The Promise of Abenomics

Joseph E. Stiglitz

05 April 2013

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TOKYO Japanese Prime Minister Shinzo Abe’s program for his country’s economic recovery has led to a surge in domestic confidence. But to what extent can “Abenomicsclaim credit?
Interestingly, a closer look at Japan’s performance over the past decade suggests little reason for persistent bearish sentiment. Indeed, in terms of growth of output per employed worker, Japan has done quite well since the turn of the century. With a shrinking labor force, the standard estimate for Japan in 2012 – that is, before Abenomics – had output per employed worker growing by 3.08% year on year. That is considerably more robust than in the United States, where output per worker grew by just 0.37% last year, and much stronger than in Germany, where it shrank by 0.25%.
Nonetheless, as many Japanese rightly sense, Abenomics can only help the country’s recovery. Abe is doing what many economists (including me) have been calling for in the US and Europe: a comprehensive program entailing monetary, fiscal, and structural policies. Abe likens this approach to holding three arrows taken alone, each can be bent; taken together, none can.
The new governor of the Bank of Japan, Haruhiko Kuroda, comes with a wealth of experience gained in the finance ministry, and then as President of the Asian Development Bank. During the East Asia crisis of the late 1990’s, he saw firsthand the failure of the conventional wisdom pushed by the US Treasury and the International Monetary Fund. Not wedded to central bankers’ obsolete doctrines, he has made a commitment to reverse Japan’s chronic deflation, setting an inflation target of 2%.
Deflation increases the real (inflation-adjusted) debt burden, as well as the real interest rate. Though there is little evidence of the importance of small changes in real interest rates, the effect of even mild deflation on real debt, year after year, can be significant.
Kuroda’s stance has already weakened the yen’s exchange rate, making Japanese goods more competitive. This simply reflects the reality of monetary-policy interdependence: if the US Federal Reserve’s policy of so-called quantitative easing weakens the dollar, others have to respond to prevent undue appreciation of their currencies. Someday, we might achieve closer global monetary-policy coordination; for now, however, it made sense for Japan to respond, albeit belatedly, to developments elsewhere.
Monetary policy would have been more effective in the US had more attention been devoted to credit blockages – for example, many homeowners’ refinancing problems, even at lower interest rates, or small and medium-size enterprises’ lack of access to financing. Japan’s monetary policy, one hopes, will focus on such critical issues.
But Abe has two more arrows in his policy quiver. Critics who argue that fiscal stimulus in Japan failed in the pastleading only to squandered investment in useless infrastructure make two mistakes. First, there is the counterfactual case: How would Japan’s economy have performed in the absence of fiscal stimulus?

Given the magnitude of the contraction in credit supply following the financial crisis of the late 1990’s, it is no surprise that government spending failed to restore growth. Matters would have been much worse without the spending; as it was, unemployment never surpassed 5.8%, and, in throes of the global financial crisis, it peaked at 5.5%. Second, anyone visiting Japan recognizes the benefits of its infrastructure investments (America could learn a valuable lesson here).
The real challenge will be in designing the third arrow, what Abe refers to as “growth.” This includes policies aimed at restructuring the economy, improving productivity, and increasing labor-force participation, especially by women.
Some talk about “deregulation” – a word that has rightly fallen into disrepute following the global financial crisis. In fact, it would be a mistake for Japan to roll back its environmental regulations, or its health and safety regulations.
What is needed is the right regulation. In some areas, more active government involvement will be needed to ensure more effective competition. But many areas in which reform is needed, such as hiring practices, require change in private-sector conventions, not government regulations. Abe can only set the tone, not dictate outcomes. For example, he has asked firms to increase their workers’ wages, and many firms are planning to provide a larger bonus than usual at the end of the fiscal year in March.
Government efforts to increase productivity in the service sector probably will be particularly important. For example, Japan is in a good position to exploit synergies between an improved health-care sector and its world-class manufacturing capabilities, in the development of medical instrumentation.
Family policies, together with changes in corporate labor practices, can reinforce changing mores, leading to greater (and more effective) female labor-force participation. While Japanese students rank high in international comparisons, a widespread lack of command of English, the lingua franca of international commerce and science, puts Japan at a disadvantage in the global marketplace. Further investments in research and education are likely to pay high dividends.
There is every reason to believe that Japan’s strategy for rejuvenating its economy will succeed:  the country benefits from strong institutions, has a well-educated labor force with superb technical skills and design sensibilities, and is located in the world’s most (only?) dynamic region. It suffers from less inequality than many advanced industrial countries (though more than Canada and the northern European countries), and it has had a longer-standing commitment to environment preservation.

