Offbeat: Tale of Two Countries | Value Research US realty has managed a soft landing on cheap funding from Japan and China
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Offbeat: Tale of Two Countries

US realty has managed a soft landing on cheap funding from Japan and China

Everybody remembers Lee Iaccocca, even though few will remember his companies a decade from now. But who can tell me the current chairman of Toyota/ Honda without googling the Net?

Brash, loud, attention-grabbing, fast-talking, Iaccocca was the quintessential, egotistical 'ugly' American. Coincidentally, his company was bankrupt, cash-strapped and in need of fiscal support.

Toyota has been efficient, quiet, profitable, yet paranoid about its position -- a typical Japanese trait. So are the other Japanese -- despite being the biggest creditor nation in the world, they have the highest suicide rate, mostly driven by personal depression. Their paranoia about self-respect, a yearning for security and a self-effacing attitude to performance give them a unique behvioural niche in the comity of nations.

These (sometimes) diametrically opposite national characters often result in very strange phenomena. Monetarists (a.k.a. the Chicago School of Economics) have laid out the generally accepted principle of economics that an injection of money into an economy has the effect of 'heating up' the economy, very much like the injection of 1-2 pegs of rum would have on a college kid in Delhi.

The underlying "theory-in-use" is that a "feeling good" economy will see an acceleration of the velocity of money, leading to a spiral of higher asset prices (as the excess cash flows through), a "wealth effect" -- induced higher consumption expenditure, higher incomes and employment as a result, and ever-higher personal consumption, asset-prices and so on.

At some point, the story goes, like the college kid on his 14th peg, successive injections of cash have a dysfunctional effect on the economy (as also the rum with the tippler), leading to the law of diminishing marginal returns kicking in. An increasingly soporific economy, drunk on cash, loses 'traction' and responds in smaller increments to a unit injection of cash. This manifests itself in the form of ('supply-side') inflation. Look at the US circa 2004.

The Austrian School of Economics puts a moralistic spin to this phenomena. Every "night-out" of excess (drinking) should be followed by a hangover, which has to be slept off and retched out, they say. It takes time to work out the ""inflationary excess" and the inflation-targeting policies of a good central bank should now increase the real cost of debt (by steep interest rate hikes), which will force borrowers to pay-or-perish. Debt repayment is a deflationary activity, which slows down growth, increases consolidation. The "morally good" (i.e. debt-averse) will consolidate, the binge-borrowers will slow down or die and the world will be upright again. These cycles of debt-and-repayment, inflation-and-deflation, boom-and-bust, growth-and-consolidation have a deeply moral dimension to them. After all, Economics was originally called "Moral Philosophy".

In Japan, however, we see a different phenomena. This no-name pattern seems to be unique to Japan. A long-awaited jump in GDP growth has come with a little blip in inflation, mostly driven by energy prices. The export surplus has grown faster than the GDP growth, suggesting continued sluggishness in the economy. Personal consumption continues to slide, leading to ever-higher savings. In short, the "injection of cash" from the US has not circulated, with no commensurate jump in domestic consumption despite low unemployment and (presumably) wage inflation plus higher stock prices.

The US has just gone through the biggest asset bubble in history, but has managed a soft-landing because of cheap funding from Asia, principally Japan and China. By any metric, the US should have been bankrupt, if not insolvent. Its saviour has been Bretton Woods I, the understanding reached in 1944 to peg the dollar to gold. As a result of this agreement, central banks of the world started to maintain their currency reserves in the form of dollars, rather than Gold.

This practice made life easy for the central banks, who would no longer have to ferry gold around the world. Slowly, this became a custom. In 1971, Nixon quietly de-linked the dollar from gold, effectively giving himself the right to increase the world's supply of gold (or reserve currency, whatchamacallit).

As the world's largest surplus-generator over the last 3 decades, Japan deserved to own most of the wealth so generated. If money is "accumulated sweat", most of that surplus sweat belonged to Japan (morally speaking). Had Japan chosen to hold its surplus in the form of gold, it would have turned the tables on the US (economically speaking) and would have been holding most of the world's stock of gold. More importantly, the US dollar would have lost its (now notional) gold-backing, and would have plummeted in value.

But this is what should have been. In actual practice, Japan has chosen to keep its reserves in dollars, quietly acquiescing to American rapaciousness. Effectively, what has bailed out the US from the consequences of its recent twin asset bubbles, is not the 'brilliance' of Alan Greenspan, but the dim-wittedness of the mandarins at the Bank of Japan.

Generally, I refrain from political commentary, but one can hazard a guess that had this not been so, the US would have found it more 'useful' to annex Japan (and perhaps Canada) rather than Iraq and Iran with their relatively 'inconvenient' citizens.

So let's now point out the 'behaviour traps'. On the one hand, you have a drunkard, who quaffs peg-after-peg of rum, with nary a concern for the means to pay the check. And on the other hand, you have a bartender, who is more concerned with finding an outlet for the booze he generates with his "accumulated sweat".

In the first case, you have a 'monkey' who behaves predictably. He gets a 'free lunch', chooses not to look the gift horse in the mouth and picks up all that is offered. The US now takes up more than three-fourth of the world's savings. What is relatively surprising is the Japanese behaviour trap. Here, you have a production-cum-savings machine that needs an outlet for the surplus cash it generates. If money is the medium to facilitate an exchange of human behaviour, then this is a very rare "Nash's Equilibrium".

In game theory, the Nash equilibrium is a kind of optimal strategy for games involving two or more players, whereby the players reach an outcome to mutual advantage (or disadvantage, if you like). If there is a set of strategies for a game with the property that no player can benefit by changing his strategy while (or if) the other players keep their strategies unchanged, then that set of strategies and the corresponding payoffs constitute a Nash Equilibrium.

What is unusual about this (Nash) equilibrium is that this 'optimal' strategy is one of apparent advantage to the US, but is of apparent disadvantage to Japan. To a casual observer who believes that 'maximising economic utility' is the objective of all economic activity, this state of equilibrium is incomprehensible.

But what if Japan is beyond economics? What if it only seeks an outlet for its productivity, in order to maximize happiness? As individuals, we know that happiness comes not from "accumulated sweat" (i.e. money) but from sweat itself, i.e, work and activity.

Nature has no mechanism to store 'sweat'. Some species are known to store food, but you cannot store sweat. As individuals, we are not constructed to feel good about wealth. Happiness can only come from work.

That is how nature meant us to be. So Japan, in its search for happiness, no longer seeks wealth or money, but activity. For the first time in the history of mankind, we have a whole nation that behaves like it has moved up Maslow's Hierarchy.

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