Why Japan's Debt Is A Non-Issue

On January 27, 2011, S&P lowered Japan's long-term sovereign debt rating for the first time in nine years to AA- from AA. According to S&P, the government "lacks a coherent strategy" to tackle Japan's debt load, which could lead government debt ratios to peak only in the mid-2020s. Japan's gross-public-debt-to-GDP ratio, which was 189.3% in 2009, is the highest among developed economies.



Though a sovereign debt crisis like that of Greece is not imminent, without increasing the national tax burden—which is relatively low compared to other major economies—Japan will not be able to sustain public spending without incurring more debt. Japan's aging population and underfunded pensions exacerbate this burden. Issuing more debt to finance public expenditures is easier for Japan compared to other European countries with high debt because Japan benefits from low debt-servicing costs in part due to chronic deflation. Unlike Greece, Japan maintains a current account surplus and a net foreign asset position. Locals hold around 95% of Japan's debt, whereas foreigners hold more than three-quarters of Greece's debt.

Unless proposed expenditures are minimized, Prime Minister Naoto Kan’s administration will struggle to fund its 2011 budget without reneging on its JPY44-trillion cap on new bond issuance. Tax revenue will fall alongside corporate profits and personal income. Since Kan’s aggressive advocacy of a consumption tax hike cost his party the Upper House, plans for the hike are likely to be shelved. A corporate tax cut remains under consideration, but budget deficits will be hard to shake off without a corresponding increase in revenue elsewhere.

S&P estimated (according to its January 27, 2011, note "Ratings On Japan Lowered To 'AA-'; Outlook Stable") that Japan's government fiscal deficits will decline from an estimated 9.1% of GDP in FY2011 (ending March 31, 2011) to 8.0% in FY2013. Unless the government undertakes a fiscal consolidation program, S&P does not foresee Japan achieving a primary external balance before 2020.



Japan's Cabinet Office estimated that the primary fiscal deficit, which excludes debt-servicing costs, will total JPY21.7 trillion in FY2015, 4.2% of GDP. In FY2020, Japan is estimated to post a primary budget deficit of JPY23.2 trillion, or 4.2% of nominal GDP. If real GDP grows more than 2% each year, Japan's primary balance deficit would be 3.2% of nominal GDP in FY2015 and 2.5% in FY2020.

The OECD forecasts that Japan's gross public debt will exceed 200% of GDP in 2011. In order to halve the primary budget deficit by 2015, the OECD maintains that additional tax revenue need to be generated and that the BoJ should "should implement more ambitious quantitative easing measures to relax monetary conditions in the face of entrenched deflation and maintain such policies until underlying inflation is significantly positive."

Japan’s long-term public debt has risen to JPY862 trillion (US$9.26 trillion), nearly 200% of the nation’s 2009 gross domestic product. Japan’s debt was 189.3% of GDP in 2009 and is projected to grow to 204.3 % in 2011.On January 18, 2011, credit-default swaps (CDS) used to protect payment of Japanese government debt, hit a six-month high and climbed to 86.49 bps. This means that it costs $86,490 to insure $10 million in Japanese debt. CDS for U.S. debt were 49.85 bp.



Why The Debt Is "Manageable"

The financing of Japan’s public sector debt is currently enjoying an extremely virtuous confluence of events—the strong home bias of domestic investors, ample domestic savings, and modest deflation. As long as these persist, financing the public sector debt should not be problematic...In the near term, it seems likely that the three conditions that have eased the financing of Japan’s public debt will persist.

While JGB market participants believe Japan occupies the worst fiscal position in the world, the nation's fiscal problems can still be rectified with tax hikes. The basis for this optimism appears to lie in Japan's low social contribution rate, one of the lowest in the world at 39%. A social contribution rate of 52.3%, a rate on par with European nations, would be sufficient to cover recent fiscal deficits.

In addition, the JGB market seems to have concluded that the Japanese government can fiscally consolidate because the there is room to raise the consumption tax rate, currently the lowest in the world at 5%.



Despite the high level of government indebtedness, the budgetary burden of servicing debt interest is not especially high as a share of GDP and revenue, especially once account is taken of the relatively low tax/GDP ratio. This reflects the fact that interest rates on government borrowing remain low in nominal and real terms.

