It’s interesting that two of the questions I get asked the most are almost polar opposites:
- “Isn’t inflation inevitable?”
- “Are we the next Japan?”
The first question is raised because of both our massive budget and trade deficits and the dramatic increase in the monetary base. I’ve written posts that address whether high inflation is coming and also on some widely regarded myths on inflation.
The question about Japan arises because both the U.S. and Japan experienced real estate bubbles and banking crises and have economies burdened by debt. While the concern of the first question is rising inflation, the concern of the second is that we will experience a decades-long period of deleveraging. The result would be the U.S. looking like Japan — with a prolonged period of very low interest rates, deflationary pressures, fiscal deficits as far as the eye can see and an economy dependent on government spending for life support.
While it is possible that our future will look like Japan’s recent past, there are many differences between the two situations. Edward Chancellor, author of Devil Take the Hindmost, provided the following examples in an Institutional Investor article about using the past as a guide for today’s market turmoil:
- Japan’s asset bubble was far greater. Commercial real estate prices rose 500 percent as compared to 100 percent in the U.S.
- The subsequent decline in value of Japanese stocks and real estate was three times the GDP versus about two-thirds in the U.S.
- Japanese corporations had loaded up on debt during the boom. In our case, consumers became mired in debt.
Perhaps the greatest difference between the two situations is in the policy responses. Japanese authorities were slow to react. They didn’t begin stimulative fiscal or monetary policies until years after the crises began. Interest rates didn’t fall to zero until near the end of the decade. By then, deflation had become entrenched. Contrast this with the rapid response of the U.S.
The bottom line is there are risks on both sides. If our economy begins to recover and the velocity of money returns to normal levels, it’s imperative the Fed remove the monetary stimulus it injected or we’ll experience rising inflation. On the other hand, there’s also the risk it could tighten money policy too quickly, as it did in 1937 when it sent the economy reeling.
It’s important to recognize neither scenario is inevitable. As I mentioned on Wednesday, Philip Tetlock demonstrates in his book Expert Political Judgment that those who forecast extreme outcomes, while occasionally getting it right, most often are wrong. They’re wrong more frequently than those who forecast more moderate outcomes.
The research shows that economists have no better track records at forecasting than the proverbial chimps. Therefore, you’re best served by not focusing on the noise created by the financial media — which is meant to get you to tune in, but should be treated as nothing more than what Jane Bryant Quinn called investment porn. Instead, you should focus on the things you can control: the amount of risk you take (your asset allocation), the costs of investing, tax efficiency and the amount of money you spend.
