Japan's Attempt at Launching Their Version of Our Quantitative Easing Strategy
Posted on Thursday, June 13, 2013
An interesting experiment might have just exploded in the laboratories of the Bank of Japan since they made the announcement on April 4th that they would be launching the Japanese version of our Quantitative easing strategy, except, theirs would be three times the size of ours because more is better. Initially it looked like the Nikkei 225 (their version of our S&P500) liked it, but now it looks like they’re in big trouble. The world is maybe telling them that you can’t print your way to prosperity and you actually have to have real economic growth to grow. So, the big question is how is their experiment any different than the one we’ve been testing for the last few years?
The third largest economy in the world, Japan, recently thought it would be a good idea to copy big brother, America, and launch a huge stimulus plan of their own, flooding the market with Yen and attempting to jump start their economy. You can’t blame them. Japan has been in a recession since 1990, and the reality of their demographics has kept them in a recession with few signs of economic life. Let’s look at that demographic and see what it means. Post WWII, America had something that Japan did not: many men coming home from the war to make babies. The “baby boom” began in 1946 and ended in the year I was born, 1964, to produce almost 80 million new Americans, known to the world as “baby boomers”. Japan, because they lost such a huge percentage of their male population, never had that boom. Those are the cold, hard economic facts, and as a result, as those demographics played out, Japan ended up with the oldest population of any developed nation in the world. Old people tend to have predictable patterns when it comes to money; they save, they pay off debt, they’re frugal and they don’t like risk. Unfortunately, all of these things are required to grow and economy. People have to borrow, spend, invest and take risk in new business ventures to keep growth alive. Well, Japan did not have those things after the war.
Enough history. Here we are today, with Japan in its 22nd year of recession, and they get a big idea. “Why don’t we try some of the QE that Ben Bernanke and America keep doing to see if we can artificially pump up our economy and ‘jump start’ these old people who don’t borrow, don’t spend and don’t like risk. If we can really get our currency cheap, then the price of our exported goods will drop, so more people will buy them.” So really, the strategy is to put Japan on sale and hope the sale will stimulate economic growth. While that might work for the short term, the hard truth is that the demographic of that country will not change, and to have a sustainable economy, you can’t have 100% of your revenue coming from exports.
Here’s what happened so far: The announcement happened on April 4th, and the Nikkei went from 12,634 to 15,627 in about 5 weeks! Japan is thinking, “Hey this American QE thing is awesome”, except in the last 16 trading days, the Nikkei fell 2750 points, almost giving back all of its recent gain. So, maybe this artificial stimulation thing is not good.
When you think about it, they are just trying to do what we have, so far, successfully done, which is artificially inflate our stock market and hope that it somehow spills over into our real economy, which it has done to some extent.
So here is my take on things. Although Japan is a much smaller and older economy than ours, we need to use them as an example of how quickly artificial stimulus from the government can unravel when the underlying fundamentals are weak. I think, we may have gotten away with our experiment in America for the moment, but I have no doubt that we are living on borrowed time. In the words of famous economist Harry Dent, “Demographics trump economics in every society since the beginning of time.” In other words, human beings have the same habits across many different cultures as they age, and old people don’t like to borrow, spend or take risk. So on that note, I will leave you with a thought. Those 79 million “baby boomers” who catapulted America into the world’s biggest and strongest economy are turning 65 years old at the rate of 10,000 per day. Borrowed time is an understatement, and this experiment of unlimited government stimulus will end badly some day.
Everyone, including investment professionals, educators and regular people, would agree that when the US government prints money, it devalues the dollars that are already in our possession as citizens, which means we buy less goods and services with the same dollars. What if I told you that this broadly accepted economic belief is absolutely wrong? Even though the government is printing $80 billion per month to buy back bonds from banks, also known as quantitative easing, it has not caused inflation and may never cause inflation.
Before I explain why, let me give you an example: After the great stock and real estate market crash of 2008, the government went on a stimulus rampage printing trillions of dollars, first, to bail out all of the institutions that caused the problem in the first place, and then to stimulate the economy by attempting to get more money into the system. This money print was the biggest intervention that the world had ever seen and was counted in trillions of dollars. It is still going on today through QE3 at a rate of $80 billion per month. Therefore, any thinking person on the surface would have assumed that this would eventually cause inflation. But it didn’t. In July of 2007, as the market started to slide downward off its peak, the inflation rate in the US was 2.36%, and here we are today, 6 years and trillions of printed dollars later, and our inflation rate as of April 2013 was 1.06%. So, not only do we not have an inflation problem, it actually continues to look like we have a deflation problem. So how could this be?
