Toshio Masuda


Toshio Matsuda, Commentator & Intl Economist

Straight from the Shoulder

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gStraight from the shoulder g by Toshio Masuda Feb 20, 2008
( Free of charge to the people I met)

An Appeal to Federal Reserve Board Chairman Ben Bernanke

by Toshio Masuda February 20, 2008

It has now been generally recognized that from 2001 to 2006 the U.S. economy was not enjoying strong growth. Not only was the U.S. economy not expanding, it was actually falling into recession. If we cancel out the effect of the asset bubble, the true average growth rate minus Mortgage Equity Withdrawal (MEW) in 2001 and 2002 was actually around -0.85% and from 2003 to 2006, the average growth rate was extremely low at 0.75%. So the U.S. economy has clearly been in recession.

We should not forget that during that six-year recession period the Federal Reserve Board (FRB) raised interest rates in increments of 0.25% at 17 consecutive meetings of the Federal Open Market Committee (FOMC) beginning with the meeting in June 2004. These interest rate rises did indeed burst the credit bubble while they also caused a further entrenchment of negative growth. In August 2007, to stave off the credit crunch caused by the subprime mortgage issue and the adverse effect of the broader credit crunch on the actual economy, the FRB cut the Official Discount Rate. The FRB has also cut the federal funds rate by 2.25% since September 2007.

On top of this, the U.S. Department of the Treasury announced an emergency economic stimulus package comprising 16 trillion yen worth of tax rebates. The monetary loosening in August and the rate cuts from September onwards put downward pressure on the dollar and the dollar has been continually depreciating since then. The sudden fall in the value of the dollar since the end of last year has led to a sudden increase in the price of commodities in dollar-denominated commodities markets. It has led in particular to surges in the price of essentials such as gasoline and food, and generated increased inflationary pressure. Surveys of finance industry insiders show that 100% of respondents expect a rate cut of 0.5% or more at the next scheduled FOMC meeting on March 18, and approximately 40% of those respondents expect a rate cut of 0.75% or more. There is also 100% expectation of yet an additional rate cut of 0.5% or more at the FOMC meeting on April 30.

FRB Chairman Bernanke's monetary policy emphasizes short-term management of the economy and does not prioritize the tackling of inflation. Here, Bernanke is making a big mistake. He has no awareness of the real position of the U.S. economy. The FRB's current task is not to prevent the U.S. economy falling into recession, but to get the U.S. economy out of the current recession. He is also forgetting the golden rule that, whatever the circumstances, the FRB's highest priority must be to avoid inflation. In other words, the FRB currently lacks a definite policy. Bernanke is also ignoring the nature of the market. In financial markets, the best way to escape from recession is to force the markets to fall as far as they will go. The market must be allowed to hit the bottom.

The recent decision to implement an emergency interest rate cut before the scheduled FOMC meeting showed that financial markets, both in the U.S. and around the world, had dragged the FOMC into making a decision. Bernanke has forgotten the FRB's core mission and in this instance he made a poor call to reduce rates. That is why even now the market continues to respond negatively.

U.S. consumers are currently struggling with price increases.@ The price of wheat has risen 366% since 2006 from $3 per bushel to $11 per bushel, the price of crude oil has risen by 475% since 2002 from $20 a barrel to $95 a barrel, and the price of gold has risen by 370% since 2001 from $250 an ounce to $920 an ounce. In addition, the subprime problems mean that mortgage lenders are becoming increasingly reluctant to finance new homes. This has caused a dramatic increase in the demand for rental accommodations, pushing up rental costs to around 30% or more of disposable income. This in turn has reduced household spending in other areas and consumption has stagnated. As rents account for such a large part of household expenditure, rising rents further accelerate inflation and inflation further reduces consumption, an extremely unwelcome state of affairs. The nature of inflation means that if it begins to spiral, it may reach a stage where it cannot be halted by policy measures. History teaches us that countries which fall into an uncontrollable inflation spiral will always go to war.

Bernanke is embarking on a very dangerous course of action which could lead to a major downturn like the Great Depression that befell the U.S. in 1929.

Comparing the Situation in 1929 and 2008

In the 1920s, the U.S. economy suffered from surplus production. Now, it is China that is in a state of surplus production and the U.S. is suffering from surplus consumption (including the housing bubble).

In the 1920s, a housing bubble occurred due to the overextension of credit. The situation is exactly the same today.

In the 1920s, credit expanded far beyond the level necessary for production. That is also a characteristic of the current situation.

In the 1920s, there was not sufficient demand to justify capital investment. This factor also applies in 2008.

What FRB Chairman Bernanke needs to do immediately is not "hold discussions with the market" but to implement policies to prevent inflation from occurring in the midst of a recession. The FRB must stand independent from the government and fight against inflation, even if it has to ignore the markets. If things continue as they are, there is a high probability that the U.S. economy will fall into a persistent period of stagflation. Stagflation, which refers to inflation during a recession, is the most dangerous of all economic environments. It would require courage, but if the FOMC were to go against market expectations and raise interest rates by 0.25% on March 18, the market would likely, slump dramatically and bottom out. Interest rate cuts and measures to stimulate the economy should both be implemented after the economy has bottomed out. Policies which are designed to preempt market forces will only increase market confusion and accelerate inflation. Even if the FOMC does not vote for an interest rate rise, simply maintaining rates could also be enough to let the market bottom out. If Bernanke can do that, he will be able to win the trust of the world like his predecessor Alan Greenspan.

[I must be a bad joke if you say that he would be about to avoid his own mission and responsibility and push politicians towards war?]

There is something Japan can do to help this complex credit and equity market strain in the U.S. economy. If Japan enacts a handsome public expenditure to stimulate its domestic demand, that will help the U.S. economy find a way to rely on exports with lower dollar values. During 2008, from the perspective of comparative advantage, the only possible investment recommendation is Japan.

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Written by Toshio Masuda