A tale of two bubbles

Bubbles last until they feel like fundamentals, and until last week, investors believed that tech stocks could only head up and the Japanese yen could only head down. By Monday’s market opening, investors cowered for shelter as the two bubbles popped in unison.

The Biden administration in Washington and the Kishida government in Tokyo both pursued the same unsustainable policy, ballooning the government balance sheet to push up asset prices.

By July 31, when the Bank of Japan raised its short-term interest rate to 0.25% from zero and announced that it would “taper” its purchases of government bonds, the central bank owned half the outstanding float of Japanese government bonds.

Japan’s debt-buying binge pushed up inflation expectations, weakened the yen and buoyed Japan’s stock market during the past three years.

A lower yen translated foreign earnings into a larger sum of local currency and inflation reduced real wages, causing a transfer of national income to corporations away from households.

As the above chart shows, the yen exchange rate, expected inflation (as reflected in the yield difference between inflation-indexed and ordinary coupon government bonds) and stock prices moved in unison. Japan’s major stock indices lost more than 20% through the August 5 session before rebounding at the August 6 opening.

Meanwhile, in the United States, the Biden administration tried to shovel money into consumers’ pockets by increasing transfer payments, as I explained in an August 2 analysis.

Washington’s choice of weapon was fiscal rather than monetary: Transfer payments (federal checks to individuals) rose nearly 20% above the long-term trend.

Economist Lawrence Summers, who served as president Barack Obama’s Treasury