The Japanese Problem is now ours
Ben Bernanke claims to be an expert student of the Great Depression and its causes. Therefore, many feel comforted that he knows what to do should in order to avert a repeat of 1929. But does he know how to prevent a repeat of the Japanese Problem?
The Japanese Problem is that of an economy which succumbed to a bubble economy in the 1980s and two decades later has still not fully recovered. The Bank of Japan (BoJ) and the Japanese government have managed all manner of stimuli in the last 15 odd years, all to no avail. Japan still suffers from deflation, has a massive government deficit and debt, and has a fragile banking system and economy.
The most important lesson to take away from the Japanese misadventure is that debt bubbles, once popped, are highly deflationary, self-propelled phenomena. There is no magic elixir to end the pain and the suffering. Easy money is certainly not the cure. Loose fiscal and monetary policy is what gets countries into dire straits, not what helps them out.
In one of my first blog entries, called The U.S. Economy 2008, I said:
“To my mind, this is a re-run of 1980s Japan, where the Japanese have resisted the credit-unwind process. After the crash in 1987, all central banks around the world adjusted to a tighter monetary policy after it was clear the ’87 Crash was not going to cause a depression. Tightening (and the unwinding of the S&L crisis) did eventually result in the 90-91 recession but we pulled out successfully.
Japan did not tighten because the United States requested they keep interest rates low to get the Dollar-Yen exchange rate down (very similar monetary policy to Greenspan’s loose policy post-LTCM and Russian devaluation in 1998). This was a grave error because the result was an even larger bubble, which popped in 1990. The Japanese real estate sector kept going strong until 1992, before it collapsed.
Even after massive stimulus campaigns by the Japanese since then, the Nikkei is easily down more than two-thirds from its all time highs over 15 years later! Japanese residential property prices are half of their peak levels. All the while, the Japanese have pumped money into the economy like mad, running massive budget deficits.
An inflationary monetary policy and Keynesian government spending stimuli are not a panacea to a post-bubble depression. This is a lesson the Fed has failed to take on board.”
Gillian Tett at the FT echoes these concerns, not only about the Fed, but about all Western central banks. She says:
“It is a salutary tale that western policymakers would do well to note. In the past 10 months, as a financial crisis has swept through western markets, U.S. and European central banks have also produced all manner of crisis-busting, money-market manoeuvres. And, perhaps unsurprisingly, some of these seem to have been copied from 1990s Japan.
Thus far, these steps have won widespread plaudits from market participants. And I would not criticise the western central banks for acting to avert a full-scale financial collapse in this way. But the more I look at these measures, the more I wonder how the U.S. and European banks will avoid the Japanese trap.”
–Gillian Tett, FT, 13 Jun 2008
To my mind, the way forward is a systematic liquidation of excess credit combined with a concerted effort to ease short-term financial stress. This would lead to a short but sharp downturn. However, for now, monetary authorities seem resistant to giving my particular cold turkey method of medicine to a global economy addicted to excessive credit.