PIMCO's Bill Gross in fact just identified this same feedback loop in the United States, although he doesn't realize it. In point of fact fully $500 billion of the deficit from last year was spent directly and indirectly on handouts to an increasingly unemployed population, thereby increasing the incentives to be unemployed as opposed to seeking employment. This in turn is reflected in the participation rate which has fallen in this recession thus far to levelslast seen in 1983, destroying twenty five years of labor force progress in less than 18 months!
This in turn has raised the specter that the $500 billion in outlays via these "handouts" has become structural, and thus will mutate into a similar demand that The Fed either "print more or we deflate hard", exactly as happened in Japan.
The problem is that eventually you deflate anyway as it is not possible to couple your reflationary attempt with any sort of parity (or better) into personal income. The ultimate outcome is thus certain - the economy will deflate anyway but you will destroy the purchasing power of every saver in the nation along with everyone's ability to earn a living first!
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Paul Volcker recognized this in the 1970s and did what was necessary to stop the cycle before it resulted in the destruction of our government. We now have a cadre of limp-wristed Central Bankers who believe they can ignore the lessons of history, including Zimbabwe, Argentina and Weimar Germany.
THEY ARE WRONG.
There is only one way out of a liquidity trap that does not involve impoverishing everyone: you force those who are overlevered, no matter who they are, through bankruptcy and by doing so you default the insoluble debt, removing it from the system.
This often causes severe asset price deflation as assets are forced into liquidation, but it restores balance between asset prices and earnings while at the same time allowing those who have been prudent and did not take on excessive leverage to survive and even prosper during the necessary period of adjustment.
While I would hate to see Japan follow the idiotic prescription put forth by Mr. McCully and detonate itself, it is preferable that it happen there to here in The United States.
I therefore suggest that Japan's central Bank immediately adopt PIMCO's suggestions, in the hope that we will be able to learn by watching them implode their currency and nation, and through observance of the idiocy of this path avoid the same fate ourselves.
Godspeed to the BoJ.
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