If the comprehensive agenda that Abe has laid out is executed well, today’s growing confidence will be vindicated. Indeed, Japan could become one of the few rays of light in an otherwise gloomy advanced-country landscape.

Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, was Chairman of President Bill Clinton’s Council of Economic Advisers and served as Senior Vice President and Chief Economist of the World Bank. His most recent book is The Price of Inequality: How Today’s Divided Society Endangers our Future.

The Thesis For Precious Metals And Miners, II: Monetary Issues And Market Outlook

Apr 6 2013, 02:28

by: Emmet Kodesh

"Sound money still means today what it meant in the 19th century: the gold standard" (von Mises, The Theory of Money & Credit).

The panic selling of precious metals (PM) and miners early in April leads me to expand my previous piece examining the thesis for PMs. I expected to find evidence for people to sell down their positions. However, exploring fiscal-monetary and global-commercial dynamics relevant to the sector suggests that a 10-20% allocation remains sound. In fact the case strengthens each week that major Central Banks continue their debt expansion and thus undermine the economy and in time weaken the USD. Those whose current income stream is adequate can incrementally increase their PM and miner allocation.

First I will review monetary policy and the economy and how they affect markets. Including international trade and currency shifts to the context I will consider whether PMs, PGMs (Platinum Group Metals) and the miners still merit overweighting.

The S&P is up 10% YTD and 18% since the June 01, 2012 low. Under a sound monetary regime that would be wonderful. But this market surge is not based on fundamentals but M2 expansion (fiat money supply) and rising nominal asset values. This is the classic definition of inflation:
"A rise in the money supply and a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services." 
The volume is masked only by consumer deleveraging and falling net worth. The Fed, Banks and markets are drowning in liquidity while Main Street is parched.

With the onset of QE forever, $85 Billion /month in Fed buying Treasury debt, the M2 is growing 6.6% yoy. The prices of oil, gas, corn and all the meat, dairy and wheat prices tied to corn have doubled or more in the past five years. Most people pay every week for this inflation while real net income, worth and employment decline substantially. The $1 Trillion in student debt is an enormous factor in the mix of private and government debt and unfunded liabilities of about $120 Trillion.

Monetary expansion mixing with more obvious forms of debt will create hyperinflation that will cause commodity prices to spike. In the ensuing collapse of asset values and the economy (depression), the value of PMs will rise even though miners will suffer amid the general economic decline. Oil and gold prices will spike.

The M2/M1 ratio is declining because consumer liquidity is falling with declining wages, net worth and saving. The decrease in monetary volume reflects economic distress that will damage the markets. We have seen this the past two weeks in which the indices have begun a down-up-down-up whipsaw pattern I predicted here and here.

The flip side of the Fed's USD protection schemes are debt creation and socio-economic destruction, arguably the main goal. Monetary magic cannot suppress reality much longer:

"How pale is the art of sorcerers, witches and conjurers when compared with that of the government's Treasury Department." - (The Theory of Money & Credit, Ludwig von Mises)

Everyone loves double and triple-digit green days, but when they are bought by debt creation the bases of the economy are eroded and the demand for US government debt declines. The rapidly growing establishment of bilateral and multi-lateral ex-USD trade accords and credit facilities hastens the day when buyers for Federal debt dwindle. When demand for US debt sags, the bond bubble will burst eliciting a plunge of the ski-jump markets. This is one reason a mandated conversion of IRA - 401k accounts to Treasury bonds may occur. Such a decree is another example of a fiat culture.

