Is the U.S. Following in Japan’s Deflationary Footsteps? Part 2

In Part 1 of this article I spoke about how the U.S. is following the Japan deflationary example in both the Stock and Real Estate markets. In Part 2, I will address the 5, 10 and 30 year yields of the Japanese Government Bonds (JGB) and U.S. Dollar T-Bonds first and speak to the likeliness the U.S. will follow the Japan example of increasing Debt as a percentage of GDP to fight the deflationary credit contraction occurring. I’ll then correlate the four areas discussed in Part 1 and Part 2 with contemplations on how gold priced in U.S. Dollars will perform moving forward.

Do Bond Yields Speak to Deflation?

Lower interest rates normally indicate an opportunity for businesses and individuals to borrow cheaply and help expand the economy. But what happens when falling interest rates don’t attract anyone? How have lower yields done for stimulating Japan’s economy the last 10 years?

The fact of the matter is, banks are in a business to make a profit. They don’t see the benefit of locking in loans where they take on the longer term interest rate risk in an economy that is built on the back of government spending, the only thing that’s propping up GDP.

Worse for the banks is the fact they are still trying to work on keeping their balance sheets from slipping deeper into the red. They choose to allow squatters to live for free instead of foreclosing on them and marking to market an asset that will weaken their balance sheet.

Yet Caroline Baum from Bloomberg says the current low rates and spread represented by the yield curve shows no sign of a recession.”Slowdown, yes; recession, no. That’s the message of the yield curve.”

The Federal Reserve itself would have you believe the yield curve predicts the future as seen in their chart below.

Outside of government spending, we’ve had a “slowdown” since about 2007. The recession never ended to begin with, it was just taking a breather while the government went on its spending spree, bailing out their favored sons. So far, it has resulted in some stability. But what lies underneath the facade will eventually reveal the emperor has no clothes.

Looking at the Japan Example

If there are no businesses taking loans and thus no expansion, interest rates have to stay low for the time being. In fact, that’s what has happened with Japan’s interest rates as seen in the following chart.

As shown in Part 1, during Japan’s deflationary episode, businesses have struggled to expand as represented by the fall in the NIKKEI index. Granted there have been some success stories, but it is only through concentrating on exporting that Japan has saved its banks. But the global recession of 2008-2009 has put Japan in a precarious situation that has many wondering if they’ll be able to climb out as Industrial Production has fallen off the cliff as seen in the following chart.

The U.S. doesn’t seem to be able to follow the Japanese example of an export driven recovery with their higher wage rates compared to the rest of the world as unions continue to demand more and more while Rome is burning. I don’t think the U.S. stands a chance at recovery without a change in this dynamic. Something has to give and unfortunately it will be the lifestyle of the American worker as God forbid the unions to give up anything.

Japanese Government to the Rescue!

Without businesses and individuals borrowing, the Japanese government has had to step up to the plate in an effort to keep the economy from collapsing further. The result has been Japan has a Debt to GDP ratio of 200% which will be analyzed in a moment.

The U.S. 5, 10 and 30 Year bonds have entered Japan’s low interest territory in an attempt by the Federal Reserve to try and stimulate the economy, so far, to no avail.


If the Fed comes to the conclusion they need to do more to stimulate the economy, rather than let the market itself decide things, will they continue with the Japanese spending solution? Is the Japanese government debt the same as the U.S. governments debt? How does Japan’s entrance into the deflationary spiral compare to the U.S. current entrance into a deflationary environment? Are they the same scenario to give us a clue as to what will happen next?

To answer these questions, the debt of each country and historic comparisons need to be analyzed.

Japan and U.S. Debt to GDP Analysis – Clues in the Data

Japan’s Debt to GDP ratio is higher than any other country in the world as seen in the following chart.

Yet despite this ominous statistic, the YEN has continued to appreciate versus the dollar and other currencies.

What would cause the YEN to be so strong when the interest on their debt is currently pushing 10% of GDP with an aging and declining population supporting it?

One difference between the debt of Japan and the debt of the U.S. is that in Japan, 87% of the debt is held domestically as seen below.

The U.S. meanwhile has Japan as it’s largest creditor followed by China. The U.S. has to cater to what Japan and Chinese want while Japan has to worry about keeping it’s public debt holders happy. Both countries rely on GDP to keep expanding in order to keep their economies flowing while at the same time preventing any potential exchange of this debt to other assets with less perceived risk.

The Japanese have also been historical savers compared to the U.S. citizenry, saving a full 2% more allowing for additional monies available to the market. However, this amount of savings has been on the decline as seen in the chart below, which doesn’t bode well for growth in Japan. Another point to ponder is the fact Japanese savers only had 7% of their household savings invested in equity and mutual funds, a far cry from the 50% – 75% recommendations of U.S. advisors today, and over half in government insured accounts (bank and postal). The U.S. has seen their savings rate increase in the last year, but the banks still are not lending.

