What have we learned from Japan’s lost decade?
An interesting article on the Financial Times dated Feb 17th 2009 by Martin Wolf:
What has Japan’s “lost decade” to teach us? Even a year ago, this seemed an absurd question. The general consensus of informed opinion was that the US, the UK and other heavily indebted western economies could not suffer as Japan had done. Now the question is changing to whether these countries will manage as well as Japan did. Welcome to the world of balance-sheet deflation.
Wolf first argues that comparing the current downturn to the one experienced by the U.S. in the early 1980s is misguided. Then, monetary policy worked, now it wouldn’t:
First, comparisons between today and the deep recessions of the early 1980s are utterly misguided. In 1981, US private debt was 123 per cent of gross domestic product; by the third quarter of 2008, it was 290 per cent. In 1981, household debt was 48 per cent of GDP; in 2007, it was 100 per cent. In 1980, the Federal Reserve’s intervention rate reached 19–20 per cent. Today, it is nearly zero.
When interest rates fell in the early 1980s, borrowing jumped (see chart below). The chances of igniting a surge in borrowing now are close to zero. A recession caused by the central bank’s determination to squeeze out inflation is quite different from one caused by excessive debt and collapsing net worth. In the former case, the central bank causes the recession. In the latter, it is trying hard to prevent it.
He then argues that Japan spent its political capital unwisely in failing to act decisively. The same scenario appears to be playing out in the U.S. today, with Treasury Sec. Geithner public-private partnership plan to save the banks:
Third, recognising losses and recapitalising the financial system are vital, even if, as Mr Koo argues, the unwillingness to borrow was even more important. The Japanese lived with zombie banks for nearly a decade. The explanation was a political stand-off: public hostility to bankers rendered it impossible to inject government money on a large scale, and the power of bankers made it impossible to nationalise insolvent institutions. For years, people pretended that the problem was downward overshooting of asset price. In the end, a financial implosion forced the Japanese government’s hand. The same was true in the US last autumn, but the opportunity for a full restructuring and recapitalisation of the system was lost.
The bad news is that the debate over fiscal policy in the US seems even more neanderthal than in Japan: it cannot be stressed too strongly that in a balance-sheet deflation, with zero official interest rates, fiscal policy is all we have. The big danger is that an attempt will be made to close the fiscal deficit prematurely, with dire results. Again, the US administration’s proposals for a public/private partnership , to purchase toxic assets, look hopeless. Even if it can be made to work operationally, the prices are likely to be too low to encourage banks to sell or to represent a big taxpayer subsidy to buyers, sellers, or both. Far more important, it is unlikely that modestly raising prices of a range of bad assets will recapitalise damaged institutions. In the end, reality will come out. But that may follow a lengthy pretence.
Finally he says that Japan’s subsequent turnaround at the end of the “lost decade” was due to growth in exports and consumption spending rather than any government plan to inject liquidity into the banks:
Yet what is happening inside the US is far from the worst news. That is the global reach of the crisis. Japan was able to rely on exports to a buoyant world economy. This crisis is global: the bubbles and associated spending booms spread across much of the western world, as did the financial mania and purchases of bad assets. Economies directly affected account for close to half of the world economy. Economies indirectly affected, via falling external demand and collapsing finance, account for the rest. The US, it is clear, remains the core of the world economy.
Prof Paul Krugman from whose blog I first saw this FT link, agrees with him:
But a closer look at that recovery is not encouraging. The chart above is a quick-and-dirty summary of the sources of Japanese growth from 2003 to 2007. It shows the change in real GDP, the change in real consumer spending, the change in real business investment, and the change in real net exports, all as percentages of 2003 GDP. What we see is nothing special happening to consumption, which grew more or less at its long-term trend growth rate, and only a modest investment boom. Exports were the driving force behind recovery.
And needless to say, we can’t all export ourselves out of a global slump.
So, how does this end?
Indeed, what should we do? Are we over-stating the importance of saving banks from bankruptcy by wasting hundreds of billions of taxpayers’ money?