The Price of Liberty is Eternal Vigilance
Recession Turns Japanese?
Most of us are concerned about the course of the economy and the measures planned in Washington to stimulate a recovery. The following article was published on the web site of minyanville.com. We thought it insightful and of interest to our viewers. It was written by James Quinn, a senior director of strategic planning for a major university.
Every day seems worse than the previous day: 500,000 people laid off every month. A banking system on life support. Plummeting home prices. Retailers going bankrupt in record numbers. Mounting foreclosures. And consumer confidence at record lows.
Not only is the bad news not going away, it's going to get worse and last longer than most people can comprehend. The US is facing a 2-decade downturn -- and attendant social unrest -- just as Japan did in the period from 1990 until the present day.
It took 28 years to get to this point, and it will take at least a decade to repair the damage. Some indisputable facts will put our current predicament in perspective:
The US National Debt was $930 billion in 1980, or 33% of GDP. Today it is $10.7 trillion, or 76% of GDP. The national debt has grown by 1,150% in 28 years.
GDP was $2.8 trillion in 1980. Today, it is $14 trillion - and declining. GDP has grown by 500% since 1980 - which means the national debt has grown more than twice as fast as GDP.
Total US consumer debt in 1980 was $352 billion. Today, US consumer debt totals $2.6 trillion - 738% in 28 years. Revolving credit increased from $56 billion in 1980 to $982 billion today, a 1,750% increase in 28 years.
The real median household income was $41,258 in 1980. The real median household income in 2007 was $50,233. Over the course of 28 years, households are bringing home 22% more. The trickledown theory turns out to be a drip.
The personal savings rate was 12% in the early 1980s and reached negative 1% during the Bush administration. It has inched above 2% in the last few months.
After examining the data, it's clear we have borrowed ourselves to the brink of disaster. The only logical way to resolve this quandary is to reduce spending, pay down debt, and increase savings. This is what consumers have begun to do. With consumer spending accounting for 72% of GDP, a drop in spending means serious recession. The excesses are being painfully wrung out of the system.
To all those buy-and-hold advocates: Please take a long hard look at the following chart.
On December 29, 1989, the Japanese Nikkei Index reached 38,957. Today, the Nikkei Index stands at 8,106, an 80% decline over the course of 2 decades. It was at this same level in 1983, 26 years ago. This is what you call a secular bear market.
There have been 3 bear market rallies of 60% and 1 rally of 140% - but the market is still 80% lower than it was at peak.
As for the US, we've already lost a decade:
The S&P 500 reached 1,553 in 2000 and took 7 years to breach that level in late 2007, at 1,576. It currently stands at 850 (its 1997 level), 46% below its all-time high.
As the US stands poised to make many of the same mistakes Japan made in the 1990s, another lost decade could be in the cards. History doesn't repeat, but it does tend to rhyme.
Causes of Japanese Bubble
1. The Bank of Japan cut its discount rate from 9% in 1980 to 4.5% by 1986. At the behest of the U.S. government, to comply with the Louvre Accord of 1987, they reduced the discount rate to 2.5% and kept it there for 3 years. This lax monetary policy created a bubble in the stock market and the real estate market. The monetary supply grew at a rate of 9% throughout the 1980s; at the same time, the stock market jumped 160% in the space of 3 years. A speculative frenzy took hold of the Japanese public.
2. With interest rates at historic lows, Japanese banks provided cheap and easy credit to companies and consumers. Consumer debt grew 700% from 1980 to 1990. Japanese corporations took advantage of the soaring stock market to raise $638 billion through stock offerings. This easy money policy, along with deregulation, tax incentives, and zoning regulations, led to the biggest real estate bubble in history. Prices reached such heights that intergenerational mortgage loans were required to buy a home.
3. When it became clear that there was an out-of-control speculative frenzy, the Bank of Japan raised rates to 6% from 1989 into 1990, leading to the collapse of the stock and real-estate bubbles. Both the stock market and land values are now 80% below their peak 1989 levels. The cumulative losses in the stock market and by landowners total $15 trillion since 1990.
And the Japanese experience is that their government didn't sit idly by: They used all the tools at their disposal - and made the conditions much worse. Are you getting the picture?
Japanese Government Blunders
1. The Japanese government has prolonged their downturn for an additional decade by not allowing bankrupt banks and corporations to liquidate. Zombie banks and corporations existed for decades without writing off the billions of bad debts. They hoarded all the money provided them by the government. Sound familiar?
2. The Japanese tried every trick in the Keynesian playbook: Zero interest rates, public-works projects, tax rebates, and tax decreases. The government built thousands of bridges and roads, driving up government debt to enormous levels. Between 1990 and 2000, the Japanese government instituted 10 fiscal stimulus programs totaling $1 trillion. None of these programs worked. Sound familiar?
3. The Bank of Japan purchased commercial paper. The government bought shares of public companies to prop up the stock market. Japan created a $500 billion bank bailout fund, with over $200 billion going towards the direct purchase of stocks. Politicians chose which companies would be propped up. This further distorted the free market. Sound familiar?