But to really get at the heart of where the U.S. economy is today and where Japan economy was at the beginning of their deflationary episode, and to see if the U.S. government can rely on the same data to weather any deflation  moving forward, a side by side comparison is needed.

The following table shows just such a comparison. Remember, the Debt to GDP ratios below are as of the end of 2009. The actual 2010 Debt to GDP numbers accounting for the additional government spending since the end of 2009 puts Japan at 200% and the U.S. moving closer to 100%. The table also doesn’t include the actual unemployment rate for the U.S. as the rate shown doesn’t represent disgruntled workers (those who are not actively looking for work are not counted in this figure). The actual number of unemployed is much higher, falling between 16% – 22%. U.S. Debt is currently 13.18 Trillion, almost a Trillion more than at the end of 2009.

All data from CIA Factbook or OECD

*Authors estimate based on CIA Factbook data

** Does not include 2010 budget deficit which will push this figure closer to 100% as seen in the above GDP chart

Buried in the data is the fact the U.S. has a much higher unemployment rate than Japan and Japan’s Debt to GDP ratio was already north of 100% when they started their deflationary episode as seen in the following chart.

In May 2010, the IMF warned Japan that they were  growing more vulnerable to sovereign risk, estimating the country’s gross debt-to-GDP ratio at 227. The risk is in the fact that if they can’t raise money any longer domestically as their citizens refuse to take on anymore of their bonds, they will be forced to go abroad. This in turn could accelerate it’s own problems in the economy accentuated by the business downturn as a result of the current world wide recession (government green shoots aside). Perhaps Japan may need to sell some U.S. bonds to raise capital (something to think about).

There’s another problem and that is the expanding role of the Central Bank since the crisis began in Japan and the United States. While Japan’s household and non-financial businesses have been busy deleveraging themselves, the Japanese government has been increasing their debt by as much as it did during the decade of expansion as seen in the chart below.

One thing the Central Bank of Japan is doing to try and stimulate is buy more and more government bonds. This is what is known as quantitative easing where a central bank will create money out of thin air (not literally, but by pressing a computer key) to, as in the case of the Bank of Japan, buy government debt. The hope is to ultimately get the economy moving and people spending again (emphasis on the word “hope.”).

But according to the McKinsey Global Institute, there will be hell to pay if the Central Bank implements quantitative easing as policy.

Central bank interventions in financial markets cannot be perpetuated indefinitely and need to be wound down eventually – in principle, the sooner, the better. This conclusion derives from the fundamental principle that central banks cannot substitute for the market nor become the “buyer of last resort” of financial assets: the broad policy role of central banks as an anchor of stability in the medium and long term should not be overshadowed by short-term intervention in financial markets.

Yet this seems to be exactly what Japan,  Europe and the U.S. Federal Reserve are doing, albeit Japan is by far the worst offender.

What Bernanke and company seem to be trying to do is forgo the gradual rate of government intervention though and put as much as possible into the system now to get the economy going. However, you can’t squeeze blood from a turnip and the Fed can’t get individuals and businesses to borrow and grow the economy. This is one thing that is out of their control.

So while the YEN has had domestic saving, stable unemployment, net exports and a trillion in reserves to battle deflation, allowing its government to double it’s Debt to GDP without any problems, what does the U.S. have going for it to support the U.S. dollar?

The answer is, none of the above. Unemployment is high, they are a net imports, they have minimal reserves, and the increase in domestic savings only has occurred in the last year as investors run away from the volatile markets and into the safety of cash. Add to this the problem of banks not lending (problem for the government anyway), and how does one think the U.S. government and Federal Reserve will save the day?

If I really knew how to work graphics, I’d put the picture of Bernanke on the Mighty Mouses cartoon figure. But Mighty Ben can’t get businesses and individuals to take out loans.

If one were to look at just where U.S. banks are headed, Japan provides the perfect example in this case of what occurs when no one wants to take out a loan as seen in the following chart. It was only through an export driven economy that they had any life at all, but as I mentioned, that has come to a halt. What will get U.S. businesses and individuals to take out a loan (if they can get one). What would higher interest rates do to complicate things. I shudder to think.

While the U.S. continues to slide down the hill of deflation, investors are worried the government adding of trillions more debt will eventually cause inflation and possibly hyperinflation. While at some point this is likely, I believe it to be a ways off. I explain this in more detail in my forthcoming book, “Buy Gold and Silver Safely” which will be coming out soon, and will address it here in articles in the weeks and months to come.

For now, we are clearly in a deflationary environment with the Fed’s monetary inflation doing little to stop the credit contraction excesses of the last few decades.

Using Japan as an example, although not a perfect one…but close, there is room for the government to add even more debt before people lose faith in the dollar. The U.S. dollar is still considered a safe haven by U.S. citizens just as it is in the rest of the world, at least the 70% who use it. But the Japan example doesn’t look too promising moving forward as the U.S. slides further into deflation. Will people rush to the U.S. dollar or EURO for safety when the YEN hits the fan?

