Five Things You Need to Know: Praying for a Lost Decade
Are we like Japan? We'd better hope so.
1. Praying for a Lost Decade
Japan experienced more than a decade of deflation... Could something similar happen here? In a word, No. But something far worse could."
-- Kevin Depew, Five Things You Need to Know, Sep. 12, 2006
As a writer, it's unorthodox and typically frowned upon to quote your own articles, but in The Age of Self-Evidence it's increasingly dangerous to rely on Outside Sources, so we're at an impasse of sorts. Almost. Let's compromise; if you'll allow me to reach back and quote my own articles, I'll show you which Outside Sources demand such licentiousness.
The Financial Times this morning featured an Op-Ed piece by Andrew Scott, a professor of economics at London Business School, on the ability of America and Britain to handle the coming decades of extreme debt. As you might expect -- otherwise, why would I bother commenting on it -- the view was egregiously optimistic.
"Markets have financed much larger levels of debt than are predicted for the UK and US," Scott writes. "The largest increases are related to war but, as Japan's recent experience shows, this is not always the case."
Ah yes, Japan. This is why I went back to the Minyanville archives to dig up some old dirt. I mean, we could talk about Japan and the Lost Decade and America and The New Lost Decade and the magnitude of the ongoing private to public debt transfer and all that will eventually come to pass -- the increased taxation, the municipal bankruptices, the failed promises to pensioners, and so and so forth. But there's very little new to unearth there.
Instead, what I found remarkable about the economist Scott's comments on Japan is that in a matter of a little less than four years we've gone from disbelief that America could ever experience a lost decade of growth like Japan's to full-on neck-bowed pleadings, "Please, God, please let us be like Japan." For that is the nut of Scott's analysis.
How much government debt can we handle? We just don't know, admits Scott. "The difficulty with this alarmist view is that economics does not tell us what is a "high" level of debt," he writes. And so the best we can do is look back in history to other bouts with exploding government debt.
2. The Stealth Depression
Considering Japan for a moment, and contextualizing our own situation, despite the conventional view that the Great Recession has, technically, ended, the question might rightly be asked, Are we in a Stealth Depression?
Let's answer it this way: Suppose a person with an income of $1,000 normally spends $900 and saves $100. The $900 becomes someone else's income and the $100 will be loaned out by the bank to be spent somewhere else.
As Richard Koo explains in his book Balance Sheet Recession, during a balance sheet recession the person with $1,000 income still spends $900 and saves $100. The $900 enters the economy as someone else's income, as usual, but the $100 finds no borrowers as companies pay down debt. In our case, this balance sheet repair is occurring on multiple fronts -- from the banks themselves, from companies, and from consumers.
As banks find no takers for the money to be lent, or in our case as increased lending standards and risk aversion whittles down the pool of available borrowers, interest rates are engineered lower to make the money cheaper and to try to "stimulate" the economy. As we have seen, they can fall to zero, even negative in real terms.
Another consequence is that the economy sees demand of only $900 generated as that $900 spent is someone else's income. If that person saves 10%, then that (10% of 900 is 90) reduces the economy further, to $810, and so on. As happened in Japan, that cycle slowed the economy, reduced asset prices even further, and forced companies to work even harder to pay down debts.
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