Interesting that NZ was #3... the WSJ had a good article on whether the US would follow along the Japanese
experience of the 1990's..........
November 7, 2001
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Is the Faltering U.S. Economy in Danger
Of Emulating Japan's Long, Slow Swoon?
By JACOB M. SCHLESINGER and PETER LANDERS
Staff Reporters of THE WALL STREET JOURNAL
The Federal Reserve's decision to cut its benchmark interest rate to 2%, its 10th rate cut this year, moves the U.S. central bank closer to the day when it runs out of rate-cutting ammunition. And that raises an unsettling question: Could the U.S. be going down the same dismal economic path trod by Japan a decade ago?
With each passing week, the similarities increase. In the 1980s, Japan was considered the model capitalist economy; in the 1990s, the U.S. held that distinction. In both cases, the good times ended with the bursting of a stock-market bubble, pricked, at least in part, by a nervous central bank. In both cases, predictions of a quick turnaround proved to be wrong.
The excessive American investment in fiber-optic high-speed phone lines echoes Japan's decade-earlier investment binge in memory-chip factories. The plight of one well-respected American company, Enron Corp. -- which has lost two-thirds of its market value in just three weeks -- is reminiscent of the previously invisible weakness Japan's slump exposed at many of that country's banks. Even the recent squabbling in the U.S. Congress that threatens to derail a package of economic-stimulus measures sounds eerily similar to the bureaucratic and political wrangling that stymied bold fixes in Japan.
And now, U.S. monetary policy, considered to be the most powerful tool for countering the nation's downturns, is looking increasingly like Japan's, as interest rates fall toward zero.
Federal Reserve Cuts Funds Rate By Half Point to 40-Year Low Level
Japan has endured a decade of stagnation. Could that happen here?
Most analysts continue to answer with a resounding no. They point out that Japan burst not just a stock-market bubble, but also a real-estate bubble, which in turn laid low its banking system. The U.S. bubble appears to have been limited to stocks, and the American banking system remains strong.
U.S. policy makers also insist that they are wiser than their Japanese counterparts, in part because they have learned from Japan's mistakes. And, they add, the U.S. economic and political system is more flexible than Japan's and better able to make the necessary repairs.
Not an 'Apt' Comparison
"It's easy to raise the suspicion that the Japanese and American economies have some similarities," U.S. Treasury Secretary Paul O'Neill said in a recent interview. "I don't think it's apt to make a comparison." Among other things, he says: "They're not an open economy. One of the things that has really been beneficial to our economy is this openness and the challenge that we have permitted to come in here, from foreign suppliers from all over the world ... ."
Moreover, the U.S. central bank hasn't yet exhausted its rate-cutting options. In announcing its half-point rate cut Tuesday, the Fed's policy committee made clear that it remained poised to keep cutting rates down into the 1% range if deemed necessary. "For the foreseeable future," it declared, "the risks are weighted mainly toward conditions that may generate economic weakness."
U.S. markets have rallied in recent weeks on the assumption that the Fed still will be able to turn things around by next year. Indeed, after trading a bit lower Tuesday in the hours before the Fed's 2:15 p.m. EST rate announcement, the Dow Jones Industrial Average soared 150.09 points, or 1.59%, to finish at 9591.12, just 14 points below its close the day before the Sept. 11 terrorist attacks on the U.S.
Fed Chairman Alan Greenspan continues to cling to his faith in the U.S. economy's future. "The long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate," the Fed said in its statement Tuesday.
Yet the Japanese were no less confident about their economy a decade ago, even as it slipped into prolonged crisis. "Our foundations are solid," declared Bank of Japan Governor Yasushi Mieno, as he started cutting interest rates in 1991.
Japan's Nikkei Stock Average peaked near 40000 in December 1989. But in 1991, when three leading economic institutes issued long-term forecasts for Japan through the next decade and beyond, each saw long-term economic growth continuing at between 3% and 5% a year. Instead, the country grew at an annual average of 1.1% between 1992 and 2000.