It’s all about the banks and the way our banking system works. Let’s say you are a bank and you have a billion dollars worth of treasury and mortgage bonds on your balance sheet, and the government comes knocking on your door, offering to buy those bonds from you at a great price, allowing you to get them off your balance sheet. You decide to sell those bonds to the government, since they are paying almost no return and might even be risky if they are mortgage bonds. Here is the key: when the government takes those bonds from you, they don’t drive a truck over to your bank and give you the cash. They simply increase your reserve account in the virtual world of digital money, improving your balance sheet as a bank and improving your finances, as a business, but not necessarily stimulating spending from your customers. For that to actually happen, you the banker, need to lend that money out to businesses and consumers who will eventually go out and spend it in the real economy and cause inflation. Well, lending requirements today are stricter than ever before, and aging baby boomers are much more interested in paying down their debt than increasing it. Banks are asking for record down payments on real estate transactions, and banks are finding it more attractive to invest their reserves in stocks and corporate bonds than take the risk that when the next crisis occurs, they are left holding a bunch of bad loans.
So, because of the way our banking system is structured, it is possible to print trillions of dollars and not be able to re-inflate the economy. If massive government stimulus has not been able to re-inflate the real economy, it means that you need to be super cautious coming into the summer and should be sweeping your portfolios for potential landmines now, before the next major crisis hits.
Gold has been one of the top performing investments for the last 12 years, 10 years and 5 years, but definitely not for the last 2 years. Gold recently fell from its October highs, and it’s currently 23% lower than it was 7 months ago. Even considering that drop, it still has outperformed the S&P 500 for the last 12 years,10 years and 5 years, so don’t get too excited about the hype from the financial entertainment network. Also, speaking of hype, this recent correction in gold was touted by the talking heads as an unprecedented move and something that had not been seen since 1982! Given my inherent distrust of the media, I decided to go back and do some homework to see if this recent pullback was simply a pullback or if it was something truly extraordinary that indicated some type of unusual warning signal.
I went back to May of 2006, the first time gold pulled back from its run that began in 2000, and between May and June of 2006, it dropped 19.71%. Then, between March of 2008 and October of 2008, it corrected 27% before continuing its meteoric rise. Then, between August of 2011 and July of 2012, it corrected again and gave back 15% from its new high, and recently, between October of last year and May of this year, it gave back 23%. So, clearly nothing extraordinary or unbelievable has occurred in this recent pullback even though the media would like to make you believe that it has. Gold’s recent trading pattern is definitely getting my attention, in a good way, because of the possibility of the coveted triple bottom that traders dream about as one of the most powerful buying signals there is. If you look at the 3 month chart on GLD, you’ll see where it fell from 151 down to 131, then bounced up to 142, then touched 131 again about 10 days ago, and is now heading north currently at 136. We may never see that triple bottom, and GLD might just take off again like it has done in the past, but if we do see it around that 131 number again, and it holds, that would be a very strong technical buy signal for all of you traders out there. So, keep an eye on the charts, whether you are looking to buy gold or trying to decide if it’s time to sell some.
Is the S&P500 setting itself up for a summer rally or a good old fashion summer crash? From a technical perspective, currently the S&P500 sits around 1657, after breaking out above the 1550 resistance level. This break-out signaled the next and possible final phase of a four year cyclical bull rally. According to the technical experts over at UBS, who I’ve personally known for over 22 years, the resistance levels to watch here are between 1650-1660, which is where we are sitting right this very moment. If this recent speculation continues, we could maybe see 1710, or another 3 % on the upside, but not much more room is left in this rally if you look at the charts. On the downside there is some decent support around 1474 and then at 1400 below that, so from what I can see, this stock market offers much more short term downside risk than upside reward, so be careful and think about taking some chips off the stock table for the summer.
Just when you thought things couldn’t get any better, the average price of a new home in America has finally made it back to $330,000 which is where it was in 2007, before the bubble burst. Now on the surface, that might seem like good news, just like the stock market finally making it back to its 2007 highs and now exceeding them.
Is there an investment opportunity for you in this real estate revival that we have been witnessing over the last 12 months or so, or is there a dangerous landmine that you need to avoid? Like I said, the average price of a new home has just got back to $330,000, which we have not seen since 2007, before the crash, before the bubble burst and before we experienced our worst real estate and stock market fall ever, since the Great Depression. The first question we have to ask is, “If the greatest real estate crash ever was caused by an artificial bubble, filled with sub-prime mortgages and liar loans, then how can we recover back to prices that were artificial in the first place, hence the term bubble?” There are only a couple of possible answers to this question.
One answer is that we are in another artificially funded bubble and it will eventually burst. I don’t think this is the case because banks are no longer making sub-prime loans, and it is harder to get a loan today than ever before, even if you have real documented income and a good credit score. Another possible answer number is people’s finances have dramatically improved, and they now have more disposable income than before and are spending it on new houses. Well, this one’s not correct either because according to recent report, real disposable income is actually 2.3% lower than it was in 2007, so there goes that theory. How about population growth? After all, if there are more people in America, then more houses are needed, right? Well, according to the most recent data from the US Census Bureau, population growth in America is on track to be the slowest it’s been since 1930, so that’s not the answer either.
