Here is a question from a reader which I found to be well stated and probably of a more general interest.
"I was thinking about your general forecast which you posted a while ago, and I wanted to see if my understanding of it was correct.
You had said that your forecast for the US was stagflation because the US is a net importer, unlike Japan which is a net exporter, despite both countries pursuing a policy of ZIRP + QE.
Is the reason for Japan's deflation that all the excess liquidity leaves Japan in search of a yield (due to ZIRP + QE), and not into tangible goods (due to Japan being a net exporter/net producer)? This would be in contrast with the US, where much of the excess liquidity from ZIRP + QE flies into tangible goods due to the imbalance caused by the US being a net importer/net consumer (though undoubtedly much of this excess liquidity leaves the US in search of a yield as well). Is this correct?"
This is a very nice summation of a portion the effects, but misattributes the causes. And like most summations it crushes many of the key points of a slightly more complex theory and overstates the importance of current trade balance.
In a fiat currency not constrained by external standards or other exogenous constraints, monetary inflation and deflation are always and everywhere a policy decision. As latitude on the monetary supply is constrained, so obviously the freedom to decide (choose if you will) is obviously constrained to a similar degree.
If you are Greece and under some contraints imposed by the ECB that controls your currency, you have fewer choices and greater prices to pay in making them. If one controls their own currency and is large and 'important' enough to make their decisions stick it is another matter altogether. The Wall Street banks understand this all too well.
The US is a democratic republic and a huge net debtor, in both current and future obligations. The choice of genuine deflation as such would therefore be a national economic and political suicide favoring foreign holders of its debt. I cannot think of a reasonable scenario for such a choice except for coercion such as war reparations and under heavy constraint. But it is a possible choice.
Further complicating the decision is the inescapable fact that the US holds what is still the world's reserve currency despite a movement to alternatives. A stronger dollar and monetary deflation would crush the world economy by destroying the interconnected global banking system as it is now constituted, in addition to devastating its own domestic economy. Deflation does favor the ends of a powerful few, however, so it cannot be said to be off the table.
Further complicating matters is that the people of the US are more independently minded, educated, and well armed than is normal around the world, despite a more recent program of cororatist propaganda that seems to have co-opted their news media. They are more like the Swiss in some regards. I know this comes as a surprise to most of them, but it is how it is. The US is a beacon of liberty to the world for good reasons, although that beacon occasionally flickers and suffers abuses, sometimes seemingly irrecoverable.
Their increasingly predatory financial system, together with the ownership of the world's reserve currency, probably dictated the accumulation of that large debt, significantly held by foreigners, if one subscribes to the theory of Triffin's Dilemma, which I do. The US had to print more than it consumed to supply currency for growth in the developing world, which was unfortunately engaged in currency manipulation and state mercantilism, and the financial system turned this into debt which it owned.
So the obvious choice is for a monetary inflation to soften the blow of what is going to be at least a de facto default on what is now a mathematically unpayable debt. Let's be clear about this. The US is facing a default and the bulk of the discussion now is about how to distribute the pain, and not fix the problems which caused the crisis in the first place.
The mercantilists who hold dollars, as a result of their gaming the global trade and fiat regimges, wish the US to suck it up and take it all. This is preferable to growing their own domestic economy and allowing their people to become more independently powerful, thereby threatening them. And the domestic monied interests wish the pain to fall largely on the weak and the many, the elderly and the poor. All of these actors are in a power position because they were the greatest beneficiaries of those structural distortions that have led the world to this crisis in the first place.
And yet the monetary inflation will not be able to have its usual effect, the magic that fiat has worked in the post WWII environment. This is because the economy is distorted, and organic growth of jobs and the median wage has been rendered untenable without significant reform in the domestic economy and global trade.
And the powers that be and the thought leaders are stuck in a credibility trap, through which they cannot effect the required reforms without indicting themselves, or at the least, dismantling the socioeconomic structure to which they own their ascendancy, whether it was through sheer luck and positioning in one of the bubbles, or in service to the monied interests by dismantling the regulations and promoting the frauds.
So the most likely course is an ineffective attempt to maintain the status quo, which cannot possibly become self-sustaining. And this is stagflation, which will continue until some crisis is large enough to change it.
It is tempting to use Japan as an experimental counterpoint to the US, but highly misleading and the cause of much misunderstanding.
Japan is most unlike the US, although the Yanks like to think of the rest of the world as little Americas, yearning to evolve into their image. The political structure is that of a one party government that was imposed on a military oligarchy which in turn had evolved from a relatively recent system of feudalism. There was no popular revolution in Japan that created their system of government. It was imposed. And the people have adopted it to suit their own preferences. There is nothing wrong with that. Nations should be able to have the type of society that suits their national character within some reasonable degrees of freedom of choice. One size does not necessarily fit all.
The Japanese economy is highly controlled and centrally planned, following an industrial policy formed by an entrench bureaucracy in MITI and the handful of kereitsus that essentially run the country like feudal lords of old.
It is a closed society, an island, with a largely homogeneous population and limited immigration. The oligarchy has a sense of national honor and responsibility. The social mores would not permit the type of personalities of the 'greed is good' world view, at least not explicitly.
Deflation suited them, and that is what they obtained. But it is important to realize that the people did not suffer deprivation because of the social contract between rulers and people, the lords and serfs. This social contract is essential to understanding the situation. And of course the fact that the people continue to have a decent, if somewhat constrained by western standards, style of living that has been consistently acceptable to them for many years.
Lower prices yes, but the losses and deprivations were not visited on the people, at least not yet. There is not the same cult of selfishness and greed, and denigration of obligation as there is in the states. Contrast CEO pay in Japan and the US. The losses were exported around the world and finessed by an increasing government debt, much of it wasted on the keiretsu's pet projects, despite the ongoing trade surpluses. But Japan appears to be heading for a change as the corruption and mismanagement of the oligarchy continues to peak through the studied facade.
So this is more the basis of my forecast, and I do not see a change in this until the US changes its financial system, and reforms its political system in a meaningful way, to diminish the influence of wealth and power and restore a balance with the voting public. There are no such things as free trade or free markets, just as there is no free lunch. All is subject to imperfection and abuse, and requires diligent effort, frank discussion, transparency, and conscious intentions. Opening your markets to slave labor makes everyone a slave.
The world economy is a very complex system, and those who think they understand it with slight effort are probably wrong and sometimes tragically so. Unfortunately they are also easily led, and in the pursuit of simple solutions may choose power over wisdom, to their own destruction.
