Tapering Toward Tragedy [Dow Jones Industrial Average, SPDR S&P 500 ETF Trust]

printing QEMartin D. Weiss: When governments create gigantic monetary bubbles, what happens when they try to reverse the process?

What happens when they begin to tighten credit in some way — be it by raising interest rates or by slowing down the money printing presses (“tapering”)?

For some answers, I suggest we revisit the recent history of Japan.

The Greatest Monetary

Bubble of the 20th Century

I first went to Japan in 1979 — on a Fulbright fellowship to study the Japanese economy and culture for my doctoral thesis.

I spent two years in Tokyo. I visited dozens of banks, insurers and technology companies. I interviewed scores of decision makers. And to get an insider’s view, I even joined the international department of a major Japanese brokerage firm.

Since then, I’ve been back many times, often at critical turning points — when Japan was at the peak of its real estate bubble, when it was near the nadir of its 23-year depression, and last year, when it was still struggling to recover.

My research on Japan is complex. But my answer for you today is simple: Bubbles, especially monetary bubbles like ours, always end badly.

I feel it is essential that you understand this. Without this unique comparative perspective, you risk getting caught in serious deceptions — regarding the federal deficit, the Fed’s money printing presses, and its recent first steps to slow them down. You risk getting hooked on the same kind of bliss that repeatedly lured millions to their financial Armageddon for decades.

Let me take you back a few years to a historically accurate fictional scenario, and you’ll see what I mean …

The Bubble Economy

Bank of Japan, Tokyo

The time is early January 1990; the place, Tokyo.

We are visiting the relatively Spartan offices of the Bank of Japan, and we are ushered in for a brief visit with the 26th governor, Yasushi Mieno.

Mr. Mieno knows nothing of the expression “irrational exuberance” — the words his counterpart in America, Fed Chairman Greenspan, won’t make famous until later in the decade. But he certainly understands what it’s all about.

Mieno uses a different term — “baburu keizai” — the bubble economy. For months now, he has been watching with growing alarm, as wild speculation has overtaken the Japanese stock market, real estate market and the entire economy … driving asset prices through the roof, growing wilder by the day.

The governor’s manner is mild, but his words are not. He speaks with a mixture of pride and fear about the Nikkei 225 Average, once lower than our Dow Jones Industrials, but now close to 39,000.

He laments that a square inch of land in the fashionable Ginza district of Tokyo costs more than all the real estate in a square mile of good land in the U.S.

He voices “very serious concerns” about roreika — the aging of the Japanese population, a demographic time bomb that’s expected to explode before the end of the decade.

He does not tell us what he’s going to do about it. But sure enough, a few days later, he decides Japan can’t risk it anymore. It’s too dangerous for the long-term health of the entire nation. It’s a threat to national security.

So he raises interest rates by a small notch — not enough to cause any disruptions; just enough, he believes, to cool things down a bit.

But his action is tantamount to looking for a gas leak with a lighted match: Japan’s entire bubble economy blows up.

To his surprise, the Nikkei crashes nearly 50 percent within two years. And to the utter dismay of every Bank of Japan governor since, it never recovers.

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