Like Asia, European equities have gotten a lot cheaper compared to historical averages. Another simi...
Is the US the Next Japan?
09/30/2011 10:15 am EST
There are some sobering similarities between America’s current economic situation and the spot Japan has been in for decades and more people are starting to wonder if the US is "going Japanese," observes Gary Shilling of INSIGHT.
Interest rates close to zero and all the related issues are relatively new in the US and Europe, but they’ve been around in Japan for two decades. So, many wonder if the US is headed for Japan’s 20-years-and-running deflationary depression.
And regardless, what does the Japanese experience tell us about living in this atmosphere?
There are a number of similarities that suggest that America is entering a comparable long period of economic malaise. The Age of Deleveraging forecasts a similar decade, at least quite a few years, of slow growth and deflation, as financial leverage and other excesses of past decades are worked off.
The recent downgrade of Treasuries by S&P parallels the first cut in Japanese government bond ratings in 1998, followed by S&P’s cut to AA-minus early this year and Moody’s reduction from Aa2 to Aa3 last month.
The recent slow growth in the US economy—real GDP gains of 0.4% in the first quarter and 1.0% in the second—looks absolutely Japanese. Furthermore, the prospects of substantial fiscal restraint in the US to curb the federal deficit is reminiscent of tightening actions in Japan in the mid-1990s.
Although the Japanese economy was growing modestly at the time, deficit- and debt-wary policymakers in 1997 cut government spending and raised the national sales tax to 5%. Instant recession was the result.
Big government deficits in recent years are another similarly between these two countries and a worry the US net federal debt-to-GDP ratio is headed for the Japanese level. Japan’s gross government debt last year was 226% of GDP, far and away the largest ratio of any G7 country.
All governments lend back and forth among official entities, so their gross debt is bigger than the net debt held by non-government investors, and Japan does more of this than other developed lands. Still, on a net basis, her government debt-to-GDP is only rivaled by Italy’s, and leaped from a mere 11.7% in 1991 to 120.7% in 2010. Is the US far behind?
Japan, in reaction to chronic economic weakness, has spent gobs of money in recent years—much of it politically motivated but economically questionable, like paving river beds in rural areas and building bridges to nowhere.
Is that distinctly different than the $814 billion US stimulus package that was supposed to finance shovel-ready infrastructure projects, when, in reality, the shovels had not even been made yet?
A key reason for the 2009 and 2010 US fiscal stimuli and continuing deficit spending in Japan is that aggressive conventional monetary ease did not revive either economy. Zero interest doesn’t help when banks don’t want to lend and creditworthy borrowers don’t want to borrow.
Both central banks found themselves in classic liquidity traps, so both resorted to quantitative easing, without notable success.
But Differences, Too
There are, then, many similarities between financial and economic conditions in the US and Japan. Nevertheless, there are considerable differences that make her experience in the last two decades questionable as a model for America in future years.
The Japanese are stoic by nature, always looking for the worst outcome, while Americans are optimistic—not as optimistic as Brazilians, but still prone to look on the bright side. Otherwise, why would the Japanese voters stand for two decades of almost no economic growth?
Japanese are comfortable with group decision-making, while Americans revere individual initiative, something the Japanese disdain. The nail that sticks up will be pounded down, is a favorite expression there.
Perhaps because of this, the government bureaucracy in Japan is much stronger than in the US, while elected officials have less control and room for initiative.
Despite little economic growth, Japanese enjoy high living standards. And the Japanese are an extremely homogenous and racially-pure population.
In a related vein, immigration visas don’t exist in Japan, so there’s nothing in Japan like the chronic shift of US income to the top quintile. Nothing like the two-tier economic recovery that benefited top-tier stockholders in 2009-2010, but left the rest struggling with collapsing prices for their homes and high unemployment.
Japan in the post-World War II era has been an export-led economy. “Export or die,” is the watchword.
The result of robust exports and weak imports, linked to anemic domestic spending, is her perennial current account surpluses, which, along with earlier high saving by households and now by businesses, allow her to finance her huge government deficits internally, with foreigners owning only 5%. As a result, her government bond yields are extremely low.
In contrast, the US is a chronic importer with a chronic current account deficit. So foreigners have perennially bought Treasuries with the resulting dollars they earn, and they now own about 50% of them.
And Treasury note and bond yields are much more controlled by global forces and higher as well than in Japan.. The US is largely an open economy, but Japan’s—except for her formidable export sector—is largely closed to the outside world.
Another big difference is the chronic strength in the yen and longtime weakness in the dollar, resulting in part from the difference between Japan’s chronic current account surplus and America’s chronic deficit. Even near-zero short-term rates and a ten-year government bond yield of about 1% do not deter those who lust for the yen.
Of course, in a zero-interest-rate world where returns have dropped close to traditionally low Japanese levels in the US and elsewhere, Japan at present does not have much of a competitive disadvantage.
The yen’s strength has led to Japanese manufacturers moving much of their production to lower-cost areas, but deflation in Japan has offset some of the difference. Corrected for deflation and on a trade-weighted basis, including trading partners such as Switzerland with robust currencies, the yen has been relatively flat since the 1980s, according to a Bank of Japan analysis.
Nevertheless, the government has intervened in currency markets numerous times—most recently spending $13 billion in early August—to arrest the yen’s climb vs. the greenback. And, of course, a government intervening against its own currency can’t run out of ammunition, since it can easily create more of its own currency to sell on the open market.
Still, intervention success has been limited, short-lived and expensive. Even a determined government with unlimited ammo has not been able to overcome the gigantic global currency markets that trade trillions of dollars daily.
We conclude that the differences between the US and Japan are too great to use the Japanese economic experience in the last two decades as a template for the US in coming years. Still, we expect a similar lengthy period of slow growth and deflation as the economy delevers.
In any event, can policymakers do much to forestall this outlook? We argue that they can’t any more than the Japanese have been able to generate robust economic growth.
As we’ve been discussing, near-zero interest rates have distorted the financial and economic scene by pushing many investors into risky investments in foreign lands, commodities, junk securities, and other investments they may come to regret.
But many remain in bank CDs and money market funds for safety despite almost nonexistent returns. Money market 7-day interest returns in August were a trivial 0.03%, and they would have been negative in many cases if fund managers had not waived their fees.
And this condition will likely persist. The federal funds rate target, which rules other short-term returns, has been in the 0 to 0.25% range for three years, and the Fed intends to keep it there for two more years, barring a burst of inflation or a big drop in unemployment.
Will Americans be discouraged by low returns and save less, or will they save more to reach lifetime goals? They’ll do the latter, in our judgment, which is one more reason why we expect the saving rate to jump back to double digits.
Others, which we’ve discussed many times, include distrust of volatile stocks, the shrinking house appreciation that was tapped earlier to fund oversized spending, the postwar babies’ desperate need to save for retirement, and chronic high unemployment, which encourages saving for contingencies.
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