The Keynesian Abenomics is Raising Prices in Japan

Posted by PITHOCRATES - April 14th, 2014

Week in Review

Money is a temporary storage of value.  We created money to make trade easier.  We once bartered.  We looked for people to trade with.  But trying to find someone with something you wanted (say, a bottle of wine) that wanted what you had (say olive oil) could take a lot of time.  Time that could be better spent making wine or olive oil.  So the longer it took to search to find someone to trade with the more it cost in lost wine and olive oil production.  Which is why we call this looking for people to trade goods with ‘search costs’.

Money changed that.  Winemakers could sell their wine for money.  And take that money to the supermarket and buy olive oil.  And the olive oil maker could do likewise.  Greatly increasing the efficiency of the market.  There is a very important point here.  Money facilitated trade between people who created value.  Creating something of value is key.  Because if people were just given money without producing anything of value they couldn’t trade that money for anything.  For if people didn’t create things of value to buy what good was that money?

Today, thanks to Keynesian economics, governments everywhere believe they can create economic activity with money.  And use their monetary powers to try and manipulate things in the economy to favor them.  And one of their favorite things to do is to devalue their money.  Make it worth less.  So governments that borrow a lot of money can repay that money later with devalued money.  Money that is worth less.  So they are in effect paying back less than they borrowed.  And governments love doing that.  Of course, people who loan money are none too keen with this.  Because they are getting less back than they loaned out originally.  And there is another reason why governments love to devalue their money.  Especially if they have a large export economy.

Before anyone can buy from another country they have to exchange their money first.  And the more money they get in exchange the more they can buy from the exporting country.  This is the same reason why you can enjoy a five-star vacation in a tropical resort in some foreign country for about $25.  I’m exaggerating here but the point is that if you vacation in a country with a very devalued currency your money will buy a lot there.  But the problem with making your exports cheap by devaluing your currency is that it has a down side.  For a country to buy imports they, too, first have to exchange their currency.  And when they exchange it for a much stronger currency it takes a lot more of it to buy those imports.  Which is why when you devalue your currency you raise prices.  Because it takes more of a devalued currency to buy things that a stronger currency can buy.  Something the good people in Japan are currently experiencing under Abenomics (see Japan Risks Public Souring on Abenomics as Prices Surge by Toru Fujioka and Masahiro Hidaka posted 4/14/2014 on Bloomberg).

Prime Minister Shinzo Abe’s bid to vault Japan out of 15 years of deflation risks losing public support by spurring too much inflation too quickly as companies add extra price increases to this month’s sales-tax bump.

Businesses from Suntory Beverage and Food Ltd. to beef bowl chain Yoshinoya Holdings Co. have raised costs more than the 3 percentage point levy increase. This month’s inflation rate could be 3.5 percent, the fastest since 1982, according to Yoshiki Shinke, the most accurate forecaster of Japan’s economy for two years running in data compiled by Bloomberg…

“Households are already seeing their real incomes eroding and it will get worse with faster inflation,” said Taro Saito, director of economic research at NLI Research Institute, who says he’s seen prices of Chinese food and coffee rising more than the sales levy. “Consumer spending will weaken and a rebound in the economy will lack strength, putting Abe in a difficult position…”

Abe’s attack on deflation — spearheaded by unprecedented easing by the central bank — has helped weaken the yen by 23 percent against the dollar over the past year and a half, boosting the cost of imported goods and energy for Japanese companies.

Japan is an island nation with few raw materials.  They have to import a lot.  Including much of their energy.  Especially since shutting down their nuclear reactors.  Japan has a lot of manufacturing.  But that manufacturing needs raw materials.  And energy.  Which are more costly with a devalued yen.  Increasing their costs.  Which they, of course, have to pay for when they sell their products.  So their higher costs increase the prices their customers pay.  Leaving the people of Japan with less money to buy their other household goods that are also rising in price.  Which is why economies with high rates of inflation go into recession.  As the recession will correct those high prices.  With, of course, deflation.

Keynesians all think they can manipulate the market place to their favor by playing with monetary policy.  But they are losing sight of a fundamental concept in a free market economy.  Money doesn’t have value.  It only holds value temporarily.  It’s the things the factories produce that have value.  And whenever you make it more difficult (i.e., raise their costs by devaluing the currency) for them to create value they will create less value.  And the economy as a whole will suffer.


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Quantitative Easing

Posted by PITHOCRATES - June 24th, 2013

Economics 101

The Gold Standard prevented Nations from Devaluing their Currency to Keep Trade Fair

You may have heard of the great gamble the Chairman of the Federal Reserve, Ben Bernanke, has been making.  Quantitative easing (QE).  The current program being QE3.  The third round since the subprime mortgage crisis.  It’s stimulus.  Of the Keynesian variety.  And in QE3 the Federal Reserve has been ‘printing’ $85 billion each month and using it to buy financial assets on the open market.  Greatly increasing the money supply.  But why?  And how exactly is this supposed to stimulate the economy?  To understand this we need to understand monetary policy.

