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Politics : Formerly About Applied Materials -- Ignore unavailable to you. Want to Upgrade?

To: John Trader who wrote (55286)	11/10/2001 6:31:37 PM
From: Jacob Snyder	Read Replies (1) \| Respond to of 70976

More on Japan vs. U.S.: ML 11/9/01: Why The U.S. Isn’t Japan Might the U.S. follow in Japan’s depressing and deflationary footsteps? The short answer is no, we don’t think so. That said, we don’t have a client meeting where someone doesn’t raise that question. So we decided to take a systematic look at the differences between the U.S. and Japan to see why policy will work in the U.S., as it hasn’t in Japan. Let’s begin with the nature of the respective bubbles in the U.S. and Japan. Even that terminology is misleading, because the difference in scale between the two events is so huge. At the market peak, the S&P 500 sold at a 28 multiple of trailing operating earnings and many highflying tech stocks had triple-digit P/E’s. By contrast, at the height of the Japanese bubble, the Imperial Palace grounds were worth as much as California. The quantum gap between those sets of valuations is obvious. It’s taken a decade for land in central Tokyo to go from being worth as much as the fifth largest economy in the world to just being extremely expensive real estate. But Japanese banks made loans based on those outlandish real estate valuations. Once real estate prices went south, banks were saddled with mountains of nonperforming loans that they then did their best to ignore. The result is that Japan has been without a functioning system of financial intermediation for the past decade. It is very difficult for any economy to grow under that circumstance. By contrast, U.S. banks never made loans based on excessive equity valuations. While default rates inevitably rise in recessions, the U.S. financial system remains well capitalized and basically healthy. High-yield investors lost the bets they made on new telecom companies, but the high-yield market continues to function. While lending standards always tighten in recessions, credit is more available now than has usually been the case in downturns. All that said, the big fear is that the Fed will end up “pushing on a string.” Japan finds itself in a liquidity trap, with zero interest rates failing to stimulate activity. With the Fed funds rate now down to 2% and headed lower, could the same thing happen in the U.S.? Again, the answer is no, we don’t think so. Pessimists claim that Fed easing this year has had no impact on the economy. But monetary policy operates with a lag of about nine months. It would only be around now, at the soonest, that the Fed’s initial easing would begin to impact activity. Indeed, since Fed policy didn’t actually move into stimulative territory until May, the larger impact would only be developing next year. Of course, September 11 delayed any pickup in the economy. Beyond that, there is powerful direct evidence that, unlike Japan, the U.S. economy remains very interest-rate sensitive. Mortgage refinancing activity has been running at record levels during the past month, a direct response to lower rates. And when auto makers introduced zeropercent financing, vehicle sales jumped to a record pace. Ultimately, the U.S. economy is simply far more flexible than the Japanese economy. Japan’s problems, as serious as they are, could have been largely solved if hard policy choices were made years ago. But the Japanese political system is a case study in paralysis. Whatever one thinks of U.S. politics, the system responds to crisis. And we believe the strength of U.S. companies lies in their willingness to restructure in the face of adversity, renewing their profitability, as well as the ability of the broader economy to resume growth. Central Banks Ease Key central banks delivered a coordinated easing move for the world economy. As usual, the Fed led the way, cutting the funds rate 50 basis points to 2%. More surprising, the Bank of England and the laggard ECB followed with 50 basis point cuts of their own. That brought the BOE’s base rate to 4% and the ECB’s repo rate to 3.5%. More easing will follow everywhere, eventually setting the stage for a global recovery. The Fed funds rate is now at a 40-year low and hasn’t hit bottom. The minutes from the October 2 FOMC meeting, as well as the announcement that followed the November 6 FOMC meeting, both point to further easing. But with the funds rate now down to 2%, further moves will probably be in 25 basis point increments. We expect the funds rate to be down to 1.5% in early 2002 and don’t rule out the possibility that it could move even lower. With Greenspan’s favored inflation gauge, the PCE chainweight price index, running at around 1.5%, the real Fed funds rate is still slightly positive. The real funds rate has gone to zero or negative in most prior recessions. So the current degree of monetary accommodation is not excessive, as the Fed made clear in the October minutes. Eventually, we think the Fed will have to reverse course. We don’t expect that to happen until after the economy has put in at last one solid quarter of growth. Given our forecast, we expect the Fed to be tightening during the second half of 2002. As for the ECB, better late than never. The euro actually weakened after the move, because investors feared that the ECB would wait an inordinate period of time before easing again. But the ECB’s language has turned dovish and we expect at least another 50 basis points of easing from them. We think a European recovery is likely to lag that in the U.S. by three to six months. But a synchronized global upturn should be in place in 2003.