Many observers have noted that the US is unwilling to take its medicine. In the Asian financial markets crisis of 1997, nations with large current account deficits and domestic asset bubbles saw their prosperity unravel as asset prices collapsed, leading to borrowers defaults, a contraction of credit which spiraled into a crunch, and withdrawal of foreign capital which led to sharp declines in their currencies. The IMF rescue packages required the recipients to slash government spending to bring budgets into balance, let foundering financial institutions fail, and raise interest rates sharply. The result was large scale bankruptcies, high unemployment, and riots.
Instead of performing radical surgery, the US instead is acting as if it can validate inflated asset prices, or at least keep them from falling too much. Like Japan after its bubble years, this means propping up diseased financial institutions, squeezing workers, and enduring protracted stagnation.
Tim Collins, a private equity investor who has considerable experience in Japan, elaborates in the Telegraph:
The US could be facing a “lost decade” like that suffered by Japan in the 1990s as the markets fail to respond to interest rate cuts and the US Federal Reserve runs out of options, the head of one of the leading private equity firms said today.
Tim Collins of Ripplewood Holdings, said the Fed was “running out of policy alternatives” as it attempted to prevent a long recession in the US.
Mr Collins….believed a “sharp repricing of assets” was the most likely outcome.
But he said: “My fear is that we will prolong it and suffer a death of a thousand cuts after we have exhausted all the options.”
“Even without a recession and with all of the policy tools available we still have hundreds of billions of dollars of losses.”
Japan has only recently emerged from a period of zero interest rates.
He said the future would not be clear until a recession had laid bare the true state of the financial system. “You have to wait for the tide to go out to see who is wearing a bathing suit,” he said.
But the chairman of Ripplewood, which last year completed the $2bn buyout of Readers Digest, rejected the argument, put forward by some at this year’s SuperReturn private equity conference in Munich, that Sovereign Wealth Funds would replace struggling banks to provide debt to private equity companies.
“The financial markets operate on the basis of the multiplier effect in the banking system and you cannot replicate that with what is effectively equity, not debt, from sovereign wealth funds.”