Global: The Next Japan?
By Stephen Roach (from Tokyo)
morganstanley.com
Deflation denial continues to pervade the macro debate. I usually introduce the topic into my presentations by asking the assembled clients to indulge me in the American children’s game of "word association." I will say one word and they have to come up with the next word that immediately pops into their minds. The word I select is "deflation," and the unanimous response is "Japan."
In a nutshell, that’s the essence of today’s deflation debate. It is largely defined by the US-Japan comparison. To the extent that America can distinguish itself from the Japanese experience -- solvent banks, flexible markets, mark-to-market securities pricing, a two-party political system, etc. -- the case for US deflation is then usually dismissed out of hand. That’s when I pause and add that you don’t have to be Japanese to worry about deflation. The case for US deflation stands on its own merits. In my opinion, we get into trouble by linking the assessment of US deflation to the sad saga of Japan.
That’s not to say there aren’t some important similarities between the US and Japan that bear careful noting. Two, in particular, come to mind -- the asset bubbles and the impact of those bubbles on the real economy. On the first count, I hear repeatedly that Japan’s bubble was much bigger than America’s. After all, it wasn’t just the Nikkei; it was also an outsize property bubble. It was the interplay between these two asset bubbles that wreaked such havoc on Japan in the late 1980s and early 1990s. The truly astonishing thing is that America can’t look in the mirror and see precisely the same pattern. The Nikkei reached its peak of 38,915 on December 29, 1989. Over the ensuing 21 months it would go on to lose 38.5% of its value while Japanese land prices, as measured by the Japanese Real Estate Institute, would continue to rise by approximately 15% before peaking in September 1991. Fast forward to America. Between December 31, 1999 and September 30, 2002, the S&P 500 lost 45% of its value -- actually worse than the initial decline in Japan. Over the same 33-month period, nationwide US home prices as measured by the Fannie Mae (OFHEO) index rose around 15%. If that’s not Japanese-like, I don’t what is. Property bubbles typically outlast those in the stock market. It was true of Japan in the early 1990s and it appears to be true of America today.
Nor does Japan have a monopoly on bubble-induced distortions in its real economy. Japan’s capital spending binge during the bubble has been well documented -- the IMF calculates that real private fixed investment per capita nearly doubled over that period. In America, a similar calculation puts the per-capita increase in real fixed investment at 73% over the 1992 to 2000 interval, only slightly shy of Japan’s binge. But the American consumer more than made up for the difference. Spending freely out of the asset bubble, the US personal saving rate plunged from a pre-bubble 6.5% reading in late 1994 to just 1.9% in late 2000. By contrast, in Japan, the so-called propensity to consume -- the inverse of the saving rate -- actually edged down in the late 1980s from 78.6% in 1984 to 75.5% in 1989. Unlike Japan, where the bubble manifested itself mainly in the form of a massive overhang of the capital stock, America’s bubble led to serious distortions in both capital spending and consumer behavior.
Alas, there’s more to this comparative saga. America also stacks up very poorly with Japan from the standpoint of its international indebtedness. During its bubble, Japan remained a net creditor to the rest of the world, with its net foreign asset position holding roughly steady at around 10% of its GDP. By contrast, the United States borrowed freely from abroad to fund the excesses of domestic consumption. Courtesy of ever-widening current-account deficits, America went from being the world’s largest creditor to the world’s largest debtor; during its bubble, the US net foreign asset position went from -2% of GDP in 1994 to a record -20% of GDP in 2000. The bubble enticed America to live well beyond its means, as those means are defined by domestic production and income generation. Lacking any autonomous demand growth of its own, the rest of the world has been more than delighted to go along for the ride -- at least until now. But unlike Japan, which was able to finance its bubble economy on its own, the bubble-induced excesses of a saving-short US economy have largely been financed through the "kindness of strangers." Despite the dollar’s seemingly Teflon-like resilience since the mid-1990s, I find nothing comforting about America’s increasingly precarious dependence on external financing. It sets the United States up for the possibility of a much more wrenching post-bubble adjustment in its currency and its external sector than Japan ever had to face.
Then there’s domestic debt -- especially that of the private sector. No matter how you cut it, America’s private sector debt loads are currently at their post-World War II highs. That’s especially true of households, where the debt-to-GDP ratio currently stands at 76%; by way of comparison, this same ratio was a mere 63% at the onset of the past recovery a decade ago. Indebtedness has also moved into uncharted territory in the business sector, where the debt-to-GDP ratio has now climbed to 69%, fractionally above the highs reached in 1987. The US experience is, in some respects, the mirror image of that which unfolded in Japan during its bubble. For the Japanese nonfinancial corporate sector, the debt-to-GDP ratio averaged an outsize 175% over the 1987 to 1993 interval; it subsequently soared to 235% by 2001. For Japanese households, the debt-to-GDP ratio rose from just 61% in the early 1980s to 74% in 1989, and then increased only slightly further to 77% in 2001. Consequently, unlike America, the Japanese consumer has been far more judicious in adding to indebtedness; Corporate Japan, by contrast, is in far worse shape.
History tells us that excess debt is the legacy of any asset bubble. That is undeniably the case in America today, just as it was in Japan in the late 1980s. Nor can the lessons of Japan’s public sector indebtedness be ignored -- a general government surplus of 2% of GDP in 1990 that has since morphed into a 7% deficit. For a fleeting moment, America also had a 2% surplus in 2000 -- only to see it vanish into thin air due to a weak economy and Bush Administration tax cuts. Our current projections call for nearly a 2% deficit in the current fiscal year -- a swing of four percentage points in the past two years alone. With Washington now sending signals of more tax cuts to come in the post-election period, a Japanese-like public sector debt problem suddenly doesn’t seem all that remote for America’s post-bubble economy.
Notwithstanding the worrisome legacy of America’s post-bubble economy, I am not inclined to believe that America faces a Japanese-like lost decade as penance for its sins. The reason boils down to one word -- flexibility. The US economy has it and the Japanese economy does not. Only now, nearly 13 years after the popping of the Nikkei bubble, is Japan finally contemplating the heavy lifting of post-bubble repair. And the verdict is hardly clear-cut that the recent Koizumi cabinet reshuffle will be sufficient to break the gridlock on financial sector reform. While there can be no doubting the reform credentials of the new financial czar, Minister Heizo Takenaka, there can also be no doubting the long-standing intransigence of the anti-reform forces still residing in the ruling LDP hierarchy. In poring through the recent analysis of our Japan team in preparation for my current Asian swing, I am struck that even today the best case that can be made for Japan is glacial-like when compared with the pyrotechnics of America’s mark-to-market system. Lest we forget, there was a near instantaneous vaporization of some $460 billion in market capitalization for America’s notorious "gang of five" -- Enron, WorldCom, Tyco, Qwest, and Computer Associates. In Japan, the "convoy system" is still struggling to keep the moribund Daiei retail company on life support.
America is not Japan. But that doesn’t mean its post-bubble legacy should be treated lightly. What strikes me as I now return to Japan is that denial finally seems to be cracking. There is the palpable sense of an urgency to reform that has captivated the debate in a fashion I haven’t seen here in years. There are no guarantees that it will work this time, but the debate and the political maneuvering seem to have a new intensity. America, by contrast, remains the land of denial. We have a defensive central bank that still doesn’t want to admit it could have done anything about the asset bubble. And we have a White House that categorically dismisses the twin perils of double dip and deflation as bad things that happen to others. The focus in Washington is on war, not on navigating the perilous course of a post-bubble economy. Maybe it’s not so far-fetched after all to begin worrying about the next Japan. |
