The US is not Japan

ZIRP (Zero Interest Rate Policy) has arrived in the US. And with it comes the inevitable comparisons with the last major country to employ the policy – Japan.

The low hanging intellectual fruit is to conclude that what happened in Japan will happen in the US. Japan employed ZIRP for years with little affect ergo the US will have the same experience. Japan struggled unsuccessfully to fend off deflation so the US will struggle unsuccessfully to fend deflation. But if we go beyond the sound bite and dig a little deeper we just might see that the US is not Japan therefore to assume an identical outcome is just too, well, sound-bitey.

For example, from a central bank perspective consider what Martin Wolf points out in his commentary today re deflation, Japan, and the US: “At this point, one might wonder why Japan has struggled with deflation for so long. I have little idea. But the explanation seems to be that the Bank of Japan did not wish to take such drastic measures (as the Fed has done) and the Ministry of Finance did not dare to force the point. Such self-restraint will not deter the US authorities.”

No doubt that the US consumer will need to drift closer to his/her Japanese counterpart as the deleveraging process continues to push Americans toward a more frugal future. But old habits are hard to shake, and with so much money being pumped into all facets of the US economy one should assume that the cutbacks in US consumer spending will never approach the levels in Japan.

While some fret over deflation, others worry that the flood of money will inevitably produce inflation. This is a justifiable concern. But that is a problem for another day. For today’s problem, the analogy that best fits is the one describing the firefighter and a house on fire – you don’t worry about water damage when the house is ablaze. Besides, once the credit crisis/deflation blaze is extinguished the Fed has ample policy options to address the more familiar risks of inflation.

The last point to make re the Fed and its announcement yesterday is their intention to purchase longer-dated assets to force rates lower, specifically in the mortgage arena. In this regard, it is worth noting that such action may have a powerful side effect – the pricing of illiquid, hard to value assets tied to mortgages. This aspect was part of the original TARP proposal (price discovery) and may result in write-ups of assets held on the banks' books written down to 20 cents on the dollar.

Investment Strategy Implications

With the TED spread sitting at 1.57% this morning, all due to LIBOR, the flood of money from the Fed coupled with anything resembling $70 or better in operating earnings for the S&P 500 in 2009 (current bottom up estimates sit at over $80) may be more than enough to draw investment funds out from under the mattress (3 month Treasury rates at 0.01% today) and into financial assets.

The past is prologue. The US is not Japan.