Interest rates close to zero and all the related issues are relatively new in the U.S. and Europe, but they’ve been around in Japan for two decades. So, many wonder if the U.S. is headed for Japan’s 20-years-and-running deflationary depression. And regardless, what does the Japanese experience tell us about living in this atmosphere?
The Japanese bubble economy was cruisin’ for a bruisin’, and its demise was aided by the Bank of Japan’s hike in interest rates, starting on May 31, 1989. Soon, exuberant real estate prices collapsed as did stock prices and economic growth nearly ceased. Lately, the earthquake and tsunami have added to Japan’s woes, at least on a short-term basis. Real GDP fell 1.3% in the second quarter from a quarter earlier at annual rates, following the 3.6% drop in the first quarter and the third quarter in succession to decline.
Similarities
Gallery: Gary Shilling's 10 Investments To Buy There are a number of similarities that suggest that America is entering a comparable long period of economic malaise. The Age of Deleveraging forecasts a similar decade, at least quite a few years, of slow growth and deflation as financial leverage and other excesses of past decades are worked off. The recent downgrade of Treasurys by S&P parallels the first cut in Japanese government bond ratings in 1998, followed by S&P’s cut to AA-minus early this year and Moody’s reduction from Aa2 to Aa3 last month.
The recent slow growth in the U.S. economy—real GDP gains of 0.4% in the first quarter and 1.0% in the second—looks absolutely Japanese. Furthermore, the prospects of substantial fiscal restraint in the U.S. to curb the federal deficit is reminiscent of tightening actions in Japan in the mid- 1990s. The economy was growing modestly, but deficit- and debt-wary policymakers in 1997 cut government spending and raised the national sales tax to 5%. Instant recession was the result.
Big government deficits in recent years are another similarly between these two countries.
The U.S. net federal debt-to-GDP ratio is also headed for the Japanese level.
Japan’s gross government debt last year was 226% of GDP, far and away the largest ration of any G-7 country. All governments lend back and forth among official entities so their gross debt is bigger than the net debt held by non-government investors, and Japan does more of this than other developed lands. Still, on a net basis, its government debt-to-GDP is only rivaled by Italy’s and leaped from a mere 11.7% in 1991 to 120.7% in 2010. Is the U.S. far behind?
Japan, in reaction to chronic economic weakness, has spent gobs of money in recent years, much of it politically motivated but economically questionable, like paving river beds in rural areas and building bridges to nowhere. Is that distinctly different than the U.S. 2009 $814 billion stimulus package that was supposed to finance shovel-ready infrastructure projects when, in reality, the shovels had not even been made yet?
A key reason for the 2009 and 2010 U.S. fiscal stimuli and continuing deficit spending in Japan is because aggressive conventional monetary ease did not revive either economy. Zero interest doesn’t help when banks don’t want to lend and creditworthy borrowers don’t want to borrow. Both central banks found themselves in classic liquidity traps, so both resorted to quantitative ease, without notable success.
But Differences, Too
There are, then, many similarities between financial and economic conditions in the U.S. and Japan. Nevertheless, there are considerable differences that make Japan’s experience in the last two decades questionable as a model for America in future years. Note, however, that every time I visit Japan, I return convinced that I understand less about how they function than I did on the previous trip. I’m sure they behave rationally, but it’s a different rationale than in the West, or at least the one I understand.
The Japanese are stoic by nature, always looking for the worst outcome while Americans are optimistic—not as optimistic as Brazilians, but still prone to look on the bright side. Otherwise, why would the Japanese voters stand for two decades of almost no economic growth? Japanese are comfortable with group decision-making while Americans revere individual initiative, something the Japanese disdain. The nail that sticks up will be pounded down, is a favorite expression there. Perhaps because of this, the government bureaucracy in Japan is much stronger than in the U.S. while elected officials have less control and room for initiative.
Despite little economic growth, the Japanese enjoy high living standards.
And the Japanese are an extremely homogenous and racially-pure population. In a related vein, immigration visas don’t exist in Japan, so there’s nothing in Japan like the chronic shift of U.S. income to the top quintile. Nothing like the two-tier economic recovery that benefited top-tier stockholders in 2009-2010, but left the rest struggling with collapsing prices for their homes and high unemployment.
