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Tragic Events in Japan Will Only Accelerate Country's Inevitable Economic Descent

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Smart financial minds -- like John Mauldin and Ambrose Evans-Pritchard -- have been expecting a Japanese economic decline for the last few years.

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This would be the normal response of a traumatized populace. An aged populace is likely to experience worse depression and not bounce back from this tragedy. Japan is still the 10th-most-populated country on Earth, with the third-largest economy. China just passed Japan to become the second-biggest economy in the world. India will pass Japan by 2012.



Youthful countries across the world are gaining on Japan. Global competition is cutthroat. China, India, and the other emerging Asian countries will likely take advantage of Japan's misfortune by filling the hole left by Japanese manufacturers. The short-term issues of power, supply lines, and reconstruction are minor when compared to a massive loss of the Japanese population that will result in a population that is 25% smaller in 2050 than it is today.



The pundits on CNBC contend that since Japan hasn't had any detrimental effects from running debt to 225% of GDP, running it to 300% won't be a problem. Reinhart and Rogoff studies concluded that once a country breaches the 90% level, growth slows and a debt crisis is likely to ensue. Japan has been stuck in a 20-year recession, as it chose Keynesian shovel-ready projects, quantitative easing, currency manipulation, and covering up the true financial condition of its banks over accepting the consequences of a debt bubble. Remind you of anyone? The result is that Japan's real GDP is lower today than it was in 1995. The Paul Krugmans of the world would contend that they just didn't spend enough.


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The only reason Japan hasn't collapsed is due to its homogeneous population willing to buy virtually all of the debt issued by its government for the last 20 years and its prodigious ability to produce high-quality products that the rest of the world wants. Japan has maintained a consistent trade surplus, and its government debt has been held mainly by its own people, with 95% of Japanese government bonds in the possession of Japanese -- meaning the country was able to finance itself without depending upon fickle foreign investors who might prefer a return greater than 1%. This ain't 1990. The savings rate of the Japanese population had already declined from 14% in 1990 to 2% by 2008. In a recent article, Mike Shedlock explained the situation prior to the recent devastation:

The Government Pension Investment Fund, which oversees 117.6 trillion yen ($1.4 trillion), in September forecast that it would sell 4 trillion yen in assets in the business year ending March 31 to fund payouts. Sales by the fund, which helps oversee public pension funds for Japan's 37 million retirees, come as the first of Japan's baby boomers is set to turn 65 in 2012, making them eligible for pension payments. Japan choices are to default on its debt, print money to fund interest on the debt, raise taxes effectively robbing savers of their money, or undertake huge spending cuts. The dilemma stems from years of Keynesian and Monetarist [economics].

The new tragedy will just accelerate the conversion of Japanese savers into forced spenders. Millions of Japanese savers will be forced to spend their savings on survival, as many have lost their jobs and businesses due to the monumental damage to northern Japan.



Traders figured out what must happen over the coming years. A large swath of Japanese insurers and companies will begin repatriating assets held in other currencies to begin the rebuilding effort at home, driving the value of the yen higher. At a time of crisis a stronger yen would severely damage Japan's export-based economy even further. Therefore, central banks around the world jointly intervened. The Bank of Japan spent Y2 trillion ($25 billion), while central banks across Europe contributed $5 billion and the Federal Reserve spent $600 million to push down the yen on Friday. The Bank of Japan is doing what it does best -- printing money. Quantitative easing is an art form perfected by all central banks across the globe. Every disaster over the last 20 years, whether man-made (wars, Internet collapse, housing collapse, debt meltdown) or caused by nature, are met with the exact same solution: print money.

This method works until it doesn't work. Japan's central bank cannot reverse the demographics. From this point forward the population of Japan will be net sellers of government debt. Japanese insurance companies will be on the hook for $33 billion in claims. They will need to sell government bonds in order to make those payments. The World Bank has estimated the cost of rebuilding to be $235 billion. The government will need to borrow this money. At least 30% of its energy needs are off-line. It already imports 95% of its oil and coal. They will need to increase energy imports to make up for the nuclear energy shortage. Its positive trade balance was already in decline. The CNBC pundits can go on about how this natural disaster will be good for the Japanese economy because of the substantial rebuilding program, but they are wrong. Japan will need to issue hundreds of billions in new debt, which cannot be bought by its citizens, pension funds, or insurance companies. How many foreign investors will buy a 10-year Japanese government bond paying 1%, knowing that Japan wants to weaken its currency? None. The only choices are to raise interest rates to attract buyers or print more money. With an already suffocating level of debt, they can't allow interest rates to rise; they would choke on the interest.

The Bank of Japan will follow the same script as Ben Bernanke. They will print new yen and buy the newly issued debt, and Japan's currency will ultimately collapse. When Japan defaults on its debt, it will hurt the country's aged population. America, on the other hand, will hurt the entire world when it defaults.

The Japanese own $886 billion of US Treasuries and have bought $256 billion of US debt since October 2008. Tim Geithner will need to issue $1.5 trillion of new bonds per year. Japan will no longer be a buyer, but rather a seller. This will put upward pressure on US interest rates. Japan's reconstruction needs will put pressure on commodity and energy prices. Production and supply problems for Japanese parts and goods are already creating problems for GM (GM) and other car companies in the US. Lack of supply leads to higher prices. The tragic earthquake/tsunami/nuclear meltdown of 2011 will result in more quantitative easing in Japan and the US. This will result in even more inflation than we are experiencing today. Once the inflation genie is out of the bottle, the race to the bottom will accelerate. Gold will decide who wins the race. It has been a neck and neck race since 2001. I'm not sure it is a race anyone wants to win, but the destination is certain.



"The endeavors to expand the quantity of money in circulation either in order to increase the government's capacity to spend or in order to bring about a temporary lowering of the rate of interest disintegrate all currency matters and derange economic calculation."
-- Ludwig von Mises




Lasting through April 15, 100% of the donations made to The Ruby Peck Foundation for Children's Education will be channeled to the children of Japan as they attempt to find their footing following this natural disaster; and to kick off this drive, we'll pledge $5000 to get it started. Please do what you can, as it will add up, and thanks.
No positions in stocks mentioned.
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