The Dangers of Wanting It All (Wanting It Now)

There has been a lot written recently on the Japanese scenario - of the U.S. falling into a deflationary spiral with a banking system that can't function due to the weight of non-performing assets. This ranges from rumour (step forward Naked Capitalism) through calls to action (a nice Bloomberg article by William Pesek) to doom mongering (Robert Schiller in the Times). There's probably some denial out there too.

Here's my tuppence. The real problem with Japan wasn't low rates - although they did not help. It was low liquidity premiums. In the 90s you could pretty much repo a dry cleaning receipt for the purchase price of the clothes. With no liquidity premium, there was no incentive to take liquidity risk, and hence no incentive for the banks to lend their way back into solvency. Of course the accounting didn't help, as it allowed banks to keep non performing assets on their balance sheets at par. But it was their ability to finance their assets that allowed the deflationary cycle to continue for a decade in Japan. Right now we need a wave of liquidity to keep the banking system functioning. But equally, soon, the central bank spigot must be slowly closed.