The Japanese economy: A lesson for the US economy?
Gerard Jackson
Last year quite a few economic commentators were hesitant about the direction of the US economy, uncertain about whether it would stagnate or pickup. Some even claimed to see an ominous parallel between the US economy and the state of the Japanese economy in the late '80s, just before it sank into depression.
While others dismissed the parallel I'm still of the opinion that it contained a germ of truth for the simple reason that the policy that generated Japan's '80s boom is basically the same one generated the US boom of the '90s and the subsequent bust. That policy was one of massive credit expansion. The question was whether the US would descend into a protracted depression on par with Japan's or pull itself out.
Let us start with some economic history. In May1989 the Bank of Japan started to raise interest rates, with very little response at first. The Tokyo market continued to roar ahead while many commentators spoke sagely of permanently rising share values, though others were realistic enough to know that shares were seriously overvalued.
By the end of the year the Nikkei index stood at 38,915 and average price-earnings ratios were 70. It was January 1990 when stock prices first began to slide only to accelerate their decline with the Nikkei falling to 28,000 by March, a 30 per cent drop, triggering a panic. The end of the year saw the market about 4o per cent lower.
The property market also died as inflated assets values dropped, lumbering banks with massive non-performing loans. The situation created a crisis for the banks, seriously eroding their capital adequacy ratios. Property companies and security houses were savaged by the readjustment.
These companies borrowed huge amounts at little interest only to find themselves faced with having to repay at real rates of interest and this with their own investment and share values slashed by as much as 66 per cent. It was indeed a grim situation.
Instead of biting the bullet and taking its medicine by allowing the market to liquidate the country's unsound investments (what the Austrian school of economics call malinvestments), Japan repeated the same mistake that pushed her economy into economic stagnation from 1920-27.
This depression had also been preceded by a massive credit expansion. And despite the fact that wherever we look we always find credit expansion as the party that did the dirty deed, it is still invariably found not guilty be economic commentators.
For this situation we can blame Lord Keynes. This is mainly why observers turn to consumption as the potential saviour and the fallacious liquidity trap as the culprit, which is precisely what Paul Krugman did.
This Keynesianism ignored the economic reality that Japan's cheap money policy 'extended' investment beyond the pool of real savings. (This meant that something had to give). The situation was badly aggravated by consumption oriented policies that reduced the savings pool, when what the economy needed was the very reverse, notwithstanding Krugman's vulgar Keynesian prescription to the contrary.
The parallel made more historically-minded observers of the American scene more cautious in their economic appraisals. Nevertheless, many have them fell for the fallacy that part of the danger to the economy lay with falling share prices that allegedly cut consumer spending, as was supposed to have happened in Japan. ("wealth effect" link)
But if this were so, then the consumption goods industries would have been hit first and hardest. They weren't. It was producer prices and land prices that felt the initial impact of the recession and which fell faster and further than consumer prices, just as Austrian economic analysis predicted.
The parallel with Japan really stops at monetary policy and this why the US is making an economic recovery. Despite the depredations of its politicians, the US economy is still remarkably flexible which has already allowed a considerable shakeout of its money-induced malinvestments, unlike Japan. Moreover, the Bush tax package, despite dishonest claims by Democrats and the partisan media, accelerated the recovery process.
Unfortunately monetary lesson was learnt. The Fed has been madly pumping money into the US economy, what most economists misleadingly call liquidity, which is only laying the foundations for another recession.
Its monetary recklessness is being encouraged by a number of economists, many of them supply-siders, who argue that monetary policy needs to expand in order to maintain a "stable price level." They are evidently ignorant of the fact that the same policy brought on the Great Depression. But that's a story for another article.
Gerard Jackson is Brookes' economics editor
BrookesNews.Com
Monday 9 August 2004