Will We Have a Decade(s) Long Deflation Like Japan?

Japan vs. U.S.: Compare and Contrast

By Jeff Harding

From The Daily Capitalist.

Japan has been in decline, or at least stagnation, for 19 years. Their GDP has not grown, unless you consider 0.6% (avg.) robust annual growth. They have experienced a deflationary economy, and now, it's happening once again. They now have the highest national debt as a percentage of GDP than any other major economy. It has been argued that the U.S. is catching this Japanese “disease” and that not only will we have continued deflation, but also stagnation.

I went back and read my background material on Japan's economic history, starting with the Bank of Japan's money pumping in 1986, and was startled to see the similarities between the policies of Japan to stimulate its economy and what we are now doing. My last major article on this topic, The Japanese Disease, was written in January, 2009, just as our government was ramping up their fiscal stimulus programs, and things have changed quite a bit since then.

It is easy to say that because we have adopted many of the same Keynesian policies that failed in Japan, not only will they fail here, but that the economic results will be identical. As I write this, I am not sure the economic results will not be the same, but I think there are several major differences between Japan and the U.S. that may lead us to somewhat different results. It depends what the government will do.

Here's a quick summary of Japan's experience (excerpted from my January article):

They started with a huge credit expansion. Their discount rate was cut from 4.4% to 2.5% in 1986-1987. The result:

1. Real estate and equity prices soared.
2. To counter the speculative boom, the discount rate was raised in 1989-1990 from 2.5% to 6% and their markets crashed.
3. The Nikkei went from 40,000 in 1989 to 11,000 in 2005. Real estate values plummeted 80%.
4. GDP grew at only 1.17% from 1992 to 2003.
5. Unemployment went from 2.1% in 1991 to 4.7% by 2004 (a very high rate in Japan).
6. Consumption and investment fell dramatically.
7. Banks were not lending.

What was the response of the government to this crisis?

1. In order to kick-start the economy, the government went on an infrastructure spending binge and cut taxes.
2. From 1992 to 1995 they spent ¥65.5 trillion on projects and cut taxes.
3. In 1998 they cut taxes ¥2 trillion.
4. In 1998 they spent another ¥40.6 trillion on spending stimulus.
5. In 1999 they spent another ¥18 trillion in fiscal stimulus.
6. In 2000 they tried another ¥11 trillion spending package.
7. They set up a ¥20 trillion fund to lend directly to businesses (the Financial Investment and Loan Program [FILP]).
8. To try and push money into the system the Bank of Japan and Ministry of Finance bought more than half of existing government bonds from the private market at a cost of ¥2.22 trillion.
9. Trying monetary policy, they lowered the discount rate from 4.5% in 1991, 3.5% in 1992, 1.75% 1993-1994, to 0.5% 1995-2003.
10. They set up a $524 billion bailout fund in 1998 to buy stock in failing banks or nationalize them.

It is estimated that the Japanese spent about $1 trillion about (¥135 trillion) to cure their financial problems. But the problems lingered, banks remained weak, lending and investment was severely reduced, unemployment was high, government debt went to more than 150% of GDP [it's now 200%], and the yen devalued. Nothing seemed to work.

Remember some of the hallmarks of the Japanese experience? "Zombie Banks" were banks that the government allowed to keep their doors open although they were really insolvent. "Zombie Corporations" were the companies whose debt were held by zombie banks, but were allowed to stay in business because the zombie banks didn't write off these loans. "Window sitters," a term applied to workers of zombie companies who showed up for work every day for a paycheck, presumably gazing out the window all day with nothing to do.

The irony of it is that they are trying the same things again in this crisis, with the same results. The Bank of Japan just predicted two years more of deflation, and unemployment is up to 5.5%. Exports, the mainstay of their economy, are falling off a cliff (11 straight months of decline). It reminds me of a definition of insanity: expecting a different result to occur from the same input, over and over again.

Does the Japanese scenario sound familiar? It should since we are doing most of the same things as they did.

1. The Fed reduced the Fed Funds rate to 0.25%.
2. The government has hugely increased the base money supply in an attempt to create inflation.
3. The government has spent or pledged about $2.7 trillion dollars in direct loans, bailouts, debt purchases, grants, and wasteful spending projects.
4. The guarantees to Fannie, Freddie, Sallie, and the FHA, plus additional backstop guarantees by the Fed and the Treasury amount to almost $10 trillion.
5. The Obama Administration expects the national debt is to increase by almost $10 trillion over the next 10 years (a very conservative number considering the new national health care plans). This will get us to a national debt of about 200% of GDP.
6. Programs like Cash for Clunkers, Cash for Refrigerators, and Cash for Casas are trying to stimulate consumer spending and increase consumer debt.
7. Like Japan, mark-to-market accounting requirements for banks have been partially suspended.
8. The Fed has been directly financing corporations through its commercial paper lending window.
9. TARP, TALF and the host of other programs were implemented to keep bankrupt institutions afloat.
10. They have been buying stock in financial and commercial companies.
11. They have been buying U.S. debt, effectively partially monetizing the deficit.