Absent such measures which could be "justified" by a crisis, ex-USD trade plus Federal debt creation will drive down the dollar and collapse the fiat experiment as von Mises described:

A boom brought on by the expansion of credit money [debt] cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a "crack-up boom" and in a collapse of the money and credit system. Or the banks stop before this point is reached, renounce further credit expansion and thus bring about the crisis. The depression follows in both instances." (Interventionism, 1940)

I wrote recently that a new monetary order will be born in blood and agony. It will include the impoverishment of huge numbers of people in the West as jobless rates in Europe (and real jobless rates here) show. World events are dominated by the erosion of US solvency and the USD and transition to a multi-polar world reserve system whose currencies are linked to gold. The long-running nonsense with North Korea is a distraction from the main event: the pending collapse of the USD, Yen and the UK Pound as a result of endless debt creation and government giantism. "Foreign investors might not be keen to buy such a low-yielding asset in a depreciating currency," The Economist wrote of BoE bonds in terms that apply closely to T-Bills and the USD. The main goals of these mad trends are more government regulation of an economy it sees as a competitive power vector. For example, Federal regulations boost the Canadian LNG industry by stifling US energy development and export. Fiat governance insures crises that government will demand powers to solve.

Health Insurance, actual medical costs, what passes for education, food and fuel have risen and are rising: this is the evidence of the inflation that John Williams monitors weekly. This too will knock down the relative strength of the USD and PMs will rise accordingly despite price suppression short-selling on COMEX and the London "daily fix." It will take 8 years to give Germany back a tenth of its gold because it has been leased out and sold by broker or "bullion banks" (Central Bank proxies) even though the Fed keeps the gold on its books since it only has been 'leased.' This is the fiscal version of having your cake and eating it too: it doesn't work. For now the fiction is maintained and the price suppression scheme continues. At some point the demand for the physical metal will expose the game and the debt system will collapse. The main story is that despite the lease, swap and short sell games, PMs bounced off their secular support lines and miners remain the ultimate contrarian play. Notably, on April 5 the Junior Gold Miners ETF (GDXJ) rose 2.33% overtopping major producer Goldcorp (GG) up .70%, SPDR Gold (GLD) up 1.68%, the iShares Gold Trust (IAU), up 1.66% and the S&P (SPY) down .48%. Also a sign of things to come, Sprott Physical Silver (PSLV) up 1.99% bested the paper Silver ETF (SLV), up 1.54%. Results were mixed for PGMs perhaps because of declining economic fundamentals globally.

As for the USD, the Daily Fix sees a massive sell-off ahead. Short term the Euro has surged relative to USD and Yen. The Euro project is heading toward increased instability for which political union is the outcome-based solution. Still, the Euro will best the USD as the April 5 USD/EUR rise to $1.2999 and the decline of the ICE $-index to $82.496 portend.

Thursday April 4th the attack on metals was shown by the recovery of gold and silver miners relative to bullion. It was notable that PGMs also continued to sell down. This is a sign 1) that they are considered as precious metals and 2) that the big players know that a major slowdown in world economies is underway and accelerating due to fiscal policies leading to growing insolvency and deflationary collapse.

Consider, if world economies truly were growing it would show in major commodity producers at the base of the economic pyramid. Apple (AAPL) and Facebook (FB) do not sustain economies. Look at mining giants like BHP Billiton (BHP), Rio Tinto (RIO) and Vale (VALE). Mega-cap BHP brings the world iron ore, coal, oil and gas, silver, nickel, lead, manganese, titanium and molybdenum. Is the world economy growing? BHP is down 20% YTD and down 40% in the past two years. Its share price is at its post crash level from late 2009. Mega-cap Vale is down 24% YTD, down 30% in the past year and down 55% in the past two years. Its price is where it was in the 2nd quarter 2009.

Mining giant Rio Tinto which brings the world iron, chemical salts, and if its Asian enterprises survive Mongolian politics, copper, gold, coal and more is down 24% YTD, down 75% the past two years and priced where it was in its first bounce of the bottom in the 2nd quarter 2009. It is similar with Southern Copper (SCCO), down 16% YTD, 30% the past two years and barely above its price in 4 Q 2009. While Freeport-McMoran (FCX) the past four months is fouled by the uproar about its oil and gas acquisitions, it tells the same story about global economies: it is down 28% the past year, 47% the past two years and priced where it was in 4th quarter 2009. Caterpillar (CAT), a mainstay of global construction, is down 12% YTD and down 23% the past 2 years. Deere & Co. (DE), a mainstay of agricultural production is down 15% the past two years despite growing food shortages. If the world economic system were healthy, these major producers of essential goods would be booming but they are in decline as the fiat system dies and the forced transfer of wealth from West to East grinds fearsomely along. Economic producers, jobs and citizen liquidity are declining badly while monetary expansion and debt skyrocket. Even official metrics cannot hide the decline in employment.