In April 1992, as the Nikkei appeared to be hitting bottom at 17000, a consensus of a dozen top forecasters still foresaw Japanese economic growth for the following year at between 2% and 3%. It ended up growing 0.4%. Today, the Nikkei hovers around 10000, and the Japanese economy is back in its fourth recession of the past decade.
One reason for the unexpected length and depth of Japan's decline is that its 1980s bubble created a myriad of destructive excesses, many of which became evident only after the bubble popped. For example, it wasn't until 1991 that real-estate prices started falling -- and many analysts thought that decline would be temporary. It wasn't until the mid-1990s that economists saw how severely the fall in real-estate prices had hurt Japan's big banks.
Those bad investments continue to haunt Japanese banks. The banks didn't lend so much directly to real-estate speculators; instead, much of the money went through intermediaries such as nonbank finance companies and construction companies. Today, many of those contractors are near insolvency, and the banks may have to take huge write-offs. "We recognized that it would take a long time to be fixed, but even so, we thought that would mean two or three years," Yoshimasa Nishimura, a former head of the Japanese Finance Ministry's banking bureau, says of the bubble.
Excess Capacity
And it took manufacturers many years to recognize that the capacity they had built up during the bubble was never going to be used. Auto makers manufactured 13.5 million vehicles, including trucks and buses, in Japan in 1990. The number fell off gradually after that and now stands at about 10 million per year. For years, companies kept excess capacity and workers, betting that the falloff was temporary.
When Japan's economy first slowed, there was widespread confidence that its government could easily manage the downturn. In the 1980s, the country's fabled bureaucrats had a sterling reputation for economic management, much as Mr. Greenspan did in the U.S. during the 1990s. With short-term interest rates at 6% and a budget surplus of 8.8 trillion yen ($72.3 billion) -- or 2% of gross domestic product -- the Japanese central bank and parliament had plenty of room to cut rates, cut taxes and boost public spending.
The Bank of Japan did ultimately cut rates by almost all six percentage points. Politicians used the full surplus and even let the government run a primary budget deficit -- or deficit excluding bond issuance and repayment -- of 11 trillion yen, or 2% of GDP. But they acted too slowly and in the end failed to jump-start the economy.
American policy makers give themselves higher marks for speed of response. The Fed has cut interest rates by 4.5 percentage points in just 10 months. It took the Bank of Japan more than 4 1/2 years to do the same.
Moreover, the U.S. Congress has turned unprecedented budget surpluses into almost certain deficits with equal dispatch, passing a massive $1 trillion, 10-year tax cut earlier this year and rapidly approving $40 billion in stimulus measures and a $15 billion airline bailout in the wake of the Sept. 11 terrorist attacks. Members of Congress now are caught up in a stalemate over a plan for $75 billion to $100 billion in additional stimulus actions, but that, too, has a good chance of enactment before year's end. The Japanese Diet, on the other hand, dallied for a year and a half before passing its first stimulus package.
Even more important than the speed of America's policy makers, though, may be the flexibility of the American economy itself. Analysts say the U.S. economy has a more self-cleansing form of capitalism that discourages the many excesses that built up in Japan during the 1980s.
A decade ago, the Japanese boasted of having found the secret formula for smoothing out free-market business cycles. Companies had friendly shareholders as well as bankers who provided "patient capital" that allowed for long-term technological investments in spite of weak quarterly earnings. Lifetime employment guarantees gave workers a sense of income security, encouraging them to keep spending during downturns.
In retrospect, those same traits seem like weaknesses -- factors that shielded Japanese companies from the free-market pressures that would have made them more efficient. The U.S. system, by contrast, is considered better equipped to shift resources from unproductive to productive uses.
Even today, after the decade-long slump, the Japanese company Matsushita Electric Industrial Co. refuses to lay off any of its 130,000 employees in Japan, despite losses that are expected to exceed $2 billion this year. That's a far cry from U.S. companies, such as International Business Machines Corp. and AT&T Corp., which laid off workers even during the boom years, freeing up technology talent to go to newer, fast-growing rivals such as Dell Computer Corp. or Cisco Systems Inc.
