion of more credit somehow equaling growth. Inflating our most precious asset class, however, was the swan song of the big bubbles and the buck has stopped.

We’re now faced with the unpleasant task of cleaning up and getting back to real growth. In so doing our standard of living will be reduced because we simply cannot afford it. In reality, we haven’t been able to afford it for decades. We are in debt to ourselves to the tune of 65 trillion in unfunded mandates and to our foreign neighbors to the tune of 6 trillion. We are too far behind the curve to “grow” our way out of our debt unless we really get creative and annex Mexico with strict enforcement of payroll deductions.

America has been balancing between inflation and deflation only because the Feds are driving up the cost of pulp by driving down the value of the greenback. The fact that the asset deflating has such deep and diffused financial roots creates an insurmountable void far greater than any other asset class could. Home mortgages are the center of our financial universe. The shock wave from the deflation is so magnified by the leverage that it is overwhelming the opposing flood of fiat. While the headlines argue about whether or not we’re in a recession, we have already slipped into a deflationary spiral:

1) Deterioration of balance sheets.

2) Decline in investment and consumption.

3) Decline in employment and wages.

4) Return to 1.

1990 Japan is the most recent example of this spiral and, despite very aggressive measures to reflate their burst bubble, it cost them ten years. They cut interest rates from 6% to 0%, added over one trillion dollars over 10 stimulus packages, cut taxes, gave away shopping vouchers, bailed out banks and probably even threw in a few Ginsu knives. In the end all they got was a substantially weaker government, one now even deeper in debt. Because Japan’s riotous run up included simultaneous real estate and stock bubbles it was an order of magnitude greater than our real estate bubble alone. That and our abhorrence for savings will most likely get us out in only three years. Look for the dollar to stabilize, not from confidence in our own government but because Europe and the rest of the world will be forced to turn on their presses to shore us up. We are such voracious consumers that America herself is now too big to fail.

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This article has 47 comments:

  •  
    Mar 17 07:56 AM
    Yes. Yes. Yes!

    Contrary to other "safe" contributors, you tell it like it is.

    Most people are still in big time denial. Its conditioning over the last 5 year bull market, indeed over the last 30 years. It's different this time. Much different.
    Reply | Link to Comment
  •  
    Mar 17 08:18 AM
    The deficit is a meaningless number, except to our kids, who will be broken paying back the bill, broken by the largess of the current generation. What a disgrace. A generation that doesn't pay its bills. The George Bush way.
    Reply | Link to Comment
  •  
    Mar 17 08:21 AM
    I'm not sure Europe and Japan will be forced to " support us." Politically, the antipathy toward George Bush's America is too great. Who's going to get votes with a "let's help the US" mantra?

    Also, with so many inflation indicators among the many deflation indicators, I find it challenging to make a confident prediction of a general move in either direction.

    The one overwhelming qualifier I do see is 'poorer.'
    Reply | Link to Comment
  •  
    Mar 17 08:33 AM
    Not the same comparison and it's no longer about denial.