Currency and deposits make up over 55% of assets for Japanese households. Compared to just 14.3% in America. This represents about US$8.9 trillion in savings that could potentially be mobilized to support the Japanese government debt. Americans by contrast, hold a far greater amount of their wealth in the stock market. U.S. households have over 30% of their assets in shares and equities. As opposed to just 6.6% in Japan. Japanese household savings are over 100% of outstanding government debt. With the American government now sitting $12.7 trillion in the red, household savings are only at 50% of debt.

Japan is better placed than either the U.S. or the UK. This is partly because the debt problem is frequently overstated, as net debt is only about half the gross level, but also because the switch from investment, financed by untaxed depreciation, into incomes and spending which are taxed twice, will mean that tax revenue should rise rapidly with recovery.

The Japanese private sector remains in a position of net creditor, offsetting the government's position as a borrower, not to mention that more than 95% of Japanese debt is still held by Japanese investors. Unless the private Japanese investors switches out of the deposits, or dumps the yen in favour of other currencies, or start selling bonds in droves - I do not see this being a grave issue. Its not good but its not catastrophic.



Thats the sad part, Japan sorely needs a huge whack on the head for them to reform their economy and finances, but that is not likely to happen. So the Japanese economy will meander like a an old man but not showing any signs of dying anytime soon.

Obamafying Japan, The Democratic Party of Japan (Part 2)

Overview: Early lower house election results indicate that the Democratic Party of Japan (DPJ) has defeated the long-ruling Liberal Democratic Party (LDP) in a landslide victory. Prime Minister Taro Aso and the LDP had grown unpopular due to their response to Japan's economic woes. Though a new ruling party may not transform Japan's economy overnight, it is a step towards reform and brings many new (and much younger) faces to government in Japan.

Election Results

• The Nikkei reports that early results indicate the DPJ winning 308 of the Lower House's 480 seats. A minimum of 241 seats is required to capture a simple majority. The DPJ has won even more seats than the popular Junichiro Koizumi and his "band of reformists" won for the LDP in 2005.
• NHK estimates that voter turnout was around 69% and was the highest turnout since the current electoral system was introduced in 1996.
• DPJ President Yukio Hatoyama will be elected the country's new prime minister in a special Diet session in mid-September.
• This will be the first time since 1955 that the LDP is not the controlling party in parliament.
• DPJ President Yukio Hatoyama announced in a press conference that the DPJ will begin discussions with the Social Democratic Party and the People's New Party to form a coalition government.
  
• Prime Minister Taro Aso indicated that he will step down as party head. Additionally, LDP's Secretary General, Hiroyuko Hosoda informed Prime Minister Taro Aso that he plans to step down.
• On a Tokyo Broadcasting System (TBS) televised interview, Hatoyama stated that the DPJ would quickly compile an extra budget to restructure the current government's last stimulus package.
• The Nikkei reports that Hatoyama said the DPJ government would soon organize a grand policymaking body called the National Strategy Office which will outline Japan's national budget and set the nation's foreign and security policies.
• Kyodo News projections show the following LDP heavyweights have lost their seats: Ex-Finance Minister Shoichi Nakagawa, current Finance Minister Kaoru Yosano, Ex-Defense Fumio Kyuma, another ex-Defense Minister Yuriko Koike, and Consumer Affairs Minister Seiko Noda.
• Bloomberg reports that former Prime Minister Toshiki Kaifu lost his seat in the Aichi prefecture against a candidate half his age. Kaifu is the first former prime minister to be voted out since Tanzan Ishibashi in 1963.
• Ex-Prime Minister's son, Shinjiro Koizumi, is expected to provide the LDP a win in the Kanagawa No. 11 constituency.
• Eriko Fukuda a 28-year-old member of the DPJ, is projected to win the Nagasaki No. 2 constituency from former Defense Minister Fumio Kyuma. Fukuda is known for filing a lawsuit against the government for people that contracted hepatitis C from tainted blood products. She herself contracted hepatitis C as a child from a blood transfusion.
• NHK reports that Akihiro Ota, head of the New Komeito party and a partner of the ruling coalition, lost his seat in the Tokyo No. 12 electoral district.
• Kyodo News reports that 23 people were arrested on suspicion of election law violations.