Our survey said… cash purchases by professional investors are making up a large majority of house purchases in America, either buying to rent out or to fix up and flip. So, how long can investors support the residential real estate market, buying houses they are not themselves living in? The answer is not for long. Any time investors are driving a market instead of homeowners, it is a short lived run that will end badly because it’s all about math. As soon as the process of the homes move up too much, as it looks like they have done, and the rents that those homes can produce no longer justify the process, investors will quickly stop and the market will slide. So if you’re an investor, there may be some more room to play this game, but my bat sense is telling me that we are closer to the end of this run than the beginning, and you need to be cautious. Please remember, unlike stocks, which are liquid at a moment’s notice, the biggest risk investors have when speculating on real estate is liquidity. The definition of true safety is being able to get you money out of trouble at a moment’s notice. The problem and major risk with real estate is “when it goes south, you can’t get out”, so please be cautious.
So the good news for today, is that I am going to share with you, a brand new portfolio landmine to watch out for, to add to the extensive list of landmines that I have given you over the last few weeks from my new book titled “Portfolio Landmines” How to detect and remove potential dangers from your portfolio before they explode. The bad news is that I am running out of landmines, but everything must have a limit, and we are getting close. So grab a piece of paper and a pen, or the stylus on your smart phone, or whatever you use to take notes these days and get ready to be amazed.
I’m going to give you another portfolio landmine from my new book, in a continued attempt to teach you how to identify potential hidden dangers in the way you invest, before the next crash hits and hurts you like it did in the year 2000 and much worse like it did in 2008.
As you know, if you are a regular follower of this blog, landmines are hidden investments or practices that you don’t know are dangerous until you step on them. So, a big part of success in investing is not so much knocking the ball out of the park and making a killing, it more about not blowing yourself up when things go wrong. So let’s talk about landmine #11 “Putting All of Your Eggs in ONE SYSTEM”.
Now, when you think about the typical way that Wall Street peddles their goods, which are mostly mutual funds or what I like to call public swimming pools of money, you think about diversification, asset allocation, pie charts and graphs, allocating your money between stocks and bonds and spreading your risk between things that are not supposed to move in unison with each other. Most of the time, just like your broker claims, that works just fine…UNTIL it doesn’t, like in 2008 when the credit markets froze, the real estate market went into a free fall and stocks lost an average of about 50% of their value in a very short period of months. So, in that scenario, you could have followed Wall Street’s beloved MPT and still have been damaged beyond repair, especially if you were older and didn’t have 20 years to recover before retirement.
So today, I want to introduce you to the theory of system diversification, which is a whole different level of protection that the super wealthy have been using for years.
When you think about stocks and bonds, and now even real estate, although they are all very different types of investments, they are all part of the same system which is supported by Wall Street. Until about the year 2000, in all fairness, most people did not consider real estate to be part of Wall Street, but something happened to make real estate just as risky as stocks and bonds that changed the system forever. Wall Street figured out a way to create securities made out of residential mortgages, package them up into a nice little pool, and sell them to investors all over the world. Remember the old days when the bank that gave you the mortgage actually kept it and serviced you for 30 years? Well, Wall Street changed all of that. Now, at first banks thought it was pretty cool to lend a bunch of money, collect all kinds of closing fees, and then, 30 days later, sell the loan to Wall Street and do it all over again. The problem arose when Wall Street started hiding sub-prime loans inside of relatively clean pools, which is ultimately what corrupted the system. When everyone suddenly realized that the pool had some mortgages under the surface that would never pay off, they panicked and started to dump everything.
As a result, in 2008, the credit markets froze, which took real estate into a free fall, because if banks are not willing to lend money to people, real estate can’t work. Especially if the loans that banks already have made are in question of default, it becomes a free fall. Well, that same issue affects another part of the system, the stock market. If banks are not able to lend to corporations to fund their short and long term cash flow needs, the stocks of those companies will plummet. If that happens, people will start to question the long term viability of the company, and their bonds will start to react over the fear of default.
These are just a few of the details of 2008, but the big surprise for many is that all of these supposedly different investments were all part of the same system. So, how can you diversify some of your risk away from this system? The answer is that you need to have some of your assets in other systems. There are several types of investments that my team and I use in my wealth management practice that are not directly part of the Wall Street machine, but the one I want to share with you today has been around for about 200 years and is the safest system this country has ever seen. This system has survived through every imaginable crisis, and it is still the most stable system anywhere. I’m talking about insurance companies and specifically having a portion of your assets inside of specially designed policies that allow your money to remain liquid, safe, earning a good rate of return and if designed properly, can be accessed 100% tax free. This “other” system has the longest track record of safety of any investment in our history, and the great thing about using it as part of your investment strategy is if you die while you are accumulating your fortune, your family gets a big chunk of money to go on without you. That is in no way similar to the stock or bond or real estate industry.
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