    The US and other world countries will help to fix this issue. The bears are saying that this is an unsurmountable problem. No! Difficult Yes. Never ending No!
    Reply | Link to Comment
  •  
    Mar 17 08:56 AM
    This dose of reality is 'refreshing' the way taking a shower with the electricity cut off, and having no hot water on tap. We wish more cautionary remarks were extant a few years ago. It was, in a small way-vis the general reaction of the public over such things as "Do we really need a 'hummer"? A home at a cool million? It seems over simplistic, but some leadership in Washington that knows what it's like to live on a modest income. What is it , exactly when we tune in to Barbara Walter's "Ten Most Fascinating People"-aren't we all being led and ancouraged to idolize the lives of the rich and famous; and in so doing, throw volatile organic compounds on a tinder dry economy already breaking out in fires, floods, hurricanes, earthquakes, tornadoes, while we wave permanent goodbye to our industrial base? It seems all we have left now is the great breadbasket. Let's hope those folks are still 'living right', and a drought, crop failure, that is to say, is not in the offing. For that is connected to the food chain, vis, overall health of our economy the way exorbitant cars, trucks, and housing is all tied to imprudent credit consumption to feed our unrestrained appetite for things we think we 'deserve'. What we deserve is a cold shower, and a thousand things for supper...every one of them beans.
    May I suggest a $2500 car ( TaTa Motors-TTM )...geothermal, and perhaps wind energy (GE already with billions in contract for them ). Cheer up, sleepy Jeanie...we can do this.
    Reply | Link to Comment
  •  
    Mar 17 09:09 AM
    Gosh, I can't even think of saying the "D" word but boy would that be scary if it just snow balled.
    Reply | Link to Comment
  •  
    Mar 17 10:05 AM
    Right ON! This country will have a hard time coming back from this credit crunch. A large portion of the US economy is dependent upon borrowing. Spending on credit is ingrained with too many. As incomes reduce, jobs disappear, credit abaids, we will see negative growth. Overseas sales will not hold up the rest of the economy.
    Reply | Link to Comment
  •  
    Mar 17 10:10 AM
    This is HOUSE making the diagnosis...and it isn't a good one!
    Reply | Link to Comment
  •  
    Mar 17 10:47 AM
    Unfortunately this is all true. Japan dealt with it by cutting rates to 0 to stop accurals of liability--every debtor became current. The US is headed there. Of course, the markets have devalued the dollar, but there are two options: US Dollar devaluation--say 4:1 or selling America by inviting unprecitented Petro and China dollars back. I look for the latter as soon as the election is over.
    Reply | Link to Comment
  •  
    Mar 17 10:50 AM
    Dont agree. In Japan Nikkei PE Ratio was 100X in 1989. And the financial system was a mess. Companies like Toyota, Mitsubish, Honda...were inefficient. Japan still is a somewhat inflexible economy.
    On the other hand, US is efficient, highly productive and the S&P500 plunged 20%. PE Ratio is around 17X, not cheap, but hardly expensive.
    And by the way, FED is much better than BOJ...
    Time to buy stocks...
    Reply | Link to Comment
  •  
    Mar 17 12:35 PM

    VennData says

    "I'm not sure Europe and Japan will be forced to " support us."

    I don't think they'll support us because they like us, but rather because if we fall, they will be severely impacted; I don't follow this sector, but the Japanese automakers will be crippled if we stop buying their cars (as would the German car companies).

    Maybe someone else can chime in why it's in the rest of the worlds interest to help the US get through this (or not?)

    Thanks. Great article and insightful comments.
    Reply | Link to Comment
  •  
    Mar 17 01:05 PM
    between the"lying loans" & mostly"wothless paper"spread around the world where are our real friends?
    Reply | Link to Comment
  •  
    Mar 17 01:36 PM
    Mr. Roskoph: Thank you for writing an article, using more data than I had, when I predicted this same general situation, last October. At that time, my thoughts were not fully appreciated, by some. Perhaps now that the wolves are in the living room some people who were in Bull Dream Land will wake up.
    Reply | Link to Comment
  •  
    Mar 17 01:56 PM
    I'm new to this blog site, and enjoyed this read greatly. The autor is correct on many items. What is interesting, is how many of the comments are about "george bush" and how this is all his fault. That is rubbish. This bubble and all the debt behind it has been brewing for years, far before GB ever took office. Besides, if US consumers didn't spend money like it grew on trees, we'd not be in this situation in the first place. Politicians and Ben Bernake alike are standing on the sidelines of this one, unable to do anything.
    Reply | Link to Comment
  •  
    Mar 17 03:34 PM
    Well folks, from the looks of the sentiment here I say it's time to buy.
    Reply | Link to Comment
  •  
    Mar 17 04:46 PM
    MDR, AAPL, HOC all American companies with perfect balance sheets, growth, exquisite management -- the Ibanks, mortgage lenders are one part of the economy; there's alot that is right with the rest.
    Reply | Link to Comment
  •  
    Mar 17 05:05 PM
    Have you looked closely at Harry Dent's work on demographic economics? I will have an interview with him up tonight on site....