What Will a DPJ Win Mean for the Economy?

• Heizo Takenaka, former Finance Minister under Koizumi, notes, "Japan's politics and its economy are just not sustainable in their current forms...something has to give, be it the ruling party, the yen, the bond market, the stock market or a combination thereof."
  
• Naomi Hasegawa, Senior Fixed Income Strategist, Mitsubishi Debt Research Division: The DPJ promises to shun U.S. dollar bonds if elected.
• Sentaku Magazine: "The DPJ's announced economic policy may be summarized as one of 'reckless spending.' It calls for, among other things, making all expressways free of tolls, giving every child 26,000 yen a month until he or she finishes the nine years of compulsory education and providing compensation for farmers who have to sell their products below cost. It is estimated that these policies would cost an estimated 20.5 trillion yen in fiscal 2012."
• The LDP proposed to outspend the DPJ, but the DPJ seemed more likely to rebalance economic growth towards domestic demand. JGB issuance was likely to increase with fiscal expansion regardless of which party won.
  
• Though the DPJ promises it won't hike the consumption tax for another four years, it is highly likely it will need to do it earlier because tax revenues may not keep up with increased government expenditure.

What Will a DPJ Win Mean for Domestic and Foreign Politics?

• DPJ wants to turn the bureaucrat-driven government into a more cabinet-driven one.
• Gerald Curtis, FT Columnist: "The DPJ talks about replacing bureaucrats with politicians in key ministerial positions but says virtually nothing about what policies these newly empowered politicians would implement.".
• Japan may become slightly more pacifist and less pliant to the U.S..
• American Enterprise Institute fellows Dan Blumental and Gary Schmitt believe, "Tokyo's foreign policy is unlikely to change drastically," but caution that "the fact that Japan will now have truly competitive political parties means that Japanese policy makers will be more attuned to public opinion.".

p/s photo: Fiona Xie

Obamafying Japan, The Democratic Party of Japan

Overview: With the Democratic Party of Japan's (DPJ) historic win over the Liberal Democratic Party (LDP) in Japan's lower house elections, Japan is bracing for a short-term rise in stocks and bond yields. The DPJ has made campaign promises that will necessitate a great deal of government spending. This spending is expected to push up consumer consumption and environmental stocks. However, the spending is expected to be financed by the government issuing more bonds (despite the DPJ's claims that they won't issue new bonds), weighing on bond prices and pushing up yields. However, in the longer-term, doubts about the DPJ's ability to deliver on their policies may cause the stock market gains to eventually unravel.

Impact on Currency: Continued Yen Strength

• Immediate market impact: The Japanese Yen opened strong against the U.S. dollar after the DPJ election win, rising to 92.90 from 93.60 and strengthened further to 92.67 by the close of Tokyo trading . The yen also strengthened against the Euro to 132.95 from 133.85 in the early morning and saw 132.47 by the end of the day in Japan.
  
• The U.S. dollar has fallen 20% against the Japanese yen since June 2007.
• As an export-driven economy, Japan's Ministry of Finance has intervened in the past to drive down the yen and protect profits at companies like Sony and Toyota.
• However, members of the DPJ are saying they have changed their stance on intervention, stating that the party has high confidence in the U.S. dollar and suggesting they will only use intervention to counter abnormal currency moves.
• There is skepticism to these claims as automakers and electric appliance manufacturers have been some of the DPJ's biggest supporters.

Impact on Bonds: Rising Yields

• Immediate market impact: Japan's 10-year government bonds opened lower after the DPJ victory. The 10-year JGBs were trading down 0.089 and yielding 1.32%, but reversed course and ended the day higher yielding 1.31%.
  
• Despite the DPJ's claims to be able to finance their spending programs through "hidden treasures" (plundering LDP government slush funds and cutting wasteful spending), it is unlikely that this can be a sustainable source of financing and the DPJ will ultimately have to increase JGB issuance significantly.
  
• Robert Alan Feldman, chief economist and co-director of Japan research at Morgan Stanley, says "The DPJ has no clear stance on monetary policy. There could be disruptive impact if senior leaders call for rate hikes in order to improve the income of depositors. Feldman goes on to point out that the DPJ also has no plans for deficit reduction".

