The Housing Chronicles Blog: Lessons from Japan

Wednesday, January 23, 2008

Lessons from Japan

Could our current financial crises in this country emulate those of Japan? Writing in USA Today, writer David Lynch suggests that we can certainly learn from their history:

Then, as now, asset values rose to stratospheric heights. Then, as now, the bubble eventually popped. And then, as now, people initially believed the economy would soon regain its bearings.

But in post-bubble Japan, the economy didn't recover as expected. Instead, it stagnated — year after painful year — until the 1990s had earned the chilling sobriquet "the lost decade."

Fortunately, Fed Chair Bernanke is well aware of what can happen when booms turn to busts:

The Fed began looking closely at the Japanese experience several years ago, as the end of the technology stock bubble in the USA ignited fears of a Japanese-style implosion. With inflation virtually extinguished in the USA, policymakers then worried about inadvertently tumbling into deflation, in which prices would decline across the board and drag the economy down with them. That never happened. In 2007, the consumer price index jumped 4.1%, the highest annual increase in 17 years...

The scale of Japan's 1980s boom and subsequent bust was breathtaking. In the five years before its 1989 peak, the Nikkei stock average rose 275%. Property prices became so inflated that the tiny spit of land surrounding the Imperial Palace in central Tokyo was briefly worth more than the entire state of California. At the time, Japan's seemingly unstoppable rise inflamed fears among Americans that the United States had slipped into permanent economic inferiority.

When the bubble finally popped in late 1989, stock and property prices nose-dived in tandem. In less than three years, the Nikkei stock average fell 63% from its peak of 38,916. It didn't hit bottom until April 2003 and a total decline of 80%. At Monday's close of 13,326, it remains a fraction of its record high.

So what did Japan do wrong?

Japanese banks, which had made loans based on wildly inflated valuations of property held as collateral, came under enormous stress. As the economy flat-lined, Japan's central bank temporized, keeping inflation-adjusted interest rates abnormally high. Among the Bank of Japan's critics was a prominent Princeton University economist, who blamed "exceptionally poor monetary policymaking" for the country's protracted malaise. The central bank's failure to lower interest rates in the early 1990s ultimately drove the economy into a deflationary death spiral, according to the Princeton academic, Ben Bernanke, who today works to ensure that his Fed does not repeat those mistakes.

In 1992, for example, amid negligible inflation and a comatose economy, the Bank of Japan's key interest rate was still nearly 4%. (In contrast, after the tech bubble burst in the USA, the Fed quickly slashed its benchmark rate to 1%.)

Eventually, in 1995, Japan began moving toward a policy of keeping inflation-adjusted interest rates near zero. But by 1999, when the zero-rate policy was fully implemented, the economic damage already had been done. Falling prices for goods and services discouraged investment and hiring. Consumers husbanded their cash for fear of what the future held. The economy was trapped.

Fortunately, history does provide some guidance:

Though recessionary symptoms are multiplying in the USA, most economists expect a brief recession that will give way to renewed, if anemic, growth in the second half of this year. Few expect to see Japan's "lost decade" replayed here.

That optimism, however, like the cheery forecasts in the early days of Japan's prolonged slump, may prove overly sanguine, according to a significant new study.

The research paper, by Harvard University's Kenneth Rogoff and Carmen Reinhart of the University of Maryland, found widespread parallels among 18 industrial-nation banking crises since World War II.

Such financial train wrecks bleed economies badly, the study found. The tally for cleaning up in Japan, for example, amounted to more than 20% of gross domestic product; if the current U.S. situation deteriorated to that degree, the bill would be a staggering $2.8 trillion.

Rogoff, former chief economist of the International Monetary Fund, says it's more likely that the subprime debacle ultimately will incur costs roughly equal to the mid-1980s savings-and-loan crisis. If so, that would mean still-sizable losses of almost $450 billion.

No comments: