You have probably never heard of Mr Takashi Ito. Neither had I, until I read a letter that he wrote to the editor of the Financial Times two years ago. I now have a copy of that letter pinned to the wall of my office.
“The US Federal Reserve’s obsession with Japan is pretty disastrous,” he wrote. “First, Alan Greenspan opened the taps wide for too long, fearing Japanese-style deflation, which fuelled the housing bubble that led to the recent financial crisis. Now, fearing the lost decade plus, the Fed is probably going to keep easing until some different but unpleasant outcome is the result. Stagflation, perhaps, or hyperinflation?”
Mr Ito saved his most damning observation until last. “This is so ironic, because for so long people have sneered at the Japanese for their inability to steer their economy to recovery. Perhaps because they have sneered so much, it is no longer possible to admit that after a huge housing bubble bursts, there is nothing to do except suffer many years of economic indignity.”
I was struck then, and I remain struck now, by that last coinage: “many years of economic indignity”. We know from their response to the earthquake and tsunami a year ago that the Japanese are a byword for stoicism. The images in the aftermath of the earthquake and tsunami were, we can all agree, shocking. But an economic lost decade, with all its attendant pain, is altogether harder to visualise. Will we be able to escape it?
Perhaps the most famous fable in the history of economics is Frédéric Bastiat’s story of the broken window. The son of a shopkeeper breaks a pane of glass. A crowd gathers. Pretty soon, the spectators start to conclude that it’s an ill wind that blows nobody any good. The shopkeeper is out by the cost of a window. But that benefit will be passed along to a glazier. What would happen to glaziers if panes of glass never got broken?
Bastiat’s point is that there are things which are seen – the broken window. But there are also things that are not seen – what the shopkeeper might have done with his money, for example, if he hadn’t needed it to pay for repairs. What is relevant at the level of an individual is just as relevant at a national level.
Government projects may seem to create work for some, but they are paid for involuntarily by taxpayers (or borrowed, which amounts to the same thing deferred into the future). Those projects may also divert spending from a more deserving group. Some government spending may even involve outright destruction of infrastructure or wealth.
Economist Paul Krugman, amazingly allowed a regular forum in The New York Times, is as guilty as anyone of the broken windows fallacy. In the aftermath of the Japanese earthquake and tsunami, he wrote that “the nuclear catastrophe could end up being expansionary… remember, World War II ended the Great Depression”.
Things have reached a pretty sorry pass when economists can justify something like World War II on the basis that it ended a depression. By that logic, who would ever want to live in a state of perpetual peace?
The ghost of Bastiat would no doubt be amused to see that economic logic is being tortured today along the same lines he first warned of. The Daily Telegraph recently quoted Legal & General’s Ben Gill in a story entitled ‘FTSE 100 could hit 7,000 if the Bank of England prints more money’. Fine.
In which case, why not let the Bank’s printing presses run permanently? The FTSE 100 could progress magically higher to almost unlimited levels – and none of us would be able to afford a cup of coffee.
Economics has coined a term for this fallacy: money illusion. Somebody who has fallen prey to the condition is unable to distinguish between real and nominal values. If quantitative easing were really a way of boosting an economy, why is there no evidence anywhere of it ever having worked?
With interest rates near zero, these are dark times for investors. The government and its central bank are determined to force us into risky assets. This may or may not work well for us, but our fate is irrelevant: the policy is designed uniquely to bail out the banks who got us into this mess in the first place.
Effectively, uncontrolled monetary stimulus, plus ongoing currency debauchery, plus manipulation of all major asset classes via that same stimulus, equals a grave threat to all investors who value capital preservation in real terms.
Happily, there is a logical response. Avoid poor-quality government bond markets (a category that for me includes America, Britain and most of the eurozone). Hold bullion. Buy hard currencies (the Singapore dollar being a good example). Buy defensive equities on valuation grounds but not on account of momentum. And avoid anybody who equates money-printing with wealth-creation. They are quite easy to spot, because many of them are economists, who really should know better.
• Tim Price is director of investment at PFP Wealth Management. He also writes
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