Impact on Stocks: Liquidity driven gains (mostly priced in already)

• Immediate market impact: After the DPJ election win, the Nikkei 225 Average opened with a 1.9% gain to 10,736 and the Topix gained 1.5% to 983.5. As the trading day wore on, enthusiasm began to wane and the impact of the yen's strength took the market down to close lower on the day. The Nikkei 225 closed 40 basis points lower to 10,492 and the Topix fell almost 40 basis points to 965.
  
• With a DPJ manifesto that focuses on increasing household disposable income by 20%, a DPJ win should give consumption stocks a boost. These stocks would include the DPJ's supporters, automakers and electric appliance manufacturers, but domestic demand stocks in general should benefit. However, with a 14.2% run up in the Topix between July 13 and August 14, these gains are already priced into the equity market.
• Retailers, environmental companies and child-related companies will be direct beneficiaries of DPJ spending programs.
  

Despite the euphoria, by electing the Democrats, its a victory for democracy, it shows that now there is a genuine alternative, a genuine two party system, and that there will be more check and balance, and hopefully better transparency. In terms of dragging the economy and the stock market from its doldrums, thats another thing altogether. As good as the feeling is, unless the Japanese go out and spend, nothing is ever going to change. That being a constant, then Japan will only move based on global demand for their exports and foreign funds inflow into investments (not now obviously).


p/s photos: Joanna Peh

Yen/Dollar Rate Above 98, Good For Stocks?

Readers would be familiar with my yen-rate theory. I expected the weaker yen to signal less risk aversion, and hence a potential to move funds back into equities. The flight-to-safety play in 2008 didn't include gold. In fact, it was mostly concentrated in U.S. treasuries, the U.S. dollar and the Japanese yen.

The Japanese yen is down more than 10% since it peaked mid-December of last year. The yen has actually fallen below the levels seen at the height of credit anxiety during the October and November low points. However equities have not jumped as I expected. The yen typically rose with risk aversion as it did at the start of the collapse in mid-September of last year.The yen-dollar rate has scaled above 98 yen as write this.

Japan is more dependent on its exports for economic success than nearly any other nation. The global recession and the strengthening of Japan's currency has made it terribly difficult for its multinationals to sell products to the world. It does not seem that the Japanese government has done anything concerte to weaken the yen.

I believe that investors are beginning to take more risk with their money again. It's likely that the risk being taken is far more incremental. I see the initial move out of yen going to high-grade corporate bonds and maybe gold. It is still early days but its a good scenario for the willingness to move out of yen alone. There is a lot of liquidity on the sidelines, and there is only so much TIPs you can buy. Further improvements in the buying of corporate bonds will necessarily cause an inflow into equities.

Besides, Japan needs a weaker yen if the economy is going to be able to do its bit to improve its export-let economy. We don't need a paralysed Japanese economy. Sticking to the yen rate theory and gradually increasing equity weighting. Risk aversion may be abating, but the flow back into equities will be gradual and more gingerly in nature owing to uncertain markets.

p/s photo: Chen Kuang Yi

Could The USA Fall Into The Japan 18 Year Stagflation Trap?

There are now increasing opinions that the US may go the way of Japan - in having a prolonged stagflation. To refresh our memory, Japan's real estate and stock market bubble collapsed quite spectacularly sometime around 1990. The first couple of years saw a lot of wealth being erased from the real estate and stock portfolio. The following 16 odd years, even till today, basically saw Japan registering a period of stagflation or what some may refer to as the L-shaped recovery - i.e. you don't really recover. Japan made many policy mistakes (that the US should and could avoid):
a) it cut policy rates two years after the bust of its asset bubble while the US eased monetary policy aggressively after August 2007
b) it went into quantitative easing reversed ZIRP (zero interest rate policy) too slowly
c) it waited two years after the bursting of its bubbles to do a fiscal stimulus (and reversed it too early with a consumption tax) while the US did one – albeit a failed one – last year and is doing another large one now
d) it created a convoy system of zombie banks and corporate that were restructured too late while the US may become more aggressive in cleaning up the financial system
e) it had structural rigidities – like lifetime employment – that slowed down the adjustment while the US has a more flexible labor markets

If we were to look at the missteps by Japan, we might easily conclude that the US reacted much faster, swifter and the structural and employment adjustments were rapid as well. However, we must also acknowledge that Japan's bubble was in stocks and real estate - as bad as that sound, there were very little leverage or derivatives enlarging the bubble. The current credit implosion is largely driven by a leveraged credit, based on insufficient capital, propeled by new fangled derivatives. Thus in that light, the situation faced by the US was a lot worse than Japan.