Fertility rates in Japan are about the lowest in the world and life expectancy is high. So the rapidly aging and declining population lack the innovation and dynamism of more youthful populations in the U.S. where immigration, legal and illegal, is high as are fertility rates.
Export-Led
Japan in the post-World War II era has been an export-led economy. “Export or die,” is the watchword. The result of robust exports and weak imports linked to anemic domestic spending is its perennial current account surpluses, which, along with earlier high saving by households and now by businesses, allow it to finance its huge government deficits internally, with foreigners owning only 5%. As a result, Japna’s government bond yields are extremely low.
In contrast, the U.S. is a chronic importer with a chronic current account deficit. So foreigners have perennially bought Treasurys with the resulting dollars they earn, and they now own about 50% of them. And Treasury note and bond yields are much more controlled by global forces and higher as well than in Japan. The U.S. is largely an open economy but Japan’s, except for her formidable export sector, is largely closed to the outside world.
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Gallery: Gary Shilling's 10 Investments To Buy Another big difference is the chronic strength in the yen and long-time weakness in the dollar, resulting in part from the difference between Japan’s chronic current account surplus and America’s chronic deficit. Even near-zero short-term rates and 10-year government bond yields of about 1% do not deter those who lust for the yen. Of course, in a zero interest rate world where interest returns have dropped close to traditionally low Japanese levels in the U.S. and elsewhere, Japan at present does not have much of a competitive disadvantage.
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The yen’s strength has led to Japanese manufacturers moving much of their production to lower-cost areas, but deflation in Japan has offset some of the difference. Corrected for deflation and on a trade-weighted basis, including trading partners such as Switzerland with robust currencies, the yen has been relatively flat since the 1980s, according to a Bank of Japan analysis.
Nevertheless, the government has intervened in currency markets numerous times, most recently spending $13 billion in early August, to arrest the yen’s climb vs. the greenback. And, of course, a government intervening against its own currency can’t run out of ammunition since it can easily create more of its own currency to sell on the open market. Still, intervention success has been limited, short-lived and expensive. Even a determined government with unlimited ammo has not been able to overcome the gigantic global currency markets that trade trillions of dollars daily.
Deflation
Japan, of course, is mired in deflation, and while we continue to believe America is headed there as well, the U.S. CPI is still rising. In fact, many in and out of the Fed believe serious U.S. inflation is in the wings. As shown earlier, the spread between 10- year Treasurys and TIPS implies an annual CPI rise of about 2% over the next decade. A similar measure in Japan reveals expectations of continuing deflation over the next 10 years.
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What’s Left To Be Done?
I conclude that the differences between the U.S. and Japan are too great to use the Japanese economic experience in the last two decades as a template for the U.S. in coming years. Still, as discussed in The Age of Deleveraging, I expect a similar lengthy period of slow growth and deflation as the economy delevers. In any event, can policymakers do much to forestall this outlook? I argue in The Age of Deleveraging that they can’t any more than the Japanese have been able to generate robust economic growth.
A decade ago, the Fed was worried about deflation infecting the U.S. and assigned a dozen of its top economists to study Japan to see how chronic falling prices could be avoided. Their conclusion: Institute massive monetary ease early before deflation becomes a well-established and anticipated phenomenon.
Now-Fed Chairman Bernanke in earlier years also believed the Bank Of Japan activities were too little, too late, and that then the Japanese central bank pulled back when the economy seemed to be reviving. Its holdings of government bonds jumped from ¥45.7 trillion in 2001 to ¥67.2 trillion in2004, but aren’t much higher today at ¥86.0 trillion. The BOJ’s securities-buying program earlier this year of ¥5 trillion, or around $65 billion, is only about 10% of the Fed’s $600 billion QE2 program. Note, however, that the Fed’s much larger quantitative easing hasn’t been a great success either, as discussed earlier.
Furthermore, the U.S. central bank’s fear of a self-feeding deflationary spiral has not occurred in Japan. That takes place when lower prices encourage potential buyers to wait for still-lower prices, which are then induced by mounting inventories and excess capacity. So those buyers wait even further, etc., in a self-feeding downward price spiral. In Japan, deflation has been an on-and-off phenomenon for 20 years with no cumulative downward spiral in prices. This graph also reveals that M2 money supply growth of about 3% annually in the last two decades has not prevented periodic price declines. Again, Japan has been and the U.S. now is in a classic liquidity trap.
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