By Michael Lombardi, MBA for Profit Confidential
We need to learn from this example…
Similar to the U.S. economy, only years earlier, the Japanese economy also burst following a boom in real estate prices. To help revive its economy, the Bank of Japan brought interest rates to near zero in 1999 and has done several rounds of quantitative easing since. The central bank of Japan has increased its balance sheet to 166 trillion yen. (Source: Wall Street Journal, March 21, 2013.)
But all this monetary stimulus—interest rates near zero for years and lots of money printing—has helped the Japanese economy. In fact, global exports from the Japanese economy fell 2.9% in February 2013 from February 2012. This is important because it shows how the Japanese economy is struggling even after implementing unheard of monetary policy intended to bring economic growth to the country—similar to what the Federal Reserve is doing now in the U.S.
February marked the eighth consecutive month of slowing exports and an increasing trade deficit (more imports than exports) for Japan—the biggest streak of trade deficits since 1980. (Source: Bloomberg, March 21, 2013.)
Japan’s national debt to gross domestic product (GDP) stands at about 204% of GDP—this shows you just how easy monetary policy has been in Japan.
The Japanese economy should be looked upon as a good example for the Federal Reserve to see how its monetary policy will play out in the U.S. economy.
What has this done for the Japanese economy with all its paper money printing? Not much, to say the least. Since 1998, wages in the Japanese economy are down seven percent, property prices are down 51%, and tax revenues are down 14%. The Japanese economy has lost its status as the second-biggest economic hub in the world to China.
The Japanese economy is proof that aggressive paper money printing will not stimulate an economy.
At home, the Federal Reserve is still planning to buy $85.0 billion worth of bonds monthly and increase its balance sheet. Before our financial crisis began, the Federal Reserve’s balance sheet stood below $1.0 trillion. Thanks to loose monetary policy and multiple rounds of quantitative easing, it has increased to more than $3.0 trillion—an increase of more than 200%.
Dear reader, the idea of easy monetary policy revving up the engines of economic growth can only go on for so long. Businesses and the individual must be willing to borrow money in order to invest and spend. Right now, we have the opposite. Corporations are hoarding their cash (afraid to spend it) and consumer confidence in the U.S. economy is at its lowest level since December 2011. (See “One in Three Americans Has No Confidence They Can Retire Comfortably.”)
Economic growth happens when individuals and businesses aren’t scared to make decisions because they are faced with economic uncertainty. Consumers and businesses must feel confident before they can spend. Easy monetary policy certainly causes the stock market to rise and a currency value to decline, but other economic benefits are limited. Japan is proof of this. And America might just prove it again.
Michael’s Personal Notes:
Municipal bonds investors might be headed towards a storm, which may cause significant damage to their portfolios. Cities within the U.S. economy are in distress—they are struggling to keep their spending in order to not increase their budget deficit.
Detroit, one of the biggest cities in the U.S. economy, was handed an emergency manager by the state to take care of the city’s budget deficit. The city is running a deficit of $327 million and has $14.0 billion in long-term obligations—mainly municipal bonds backed by the city’s water and sewer systems. (Source: “Snyder Says Detroit Needs Emergency Manager to End Fiscal Crisis,” Bloomberg, March 1, 2013, last accessed March 21, 2013.)
Michigan’s Governor, Rick Snyder, explained the city’s situation, saying, “it’s a sad day, a day I wish never happened, but it’s a day of promise.” (Source: Ibid.)
If the state didn’t intervene, then Detroit would have been the largest municipal bankruptcy in the U.S. economy—leaving municipal bonds investors in misery. In November 2011, Jefferson County, Alabama was the largest municipal bankruptcy in the U.S., involving more than $3.1 billion in municipal bonds.
Municipal bonds investors have enjoyed tax advantages in the U.S. economy, but if there is a downturn in these types of bonds, then the benefits will quickly disappear.
What’s ahead for municipal bonds investors looks even more troublesome. Williston, North Dakota’s municipal bonds were downgraded by Standard and Poor’s from “A-” to “BBB+.” (Source: KFYR-TV, February 28, 2013.) The municipal bonds credit rating went from being in the upper investment grade to almost the non-investment grade.
Moody’s Investor Services has downgraded 11 municipalities in the U.S. from stable to negative—and all these cities had a credit rating of “AAA” prior to the downgrade. (Source: Barron’s, February 6, 2013.)
On top of this, the housing market in the U.S. economy is still facing severe stress. From their peaks in 2007, home prices are still down about 30%, with very little hope in getting back to those pre-recession price levels. Remember: for municipalities, property taxes are the biggest source of revenue. Until the U.S. housing market becomes strong, the ability of cities to earn revenue will remain bleak.
And if interest rates in the U.S. economy increase, which they eventually will to hold down inflation, municipal bonds investors will face further threat. A simple rule of economics: bond prices fall when interest rates go up.
As this all unfolds, I believe municipal bond holders will become a victim. In fact, these investors are very vulnerable right now. I am keeping a close eye on the municipal bond market and struggling American cities. This municipal bond market problem could take the U.S. economy into much deeper troubles than we are already experiencing.
What He Said:
“A Stock Market’s Obituary: It is with great sadness that we announce the passing of the Dow Jones Industrial Average. After a strong and courageous battle, the Dow Jones fell victim to a credit crisis and finally succumbed on Friday, October 3, 2008, when it fell decisively below the mid-point between its 2002 low and its 2007 high.” Michael Lombardi in Profit Confidential, October 6, 2008. From October 6, 2008 to November 27, 2008, the Dow Jones Industrial Average experienced one of its biggest two-month losses in history.