Ah, today the Financial Times reminds me of the way it was back in early 2007, when it was clearly heads and shoulders above any US paper. Wonder why I have fewer days like that, It isn’t improved reporting by the US media (although they are further down the curve). I suspect that the FT has dumbed down its product for the US market. Shame, that.
Regardless, Martin Wolf is in particularly fine form today, and offers a reassessment of Japan’s lost decade. On the whole, the implications are not good.
Wolf starts by focusing on an issue ignored by most economists. Downturns are not created equal. What Richard Koo calls balance sheet recessions, that is, ones which feature excessive leverage, are much nastier beasts. This would seem to be an obvious point, yet is overlooked in many analyses.
From the Financial Times:
…,those who argue that the Japanese government’s fiscal expansion failed are, again, mistaken. When the private sector tries to repay debt over many years, a country has three options: let the government do the borrowing; expand net exports; or let the economy collapse in a downward spiral of mass bankruptcy.
Despite a loss in wealth of three times GDP and a shift of 20 per cent of GDP in the financial balance of the corporate sector, from deficits into surpluses, Japan did not suffer a depression. This was a triumph. The explanation was the big fiscal deficits. When, in 1997, the Hashimoto government tried to reduce the fiscal deficits, the economy collapsed and actual fiscal deficits rose.
Yves here. This line of thinking would have been dismissed as heretical or deranged a year ago. The party line among economists was that Japan had been too cautious, and had not administered monetary or fiscal stimulus in big enough doses soon enough. Back to Wolf:
….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.
Yves again. Doesn’t this sound familiar? Yet the US lectured Japan, and analysts smugly assumed that Japan’s crony capitalism had stood in the way of taking painful but necessary steps. Anglo-Saxon democracies would do better. Well, now they have been revealed to be every bit as much the hostage of politics. Back to the article:
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….
Yves here. I don’t think there was an opportunity then. Too close to a presidential election, too much shell shock and exhaustion among the key actors, who really did not see this one coming and did not have a grip on the problem or on policy options. Back to Wolf:
How far, then, is Japan’s overall experience relevant to today?
The good news is that the asset price bubbles themselves were far smaller in the US than in Japan (see charts below). Furthermore, the US central bank has been swifter in recognising reality, cutting interest rates quickly to close to zero and moving towards “unconventional” monetary policy.
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.
Yves here, It’s great to see his dismiss the private-public partnership tripe so succinctly, but is anyone in the US paying attention? I see too may people who should know better endorsing the idea. Back to the piece:
Yet what is happening inside the US is far from the worst news. That is the global reach of the crisis…we confront a balance-sheet deflation that, albeit far shallower than that in Japan in the 1990s, has a far wider reach. It is, for this reason, fanciful to imagine a swift and strong return to global growth. Where is the demand to come from? From over-indebted western consumers? Hardly. From emerging country consumers? Unlikely. From fiscal expansion? Up to a point. But this still looks too weak and too unbalanced, with much coming from the US. China is helping, but the eurozone and Japan seem paralysed, while most emerging economies cannot now risk aggressive action.
Last year marked the end of a hopeful era. Today, it is impossible to rule out a lost decade for the world economy. This has to be prevented. Posterity will not forgive leaders who fail to rise to this great challenge.