Japan was in much better macro and financial shape than the US before and during its stagnation: high household and national savings and low leverage of the household sector, net foreign asset position that allowed it to finance its large fiscal deficit during the stagnation via domestic savings. The US instead has had near zero household savings and massive leverage for years, large current account deficits and is the largest net foreign debtor in the world. Thus any further fiscal stimulus by the US basically is further deficits on an already damaging deficit problem. The problems are in the US are magnified by the high debt levels on the personal level as well, and would eat immediately into consumption patterns. Whereas in Japan they still had truckloads of savings.

Fiscal policy has its limits when you are already the biggest net debtor and net borrower in the world and where you need to borrow this year $2 trillion net ($2.5 trillion gross) to finance your fiscal deficit ... and your currency is still backed by nothing. The US is taking an approach to bank recap and clean-up that looks more like Japan than the successful Swedish outright takeover/nationalization process. While the bad bank idea might work, it will require the US taxpayers to pony up another $2-$3 trillion to fund that bad bank. How many trillions of USD can you print before China and Russia turn around and say "wtf...".

The US and global economy are truly risking a near-depression if the policy reaction is not bold, aggressive, sustainable and credible. For almost every action that the Treasury or the government has proposed, there will be tons of criticisms, and that's beauty and beastly side of a true democracy. This credit crisis is not quite like any we have seen before as it involved an enormous amount of leverage, hence we have no textbook solutions to guide us. Hence, we can be assured that every single policy action, be it the TARP, the reworked and reworked stimulus plan, the bailouts, and now the bad bank idea ... will have a lot of detractors... and probably not many cheering the measures even if they agree (as no one is really sure they will work well).

We also have to remember that there are mainly two main schools of economic thought - though you could probably have tens of shools of economic thought on this - either you are a Keynesian or you are Gasparino (libertarian market purist). The latter being that mainly you think the markets should be allowed to correct itself, and bad companies should be allowed to fail, and shareholders should not be saved... or something to that effect. There are still many more who have opinions along those lines of thought which differ here and there, so you can understand why everyone is an asshole and an expert at the same time.

Back to the Japan trap, its government spending soared (after a couple of years following the correction) as a massive public works program covered the country with cement. Yet Japan also prevented the bust from performing its role of creative destruction. Businesses were reluctant to shed workers and renege on their lifetime employment guarantees. Japanese authorities encouraged banks to supply new credit to weak companies. This served to worsen the bad-debt problems within the banking system, which came to a head in the 1997 financial crisis. Academic research suggests that the increasing dominance of certain industries by so-called "zombie" firms tended to depress job creation and lower productivity. Product prices in zombie industries were low because of excess competition. Low prices and high wages reduced profits and discouraged new investment.

I was working for Nomura, the biggest Japanese securities firm then from 1988-1991, and I can say that Japan did one thing right: government spending increase. They did many things wrong which was what dragged the recession into a stagflation period for over ten years: they did not force bad banks to fail; the worst was allowing banks to not act on bad debts thus keeping technically insolvent businesses alive for years; the life-time employment culture caused many companies not to restructure; not allowing the banks to seek foreign investment to replenish their capital; not allowing foreign ownership of banks and most other companies which would have restructured many of them and given them much needed capital.

Hence to use the Japan experience to somehow link it to the futility of what the US government agencies are doing is flawed, very flawed. The bubble was deflated in stocks and property, stocks crashed because its a relatively open market with foreign participation, property died slowly as there were too many regulations preventing foreign ownership. I basically think that the US moved fast and aggressively, and industries are being restructured quickly, ... I don't like the bad bank idea but it will work best if you don't take the nationalisation route. The US will throw everything at the problems at hand. Its not much point to harp on how much money they will be flooding the system to do that. Yes, the USD is doomed for a long long depreciation. Its the lesser of two evils, throw more money at the problems... as not doing anything will be anarchy.

