Japan’s “Lost Decade” Are we bound to repeat it?
Lately, many economists and financial expert-types have been drawing comparisons between what is happening in the US right now with what Japan has experienced in their economy since 1989. Many of the pundits believe that our current economic policy will lead us right to where Japan finds itself today, and everyone agrees that is not the place we want to go. Because the number of parallels between the origins of their situation and ours is striking, the issue warrants further exploration.
During the mid to late 1980’s Japan’s manufacturing and technological prowess were in high gear, and they were making money hand over fist. As money built up in the banks from this expansion, credit and loans became easier to obtain, as banks wanted to put this money to work. The large profits that were rolling in fueled a large wave of speculation by Japanese corporations and banks. Since credit was easy to obtain, everyone was borrowing money to buy real estate and Japanese stocks. This lead to a rapid rise (bubble) in both property values and the Japanese stock market, which peaked in 1989.
It was at this time that the Japanese Finance Ministry began to recognize that the pace of this expansion could not go on forever. In an effort to curb the excessive speculation, they hiked interest rates sharply. (Most of the loans were secured by unrealistically high valuations of the property holdings.) It was not the ministry’s intent to burst the bubble that had developed. Rather, they just wanted to reduce the excessive speculation. Unfortunately, their action did burst the bubble, the Japanese stock market crashed, and property values plummeted. A sizable chunk of the easy-money loans turned bad, which lead to a crisis in the banking sector. At that point, several banks on the brink of failure were bailed out by the Japanese government.
With the banks balance sheets in poor shape, credit now became very difficult to obtain. This had the effect of virtually shutting down capital investment in the Japanese manufacturing sector. In an attempt to reignite the economy, the Japanese Finance Ministry lowered official interest rates to zero, where they have remained for years. Despite the low cost of money, banks were reluctant to lend. During those years, economic expansion was non-existent, and the country fell into a deflationary cycle. The Japanese government’s policies and their subsequent effects eventually caused Japan’s currency, the Yen, to depreciate against other currencies in the world.
As you can see from the chart, the Japanese stock market (as measured by the Nikkei Index) is off about 70% today from the highs reached in 1989. Unemployment runs fairly high in Japan, but with the Japanese tradition of saving and frugality, the impact has been relatively limited on the average Japanese family, although their savings rate has come down considerably the last several years.
Does any of the above sound familiar? It should, because a lot of what occurred in Japan 15 to 20 years ago is occurring here in the US, e.g. bailing out banks, low interest rates for an extended time, tight credit and a weak currency. Could the same scenario occur here in the U.S. over the next decade or longer? Remember, Japan’s “Lost Decade” has been going on for over twenty years. Whether we follow the same path remains to be seen, but there are some key differences between the U.S. today and Japan:
Japan is a nation of savers not spenders (although they are beginning to spend more), while the U.S. is a nation of spenders. Since the Japanese save so much their economy is not lifted by consumer spending, while in the U.S. the consumer is 70% of GDP and thus could generate some economic growth. But, more people will have to be employed for that to happen.
- The entrepreneurial drive is much more dynamic in the U.S. than Japan, and could be a significant advantage of our economy over that of Japan’s.
- The U.S. has been much quicker to act, as the Federal Reserve has injected a lot of liquidity into the financial system, whereas Japan was much slower to act.
- Since the vast majority of Japanese debt is held within Japan, while the U.S. debt is held mostly by other countries, inflation may be easier to obtain in the U.S. as other countries demand higher interest rates from their debt holdings. The main problem in Japan as been deflation.
Only time will tell if the U.S. will have a lost decade similar to Japan’s over the next 10 to 20 years. There are a lot of similarities, but there are also a lot of differences, so we will have to wait and see.