Friday, October 17, 2008
Lessons from Japan's Malaise - Bill Emmolt
Japan's stock market collapse began in January 1990 and continued throughout that year. The property market followed, with a lag. Yet the Bank of Japan did not try to prevent this financial crash from damaging the real economy by cutting interest rates, as the U.S. Federal Reserve has done spectacularly during the past three months. To the contrary, Japan's central bank used its monetary policy as if to make sure that the country's asset-price bubble had truly burst: It carried on raising interest rates until September 1990 and did not make its first cut until July 1991, 17 months after the financial crisis began. In fact, the Bank of Japan did not begin using monetary policy as an aggressive tool to arrest the slump until deflation had set in toward the end of the 1990s. Japan did do two things: It used a massive increase in public spending, particularly on construction projects, to try to rescue indebted firms and to inject public money into the economy; and it helped banks conceal the true extent of their losses and their bad-debt burdens, in order to prevent markets from clearing at painfully low prices. The best that can be said about the Japanese experience is that its vast fiscal stimulus may have averted a deep recession at the price of a long stagnation. It also greatly delayed the necessary restructuring of the country's banking system and, by providing huge cash flows to political lobbies, greatly delayed political reform -- a mistake from which the country is still suffering. The circumstances of Japan in 1990 and the United States today are, of course, different. Nevertheless, some parallels that can be drawn may be instructive. One is a bearish indicator that should make economists and financial markets cautious about U.S. economic data. In Japan in the early 1990s, it took an amazingly long time for the collapsing financial system to drag the economy down. Indeed, for two years, some commentators claimed that the crisis was a mirage, a trick by the Finance Ministry to convince foreigners that Japan was in trouble when in fact it was still steaming ahead. It took so long for the underlying economic impact to become visible because the first losers in Japan's stock market crash were financial: banks, insurance companies and other institutional investors. The damage to the real economy came when private companies and consumers began to find their credit conditions worsening and their debt-service costs unaffordable. So far, given the magnitude of events in U.S. and European credit markets and in the U.S. housing market, the economic data are quite mild. It feels as though a recession is coming, but unemployment has not risen much and credit conditions for corporations have not tightened much. This week's housing data even suggest the construction slump might soon be over and price drops might slow. The real lesson from Japan is: Be careful in jumping to judgment. Of course, it could be that the data speak the truth: that there are enough supportive elements in the economy, such as rising exports and an expansionary monetary policy, to keep the recession mild. It may be that corporate America as a whole has stronger balance sheets and less debt and so isn't affected the same way as was corporate Japan. But it may take a while before the situation is that clear. We have yet to see how consumers will respond to declines in house prices and to job insecurity; we have yet to see how far the write-offs by banks and investment banks will feed into changing credit conditions for private companies. The other lesson from Japan is that not allowing markets to clear, or at least reach some sort of new equilibrium, risks storing up even bigger problems for the future. The biggest differences between the U.S. and Japanese economic and financial systems lie in flexibility, transparency and rapid adjustment to new realities. America at its best is a mark-to-market, take-your-punches economy, whereas Japan was and is a cover-up economy. That is why the thought of direct federal intervention in the housing and mortgage markets makes me squirm. To socialize the problem in that (massive) way would be profoundly un-American and, worse, could help turn recession into stagnation, as it did in Japan. Such thoughts, anyway, are surely premature. An economy that has barely entered recession, with unemployment still below 5 percent, amid a buoyant global economic climate in which neither demand nor capital is scarce, is not an economy that requires such measures. For the moment, it needs what Ben Bernanke's Fed is doing, namely an expansionary monetary policy along with emergency actions to prevent bank collapses from bringing down the whole financial system. Unlike Hillary Clinton, Bernanke at least appears to have studied what actually happened in Japan during the 1990s.