Thus there will be hyperinflation and then a deflationary depression as a low growth economy reliant on services, social media and consumer accessories is whipsawed between falling incomes and vitiated fiat currencies. The attack on PMs is part of the process that destroys the USD in the guise of defending it while only postponing, as von Mises and thousands of others have shown, the collapse of the credit/debt boom and depth of the eventual depression. Consider:

"The orchestrated move against gold and silver is to protect the exchange value of the US dollar. The Federal Reserve is creating $1.2 Trillion / year, but the world is moving away from the use of the dollar for international payments and, thus, as a reserve currency" comments former Assistant Treasury Secretary, Paul Craig Roberts and adds:
"The result is an increase in supply and a decrease in demand for US debt. That means a falling price. The orchestration against bullion cannot ultimately succeed. It is designed to gain time for the Federal Reserve to continue financing the federal budget deficit by printing money..."
Initially bullion may rise most from this policy but the suppressed miner-suppliers are positioned to out-perform as they did early in the last decade. As Rick Rule has said, "fortunes will be made" from the extreme under-valuation in the sector.

As I have written, the market outlook is grim. The ISM reported April 3 (Dow down 111) that the manufacturing and service sectors slowed significantly in March while the media cheered the new nominal highs.

The ISM manufacturing index dropped from 54.1 to 51.3, below the 12-month average of 51.7. The index for new orders fell further, from 57.8 to 51.4. The basics of economic growth, oil and coal, chemicals and machinery accounted for the decline which experts termed "unexpected." Forestry, agriculture and fishing, life essentials also declined. Service sector ISM fell from 56 to 54.4 below the expected 55.5. New orders, prices and hiring all were down. Arts, entertainment and recreation grew in a version of whistling past the graveyard. The ISM reported "underlying concern about the future of the economy." That's an understatement: half of American College students drop out before matriculation because of rising costs and debt. Official private sector job growth per ADP was 158,000, very weak.

It is more illuminating to check workforce participation, actual % of working age Americans employed full time (about 59%) or the tracking done by John Williams at American Business Analytics which continues to show an actual unemployment rate of 23% amid "patterns of low level stagnation" in the economy generally.

One more note on overseas developments that foreshadow changes here. Spanish pension funds are now required to invest in Sovereign debt (bonds). Spanish social "security" is invested 97% in the sovereign debt of a nation with 58% youth unemployment. This nation will collapse and be ruled by force: corporate - fiscal fascism is returning to Europe. Italy has a debt/GDP nearing 130%. The BoJ will double Japan's monetary base in the next two years. Its Debt/GDP is 234%.

Central Banks want to buy PMs cheap: On 6-18-12, the Federal Reserve and FDIC circulated a letter to banks that proposes to harmonize US regulatory capital rules with Basel III that sets the reserves a Bank must hold to support its solvency. It's "a global standard on bank capital adequacy, stress testing, and market liquidity risk." At the top of the proposed changes regarding "zero-percent risk weighted items" gold bullion is listed right after cash.

In addition to massive Asian buying of PMs and increasing shifts to ex-USD trade, this is a major boost to the gold market. Now banks will be allowed to hold bullion in their vaults and count it among their Tier 1 assets - in other words, the least risky assets. It is clear that Banks are holding down PM prices not only to direct money to market but to facilitate their own bargain-buying of gold. Geologist Byron King recently emphasized this pattern and suggested that a major re-organization in the reserve structure will be in place by late this year.

"Fiat money is inflationary; it benefits a few at the expense of many others; it causes boom-and-bust cycles; it leads to over-indebtedness; it corrupts society's morals; and it will ultimately end in a depression on a grand scale," writes Thorsten Polleit of the von Mises Society. Conversely, precious metals and the miners that produce them do not distort financial systems and economies. In addition to their technical-industrial uses, their utility as stabilizers of value and exchange is growing as the fiat experiment dies of its own decrees and prepares to take most of the world economies down with it.

While most people should limit their holdings of PM and PGM bullion and miners to 10-25% depending on their need for steady income stream, the case for precious metals and miners is intact. Reviewing the fundamentals shows that the thesis grows stronger every week despite market noise and because of financial maneuvers. As many observers have noted, prices are at capitulation levels. Fade the ski-jump market and add some bullion and miners at these pessimism prices. For maximum peace of mind and in life, review my article "Gold, Silver, Equities or a Farm."