Keynesians hate the gold standard.  They do not like any restrictions on the government’s central bank’s ability to print money.  Which the gold standard did.  The gold standard pegged the U.S. dollar to gold.  Other central banks could exchange their dollars for gold at the exchange rate of $40/ounce.  This made international trade fair by keeping countries from devaluing their currency to gain a trade advantage.  A devalued U.S. dollar gives the purchaser a lot more weaker dollars when they exchange their stronger currency for them.  Allowing them to buy more U.S. goods than they can when they exchange their currency with a nation that has a stronger currency.  So a nation with a strong export economy would like to weaken their currency to entice the buyers of exports to their export market.  Giving them a trade advantage over countries that have stronger currencies.

The gold standard prevented nations from devaluing their currency and kept trade fair.  In the 20th century the U.S. was the world’s reserve currency.  And it was pegged to gold.  Making the U.S. dollar as good as gold.  But due to excessive government spending through the Sixties and into the Seventies the American central bank, the Federal Reserve, began to print money to pay for their ever growing spending obligations.  Thus devaluing their currency.  Giving them a trade advantage.  But because of that convertibility of dollars into gold nations began to do just that.  Exchange their U.S. dollars for gold.  Because the dollar was no longer as good as gold.  So nations opted to hold gold instead.  Instead of the U.S. dollar as their reserve currency.  Causing a great outflow of gold from the U.S. central bank.

Going off of the Gold Standard made the Seventies the Golden Age of Keynesian Economics

This gave President Richard Nixon quite the contrary.  For no nation wants to lose all of their gold reserves.  So what to do?  Make the dollar stronger?  By not only stopping the printing of new money but pulling existing money out of circulation.  Raising interest rates.  And forcing the government to make REAL spending cuts.  Not cuts in future increases in spending.  But REAL cuts in current spending.  Something anathema to Big Government.  So President Nixon chose another option.  He slammed the gold window shut.  Decoupling the dollar from gold.  No longer exchanging gold for dollars.  Known forever after as the Nixon Shock.  Making a Keynesian dream come true.  Finally giving the central bank the ability to print money at will.

The Keynesians said they could make recessions a thing of the past with their ability to control the size of the money supply.  Because everything comes down to consumer spending.  When the consumers spend the economy does well.  When they don’t spend the economy goes into recession.  So when the consumers don’t spend the government will print money (and borrow money) to spend to replace that lost consumer spending.  And increase the amount of money in circulation to make more available to borrow.  Which will lower interest rates.  Encouraging people to borrow money to buy big ticket items.  Like cars.  And houses.  Thus stimulating the economy out of recession.

The Seventies was the golden age of Keynesian economics.  Freed from the responsible restraints of the gold standard the Keynesians could prove all their theories by creating robust economic activity with their control over the money supply.  But it didn’t work.  Their expansionary policies unleashed near hyperinflation.  Destroying consumers’ purchasing power.  As the greatly devalued dollar raised prices everywhere.  As it took more of them to buy the things they once did before that massive inflation.

The only People Borrowing that QE Money are Very Rich People making Wall Street Investments

The Seventies proved that Keynesian stimulus did not work.  But central bankers throughout the world still embrace it.  For it allows them to spend money they don’t have.  And governments, especially governments with large welfare states, love to spend money.  So they keep playing their monetary policy games.  And when recessions come they expand the money supply.  Making it easy to borrow.  Thus lowering interest rates.  To stimulate those big ticket purchases.  But following the subprime
mortgage crisis those near-zero interest rates did not spur the economic activity the Keynesians thought it would.  People weren’t borrowing that money to buy new houses.  Because of the collapse of the housing market leaving more houses on the market than people wanted to buy.  So there was no need to build new houses.  And, therefore, no need to borrow money.

So this is the problem Ben Bernanke faced.  His expansionary monetary policy (increasing the money supply to lower interest rates) was not stimulating any economic activity.  And with interest rates virtually at 0% there was little liquidity Bernanke could add to the economy.  Resulting in a Keynesian liquidity trap.  Interest rates so close to zero that they could not lower them any more to create economic activity.  So they had to find another way.  Some other way to stimulate economic activity.  And that something else was quantitative easing.  The buying of financial assets in the market place by the Federal Reserve.  Pumping enormous amounts of money into the economy.  In the hopes someone would use that money to buy something.  To create that ever elusive economic activity that their previous monetary efforts failed to produce.

But just like their previous monetary efforts failed so has QE failed.  For the only people borrowing that money were very rich people making Wall Street investments.  Making rich people richer.  While doing nothing (so far) for the working class.  Which is why when Bernanke recently said they may start throttling back on that easy money (i.e., tapering) the stock market fell.  As rich people anticipated a coming rise in interest rates.  A rise in business costs.  A fall in business profits.  And a fall in stock prices.  So they were getting out with their profits while the getting was good.  But it gets worse.

The economy is not improving because of a host of other bad policy decisions.  Higher taxes, more regulations on business, Obamacare, etc.  And a massive devaluation of the dollar (by ‘printing’ all of that new money) just hasn’t overcome the current anti-business climate.  But the potential inflation it may unleash worries some.  A lot.  For having a far greater amount of dollars chasing the same amount of goods can unleash the kind of inflation that we had in the Seventies.  Or worse.  And the way they got rid of the Seventies’ near hyperinflation was with a long, painful recession in the Eighties.  This time, though, things can be worse.  For we still haven’t really pulled out of the Great Recession.  So we’ll be pretty much going from one recession into an even worse recession.  Giving the expression ‘the worst recession since the Great Depression’ new meaning.


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