In part, it is U.S. policy makers' willingness to inflict short-term pain that allows for that flexibility. American officials argue that Japan would have come out of its crisis more quickly if it had handled its banking crisis the way the U.S. handled the American savings and loan crisis in the 1980s. Back then, U.S. government-ordered thrift shutdowns and foreclosures caused shareholders to lose their investments and borrowers to lose their properties. In Japan, failed banks were propped up, and their problems allowed to fester.
Still, American-style free markets are hardly immune from excesses, and more and more become apparent the longer the economy idles. Telecom companies spent tens of billions of dollars to lay tens of millions of miles of fiber-optic cables, an estimated 2.6% of which is now being used..
Blue-chip American Express Co. ended up writing off more than $1 billion in junk-bond investments that were considered relatively low risks until the economy went sour. "Subprime" lender Providian Financial Corp. sent its earnings and stock price soaring in the late 1990s by tapping the once largely ignored pool of consumers with checkered borrowing records. Providian insisted that it used sophisticated models to limit its risks. Nonetheless, it ended up announcing a surprising 71% drop in third-quarter earnings last month, and its stock fell by more than half.
More surprises are almost certainly in store. Many analysts argue that the U.S. stock market -- even at more than 25% below its peak -- remains a bubble waiting to deflate further. The Standard & Poor's 500-stock index still is trading at a price-to-earnings ratio of between 21 and 28 times earnings, depending on the measurement, and would need to fall at least 30% to reach its historic average P/E ratio of 15, according to the Leuthold Group, a Minneapolis-based investment research firm.
Surge in Borrowing
To some analysts, the large amount of consumer debt outstanding in the U.S. is the ticking time bomb that could rival the bad loans dragging down Japanese banks. American households borrowed freely and dipped deeply into savings during the 1990s. In good times, with wages and stock portfolios rising, the situation seemed manageable. But now, as income-growth slows and mutual funds shrink, the burden could spin out of control. The Fed estimates that the household debt-service burden -- the ratio of debt payments to after-tax income -- rose above 14% earlier this year for the first time since 1987. At about the same time, the number of Americans filing for personal bankruptcy hit a record 390,064.
One reason for the surge in American borrowing has been a sharp increase in the number of new home mortgages and a wave of mortgage refinancing to take advantage of falling interest rates and rising home values. Both home sales and consumer spending, backed by rising housing values, have been rare bright spots over the past year in an otherwise dismal economy.
But there are dangers as well. One concern: that the sharp rise in home prices over the past four years -- nearly 20% nationally, when adjusted for inflation, and more than 60% in hot markets such as Silicon Valley, according to the Office of Federal Housing Enterprise Oversight in Washington -- could turn into a miniature version of Japan's real-estate bubble.
Another worry: that America's housing market isn't driven entirely by free-market forces. Rather, this theory goes, it is propped up by Japan-like government subsidies and easy loan terms made possible by widespread assumptions that the government would pick up the tab for any defaults.
The nation's mortgage market is dominated by Fannie Mae and Freddie Mac, government-chartered companies that are shareholder-owned but still enjoy various implicit and explicit subsidies, such as tax breaks and an emergency line of credit from the U.S. Treasury. The two Washington-area companies don't actually issue mortgages themselves. Instead, they buy mortgages from lenders and repackage them into tradable securities. In doing so, they play a major role in influencing the size and shape of the market by setting underwriting standards for the loans they purchase.