    A
    Reply | Link to Comment
  •  
    Mar 17 05:40 PM
    While I would agree that this is not all the fault of GB his adminstration certainly bears a large portion of responsibility. They have let the banks and investment funds run wild. Their mantra is to let corporations run the U.S. and what is good for business is great for America. Those who defend this are the ones that voted for him. All those voters will now make excuses to pass the blame.

    The only out I see is massive investment and a national goal to repair infrastructure and alternative energy (not GB's version of ethanol). At least there is a payoff in this but it probably won't happen until we have a new president.
    Reply | Link to Comment
  •  
    Mar 17 05:47 PM
    "MDR, AAPL, HOC all American companies with perfect balance sheets, growth, exquisite management -- the Ibanks, mortgage lenders are one part of the economy; there's alot that is right with the rest."

    True enough, but how will APPL (and others) who sell consumer trinkets will do when

    1) inflation / commodity prices take a huge bite out of discretionary spending
    2) people can no longer pull money out of their homes like they have been since 2001 to fund their consumption.
    3) with a slowing economy, hunkering down becomes standard, resulting in further trimming. Does anyone think we won't have serious layoffs in many sectors over the next few months?

    As good as these companies are, I'm not sure what the right time to buy them is. But I'll bet APPL will be lower in a few quarters after a few revenue misses. Last thing people will be buying is a sexy iphone or a 3rd ipod...

    Talk to anyone who lived through the Great D. The orgy of consumption we've grown up on could well evaporate. I think people are taking a hard look at their lifestyle, and looking at how they can trim back...
    Reply | Link to Comment
  •  
    Mar 17 05:54 PM
    Bingo StateofConfusion. The globe needs energy and must innovate, execute or become obsolete. I am in that position every day of my life so to me it just becomes real hard rather then hard. People will adapt. The economy is contracting fast. Our new economy is boom and bust. It's amazing when it booms and sucks so much when it busts. Other countries will come to our aid because they can buy great assets cheap and put our labor force to work. Don't expect big benefits but the pay probably won't be too different from what most people in America make now. The fab rich will stay fab rich and many of these are scanning the market for solid, long-term investment into private, profitable companies. It will be OK but to some, life is not worth living without extravagant luxuries. I doubt these types will be missed much however...
    Reply | Link to Comment
  •  
    Mar 17 06:45 PM
    To: 300mph Mar 17 03:34 PM: "Well folks, from the looks of the sentiment here I say it's time to buy." CONGRATULATIONS, Mr. 300mph; you are about to purchase the very last ticket for the maiden voyage of The Titanic, one of the largest moveable objects ever built, and thought by many to be "unsinkable."... Enjoy your trip.
    Reply | Link to Comment
  •  
    Mar 17 07:36 PM
    Great article. Finally we have someone with brains and common sense: a rare combo among most publish or perishers here.