Dr. Benjamin Powell clearly explains what happens when the government intervenes in free markets:
“Japan created a structure of production that did not meet consumers’ particular demands. Producing things that nobody wants and propping up mal-investments cannot possibly help any economy. This policy is equivalent to the old Keynesian depression nostrum of paying people to dig holes and fill them. Neither policy will revive the economy because neither forces businesses to realign their structures of production to match consumer demands.”
What We're Facing
American consumers enter this economic downturn as the most indebted people on earth. The materialistic frenzy of the last 2 decades has left the American consumer saddled with $2.6 trillion of credit card and auto loan debt. Japanese consumers entered their “lost decade” with personal savings rates of 12% annually.
After growing at a 3.9% annual rate during the 1980’s, Japan’s GDP grew only 1.1% annually between 1991 and 2003. Considering the missteps by the government and the huge demographic headwinds blowing against them, Japan still grew their economy. Japan’s cumulative per capita growth this decade has been 13.7%, compared with 12.5% for the United States. And deflation wasn't as dire.
Japanese consumer prices have been relatively flat for 15 years. CPI has never reached -1% in any single year. Japanese consumers have rationally paid down debt and increased savings.
The crux of our current crisis is housing, just like Japan’s. Irrational exuberance, as described by Yale economist Robert Shiller, led to the most outrageous housing boom in US history. Delusional home buyers were convinced that flipping houses was a road to riches. Instead, they’ve skidded off the road and fallen into a bottomless ravine.
Reversion to the mean is inevitable: Home prices have tracked very closely to CPI for over a century, and the dramatic fall from the absurd levels seen from 2000 to 2006 has finally begun to occur. Home prices in Japan fell for 14 years before bottoming in 2004. Home prices have been dropping in the US for only 3 years.
Bitter Medicine Needed
I know that many Americans are looking for President Obama to solve this crisis painlessly. But there is no easy way out. The debt must be paid off and/or written off.
The politically unpopular steps that need to occur are as follows:
1. Housing prices need to drop another 15% to 20% to reach fair value. This will result in more foreclosures. When prices fall far enough, the houses will sell and inventories will fall. If you cannot afford the payment on your home, you should become a renter. Not everyone should own a home.
2. The government and Federal Reserve need to shine a bright light on the bad debt within the financial system. The collateral or lack thereof backing up government loans needs to be revealed by Treasury and the Federal Reserve. Covering up the worthlessness of these assets is contributing to the frozen system.
3. The remaining mega-banks that have caused this crisis -- including Citigroup (C), Bank of America (BAC), Goldman Sachs (GS), Morgan Stanley (MS), and any other insolvent banks -- need to be allowed to fail, if failure is indeed their destiny.
4. Failed companies with failed strategies must go bankrupt. Allowing companies (such as General Motors (GM) and Chrysler, for example) to fail brings about restructuring; the remaining healthy companies can buy the good assets.
5. Only infrastructure projects that benefit the citizens of the country should be undertaken. These would include water pipe replacement, electrical grid upgrades and repairing structurally deficient bridges.
6. Tax rebate checks are just a redistribution of wealth from future generations to the present one. A tax decrease today is borrowed against a tax increase on our children - and it won't stimulate spending.
7. Keeping interest rates at zero in an effort to force savers to borrow and spend is penalizing the frugal to benefit the profligate. Borrowing our way out of a debt crisis will never work.
8. Consumers should be encouraged to pay down their debt loads and increase their savings rate. The sooner this can be accomplished, the sooner the country can resume growth.
9. The median 401k balance was $18,942 at the end of 2007, with 39% of workers having a balance below $10,000. Approximately 8,000 Americans turn 65 every day. 20% of the U.S. population will be over 65 by 2030. An aging population with virtually no retirement savings must increase their savings and cut consumption dramatically.
10. The CEOs who brought down the entire financial system need to be brought to justice - to be investigated and prosecuted for lying to shareholders about the true financial condition of their firms.
11. Fannie Mae (FNM), Freddie Mac (FRE), and AIG (AIG) are wards of the state; the US taxpayer has been obligated to pay $350 billion to them, in total. AIG is using these funds to undercut other insurance companies in pricing insurance policies. This will result in blameless insurance companies being put out of business by a government-supported Goliath - and one that almost brought down the financial system. These companies need to be euthanized, and any decent assets sold to viable companies.
12. Moody’s and S&P should be banned from the rating business; their monopoly must end. They colluded with the investment banks and should be punished.
13. The SEC needs to be disbanded. It is unable to enforce their vast array of regulations, and seems to serve only as a revolving door to top Wall Street jobs. An agency that doesn't work needs to be scrapped.
We know what should happen -- and we fear what will happen -- but the ultimate result will be far different than the Japanese experience. Owing to their large trade surpluses and high savings rate, the Japanese have experienced a lethargic economy, but have grown with relatively low unemployment for most of the past 2 decades. They have been able to muddle through.
The US may refuse to muddle through. We still see ourselves as the world leader, and may not acknowledge any reduction in status. America could choose to follow Neil Young’s advice: It’s better to burn out, than to fade away.
Turning Japanese, finally, would be a best-case scenario for the United States.