Which Way to Turn?

For John, BLUF:  Economics seems to be more about Faith than Reason.  Nothing to see here; just move along.

Writing for Forbes, Mr James Gruber tells us, "Forget Cyprus, Japan Is The Real Crisis".  As we remember from our last thrilling episode, the EU was going to force Cyprus, in exchange for an 11 Billion Euro bailout, to tax all savings accounts over 100,000 € at 9.9%, those under a little less.  That was rejected last week, but now Cyprus is going to tax all accounts above the insured level some 20%, which is still less than losing all the money in a bank collapse.♠

Someone I know wrote in an EMail about this:

It appears that the Cypriots now plan 20 percent haircuts for uninsured deposits (those over 100,000 Euros, about $130,000) at the large Bank of Cyprus.  If it were to fail, uninsured depositors would have no legal recourse to demand reimbursement over the insured amount, and the bank would be under no obligation to make good on uninsured deposits.  That the Government of Cyprus seeks to protect 80 percent of uninsured deposits goes well beyond legal requirements.  Apparently depositors are other banks will face only a four percent haircut on deposits over the insured amount.

He then continued with some political analysis of the Russians who put their money in Cypriot banks.♥

But, back to the Forbes article, here is how Mr Gruber starts his article:

Forget Cyprus. A much bigger story in the coming weeks and months will be in Japan, where one of the greatest economic experiments in the modern era is about to begin.  A country where government debt even dwarfs those of Europe’s crisis-ridden nations, Japan will attempt to inflate its way out of a 23-year deflationary spiral.

The overwhelming consensus among the world’s economists is that quantitative easing (QE) has saved the day in the U.S. and that Japan needs to follow suit, on a larger scale.  I beg to differ and suggest this policy will almost certainly lead to a hyperinflationary disaster in Japan.  If that’s right, it will have serious ramifications for other countries, dragged down by an acceleration of the so-called currency wars.  More broadly though, it is likely to destroy the myth pushed by today’s economists that QE is a cure-all for downtrodden economies.  It isn’t and Japan will become the template to prove it.

Mr Grube lists three "Facts" and then disputes them.  The facts are (1) that the US Economy proves stimulus works, (2) that Europe's problem is government spending cuts and (3) that Japan never tried an aggressive stimulus approach.

Fact 1:  It is far too early to tell whether U.S. stimulus policies have worked.  They have propped up the economy in the short-term, but whether that’s sustainable in the long run is open to question.  Even in the short-term though, the recovery has been slow and unimpressive.  Consider:  2012 GDP growth of 2.2% vs a post World War Two average of 3.2%, a current unemployment rate at 11.3% if you include that have dropped out of the workforce since 2008, real household incomes are still 10% below levels in 2000 and the velocity of money (M2) is the lowest in more than 50 years (indicating printed money hasn’t circulating into the real economy).

Fact 2:  Europe hasn’t pursued austerity.  Anyone who says it has is lying. But it makes for a nice political argument in favour of stimulus.  European total debt has kept climbing, now at 390%, as the private sector hasn’t paid down any debt, while governments have increased their debt portions.  No cutbacks here!

And for the curious, unlike QE, there is some historical evidence that austerity can actually work.  In my neighbourhood of Asia, the financial crisis of 1997-1998 brought tremendous pain to many Asian countries, but through austerity and sweeping economic reforms, they recovered relatively quickly and in much better shape.

Fact 3:  Those that claim that Japan has never pursued aggressive stimulus are talking rubbish.  But again, it’s nice propaganda for Keynesian advocates.  From 2001-2006, Japan embraced large-scale stimulus, with its monetary base increasing by a mammoth 36% year-on-year at its peak.  During the period, the monetary base rose 82% in total.  But economic growth was never revived, the currency rose rather than fell and inflation continued to decline.  QE in Japan was dropped because it was seen as failing.

There you have it.  There are two different views.  It is like you are driving east along a highway and you get to the Atlantic Ocean, where your road Tees.  Do you go north or south, or do you do what many cry for from Washington, you compromise and go straight ahead?

Regards  —  Cliff

♠  "(Reuters) - Cyprus conceded on Saturday to a one-off levy on deposits over 100,000 euros in a dramatic U-turn as it raced to satisfy European partners and seal an 11th-hour bailout deal to avert financial collapse."
♥  "The mega depositors realized Cyprus was less politically stable and economically strong than, say, Switzerland, but they wanted to avoid transparency requirements the Swiss impose, e.g., Swiss willingness to share information with US and other international law enforcement authorities. The oligarchs knew the risks, and took their chances. If they are reimbursed for eighty percent of their uninsured deposits, they should thank their lucky stars."