A Japanese economic lesson for the US?

By Gerard Jackson
web posted November 15, 1999

Some economic commentators claim to have observed an ominous parallel between the present state of the US economy and the Japanese economy in the late '80s, just before it went into depression. While others have dismissed the parallel I'm of the opinion that it contains a considerable truth for the simple reason that the policy that caused Japan's '80s boom is basically the same one generated the US consumer boom. That policy, of course, is one of massive credit expansion. The question is whether the US is likely to descend into a protracted depression on par with Japan's.

Starting in May1989 the Bank of Japan started to raise interest rates, with very little response at first. The Tokyo market continued to roar ahead while many commentators spoke sagely of permanently rising share values, though others were realistic enough to know they were seriously overvalued. By the end of the year the Nikkei index stood at 38,915 and average price-earnings ratios were 70. It was January 1990 when stock prices first began to slide only to accelerate their decline with the Nikkei falling to 28,000 by March, a 30 per cent drop, triggering a panic. The end of the year saw the market about 40 per cent lower.

The property market also died as inflated assets values were seriously priced downwards, lumbering banks with massive non-performing loans. The situation created a crisis for the banks, seriously eroding their capital adequacy ratios. Property companies and security houses were savaged by the readjustment. These companies borrowed huge amounts at little interest only to find themselves faced with having to repay at real rates of interest and this with their own investment and share values slashed by as much as 66 per cent. A grim situation indeed.

Instead of biting the bullet and taking its medicine by allowing the market to liquidate the country's unsound investments (what Austrians call malinvestments), Japan repeated the same mistake that pushed her economy into economic stagnation from 1920-271. This depression had also been preceded by a massive credit expansion. And despite the fact that wherever we look we always find credit expansion as the party that did the dirty deed, it is still invariably found not guilty. This is mainly why observers turn to consumption as the potential saviour and the fallacious 'liquidity trap' as the culprit. Ignored is the reality that Japan's cheap money policy 'extended' investment beyond the pool of real savings. (This meant that something had to give). The situation was badly aggravated by consumption oriented policies that reduced the savings pool, when what the economy needed was the very reverse.

The parallel is making more historically-minded observers of the American scene more cautious in their economic appraisals. Nevertheless, they too have fallen for the fallacy that part of the danger to the economy lies with falling share prices cutting consumer spending, as is supposed to have happened in Japan. But if this were so, then the consumption goods industries would have been hit first and hardest. They weren't. It was producer prices and land prices that felt the initial effects and which fell faster and further than consumer prices, just as Austrian economic analysis would expect.

What should America do when the boom busts? Simple. Exactly what it did last time — let the recession work itself out. Don't take measures to arrest it, and let the economy's flexible labour and capital markets do their work. The danger, as always, is that politicians will take it upon themselves to determine the direction of the recession. This would be disastrous. Imagine the likes of Waxman, Gore, Boxer, etc., directing the economy and you'll get some idea of the magnitude of the disaster.

Gerard Jackson is the founder and editor of Australia's only free-market magazine online, published weekly at http://www.newaus.com.au/.

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