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Monday, July 09, 2012

Japan Shock

This is really, really in the realm of the "unexpected". Japan announced that May machinery orders dropped 14.8%. The extent of the drop precludes a meaningful revision. Also the May current account balance plummeted. 

All this as Japan slowly eases into the era when a retiring population begins to draw down its savings for retirements. Most retirement savings are not in the pensions, but in the post office/government bonds. Still, the great shift is imminent.

Energy imports are part of the problem with Japan's current account balance. It remains to be seen how Japan will deal with its energy problem - the shut down of the nuclear power infrastructure has created this problem. What they will eventually decide is up to them, but Japan is such an economic powerhouse that one always must pay attention to events there. 

China's inflation continues to collapse, indicating that their economy is much worse than officially stated. Food prices are the latest to see a dramatic decline, and Chinese CPI is now hardly a factor:

Industrial profits continue to decline:

It is not surprising that PPI would fall if profits are falling. 

Although I don't know why Japanese May machinery orders collapsed so hard, I have to think it has something to do with both China and events in Europe. One would expect a big rebound in June. But perhaps we aren't going to get that big a rebound; JPM Global All-Industry EI for June hit the stall line in June. Read it and weep. The oil people are still in fantasy land. Take a look at the release and the graph - note the similarity to the 2008 sequence. There's one dip, which occurred last year this time, and then a period of consolidation, and then the second dip. After that, Bad Things Happen. 

A second, worldwide financial crash is in the offing, and there is nothing anyone can do about it. The banking system is dependent on the ability to accumulate safe, stable reserves, which have in the modern era largely been stored in government bonds. The supply of safe, stable government bonds is running out now. For example, while German short bond yields are remaining in the negative range, longer yields are fluctuating with the economic news. Every time it looks like Germany may take on some real debt to deal with the Euro crisis, Germany's long yields sheer toward US levels. This is all entirely rational.

We seem to be doomed to deflation now. The banking system cannot expand lending if it cannot accumulate reserves against lending losses, so modern Keynesian economics just doesn't work in this situation. Forget the Krugmans and their ilk - it's Jack Horner time. The dinosaurs, it develops, are all feathered, and the entire establishment can't see the blindingly obvious.

Meanwhile, back at the Euro ranch, Spanish 10 year bond yields continue to flirt close to 7%. This morning they are over 7%, but the finance ministers are meeting.

MOM said, "We seem to be doomed to deflation now. The banking system cannot expand lending if it cannot accumulate reserves against lending losses, so modern Keynesian economics just doesn't work in this situation."

Say it isn't so. Deflation - what the Bernank has been fighting so desperately to avoid. I lived through the 30s deflation and, although just a snot nosed kid, I remember the loss of hope for things ever getting better. And how persistent the psychology was. My father-in-law was almost ruined by the Depression. He never put a dime in the stock market as a result. When he died, his estate consisted of a house and some CDs.
Are we looking at another generation that is allergic to all risk like my father-in-law's?

Well, I guess it's the way of the financial world. Niall Ferguson's book on the history of money showed that the world periodically goes through these great crashes. Methinks I'm rather happy I participated in the best of what Walter Russell Mead calls the Blue Model. Not ready to die in rags and broke, but if you're correct about things, I may not have much to say about it. I' battening the hatches and doing a lot of praying.
Jimmy, no one escapes gravity.

We are looking at a generation that will have much lower living standards than the prior generation.
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