Is the U.S. Heading Toward a Japanese-Style Lost Decade?

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Two recent signs U.S. is following Japan's footsteps on the road to the Lost Decade.

1. Bernanke criticized Japanese policy makers for being too timid in their monetary response to deflation. Well guess what the latest QE Lite is? $200B a year is pathetic for the size of U.S. economy.

In fact, there's sound logic in "timid" monetary response to deflation. BoJ guys are nothing but dumb. They're well aware of the risk of hyperinflation if stimulus is too big. Perhaps they're also aware that, in face of a long-term trend of demographic change, the best monetary policy can possibly achieve is to prevent catastrophic collapse and engineer a slow slide down. I hope Bernanke is beginning to learn the same lesson after the monstrous QE I has resolutely failed to cause any sustained effect after one short year.

2. Domestic holding of treasuries has been on a steady rise.

A unique characteristic of Japanese government debt situation is the extremely high percentage of domestic holding. The U.S. has been the polar opposite. But the trend is going the Japanese way (coupled with significant and persistent shift away from equities and more interest in dividend-paying ones), although it may never reach the same level. This is a small but unmistakable manifestation of the same demographic trend. As baby boomers begin to retire, or at least save for it in earnest, they invariably focus more on income and capital preservation relative to capital gain.

The divergence between equities and bonds have received much attention. But, based on the demographics argument, I think the bond bull-run has a long way to go -- treasuries and corps (including junk) have started, munis will follow as soon as the default risk begins to clear.

So we will have a Lost Decade, U.S. Edition. People seems to think that's a bearish statement. But is it really so scary? Let's take another look at Japan's Lost Decade.

1. Japanese living standard has not deteriorated substantially, solidly staying in the same league.

2. Japanese economic power and competitiveness have persevered and even strengthened in some very important areas (auto, high-end electronics, space, etc).

3. Currency and gov debt have been by and large stable and strong over the 20 years of oh-so-scary lost decades.

The Japanese response and achievement in face of aging baby boomers is not only nothing to sneer at, it's something to strive for. But it will be harder for U.S. to survive the lost decades with the same flying color.

1. Japan was helped tremendously by the global rise in productivity, free trade, capital investment, and living standard throughout the lost decades. The U.S. will most likely face a prolonged demand/capital slump along with Europe and (later) China.

2. U.S. currency and debt are subject to much more influence from international forces. The USD reserve status is especially critical and, by the same token, vulnerable. This makes the balancing act much trickier.

In 5 years, I expect many economists in the US to look at Japan's lost decades with reluctant respect and envy. Perhaps it's time for Mr. Bernanke to fly over to Tokyo, maybe even with a few Fed economists with PhDs from decent departments.

There is one potential strength that favors U.S. -- talent/labor inflow from immigrants. This could potentially offset some of the structural deficit brought by the population aging. But how much of the potential will be realized is far from certain given the current political climate (especially if tea party gets taken over by fundamentalist social conservatives) and the expected future socioeconomic tension.

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