Wednesday, January 14, 2009
US not certain of avoiding Japan-style 'lost decade'
By Stephen Roach Published: January 14 2009 02:00 Last updated: January 14 2009 02:00 No one in their right mind thinks that the United States could fall victim to a Japanese-like lost decade. After all, the argument goes, US policymakers have the advantage of knowing what their counterparts in Japan did wrong. If only it were that simple. For starters, the parallels between crises in the two economies are striking. Both suffered from the bursting of two major bubbles - property and equity in the case of Japan, and property and credit in the US. Both had broken financial systems stemming from egregious risk management blunders. Both were victimised by a reckless lack of oversight - regulatory failures, misdirected rating agencies, and central banks that ignored asset bubbles. And the twin bubbles ended up infecting the real side of both economies - the corporate sector in Japan and the consumer sector in the US. In spite of the similarities, few believe that America is Japan. The hope rests on monetary policy. The Federal Reserve laid the groundwork for its approach in 2002 in the aftermath of the dotcom-induced bursting of the equity bubble. A landmark paper co-authored by 13 Fed staff economists concluded that the failures of the Bank of Japan in coping with the bursting of its bubbles were traceable to the lack of speed and vigour in its monetary policy response. It follows that a quicker and bolder reaction would have made a critical difference. And so the script was written for America's central bank. Bubbles come and go - not much you can do about that, the Fed has long maintained. However, if the monetary authority rides quickly to the rescue of a post-bubble economy, a Japanese-style trap can be avoided. This approach appeared to pass an important reality check following the bursting of the US equity bubble in 2000. The Fed was quick to slash the federal funds rate by 550 basis points to 1 per cent and the US economy eventually recovered. In a celebrated mission-accomplished speech, Alan Greenspan boasted of success in "addressing the bubble's consequences rather than the bubble itself". That gave the Fed licence to prescribe the same medicine as other bubbles popped. Unfortunately, those tactics backfired. The Fed's post-bubble clean-up campaign of 2001-03 now looks to have been only a one-off success - it provided a short-term fix at the cost of creating a long-term disaster. By following the anti-Japan script and lowering the policy rate to rock-bottom levels and holding it there, the Fed ended up inflating the biggest bubbles of them all - property and credit. Fear not, claim the optimists. This time, America has been much quicker than Japan to write down bad loans, inject new capital into its banks, embrace a large fiscal stimulus, and adopt the so-called quantitative easing tactics of monetary policy. Noble as these efforts are, they may not be enough. That's because they do not arrest the most powerful force at work in the post-bubble US economy - the imperative of tempering excess consumption. The over-extended, saving-short, asset-dependent US consumer has only just begun what appears to be a multi-year retrenchment. That means that the authorities in Japan and the US may have something else in common - limited policy traction and the related frustration of pushing on that proverbial string. All this raises the possibility that the US central bank may have drawn the wrong lessons from Japan's lost decade. The correct policy prescription may have less to do with the speed and scope of post-bubble clean-up tactics and more to do with avoiding major asset bubbles in the first place. Just as the BoJ failed on that score, so, too, did the Fed. Unfortunately, there is an important and ominous distinction between the US and Japan - the impacts of bubbles on their respective real economies. At more than 70 per cent of US GDP, the bubble-infected American consumer actually poses a much greater risk to today's US economy than that imparted by Japan's bubble-induced capital-spending boom, which accounted for only about 17 per cent of Japanese GDP at its peak in the late 1980s. Moreover, since the US consumer is by far the most important consumer in the world, the global implications of America's post-bubble shake-out are likely to be far more severe than those imparted by Japan. So what can the US do to avoid becoming another Japan? Quite frankly, not much. By focusing on investments in infrastructure, alternative energy technologies and human capital, the Obama Administration is correct in attempting to contain the recession and initiate a long overdue rebalancing of the US economy. However, these actions will not cure the post-bubble hangover of the over-extended consumer. That will take time and a new pro-saving mentality that encourages American families to live within their means. Like the Japan of the 1990s, the US faces stiff headwinds. And until the rest of the world uncovers a new consumer - which is not likely during the next few years - a protracted global slowdown is distinctly possible. The writer is chairman of Morgan Stanley Asia