Frugality Trumps Quantitative Easing

Once again, deflation has a firm grip on Japan. Symptoms include falling wages, rising unemployment, weakening consumer demand, and falling prices.

Please consider Japan Logs Record Wage Fall, Bonuses Sink.

Japanese wage earners' total cash earnings tumbled 7.1 percent in the year to June, the biggest annual drop on record, which could hurt consumer spending and add to deflationary pressure on the economy.

Weakening household demand for goods is playing an increasing part in pushing the world's No. 2 economy deeper into deflation, with core consumer prices falling a record 1.7 percent in the
year to June.

The Bank of Japan is already forecasting two years of deflation, so price falls alone are unlikely to push it back into full-blown quantitative easing, which in Japan involved flooding the banking system with cash to meet a specific monetary target.

But weak wages, coupled with a rise in the jobless rate to a six-year high in June, may heighten uncertainty over the central bank's forecast for a gradual economic recovery towards early next year, and put on hold any exit from its unconventional monetary policy steps.

"This puts downside pressure on prices, and deflation will worsen for the next one year. There is no way the central bank can move in this situation," said Masamichi Adachi, senior economist at JPMorgan Securities in Tokyo.

QE Checkmate

Earlier this decade Japan invoked a policy of Quantitative Easing to inject cash into the economy. It did not work as planned. However, Japan's QE policies did unleash the mother of all carry trades as investors borrowed in Yen to invest in higher yielding currencies.

Now, with US interest rates at 0 to .25%, UK interest rates at .5%, and the ECB with Eurozone interest rates at 1%, borrowing Yen at 0% to invest in other currencies does not make a lot of sense. All Japan succeeded at was driving up national debt via ridiculous Keynesian spending programs.

Moreover, with rising unemployment, and massive government debt, Japan does not want its interest rates to rise (which they would should inflation take hold). Thus, it's checkmate for Japan in regards to QE.

The UK and US are now embarking down that very same road but the result will be the same because Consumer Frugality Trumps Quantitative Easing.

Was the Fed Successful?

David asks:

Mish,

Love your blog, but I’d like to clarify one thing with you.

You often dismiss the notion that inflation is not a plausible scenario in the short / mid-term. You’re right to point out that house and other consumer goods are tanking, thus leading to deflation. But don’t you think the fact that prices don’t fall as much as they should – due to inflationist policies by the Fed – is, in itself, inflation?

Without the actions of the Fed prices of cars, houses, shares, commodities, etc would be lower. They’re not, which means we are currently experiencing inflation.


Don’t you think?

David

The Fed's effort to increase money supply have indeed had short-term impacts (at great long-term costs). However, most of those changes are still of a second derivative nature. Note that in regards to consumer spending, bank lending, jobs, and housing prices, the situation is still worsening, albeit at at a decreasing pace.

Note that Obama has promised to save 3.5 million jobs. But even if he has (which no one believes), the economy is still shedding jobs and consumer prices are still falling, especially when one properly factors in housing. Please see What's the Real CPI? for details.

It's Not About Prices!

That aside, inflation is not about prices at all but rather the expansion and contraction of credit.

Falling prices do not constitute deflation. However, they are a likely but not mandatory symptom of it.

In a credit based economy, the key issue is expansion and contraction of credit. Credit is clearly contracting. And credit marked to market (which is what matters most) has dwarfed Central Bank expansion of money supply to counteract it.

Given that the Fed and the accounting board have suspended market to market accounting it is a guess as to whether credit marked to market is expanding or not. However, the latest reports still show a contraction in bank lending as well as tightening of lending standards.

And yes the Fed has pumped up money supply. But if money just sits there as excess reserves (and this is indeed what is happening) then it does not affect prices.

Short-Term, the Quantitative Easing efforts by the US, UK, and ECB have stabilized the markets. Long-term all the governments have done is pile on more debt that must be paid back (with interest), and that will act as a huge drag on the economy at a later time.

Note that US and European banks are still reluctant to lend because of massive overcapacity everywhere. Consumers are still reluctant to borrow. The savings rate is rising.

Chinese banks are a different story. China is a command economy and if the government says lend, Chinese banks lend. One must not confuse rising commodity prices on account of China or on account of inventory replenishment in the US and Europe as a sign of a sustainable, renewed credit boom by consumers or businesses.

Demand for Credit is Weak

Moreover, the $14 trillion effort by the Fed has not done a thing for jobs, nor will it. And without jobs, credit card writeoffs will soar along with foreclosures. Congressional policies like "cash for clunkers" merely pushes demand forward while adding to debt that must be repaid via higher taxes.

In the "Recoveryless Recovery" Bernanke will continue to be stymied by consumer and business frugality. Demand for credit is weak and so is bank willingness to extend it. Thus, inflation is not yet in the picture, and when it does arrive, it will be far less than most expect.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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