So, I do think that while the problems are huge, the US will be able to recover much faster and will not fall into the stagflation trap of Japan.

p/s photos: Megan Lai

Depressing Economics

Edward Chancellor is the author of Devil Take the Hindmost and a senior member of GMO’s asset allocation team.

Governments around the world are resorting to extreme measures to stave off deflation and depression. Fiscal and monetary stimulus on a grand scale is prescribed by Keynesian and monetarist economists alike. But there’s a danger that such moves could hinder the cleansing process of the bust. Although the contraction may be mitigated, the result of depression economics tends to be weak economies overburdened with government debt. (There are now clearly two sides in the field, one is Keynesians who believe fiscal and monetary stimulus will be necessary and appropriate to revive the economy. The other side are the conservatives who believe that markets must be allowed to correct on its own accord, that bad companies must be allowed to fail. By intervening, it is usually borne by the government/taxpayers and reward shareholders and excessive risk takers. If we allowed Citi, Bank of America and AIG to fail, I shudder to think of the follow on effects. If that happens, the conservatives and market purists will not speak a word. If that happens, the US unemployment rate could have ballooned to 12% or 13% by now. If that happened, we can be damn sure that we will be dragging the entire global economy into a deep depression. Bailouts may be argued as necessary because of how the global economy is structured nowadays. No big bank failure will be localised. The nature of the defaults are different from 1930s or 1970s because it involves derivatives and very high leverage on capital. If we did not have the latter two components, yes, I think bad companies should be allowed to fail, better to use the supposed bailout funds to start new banks. But its not the case here, or will it ever be the case in the future.)

It’s common nowadays to dismiss the notion that an economy needs purging after a boom. This, after all, is what president Herbert Hoover’s Treasury secretary, Andrew Mellon, recommended in the early 1930s. "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate," Mellon is said to have declared. "Values will be adjusted, and enterprising people will pick up the wrecks from less-competent people." To give such advice today would be political suicide.

Doing nothing in the face of a credit bust, according to conventional wisdom, is to replicate Hoover’s misguided policy. In fact, Hoover never followed Mellon’s advice. In his book, America’s Great Depression (1963), economist Murray Rothbard describes how Hoover prided himself on being the first American president to use all available tools to combat a depression.

After the 1929 stock market crash, Hoover persuaded business leaders to maintain wages. He instituted policies to support agricultural prices and halt farm foreclosures. Immigration was restricted to preserve jobs for Americans. Interest rates were lowered and government spending increased. In 1932, Hoover’s last year in the White House, the federal deficit was 4.7 percent of GDP, slightly higher than it was in 1933 after president Franklin Roosevelt took the helm.

Rothbard concludes that during Hoover’s presidency, "for the first time, laissez-faire was thrown boldly overboard, and every government weapon was thrown into the breach." Yet the main consequence of Hoover’s anti-depression policy was to bolster real wages in a time of severe deflation. As a result, American labor became uncompetitive, thereby damaging employment, business profits and investment.

Conventional wisdom holds that the depression was vanquished by Roosevelt’s New Deal. In fact, unemployment remained high, and the economy didn’t properly recover until after the U.S. entered World War II. Economist Gene Smiley, like Rothbard an adherent of the free-market Austrian school of economics, provides a cogent critique of the New Deal in his book Rethinking the Great Depression (2002). Acting under the erroneous belief that the depression was created by excessive production and too little consumption, Roosevelt’s National Recovery Administration embarked on an ambitious attempt to fix prices and output. The NRA was a flop. By the end of 1934, unemployment was 21.7 percent. Later, Roosevelt engaged in a "soak-the-rich" tax policy and instituted an "excess profits tax." The decade from 1930 to 1940 is the only one in U.S. history when corporate investment declined. Smiley concludes that the New Deal created a "depression within a depression."

