But it’s the Fed’s read-between-the-lines implication that is really scary.

By taking this step, U.S. Federal Reserve Chairman Ben Bernanke hopes to reassure global traders, and presumably the American public, that he is prepared to take even more drastic steps should the recovery grind to a halt. Chief among the Fed’s options would be to buy more mortgage debt, which Bernanke believes would help keep down inflation.

Bear in mind, though, that at the height of this financial crisis, the Fed purchased a staggering $1.42 trillion in mortgage securities and some $300 billion in Treasuries to prop things up. And mortgage rates fell less than half a point. So much for that theory.

Something stinks here.

Bernanke either knows something about the state of the recovery that he’s not telling the public, or he’s trying to telegraph something he believes is inevitable.

Maybe it’s both. But this isn’t good news either way.

I have got to believe that it’s finally dawning on Helicopter Ben that deficit spending and the Keynesian formula for consumer stimulation – upon which the Fed has based its entire recovery plan – don’t work. (Something I argued in a recent report to Money Map Report subscribers – click here to sign up and get your copy.)

The housing market still stinks, mortgage rates are still falling despite being the lowest they’ve been in decades, and consumers have no money. Furthermore, the consumers that do have money are facing tighter credit standards and don’t want the debt.

Frankly, I think that’s actually a good thing because it represents a huge psychological change in our nation’s reckless spending habits. However, from the Fed’s point of view, it’s a problem because its policies presuppose that government spending makes up the difference in consumer demand until demand can once again overpower the deficits induced in the effort.

But here’s the real problem with the Fed’s policy: By propping up the mortgage market, and by implication Treasuries, the Fed is only temporarily staving off inflation, while further selling out the dollar long-term.

The fact is that inflation is as inevitable as the sun rising tomorrow and there are now some $12.4 trillion reasons why. And so the problem isn’t the mortgage market or even the manipulation of rates, but the eventual evisceration of the dollar.

Regardless of government statistics that suggest inflation is under control, the reality is that inflation is already well underway to the tune of 10% or more in this country. You know that as well as I do by what happens with your wallet every day. The costs of education, medicine, and groceries are all up, up, up. Apparently, the government bean counters are the only ones who aren’t feeling the squeeze.

The other thing to consider is that by propping up Treasuries in an effort to keep inflation low, the Federal Reserve is undermining any semblance of a strong dollar policy. Bernanke and Treasury Secretary Timothy Geithner may talk a good game, but the reality is that money flows to where it is treated best. And that doesn’t bode well for the dollar in the long-term.

Once the dust starts to settle, i nternational traders will move away from the greenback absent higher interest rates that compensate them for their investment. In fact, they’ve already begun doing just that. I know the dollar rose overnight following Tuesday’s announcement but that’s more in reaction to a short term flight to quality than a long term reflection or judgment of the dollar’s staying power.

If it were, we would not have seen the dollar fall below 85 to the Japan Yen – a 15-year low – at the same time.

And don’t forget about China. By propping up U.S. treasuries in an effort to keep interest rates from rising, the U.S. government may be trying to force the Chinese to revalue their Yuan more quickly than that government wants. This will go over like a lead balloon in Beijing, which holds nearly a $1 trillion of U.S. government paper in the form of short-term obligations.

So what we can do to profit from the situation?

News and Related Story Links:

• Money Morning: An Anemic Economic Recovery Keeps the Fed From Focusing on Inflation
• Money Morning:Inflation Isn’t Dead, Just Sleeping – And TIPS Can Protect You When It Awakens
• Money Morning:Will the Fed Opt For More Stimulus as the Economic Recovery Founders?
• Money Morning: With Mid-Term Elections Looming, Will Democrats Fire Back with a Second Stimulus

Let’s Make a Deal

Japan‘s much-ballyhooded “Lost Decade” is actually now entering its third decade. Mainichi Tokubai, which means “every day best deal,” is a social networking site “staffed” by more than 70,000 Japanese housewives who, after nearly 30 years of flat wages and an increasingly dicey Japanese economy, simply want to stretch each yen in their quest to take care of their families.

From our home here in Kyoto, where my family and I live for part of each year, I’ve had a courtside seat to this economic drama. Even my wife Noriko uses the site: She estimates she can save at least 5,000 yen (roughly $50 a month) using the site. That’s a heck of a return on investment (ROI), given that a monthly subscription is about 105 yen (about $1.05).

Here’s how it works.

Each day, local housewives – called “regional correspondents” – upload the daily specials from their local newspapers to the site. Then, armed with their “keitai,” or smart phones, they go shopping for the best deals in neighborhood markets. If getting those “best deals” means buying a handful of items from three or four different markets, so be it.

It’s that resolve to find those “best deals” that’s threatening to further drive down prices – which could be deflationary.

It’s a great way to do things for a couple of reasons. First, we already receive the daily flyers from neighborhood merchants, so we’re able to instantly compare prices with other stores instead of having to plow through a half a dozen flyers a week. Second, we’re able to do it on our schedule and when we’re ready to go shopping. Third, we don’t really worry about getting the short end of the stick any longer from notoriously inflexible Japanese merchants who, for hundreds of years, have held the upper hand here.

The other day, for example, our family bought pork, eggs, pumpkin squash, ice cream and frozen foods – including peas, beans and blueberries – all on sale at our local stores and all at deep discounts that ranged from 10% to 50%.

Those bargains are akin to the “doorbusters” that U.S. retailers offer on weekends and holidays, and the strategy is the same: Japanese retailers offer those deeply discounted goods, figuring that, once in the door, the shoppers will then buy “iro iro,” or various things – and not merely the heavily advertised “loss-leaders” that got them into the store.

