Japanese Government Blunders
When you listen to the Obama marketing team members selling their $1 trillion socialist stimulus package, they say we must avoid the disastrous course of Japan. After examining their lost decade, the results weren’t very bad. The economy was not dynamic, but Japan has retained its position as the 2nd largest economy on the planet.
After growing at a 3.9% annual rate during the 1980’s, Japan’s GDP grew at only an annual rate of 1.1% between 1991 and 2003. Considering the missteps by the government and the huge demographic headwinds blowing against them, Japan still grew its economy. Japan’s cumulative per capita growth this decade has been 13.7%, compared with 12.5% for the United States. And the horrible deflation was not so horrendous.
Consumer prices have been relatively flat for fifteen years. CPI has declined in a few years, but has never reached -1% in any particular year. The lack of demand from consumers has been a function of people being burned in the dual bubble collapse and an aging, declining Japanese population. Japanese consumers have rationally paid down debt and increased savings. The actions of the Japanese government were not rational or intelligent. A replay of these blunders is taking place in the United States today.
- The Japanese government has prolonged its downturn for an additional decade by not allowing bankrupt banks and corporations to liquidate. Zombie banks and corporations existed for decades without writing off the billions of bad debts. They hoarded all of the money provided by the government. Sound familiar?
- The Japanese tried every trick in the Keynesian playbook. Zero interest rates, public works projects tax rebates and tax decreases. The government built thousands of bridges and roads, driving up government debt to enormous levels. Between 1990 and 2000, the Japanese government instituted 10 fiscal stimulus programs totaling $1 trillion. None of these programs worked. Sound familiar?
- The Bank of Japan purchased commercial paper. The government bought shares of public companies to prop up the stock market. Japan created a $500 billion bank bailout fund, with over $200 billion going towards the direct purchase of stocks. Politicians chose which companies would be propped up. This further distorted the free market. Sound familiar?
- Japan has the highest elderly population of all the developed countries in the world. With the huge loss of real estate and financial wealth, the aging population of Japan needed to increase saving and reduce consumption to insure that they would not starve to death in their old age. An aging population deciding to save for the future made a rational decision. Sound familiar?
Dr. Benjamin Powell clearly explains what happens when the government intervenes in the free markets:
Japan created a structure of production that did not meet consumers’ particular demands. Producing things that nobody wants and propping up mal-investments cannot possibly help any economy. This policy is equivalent to the old Keynesian depression nostrum of paying people to dig holes and fill them. Neither policy will revive the economy because neither forces businesses to realign their structures of production to match consumer demands.
It is obvious that the Japanese government created the enormous stock market and real estate bubble through its loose monetary policies in the 1980’s. No matter how much money the Japanese government threw at the problem, they could not convince consumers or companies to borrow and spend. Even with zero interest rates, Japanese companies continued to pay down debt. The billions spent on infrastructure added to the National Debt and did nothing to revive the economy.
If Japan had faced up to the bad debt on its banks' balance sheets immediately, they would have experienced a short painful recession of a couple years. By not honestly assessing the true extent of the bad debt and propping up insolvent banks and corporations, Japan sentenced itself to two decades of stagnation. Japan entered this difficult period as a net exporter, with consumers who saved 12% of their income, and a government that had leeway to increase governmental debt. The U.S. has entered a more dangerous period with none of those advantages.
Audacity of Reality
Hope will not get the United States out of our current predicament. It took decades to get to this point and it will take decades to extract ourselves from this debt induced disaster. A few charts will hammer home the reality of the U.S. situation.
The chart above shows that we enter this financial crisis with total U.S. debt at record levels as of the end of the 2nd quarter of 2008. Since that time we’ve added billions more in debt. At the end of the 3rd quarter, total U.S. credit market debt was $51.8 trillion. The proposed stimulus package of $1 trillion combined with declining GDP will result in the percentage exceeding 400% of GDP by the end of 2009. Japan entered their “lost decade” with total debt of 260% of GDP. Therefore, they had more leeway to expand government debt. Their biggest advantage over the U.S. was that they did not have to convince foreign nations to buy their debt. With large trade surpluses and high savings rates, the debt was purchased by their own citizens.
American consumers enter this economic downturn as the most indebted people on earth. The materialistic frenzy of the last two decades has left the American consumer saddled with $2.6 trillion of credit card and auto loan debt. Japanese consumers entered their “lost decade” with personal savings rates of 12% annually. Japanese consumers were able to utilize savings to pay down their debt throughout the 1990’s. The American savings rate, which was 12% in 1980, fell below zero in 2006. It has since inched up to 2% in recent months. There are over 300 million credit cards in use today in the U.S. The average American with a credit card is carrying debt of $16,635, according to Experian. With unemployment skyrocketing, wage growth stagnant, and home equity extraction a thing of the past, American consumers are rationally paying down debt. The result is devastating the economy. When 72% of the economy is dependent upon consumers borrowing and spending, deleveraging by consumers will bring the economy to its knees.
The crux of our current crisis is housing, just as Japan’s crisis was related to real estate. Irrational exuberance, as described by Yale economist Robert Shiller, led to the most outrageous housing boom in U.S. history. It was aided and abetted by greedy investment bankers, sleazy mortgage brokers, dishonest appraisers, Alan Greenspan, clueless ratings agencies, and Congressmen in the back pocket of Fannie Mae and Freddie Mac. Delusional home buyers were convinced that flipping houses was a road to riches. Instead, they’ve skidded off the road and fell into a bottomless ravine.
The amazing thing about reversion to the mean is that it always ensues, eventually. The sad thing is that people keep praying that reversion won’t happen this time. Home prices have tracked very closely to CPI for over a century. The housing boom from 2000 to 2006 was so off the charts that people can not come to grips with the dramatic fall that is needed for reversion to the mean to work its mathematical magic. Politicians want house prices to stop falling in the worst way. There is nothing they can do to stop prices from falling to their natural long term equilibrium. Government intervention will only prolong the time frame and delay the recovery. Home prices in Japan fell for 14 years before bottoming in 2004. Home prices have been dropping in the U.S. for 3 years. How does another decade of home price declines grab you? It is entirely possible if the government tries to intervene in the free market process of supply, demand and price.