It is not surprising that these policies have led us to many of the same results as Japan experienced:

1. Deflation.
2. Collapsing real estate values.
3. A shrinking money supply.
4. Decreased bank lending.
5. Falling consumer spending.
6. Falling consumer credit.
7. Increased federal debt.
8. Falling GDP.
9. High unemployment.

One might ask, with all this faith in Keynesian policies, why aren't they working? Why are we still having these problems? And, why aren't we doing something different than Japan?

The reason the economy is not responding is that there is too much bad debt sitting on the books of lenders and companies. Most of it is related to the real estate bubble: home mortgages, commercial real estate loans, consumer debt, and the derivatives and other products that sit on top of it.

Banks are afraid to lend or foreclose on bad debt unless they are forced to because they know they will need to come up with additional Tier 1 capital because their capital base is insufficient. Because credit is tight, home owners are finding it difficult to refinance their loans because of stricter underwriting standards while home values are falling. CRE loans are even more difficult because commercial financing has largely dried up for troubled projects.

And, consumers aren't borrowing because they are (i) afraid of their economic future, and (ii) the big spenders, the Boomers, don't have enough saved up to retire, so savings are going up.

This is why banks aren't lending. As a result, money supply is falling. This will continue until the debt situation is resolved, but the government is doing everything it can to frustrate these corrections because they know the cure (tight money) will cause more banks and business to fail. But unless the debt is removed, liquidated, or paid, banks will remain zombies.

If we are following Japan's remedies, will we experience Japan's economic results? This depends on a lot of factors, mainly how the government reacts to economic phenomena. But, all things being equal, I think there are several key differences and similarities between the U.S. and Japan that will determine a different outcome.

Let's examine these differences:

Policy	U.S.	Japan	Outcome
Prevent banks from writing off bad debts either through suspension of mark-to-market accounting rules or by injecting massive amounts of capital into banks to keep them from bankruptcy.	Yes	Yes	This is a "yes, but ..." for the U.S. Both countries banks have seen lending collapse because of lack of loan demand and because they are afraid to take risks with capital, knowing that they might need the capital just to survive. This has led to a declining money supply (say, M1 MULT) which has thwarted inflation. Inflation is a monetary phenomenon, not just rising prices. Inflation is a reflection of people's lack of demand for an increasing supply of dollars. People have less demand for holding the flood of money which results in greater demand for goods, which results in increasing prices. So for the moment as the money supply shrinks, people hold cash (what Keynesians call "hoarding") as a sensible response to economic uncertainty, creating deflation and falling prices. I see this overhang of debt as the current big problem in the U.S. because by preventing its liquidation, economic recovery is delayed. But see the next topic.
Prevent banks from going bankrupt.	No	Yes	This is kind of a "no, but ..." for the U.S. This is a major difference between Japan and the U.S. While the Fed and Treasury bailed out of some of the big money center banks in the U.S., the FDIC is letting the majority of banks, those who do much of the real estate lending, consumer financing, and small business lending, fail. Presently 99 banks have been closed down or merged into other banks by the FDIC. While that is a small amount, the other side of the coin is that capital requirements for banks have been tightened and the FDIC is starting to require banks to write some construction loans down (not allowing them to wait until the interest reserve is used up before they have to revalue the loan). This restricts credit and will lead to more failures. Here's the most interesting fact: it turns out that only 5 major money center banks held 80% of derivatives that were on the books of 100 U.S. corporations: JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup, and Morgan Stanley. Those five banks also account for more than 96% of these companies' exposure to credit derivatives. It's about the same for credit default swaps. So, while propping up these big banks may keep a large amount of debt hanging around the economy, this phenomenon doesn't carry over to the majority of banks in the U.S. Their problems are mainly commercial real estate, equity lines, and consumer loans. I don't mean to play down the size or risk of this debt held by these 5 banks, but I think this represents a significant difference from Japan. It is incorrect to say we are bailing out all banks in the U.S. This toxic debt is a serious drag on these banks and, if the government continues to backstop their losses on them, it will delay recovery and prolong deflation. But, and this is a big "but", the U.S. is more likely to flush most of its commercial debt held by the majority of banks. I foresee many more banks being taken over by the FDIC and I believe most of it will be related to CRE debt and consumer debt. This, contrary to current thinking, is a positive for the economy and I hope that the only zombies we'll see are the big five. If we don't allow debt to be liquidated, we'll be more likely to repeat the experience of Japan. As I said, it all depends on the government's policy response as they see more and more banks fail.
Prevent corporations from going bankrupt.	No	Yes	This issue is more clear cut. Japan did not let companies fail. The banks just sat on their corporate customers' loans and the government encouraged this. Other than a few major examples, GM and Chrysler, I don't think that will happen in the U.S. Thus, the specter of zombie companies will not be a problem in the U.S., except for the few that have been bailed out. And this is being reflected in the numbers as bankruptcies, personal and business, are skyrocketing.
Entrepreneurship.	Yes	No	This is not to say that the Japanese are not enterprising, but they, like many other countries in the world, do not have the level of entrepreneurial drive and financing that exists in the U.S. According to the SBA about 44% of jobs are found in small businesses, and they have generated 64% of net new jobs over the past 15 years. Roughly 627,200 new businesses were created in 2008 and 595,600 were closed. Now that's some kind of enthusiasm. I could not find comparable statistics for Japan. Perhaps some reader could aid me in this. What I did find is a rather stagnant level of business establishments over the past few years. Let me get to the point: the U.S. economy is more dynamic and resilient than Japan's economy because of its entrepreneurial drive, and that is a significant advantage for economic recovery. It seems that Americans jump at the chance to be their own boss and are willing to take big risks to do it. Not to mention the economic rewards for success. This creates a dynamic Schumpeterian capitalism that many countries don't have. Part of the American "genius" if you will. Our economy is geared to entrepreneurial activity. How many countries have the huge pools of venture (high risk) capital that we do? How many countries send their capital here for investment in our start-ups? While venture capital investment was -63% in Q2 2009, there is a huge pool of capital waiting on the sidelines to fund new businesses. It is cyclical like everything else. And, being a believer in the ability of the economy to correct itself, barring government interfering with the process, I know that this will return with a vengeance. You could argue that new regulations will interfere with business formations, but since that trend is spreading worldwide, that is a relative problem, and we are still the best venue for starting a new business.
Government deficit financing by foreign investors.	Yes	No	The Japanese government has the ability to finance almost all its deficits internally through its recently privatized post office savings system — basically a large savings bank run by Japan Post. It controls about 25% of household assets in Japan and the government taps into it at will. Almost 20% of the national debt of Japan was held by Japan Post. Assets in 2007 were about $1.7 trillion. It has been a nice tool for the government to finance its deficit without having to rely on foreign investment or monetize its debt. As we know, the U.S. relies heavily on foreign investors to finance its deficit. They finance $3,428 trillion of the $11,545 trillion outstanding, or 30% of our debt. While increasing U.S. savings is making somewhat of a dent in this number, foreign investors have significant leverage over the U.S. In additional the Fed has been monetizing some of the debt. This is an invitation to inflate. (See below.

