A tale of 2 bubbles

Louis Proyect lnp3 at SPAMpanix.com
Fri Jan 26 13:25:49 MST 2001

Debt trap!

>From The Economist (economist.com)
Jan 25th 2001

THE shadows looming over the world's rich economies show no sign of
lifting. In the biggest, the United States, the new Bush administration has
talked openly of a downturn, and even of recession. The second-biggest,
Japan, is teetering yet again on the brink of a recession of its own. It is
true that, for now, the outlook in Europe appears more hopeful. But the
risk that everything on the economic front could go wrong this year remains
real. It is most pronounced in America; and its most fearsome guise is as a
debt trap. In simplified terms, the big worry is whether America might
follow a similar road to that taken by Japan ten years ago: a burst bubble
followed by a deep and prolonged recession, or even slump.

Judging by the ingrained optimism of most American economic commentators,
such a worry might seem risible. A year ago, most believed that America's
ten-year expansion would continue indefinitely. Now, after the bursting of
the Nasdaq stockmarket bubble, and with the economy slowing sharply, a few
admit to a risk of a mild recession. But almost all expect a bounce-back
later in the year, as monetary easing works its charm. They see no chance
that America's economy could collapse in the same way as Japan's. After
all, the two are completely different. Aren't they?

A tale of two bubbles

On the surface, the answer seems to be: yes. American banks are sounder
than Japan's were at the height of its more-pervasive bubble. The Japanese
investment and stockmarket booms in the 1980s were based on the flawed
notion that Japan had invented new economic laws-whereas America's faster
productivity growth, driven by the high-tech revolution, looks more real.
And Japan's decade of feeble growth can be blamed on policy errors more
than on the bursting of the bubble itself. Japan's policymakers failed to
encourage enough monetary expansion or to purge the country's banking
system (see article). While an appropriate policy response cannot entirely
be counted upon in America, the prospects look better than in the murky
politics of Japan.

All that said, there are enough eerie similarities between America today
and Japan in 1989-90 to be worrying. The biggest is excessive debt. Too
much debt was always at the heart of Japan's weakness. So it is alarming
that America's boom has also been fuelled by massive borrowing by companies
and households. Our survey of corporate finance in this week's issue
explores how American firms' borrowing binge has left lenders exposed to
some nasty risks. And, as if corporate debt is not alarming enough,
consumer borrowing has been even more rampant. By borrowing against paper
gains in share values, households have been able to shop until they
dropped, not bothering to save.

Optimists retort that private-sector balance sheets look healthy, because
the increase in debt has been more than matched by increased assets.
However, balance sheets also looked remarkably healthy in Japan in the late
1980s-until asset prices tumbled. On most historical measures, American
share prices remain heftily overvalued. A lot of consumer and corporate
debt has been incurred on the assumption of everlasting growth and rising
share prices.

The notion that America's bubble has been smaller than Japan's also needs
qualifying. Japan's excesses depended chiefly on crazy property prices,
while American property has remained fairly sane. But the corresponding
boost to debt and consumption in America has come from the stockmarket. At
the market's peak, American households owned shares worth 175% of their
disposable income, much higher than Japanese households' shareholdings at
the Tokyo market's 1989 peak of only 90% of their income. Just as Japan's
crash led Japanese consumers to raise their savings and cut spending, so
the risk is that the same could occur in America.

Plus ça change

Japan, in short, is not unique. America is but one more example of an
age-old phenomenon, in which rapid increases in asset prices encourage a
credit binge and overinvestment that prove unsustainable once asset prices
fall. It is no coincidence that the deepest and most protracted recessions
in recent decades have taken hold in countries that experienced booms in
property or share prices and a large build-up of debt, such as Britain and
Sweden in the early 1990s. This is not to deny that the IT revolution has
lifted America's productivity, nor that this might justify some of the
increase in share prices and hence some of the extra debt. But it would not
justify nearly enough of it to eliminate the risk of recession.

What about the argument that America has ample monetary and fiscal
ammunition? America certainly has more scope to cut interest rates and
taxes than today's Japan, where interest rates are already near zero and
the government has a massive budget deficit. But Japan had plenty of scope
to do both in 1990, when interest rates were at similar levels to those in
America today, and its budget surplus was then even bigger as a share of
GDP. Japan was slow to cut interest rates, but that was because its economy
continued to boom for almost two years after the stockmarket bubble had
burst. Although fiscal and monetary easing may be able to prevent disaster,
they may not be enough to prevent a recession, especially if there is a
large overhang of debt.

Alan Greenspan, the chairman of America's Fed, does at least have the
advantage of being able to learn from Japan. He would surely avoid the
error of allowing deflation to take hold. Even so, the Fed, whose
policymaking committee meets next week, faces a dilemma over when and how
quickly to cut interest rates. Ease too soon and by too much, and either
the bubble could reflate, paving the way for an even harder landing in
future, or the dollar could collapse. Ease too late, and America could come
to look horribly like Japan.

America has a good chance to escape the full, stagnant fate suffered by
Japan during the 1990s. But the more that the debt trap is ignored, the
more the risks will rise.

Louis Proyect
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