    I do not profess to know ‘jack’ about finance.
    I do have some common sense answers.
    a. Sub prime…forget those fools. Caveat Emptor is the name of the game. They screwed themselves. Let them pay the price.
    b. Everyone claims price controls didn’t work. Nonsense. Big corporations love to chant this. Their prices go up by ‘harmlessly’ passing on everything. They thrive on this country. Let them help pay the bills around here.
    c. The FED is unconstitutional. Either kill it or make it stick to its alleged job: control inflation. Period.
    d. Let the moronically greedy banks fail. New ones will gobble them up and be stronger yet.
    e. Greed must eventually pay. Let it do so now…at its own expense, without government intervention.
    f. It’s too bad we cannot put a halt to the present administration. As for the future wannabes, this bunch of misfits and mental cripples will do more damage then what we have now. Jefferson was right. He is the only one I would vote for as president.
    g. Lawyers may make good lawyers. They make disgusting administrators. Scrap all fiduciary laws and write reasonable ones.
    h. Stop the madness: vote all politicians and judges out of office.
    i. Add one amendment to the constitution for voting: NO CANDIDATE. This forces the dictatorial parties to rethink who they will present as candidate. In the interim, utilize the president pro-tem of the senate with a panel of all parties to ensure nothing will pass except absolute necessities.
    j. Bring all and I mean ALL troops home within 90 days. Cost savings alone will invalidate the need for additional taxes.
    k. Force the Treasury, BLS, the FED, et al to tell the truth. Reinstate realistic and truthful reports.
    l. Worry about the infrastructural mess among government agencies later.
    Reply | Link to Comment
  •  
    Mar 17 11:13 PM
    Americans are very productive and innovative. We just need to get control of consumption and divert it to investment and education. The rest of the world is catching up but that doesn't mean we have to go down.
    Reply | Link to Comment
  •  
    Mar 18 06:27 AM
    I'm reading too many blogs\news article at the moment. I keep on coming across the phrase "is now too big to fail." Does this statement send a cold shiver down your back? What is the difference between "is now too big to fail" and "this ship is unsinkable"?
    Reply | Link to Comment
  •  
    Mar 18 07:47 AM
    I beleive in the Obama Cargo Cult promises.
    We. Want. Something. Here. Now.
    Yes We Can.
    We. Want. Something. Here. Now.

    Cargo Cult is the Cure.
    Higher Taxes will cause the bounty to become reality.
    We. Want. Something. Here. Now.
    Reply | Link to Comment
  •  
    Mar 18 07:57 AM
    Everyone has a theory on the reason for the current economic contraction ,mine is slighlty different . I my occupation I have the opportunity to visit a great many homes and have noticed a common situation that seems to appear in almost every home that I am in. We Americans are saturated in junk it hangs on the wall, the floors are cluttered to the point that you can hardly walk , My point is this, the American consumer has simply ran out if space to store any more stuff, the garage is full the closets are full the basement is full . We are junkaholics and are economy is contracting because we are suffering from a junk hangover. Hopefully thic recession will cure us of binge consuming and will lead us to a more productive path
    Reply | Link to Comment
  •  
    Mar 18 08:11 AM
    Unfortunately, our real estate bubble is bigger than Japan. Commercial real estate is valued based on unreasonably low capitalization rates, partly due to excessive expectations of growth of rents, partly due to super low interest rates. Add to that the glut of CMBS and CDOs and you have a market completely out of control since 2004 with interest only loans etc.

    Japan was not this stupid.
    Reply | Link to Comment
  •  
    Mar 18 04:07 PM
    Congrats to the author for providing a thoughtful and incisive article and to all the commentators as well. I would just add that this has been building for a very long time and the logical conclusion of the current Fed which appears to be "give me your nasty junk and I will give you somewhat better junk" takes us to places I don't believe we have been before. Although everyone is bearish on real estate it seems to me that when the flood of "new money" hits Main Street as I think it eventually must, where will these folks put it? In gold and silver? Maybe, certainly the ETF are holding massive amounts of them, but a lot of people are more comfortable with brick and mortar. Perhaps that's why the homebuilders seem to be bottoming far sooner than one would expect especially when we read about the "glut" on the market. By the way, when was the last time any of you made money off something that was all over the front page of the newspaper and the evening news? One other thought: if the Fed keeps printing money to keep the system going, does it presage a "hyperinflation&q... like the one in Germany in the 20's? If we try to prevent the market from doing its work, won't the eventual result be far worse than it would have been (and this looks bad enough to me right now!).
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  •  
    Mar 18 05:22 PM
    The situation is far from similiar to what Japan's was in 1990. Corporate America, when you remove the Financial and Building related stocks are in excellent financial shape. Dividend increases exceeded 11% last year and corporate buybacks are significant.

    The problem with every administration going back 33 years is that there has been no energy policy. Ted Kennedy doesn't want windmills 5 miles off his coast. The huge oil find of the mid 1970's off California has been capped since the mid 70's without a drop of oil produced.

