Japan, Expansion of the monetary base does NOT always = Inflation.

Discussion in 'Business & Economics' started by nirakar, Jan 11, 2010.

  1. nirakar ( i ^ i ) Registered Senior Member

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    In short, Expanding the Monetary base won't create inflation while M3 money is shrinking due to unwinding loans.

    Japan had a very large expansion of it's monetary base since 1997 but has experienced deflation rather than inflation since 1997. Our text book learning and seemingly common sense would suggest that quantitative easing in the USA would result in inflation but there are exceptions to every rule.

    The question is could what happened in Japan happen in the USA?

    Japan had a huge asset bubble and an overvalued currency in the late 1980s. Japanese corporations were irrationally exuberant and borrowed heavily and spent heavily on endless expansion some of it stupid expansion.

    Japan had lowered it's discount rate to 2.5% in 1987 to deal with an economic slow down but this helped create the asset bubble. Japan raised the discount rate to 6% by 1990 to pop the bubble but popping the bubble created bad loans. The Japanese government/financial/social system was reluctant to let the companies that screwed up go bankrupt (Sounds like the USA) and tried to prop them up.

    In the real economy in increasingly competitive global manufacturing by 1990 Japan had lost it's comparative advantage. Permanent recession set in.

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    Lowering interest rates and expanding the monetary base could not heat up an economy in which lenders would no lend and borrowers would not borrow.

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    Throughout the 1990s and and 2000s there was a steady lowering of Japanese wages as older more expensive full time workers were replaced with cheaper younger part time temporary workers who never included in the commitment to it's workers that Japanese companies are famous for. Also throughout the 1990s and 2000s the cost of real estate and rents in Japan continued to decline as the 1980s real estate bubble kept on deflating long after the initial collapse. These two factors are at the heart of Japanese deflation. The USA could have declining wages for decades and could have further declines in it's real estate markets.

    Normally low interest rates and expansion of the monetary base lead to an increase in the total money supply and therefore increased inflation inline with monetarist beliefs about the causes of inflation. This did not happen in Japan and may not happen in the USA because an unwinding of loans decreases the money supply. When people pay off their credit cards they are shrinking the money supply. An article suggested that when a bank writes off bad debt they are decreasing the money supply but I think the article may be wrong unless the bank received partial payment.

    From: http://seekingalpha.com/article/136109-the-u-s-economy-not-a-repeat-of-japan
    In no particular order some sources:
    http://news.bbc.co.uk/2/hi/business/1161890.stm.
    http://www.roubini.com/us-monitor/254267/it_s_raining_vols
    http://krugman.blogs.nytimes.com/2009/06/13/way-off-base/
     
    Last edited: Jan 13, 2010
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  3. nirakar ( i ^ i ) Registered Senior Member

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    from: http://invest.obtusely.com/2008_08_01_archive.html
    I was quoting somebody quoting from an article from The Economist magazine.
     
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  5. nirakar ( i ^ i ) Registered Senior Member

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    Japanese nominal wages have fallen between 10% and 20% since 1997. Real wages have fallen a little less because of the deflation.

    Below From: http://www.bloomberg.com/apps/news?pid=20601109&sid=aFTPC.EzvUsA
    article continues
     
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  7. nirakar ( i ^ i ) Registered Senior Member

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    Below from:
    http://www.gold-eagle.com/editorials_08/saville072109.html

    The Japan Inflation Myth

    It is commonly believed that Japan's monetary authorities have created a huge amount of money over the past 18 years in an effort to elevate prices and stimulate the economy. The fact that the Yen has maintained its purchasing power and the Japanese economy has remained moribund is therefore considered in some quarters to be evidence that a high rate of money-supply growth won't lead to rising prices or meaningful economic growth in a post-bubble world.

    Before getting to our main point it is worth noting that nobody with a good understanding of economics believes that creating money out of nothing can give the economy a sustainable boost. In fact, the opposite is true. Money is not wealth and it should be intuitively obvious to anyone with common sense that creating more pieces of paper money could only damage the economy over the long-term by distorting prices, re-distributing wealth and prompting additional mal-investment. In other words, if Japan's monetary authorities had created a huge amount of new money the end result would NOT be a strong economy.

    This brings us to our main point, which is that Japan has experienced relatively SLOW money-supply growth since the 1990 bursting of its credit bubble. Specifically, the chart included herewith shows that Japan's year-over-year rate of M2 growth plunged from 12% to 2% in the immediate aftermath of its credit bubble and remained in a narrow range around 2% thereafter (note that we using M2 in this case because we don't have TMS data for Japan).

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    The beginning of of the above article is below
    M3's False Signal And The Japan Myth
    Steve Saville
    21 July 2009
    M3 is sending a false signal, again

    During April-June of last year we described the rapid growth in M3 money supply that was occurring at the time as a "major league false signal". We thought it was a false signal because it contrasted starkly with the performance of the monetary aggregate known as TMS (True Money Supply). Whereas TMS was suggesting that the rate of monetary inflation was relatively slow, and, therefore, that a deflation scare was a distinct possibility within the ensuing 12 months, M3 was pointing to an inflationary shock to the system.

    M3 and TMS usually trend in the same direction, but on those occasions when they diverge in a big way -- as they did during 2006-2008 and also during the early 1990s.......................continued..........

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  8. nirakar ( i ^ i ) Registered Senior Member

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    I no longer am so sure about the belief that I previously had that high inflation will be coming to the USA soon.
     
  9. nirakar ( i ^ i ) Registered Senior Member

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  10. kmguru Staff Member

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    My understanding is that Inflation occurs when too much money is chasing too few goods. So prices rise sharply and then you have to print money to stabilize the purchasing power and ...

    In present case, even if our government prints a lot of money, that money is mopped up by foreign entities for transactions between themselves and that does not filter down to average Joe that will run out and buy cars, or goods such that price is going to go up.

    As long as the average population do not see a dime in their pocket nothing will happen. But...a big but...what happens the foreign nations do not wish to support our debt?
     
  11. Pinwheel Banned Banned

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    I thought Japan exported their inflation via the carry trade. Is that not true?
     
  12. kmguru Staff Member

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    The only real hyper inflation we know of was Germany in 1921 when there was a demand of 2 Billion gold Marks plus 26% export duties. Because Germany was devasted in Production Capacity, now you have little production, too much money demand...causing a mess. If the London Ultimatum would have waited for a few years, this could have been averted. Japan did not face any such conditions recently. So, may be not a big deal...
     
  13. nirakar ( i ^ i ) Registered Senior Member

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    Right. If M1 goes up while M3 goes down the effect is deflationary because M1 is only relevant on inflation via it's effect on M3.

    The Yen fell due to the carry trade which raised the cost of all Japanese imports which surely was inflationary but the internal deflationary forces were greater. If the foreign nations don't offset the US trade deficit by buying US assets the dollar will fall which will raise the cost of imports. I don't know when the American borrowing will get back to normal but when that happens then the expansion of the monetary base would show up as an expansion of M3 and inflation. The US could contract it's M1 later but I don't think they will.

    What I learned from looking at Japan is that as an investor I can not depend on high inflation happening in the USA soon just because my old textbook would predict that inflation should be coming soon.
     
  14. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    It's fixed now. Sorry I did not get to this sooner.
     
  15. nirakar ( i ^ i ) Registered Senior Member

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    Thanks Billy. I am grateful that you fixed my mistake for me.
     
  16. nirakar ( i ^ i ) Registered Senior Member

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    With the US engaging in more Quantitative Easing I think Japan's history of Quantitative easing is particularly relevant to try to understand.
     

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