As far as the U.S. safety is concerned, we really don’t even know what the government is up to even when they are required to be forthcoming, at least according to the U.S. Government Accountability Office (GAO), the group that audits the Federal government.

The material weaknesses discussed in GAO’s audit report hinder the government’s ability to (1) reliably report on many of its assets, liabilities, and costs; (2) accurately measure the full cost as well as the financial and non-financial performance of certain programs and activities; (3) adequately safeguard significant assets and properly record various transactions; and (4) have reliable information to operate efficiently and effectively.

Of course the GAO is no longer allowed to audit the Federal Reserve thanks to Congress. What the Fed does must be kept secret from the American people least they catch on to their shennanigans……  Pay no attention to the man behind the curtain.

But one area to keep an eye on is what will happen when interest rates finally do return to their norm. The effect that increase will have on the Federal Budget will be felt everywhere, just as states are feeling the effects of their fiscal budgets today.

This is a concern for Japan at present as the interest paid on their debt is close to 10% of the budget. But it’s even more of a concern for the U.S. as the GAO addressed in its latest report to President Obama.

Absent a change in policy, under this scenario, the interest costs on the growing debt together with spending on major entitlement programs could absorb 92 cents of every dollar of federal revenue in 2019.

Let me repeat… major entitlement programs could absorb 92 cents of every dollar of federal revenue in just 9 years!

Sha-la-la-la-la-la, live for today
Sha-la-la-la-la-la, live for today
And don’t worry ’bout tomorrow,
hey, hey, hey
Sha-la-la-la-la-la, live for today
Live for today
The Grass Roots

Well, I guess that’s what our government does, as they don’t listen to the GAO and don’t seem to be worried about tomorrow. What does the data tell you? What are you doing to prepare for tomorrow? Which brings us to gold.

How Does All This Relate to Gold?

In deflationary times, gold’s purchasing power increases as technically the value of the dollar is supposed to move higher. Gold will buy you more goods as the prices decrease as a result of the deflationary credit contraction.

In fact, gold the past 6 months was holding steady despite the run up in the dollar. One of the factors for this strength was the fact the EURO was declining in value and the Eurozone citizens were gobbling up gold as a safe haven.

At present, the fall in the price of gold could be the result of traders locking in profit and the bounce in the EURO, causing gold traders there to take profit. I suggested those who took my advice in buying gold in EURO’s to get out of the trade back in May when the EURO hit 125, locking in a 30% profit.

But while gold may trend lower for the time being, it has shown to investors around the globe that it is more than just a commodity. Gold is taking on its historic place in society. Gold is real wealth. Gold is money.

The YEN during its last 10 years of deflation traded right along with the U.S. Dollar up until the U.S. led world recession as seen in the following chart.

But gold has even appreciated against the YEN to the tune of 247% the last 10 years. If deflation was bad for gold, then why did gold priced in YEN appreciate 247% the last 10 years? Could it be because investors chose gold over the YEN as a safe haven? This has occurred even though the YEN has appreciated versus the dollar as seen in the USD/YEN chart above.

On a side note, it makes no sense to me why the YEN is so strong when there is nothing going for it moving forward. I believe 84 to be the line in the sand (it’s fallen to 86.2 as I type this).  Will be something to watch.

The Important Reason to Own Gold

When it comes to understanding why gold needs to be a part of one’s portfolio, what else is going to give you the peace of mind that comes with the real wealth gold represents?

Think of it this way…

If the Japanese citizen were to wake up to the fact the YEN was starting to lose its grip as the Japanese government continued its quantitative easing unabated, will they turn to the U.S. dollar for a sound alternative? The Chinese YUAN is still basically tied to the U.S. dollar, will they go there? How about the EURO and the problems they have with Portugal, Spain, Ireland, Italy and the unresolved Greece situation? The choices are limited. The Swiss have their problems. Australia is a property bubble ready to erupt.  Canada is close to experiencing the same U.S. mortgage crisis.

Where does a rational thinking person turn to in protecting their portfolio from such currency risk?

While gold protects the U.S. dollar exposure risk of one’s portfolio, it also is insurance against the collapse of the system. Would a statement like “insurance against the collapse of the system” be viewed as fear mongering by some? Of course it would by those who are seen on CNBC. But this collapse is written into the data and can be seen by anyone who has spent some time researching the data.

I’ve spent the last 5 years straight researching the data. This is a far more important discussion than a 2 Part article can explain. In Chapter 4 of my forthcoming book I spend time explaining just what else an investor needs to know about this deflationary contraction as I have 100 footnotes alone related to the deflationary credit contraction that’s occurring and how this relates to the problems with the banking system and Federal Reserve balance sheets.

Whether it be real estate, the stock market, interest rates or Debt to GDP, there are many similarities the U.S. has with the Japan deflationary experience of the last decade. The purpose of understanding where we are and where we’re headed, as the Japan example has shown, will naturally lead one to consider diversifying into gold.

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About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


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