PONDERING POST-BUBBLE AMERICA
By Doug Noland
Where is the faltering U.S. economy headed? For starters,
it is not clear to us that the consequence of the U.S.
Credit Bubble is a predestined "deflation". Indeed, we can
look to the disparate environments in post-Bubble Japan and
post-Bubble Argentina as evidence that collapsing Bubbles
may end in a long, draw-out mild deflation or, in the case
of Argentina, rapid financial implosion and devastating
inflation. From the standpoint of attempting to analyze
which of these polar extremes may best apply to Post-Bubble
America, we are increasingly convinced that the dollar's
performance will play an instrumental role.
Consider first Japan. Before succumbing to extreme
financial excess in the late eighties, Japan made truly
incredible economic progress for several decades. Sadly,
the Japanese "drank the poison" and basically destroyed
their financial system in a few short years. Yet, post-
Bubble Japan remained endowed with great wealth-creating
manufacturing capacity. The Japanese multinationals have
not only survived; they have prospered. With enormous trade
surpluses, the economy has been able to muddle through a
wrenching decade-long financial quagmire.
The related trade surplus and household saving attributes
(Japan as a creditor nation) played an instrumental role in
supporting the Japanese currency. The yen today trades at
about 120 to the dollar, just off its 10-year average and
above where it began the nineties. Importantly, and
especially for retirees, the frugal Japanese saver has
maintained her purchasing power. There has been no run on
Japanese financial assets.
The Japanese Credit Bubble was a severe domestic debt
problem, but international investors and speculators played
a relatively insignificant role. The fate of the financial
system and economy did not rest tenuously on yen
confidence. The post-Bubble banking system has been an
unmitigated disaster, but the Japanese economy's debt
structures - supported by decades of sound investment and
enormous household savings - proved resilient.
Stagnant private sector credit growth was partially offset
by large government borrowing, playing a critical role in
tempering financial fragility and stabilizing the system.
Excesses, both real and financial, had not reached the
point where contracting private-sector debt growth would
lead to unmanageable collapse. Fortunately, I would argue,
the Japanese government used its fiscal and monetary powers
to ease an arduous post-Bubble transition, rather than to
sustain the Bubble.
While certainly encumbered, Japanese society has remained
cohesive through a protracted and difficult adjustment
period. The general population has not rioted or spent much
time in protest, but rather fell back on financial
discipline and its hard-work ethic. There has been too much
(typical post-Bubble) talk of policy incompetence and not
enough recognition of a most impressive performance by the
Japanese people.
At the other extreme, an arguably much less formidable and
pervasive Bubble in Argentina has left the financial system
and economy in absolute tatters. Many savers have been
completely wiped out, and the social fabric has been
severely frayed. Argentine citizens have lost confidence in
the government and the country's institutions. Sadly, bank
runs have become commonplace.
The Argentine peso has lost 70% of its value, with
inflation running rampant. Foreign bankers, investors and
speculators have abandoned the country, with international
institutions (and "globalization") under justifiable attack
from Argentine citizens, politicians, and monetary
authorities. The economy has sunk into deep depression,
with little benefit from a collapsing currency. Indeed, the
sinking Argentine peso has been a major hindrance, in stark
contrast to the experiences of post-Bubble South Korea,
Thailand, Russia and Brazil.
The boom-time Argentine economy came to depend on foreign-
sourced finance, much of it of a speculative character.
Once addicted, all involved were steadfast in refusing to
recognize the sickness. Foreign borrowings financed too
much consumption and too little of the type of sound
investment capable of creating the necessary economic
wealth to repay creditors. Once this course was chosen, it
was only a question of the dimensions of the inevitable
financial and economic dislocation.
Reliance on foreign borrowings in combination with economic
maladjustments over time combined to create acutely fragile
debt structures. Indeed, it was precisely the nature of the
speculative capital flows fostering non-productive credit
excess that proved fatal to the Argentine financial system.
Frail debt structures and economic maladjustment left the
currency, credit system, and economy hopelessly vulnerable
to both the inevitable reversal of speculative flows and
attendant capital flight.
Confidence in the peso's peg to the dollar became of
momentous consequence. Almost overnight, Argentine
financial assets were no longer an acceptable medium for
international exchange. Significantly, none of these types
of issues have played a role in post-Bubble Japan.
Considering these two post-bubble scenarios, we have very
difficult and complex questions to contemplate in our
pursuit of What Will Be Post-Bubble America. Most
regrettably, the Greenspan Fed, Wall Street, the GSEs and
Washington politicians are resolute in their determination
to stonewall the adjustment process. This dangerous course
of prolonging the Bubble is categorically based on
continued credit excess - inflating dollar financial
claims. This should not today be in dispute, and incessant
credit inflation is why we remain fixated on dollar
vulnerability and devaluation.
There may certainly come a day when faltering confidence
and a run on dollar financial assets wreaks (Argentine-
style) havoc on the U.S. credit system - especially its
acutely fragile "Structured Finance" parallel "banking"
system. However, the system today still retains its
capacity for unchecked and rampant inflation of dollar
claims (credit inflation).
The inescapable consequences of the U.S. Credit Bubble
Dilemma include only more credit and speculative excess,
heightened financial fragility, deeper economic
maladjustment and impairment, and a further debasement of
our currency. It is not at all outrageous to assert that
the U.S. system has set a perilous course toward the
collapse of the world's reserve currency. No amount of
inflation will change the facts of economic life.
There are no available shortcuts but many risky gimmicks to
prolong the Bubble, making the inevitable day of reckoning
all the more painful and Balkanizing. Nowadays, the call
for stimulating and "reflating" grows ever louder, but
there is absolutely no discussion of the consequences. Yet
there is so much at stake. It is our view that the longer
the U.S. travels down this dangerous course, the more
rapidly the Post-Bubble America pendulum swings away from a
Japanese scenario in the direction of Argentina.
Warm regards,
Doug Noland |