    The Senate and House prefer to spend their time interviewing Baseball players on steroids than they do in coming up with a concerted National effort to become as enery independent as possible. Why we are not equipping every high transmission line in this country with a wind turbine is mind boggling. Why we are not looking to create hydropower anywhere we can is distresing. Just think of the number of jobs that would be created here in the United States. We need government incentives and government mandates to achieve this.

    The problems in the financial markets are almost entirely because of greed. It is similiar to the reason why Enron, Adelphia, etc occurred. Corporate CEO's need to spend less time golfing and attending black tie affairs and need to stay home and attend to managing their companies. We do need external board of directors on the boards of financial companies. The brokers create products to pump up commissions. They create extremely high risk products and peddle them to unsuspecting individuals.

    The bankers go along for 10 years making a nice profit for their shareholders, but then want to get that last additional dollar in profits. And they do what they always do. They take undue risk and it smashes in their face. Their Yale and Harvard degrees become worthless. They need to teach how not to be greedy and learn what risk-reward is. Is that stretching of standards worth the added risk rather than incremental potential reward for an undue amount of risk.

    Those that do not perform need to be dismissed. Seven and eight figure compensation packages need to be eliminated and contracts need to be for pay for performance. But not on an annual basis but over time. Performance over 5 or ten years.

    Our government also needs to stop working like it's a beauty contest and start governing. They need to be more efficient. Corruption and incompentence needs to be removed in government as well as in the corporate penthouse. They need to work like a stellar corporation and not a nonproductive entity that strangles those that create all new jobs in this country.

    The writeoffs on the books of the financial stocks should be borne by the shareholders of those companies. However, the Federal Reserve, the SEC and other regulatory agencies need to be more proactive in mandating tighter standards of publically owned companies. When they allow 100% loans to value; when they allow real estate brokers to receive commissions and then also loan the funds to borrowers with ridiculous underwriting standards, the regulators need to step in and not allow it. Where have the Federal and State bank regulators been. Why are we not holding the bank regulators accountable. Is it because they are not accountable to anyone because they have government jobs. Just like in the corporate world, they need to lose their jobs if they are not doing theirs.

    We must eliminate greed. Once we do, once the Federal government starts working properly, Republicans and Democrats alike, we can return to being leaders in the world.

    Corporate America generally suceeds in spite of our political leaders. With a lttle help from them, just imagine what we could achieve.

    Let me also remind the writer where th DJIA average is today compared to where it was in 1990. Compare that to Japan. Look at the Japanese market today and compare it to 1990. There is no comparison. The U.S. markets are miles ahead. And we would be further ahead if all CEO's and our government leaders acted like Warren Buffet and Steve Jobs and not like the former Governors of New Jersey or New York.

    Eliminate greed and corruption from Corporate leaders and Government leaders and have them concentrate on Energy independence and we will have gone a long way in improving life in these United States. For that matter just eliminate the stupidity from doing their jobs and we'll probably get there.
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  •  
    Mar 18 05:57 PM
    I'm just a simpleton, so here are my simple observations. A normal standard for figuring how much mortgage one could afford was 3 times one's salary a decade or two ago. A modest home is now around 6 times the average. Our kids are driving to our broken schools in $50,000 Escalades with $7000 wheels and $5000 stereos. I drove a 66 Chevelle that I saved from the junkyard. Our schools are so broken that my wife now stays home to home school our daughter.( testing 2 grades above level) The only thing they think they can do to fix the system is to throw more money at it and give the teachers raises. I know I'll get a lot of flack about this, but my wife gets it done without any training. Check this and I think you'll find it to be true. Every single day there is news of either a gun, a shooting, a school bus accident or a teacher sex scandal. They campaign we need to become less dependent on foreign oil yet we ,can't drill for it ourselves. Gee! Am I missing something here? We finally realize we need alternative energy sources and they will come, it just wont be overnight. It may not be too far fetched to have $10 a barrel oil in 2015. We need to let the markets take care of themselves! They always do! We may not like it for a while, but they always do. Thanks for letting me ramble.
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