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The Bubble Continues!
The following are slightly-modified extracts from recent commentary that appeared at The Speculative Investor web site.
Japan versus the US – a comparison of bubbles
Below is a chart comparing the value of the Japanese stock market (as represented by the Nikkei225 Index) with the Dollar-Yen exchange rate (Yen to the Dollar) covering the 12-year period from the beginning of 1984 to the end of 1995. The Yen chart has been scaled upside-down so that a rising line indicates a strengthening Yen.
Notice that the Yen's exchange value trended lower during the 2 years leading up the January 1990 'bubble bursting' and for about 3 months thereafter. This is a marked difference from the US experience (the Dollar trended higher during the 18-month period leading up to the bursting of the NASDAQ bubble and continued to move higher for several months thereafter). Notice also that the Yen reversed sharply higher about 3 months after the bubble was pricked and embarked on a major up-trend that continued, with only minor interruptions, for more than 5 years.
Putting aside the completely-opposite performances of the Yen and the Dollar during the lead-up to the popping of the respective bubbles, if the US follows the path of post-bubble Japan then the next 5 years should see a period of extreme Dollar strength. In this environment the best investment will be long-dated US Government debt and the second-best investment will be cash US Dollars. The worst investments will be hard assets such as gold and silver.
We are confident that the US will not follow the path taken by Japan and that the US monetary authorities will, instead, opt for higher and higher levels of inflation. An important difference between Japan and the US is that a large portion of the Japanese voting public's net worth is comprised of traditional savings (interest-earning deposits at financial institutions), whereas the average US voter has almost no cash savings. The net worth of most Americans is determined almost entirely by the current prices of their property and stock market investments.
This difference is important because, as far as the Japanese monetary authorities were concerned, it placed a political obstacle in the path of inflation. Central banks have the power to discount (purchase) the loans and other assets of private banks. The Bank of Japan could have re-liquefied the Japanese financial system at any time during the past 10 years by monetising the non-performing loans held by the banks. This would, of course, have resulted in massive inflation and would have amounted to a devaluation of the hundreds of trillions of Yen of savings accumulated by the voting public. A more politically-palatable path, one that entailed extremely-low interest rates and huge government deficit-spending, was hence followed. The same political impediment to the large-scale conversion of illiquid assets to currency deposits does not exist in the US.
We don't want to get into any further discussion, at this time, as to why the post-bubble environment in the US will be very different from the post-bubble environment in Japan for one simple reason - the US bubble has not yet burst.
The Bubble Continues!
MZM (money of zero maturity) is a reasonable measure of liquidity within the financial system. The following chart shows the year-on-year (yoy) percentage changes in MZM growth (in red) since 1988, with arrows marking the points at which the Fed began to 're-liquefy' the system.
The US bubble commenced around the middle of 1997, just as the effects of the Asian crisis began to be felt. The first 'hiccup' occurred during Q3 1998 when LTCM (Long Term Capital Management - the oxymoron hedge fund) failed and Russia defaulted on its debt. In order to perpetuate the bubble the Fed found itself re-liquefying the system at a time when yoy MZM growth was already running at 12%. The second hiccup arrived during Q4 2000 when the NASDAQ plunged, causing the Fed to begin re-liquefying (via the 50bp rate cut on Jan-03) even though yoy MZM growth had only fallen to 8%. (We could have also mentioned the Q4 1999 Y2K-related re-liquefication, but the associated hiccup was only imaginary and the re-liquefication was 'unofficial' in that the banking system was flooded with reserves at a time when the Fed was supposedly (officially) tightening). Note that the 1989 and 1995 re-liquefications began when the yoy MZM growth rate was negative.
It appears that the yoy rate of MZM growth cannot be allowed to fall below 7%. In other words, it seems that the Fed can no longer risk letting the liquidity cycle run its natural course.
The US bubble was/is not the NASDAQ. The prices of the NASDAQ indices and the tech/internet stocks that drove these indices to such rarefied heights were symptoms of the bubble. The US bubble was/is based on a phenomenal credit-creating machine, and with $161B having been added to the total supply of money over the past 6 weeks it is clear that the machine (the bubble) is alive and well.
We occasionally hear the "pushing on a string" analogy applied to the inability of a central bank to rejuvenate a burst bubble using monetary policy. Well, from the rate at which new money has recently been created it is obvious that somebody is pushing on something, but it is certainly not a string! The "pushing on a string" analogy may turn out to be valid, but the point we are trying to make here is that the current "pushing" is happening prior to the bursting of the bubble. This is a pre-emptive strike!
We've said this before, but it bears repeating: The Fed has the power to boost asset prices as much as it wants, it just can't do it without affecting the Dollar. It looks, at this stage, like an all-out attempt is being made to support asset prices and the Dollar is being thrown to the dogs.
Steve Saville
Hong Kong
17 January 2001
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