Let’s see, in the 1980s Japan’s corporate leaders thought they were going to take over the world. Investors thought so too. They expanded. They wheeled. They dealed. Prices shot up and they all thought they were geniuses.
In the ’80s, everyone wanted to be Japanese. Management consultants used Japanese words to describe commonplace insights. For example, instead of saying that businesses always need to try to do things better, they referred to “kaizen” as if it were the secret of success. And US economists urged the Reagan Administration to have an “industrial policy” – because that was what Japan had. Japanese businesses were the envy of the world. Japan was the world’s second largest economy. But in growth and stock prices it was Numero Uno.
It turned out, as it always does, that Japan did not have the secret to everlasting success. Instead, what it had was what comes before a fall. The stock market crashed in Tokyo in 1989. The Japanese economy entered a recession. At first, the experts believed it was temporary. They urged investors to take advantage of the opportunity to buy into Japan, Inc. at record low prices. They thought Japanese industry was unstoppable…unbeatable. It would recover in no time, they said.
But Japan, Inc. didn’t recover. Instead, it went into a long, drawn-out recession that lasted year after year…with on-again, off again deflation…and several stock market rallies. Each time stocks rallied, they fell again. Each time the economy began to grow…along came another setback. This continued for the next 20 years…until March of this year…when Tokyo stocks hit their lowest point for the whole bear market. A generation of investors had been nearly wiped out. Over two generations they had made nothing. Trillions worth of wealth had been erased.
What did the Japanese authorities do during these last two decades? They fought the correction every step of the way, with the boldest attempt at fiscal and monetary stimulus every undertaken up to that point. Interest rates came down to effectively zero. And government spending soared, creating the largest deficits in Japanese history. Now, Japan’s national debt approaches 200% of GDP – a peacetime record. If it continues to grow at this rate, it will hit 300% of GDP in just a few more years.
Sound familiar? It should. The key US interest rate is now effectively zero. The Fed says it will leave it there for “as long as it takes.” And deficits have reached staggering levels – 13% of GDP. At this rate, the US debt/GDP ratio will hit 100% in just a few years. And if it continues, US debt/GDP will reach 200% not long after – as recession-reduced tax revenues meet stimulus-increased outlays.
But wait…the feds say they won’t let it happen. They’ll turn this thing around. The economy will begin to grow. Tax revenues will rise. Prices will go up.
Hey…that’s just what the Japanese said!
So far, the US is doing almost exactly what the Japanese did…propping up zombie companies and stimulating the economy as best it can.
But if it does the same thing the Japanese did, won’t the US get the same results the Japanese got?
Here is where it gets interesting. Because the US economy is not exactly like the Japanese economy. Japan had high savings…and a positive trade balance. It could run up huge government debts and “owe it to itself.” It could finance its government debts with the savings of its own people, in other words. It never had to worry about foreigners refusing to buy its bonds…or selling them suddenly.
America’s government debt is different. The US doesn’t save enough to finance its own deficits. So it depends on the kindness of strangers. And if those strangers ever lose faith in America’s ability or willingness to repay its debts, they’ll drop the dollar like an annoying girlfriend. And when they do, the whole global monetary system will come crashing down.
But suppose savings rates go up in America – to, say, 10% of GDP, like they were before the bubble years. That would make $1.4 trillion of savings available to finance the feds’ deficits. And suppose the slump continues…as we think it will, with another big scare in the investment markets. People will seek safety in…yes, you guessed it…US bonds. This will take the pressure off the dollar and permit the US to finance its countercyclical spending without depending heavily on foreigners. The recession/depression will be annoying…but not insufferable. And Bernanke will figure that has more to lose by undermining the dollar than to gain from it. In that case, the Japan-like slump could go on for many years – just as it has in Japan!