Some conservatives -- including the Fed's Mr. Greenspan -- have expressed concern that Fannie and Freddie, by using government subsidies to expand the housing market, create distortions, drawing capital away from more productive uses. The Congressional Budget Office estimates that the two companies last year enjoyed subsidies totaling $10.6 billion -- a number they say is exaggerated. Other critics say that the companies encourage more, and riskier, lending than a completely free market would allow -- a pattern that may sustain housing demand in the near term but raises the risk of a bigger bust down the road. Japan's woes have been exacerbated by formal and informal government backing for lenders. That includes a Government Housing Loan Corp. that gets a $3 billion annual subsidy and a separate state-run loan guarantee program that keeps many technically bankrupt small businesses afloat.
Fannie Mae Chairman Frank Raines rejects the notion of any similarity between his company and Japanese-style subsidies. "Their mortgage corporation has no private-market discipline -- there is no private management, no private equity capital, no private debt capital." Fannie, he says, has all three, as well as tight regulatory standards requiring the company to keep enough capital on hand to withstand a catastrophe. The company's private shareholders, he adds, have every incentive to prevent overly risky lending, since they would lose their investments even if the government were to intervene to back the loans.
Elsewhere on the business front, the vaunted flexibility of the American economy -- while perhaps raising efficiency in the long run -- could also serve to intensify a downturn. American corporations' readiness to resort to layoffs at the first sign of weakness risks battering consumer confidence. In the past three months alone, the unemployment rate has soared by nearly a full percentage point -- to 5.4% in October from 4.5% in August, and the U.S. jobless rate once again exceeds Japan's, which after a decade of stagnation still is 5.3%.
Fragile Safety Net
Even workers supposedly protected by union contracts have a fragile safety net. In the wake of the terrorist attacks, major airlines, such as AMR Corp's American Airlines and Delta Air Lines invoked force majeure clauses in their labor contracts, allowing them to skirt many negotiated protections and dump workers without advance notice. Partly as a result, the Conference Board's index of consumer confidence plunged to 85.5 in October from 114 in August, one of the swiftest declines on record.
While Japan's unique circumstances may account for some of its problems, they also may demonstrate a broader and more disturbing point: that policy may at times be relatively powerless to contain the destructive forces of a bursting bubble.
As companies are saddled with excess capacity, they have little incentive to borrow to expand, no matter how low interest rates fall. Even after the sharp drop in capital spending over the past year, the percentage of industrial capacity in use in the U.S. in September was just 75.5% -- the lowest level since 1983 and hardly an inducement for companies to build new factories.
Layoff-spooked consumers also may be unwilling to spend tax rebates enacted to encourage shopping. A recent University of Michigan survey concluded that just over one in five households have spent the rebate checks mailed out this summer, with the rest tucking the money into savings or using it to pay debt.
At the extreme, the supply overhang from a collapsing bubble can touch off a dangerous cycle of deflation, or falling prices. In a deflationary environment, consumers curb spending, waiting for goods to become still cheaper in the future. Borrowers get crushed by debt burdens as their loans become more expensive in relative terms. Companies, forced to keep cutting prices, cut back on workers and purchases of supplies, spreading pain throughout the economy.
In Japan, deflation got under way in earnest in 1998 after the collapse of a major bank and securities company. In both 1998 and 1999 wholesale prices fell 1.5%, and after a flat year in 2000, they are falling again in 2001. The U.S. isn't there yet. But commodity prices have fallen sharply since 1998, while U.S. consumer prices, by some measures, appear to be slipping. The Commerce Department reported last week that its favored measure of inflation -- the price index for gross domestic purchases, or prices paid by U.S. residents -- fell by 0.3% in the third quarter, a sharp reversal from the 1.3% increase in the second quarter and the first quarterly decline in nearly 40 years. (Analysts say the number was artificially depressed by one-time factors relating to Sept. 11 -- insurance benefit payouts that, for measurement purposes, lower insurance prices.)
In a deflationary world, the central bank's powers to respond are diminished because monetary policy works most effectively if interest rates can fall below the rate of inflation. But rates can't do that if inflation falls below zero.
host.wallstreetcity.com
will the CRB index make a double bottomwith it's 1999 lows? or is it heading even lower? If it is that's potentially
very disturbing news.
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