At least the policies adopted after the bursting of Japan’s "bubble economy" in the early 1990s prevented a severe depression and deflation. Government spending soared as a massive public works program covered the country with cement. Yet Japan also prevented the bust from performing its role of creative destruction. Businesses were reluctant to shed workers and renege on their lifetime employment guarantees. Japanese authorities encouraged banks to supply new credit to weak companies. This served to worsen the bad-debt problems within the banking system, which came to a head in the 1997 financial crisis. Academic research suggests that the increasing dominance of certain industries by so-called "zombie" firms tended to depress job creation and lower productivity. Product prices in zombie industries were low because of excess competition. Low prices and high wages reduced profits and discouraged new investment. ( I was working for Nomura, the biggest Japanese securities firm then from 1988-1991, and I can say that Japan did one thing right: government spending increase. They did many things wrong which was what dragged the recession into a stagflation period for over ten years: they did not force bad banks to fail; the worst was allowing banks to not act on bad debts thus keeping technically insolvent businesses alive for years; the life-time employment culture caused many companies not to restructure; not allowing the banks to seek foreign investment to replenish their capital; not allowing foreign ownership of banks and most other companies which would have restructured many of them and given them much needed capital. Hence for the writer to use the Japan experience to somehow link it to the futility of what the US government agencies are doing is flawed, very flawed. The bubble was deflated in stocks and property, stocks crashed because its a relatively open market with foreign participation, property died slowly as there were too many regulations preventing foreign ownership.)

Depression economics can also trigger a growing dependency on government life support. As a result, it becomes difficult to normalize policy. The economy is vulnerable to crash when taxes are raised to reduce the deficit or when monetary policy is restricted to avoid inflation. This happened after Roosevelt instituted a fiscal and monetary tightening in 1937. Japan’s economy also collapsed in 1997 after the government increased consumption taxes. After two decades, Japan’s monetary authorities haven’t succeeded in normalizing interest rates, and economic growth has never approached its prebubble level.

So what are the dangers of our current anti-depression policies? The greatest risk is that they interfere with the clearing process, or liquidation, which is necessary for economies to regain equilibrium. Households in the U.S. and the U.K. have consumed too much and saved too little in recent years. This has to be reversed. Yet the recent decision to cut British consumption taxes doesn’t help. The era of low interest rates stimulated excessive home construction and auto purchases. If the downturn is to work its cure, it makes little sense for Washington to bail out Detroit or put a floor under home prices. If General Motors Corp. becomes a zombie, then American employees of Japanese car manufacturers are likely to suffer. Now that banks around the world are receiving injections of public money, it’s inevitable that the authorities will play an increasing role in the allocation of capital. They are likely to do an even worse job than the Wall Street casino. Governments will pressure banks to lend to households and businesses even when it makes little business sense. The French government has offered money to its banks if they increase their lending next year. Immediately after the British government took control of the Royal Bank of Scotland, the bank announced a moratorium on mortgage foreclosures. Anti-depression policies are also in danger of stoking economic nationalism. French President Nicolas Sarkozy has proposed a €20 billion ($27 billion) fund to support national champions. Government support for stricken industries, whether in Detroit or elsewhere, conflicts with the principles of the World Trade Organization.

It’s well known that the Great Depression was exacerbated by tariffs, exchange controls and competitive currency devaluations. But that doesn’t mean modern politicians won’t repeat this disastrous course. Russia recently announced import duties on used cars, while India raised tariffs on steel and soybean oil. Last but not least, the massive fiscal and monetary bailout threatens to destabilize government finances. At the latest count Washington’s commitments to fight financial fires amounted to some $7 trillion, according to Bloomberg. The British government is proposing a budget deficit equivalent to 8 percent of next year’s GDP. Whitehall is also supporting banks whose loan book is a multiple of Britain’s economic product. Monetarist economists, such as Federal Reserve Board chairman Ben Bernanke, have long promised that monetary policy has the right tools to deal with any threat of depression. Yet Iceland’s recent flameout shows what happens when the financial problems of a bust exceed the government’s available resources. ( Yes, deficit spending will shatter US balance sheet, but not doing it will leave a US economy grappling with social unrest, massive unemployment, and debilitate one of their most important industry, banking and international finance. Yes, the moves undertaken by the US will ensure a long but sure death for the USD, which is the way to penalise the US, by moving more and more US assets to foreign ownership. There will come a time when most US banks and even the IBMs, Procter & Gamble will be majority owned by foreign investors, and it will come sooner than you think. Unless the government go on a super diet of savings and increased productivity after this crisis is over, the US will be only a shadow of its former self in economic might in 5 years time.)

p/s photos: Sharon Chan Mun Chi