It doesn’t actually work out that way, however – thanks to Mainichi Tokubai. Take consumer Hiroe Ishimoto, who passed – as we did – on goods the Web site told her she could buy for less at other stores.

“I live with the comfort of knowing I never get a bad deal,” she told CNN.

At the other end of the spectrum are politicians and businessmen – like the chain store association’s Ogasawara – who worry that this small-but-determined army of consumers will tip Japan into a deflationary spiral.

Japan’s Lost Decade(s)

Unfortunately, Japanese retailers and politicians don’t seem to understand what the real problem is here. Consumers are feeling squeezed and have taken matters into their own hands, because Japan’s government won’t – or can’t – solve the problems they face.

And the pain has been intense.

For three decades – in what was known as the “Japanese post-war economic miracle” – Japan posted stellar growth. In fact, it averaged 10% growth during the 1960s, 5% in the 1970s and 4% in the 1980s – enough to vault right behind the United States and make it the world’s second-largest economy.

However, following the September 1985 Plaza Accord, a steep appreciation in the yen really torpedoed Japan’s export sector. Japan’s economic growth rate skidded from 4.4% in 1985 to 2.9% the next year. In an effort to offset the stronger yen, the Bank of Japan sought to ease monetary policy: Between January 1986 and February 1987, the BOJ slashed the discount rate from 5% to 2.5%. Asset prices – primarily stocks and real estate – skyrocketed, creating one of the biggest speculative bubbles in modern history, and setting Japan up for a classic crash.

The government tightened credit, raising rates five times in 1989 and 1990. By the time rates reached 6%, Japan’s stock was poised for a full-blown retreat. From an all-time high of almost 40,000 in 1989, the Nikkei 225 plunged more than 60% by 1992, dropping below the 15,000 level. The real-estate market was also crushed: Prices plunged 80% between 1991 and 1998.

It would have been bad enough had that been the extent of the damage, but it was actually just the start. Japan’s government rolled out 10 stimulus programs during the 1990s, and none did the trick. The Nikkei dropped below 12,000 by March 2001, and has continued to decline (it closed Tuesday at 9,338,04 – a full 77% below the all-time high reached in 1989).

Japan’s economy has been stagnant ever since: Real GDP rose just 1.5% per annum during the 1990s and 0.8% a year in the 2000s. The extremes experienced during the most-recent decade exacerbated the longstanding pain. After a major global slowdown in 2000-2001 hit Japan particularly hard, a resurgence of global trade and the policies of Prime Minister Junichiro Koizumi sparked a rebound that saw Japan’s economy advance at a 2.1% annual clip from 2003 to 2007.

But the global financial crisis brought about another reversal of fortune, causing the Japanese economy to shrink 1.2% in 2008 and a full 5.0% last year.

Fast-forward to 2010 and we find that the outlook hasn’t improved a bit. Unemployment is up once again and household spending is down, according to May data – most likely in response to lower Japanese factory production data and industrial output during the same month.

Note to Obama: Beware Mr. President

Japan’s got 30 years in this game and its leaders have tried everything from zero-interest-rate policies to cramming more capital into banks and other short-term lenders. The government has also purchased commercial debt and stock outright – all under the assumption that “lending” supports the very foundations of economic growth because it translates into “productive” investments.

Japanese companies are now so weakened by the multi-decade grind that there are literally not enough of them left to take on newly available capital even if they could.

If this all sounds vaguely familiar to you U.S. readers, your mind isn’t playing tricks: The Bush and Obama administrations have called some of the same plays – and we’ve already seen some similar results. Give it time and the parallels will become even more clear.

Washington would be wise to take heed: U.S. consumers aren’t going to put up with Washington’s malfeasance and mismanagement forever. Eventually, U.S. consumers, too, will take matters into their own hands, much like Japan’s housewives have done.

And when that happens in the United States, watch out.

Once consumers get that fed up – or that scared – they will take matters into their own hands … just to survive. Once that happens, consumer actions become the kind of hard-to-factor-in wildcard that transforms any new policymaking push into three parts guess/one part projection.

If you don’t believe me, just ask the housewives of Mainichi Tokubai – the “Real Housewives” of Japan.

[Editor's Note: Keith Fitz-Gerald knows Asia. For more than two decades, the noted author, investor and commentator has worked in, traveled throughout and actually lived in the Asian markets that so many others now claim to be "experts" on.



But as the preceding essay underscores, having immersed himself in the Asian investing and business venues that he now writes about and invests in for more than 20 years, Fitz-Gerald not only has insights that few others possess, he has the kind of contacts that few others can rival.

Investors can benefit from these insights. In his advisory service, The New China Trader, Fitz-Gerald makes those years of insights and global contacts available to his readers. For more information, please click here.]



News and Related Story Links:

• Wikipedia:
  
  Consumption.
  
• Bloomberg News:
  
  Bonds Gain in Best Year Since ’05 as Rally May End
  
• Newsweek.com:
  
  Yes He Kan? Restoring confidence in Japan’s DPJ
  
• CNN.com:
  Japanese Housewives Driving Deflation.
• Money Morning News Archives:
  
  Japan News Stories
  
• Google.com:
  
  Japan’s Population
  
• Money Morning News Archive:
  
  Lost Decade News Stories
  
• InvestorWords.com:
  
  Return on Investment
  
• Wiktionary:
  
  Doorbusters
  
• Wikipedia:
  
  Junichiro Koizumi
  
• Von Mises Institute:
  
  Explaining Japan’s Recession
  
• Wikipedia:
  
  Plaza Accord
  
• Wikipedia:
  
  The Japanese Economy