Where does that lead us? I think these differences will prevent long term deflation in the U.S. Although I believe we will continue to see deflation until more debt is liquidated and banks are allowed to fail. The timing of this is impossible to remotely forecast. But, with the rising problems in commercial real estate, we'll see increasing bank failures in the next couple of years. This cleansing effect will set the stage for renewed growth. It will also set the stage for renewed inflation. I don't buy the Fed's "exit strategy."

The economy will "recover," assuming a substantial amount of debt is liquidated as I envision, and businesses will start to pull us out of this de/recession. The ensuing "recovery" will not be supported by real savings (as defined in terms of Austrian economics), but rather by a flood of paper created and supported by the Fed. As business demand for credit grows, it will put upward pressure on interest rates because there aren't enough real savings to support growth.

The Fed will keep pumping new money and credit into the economy to keep interest rates down to thwart a second collapse in the economy (as in 1937). As prices rise, the Fed will be caught between its urge to tighten credit and pressure from politicians to keep the boom going. Especially if it's necessary to insure a Democratic re-election.

Add to the mix the fact that increasing deficits and inflation will cause a decline in the dollar and pressure the government to raise interest rates to attract foreign buyers of Treasury paper. Perhaps our sovereign credit rating will be lowered if the government doesn't raise interest rates.

I think the inflationary process will last for some time because it will benefit debtors, including the federal government, and will allow them to pay down debt with cheap dollars. The perception of a recovering economy will carry the Democrats and President Obama to victory in the 2012 election.

Prices of goods will start to increase at rates not seen since the 1970s. I don't believe that we will see hyperinflation for reason that everyone, Keynesian, Monetarist, and Marxist knows how such events arise and won't let it happen. It will be reminiscent of the 1970s when, contrary to Keynesian theory, we were able to coin that wonderful word, "stagflation": inflation and economic stagnation occurring at the same time.

The result of any inflation is, ultimately, a declining economy because of the lack of real savings to support real growth. The trigger of its collapse will be the necessary and unavoidable tightening of money and credit by the Fed to control rising prices. Real wages, real production, and real prices will decline.

While I can only guess as to the timing of these events, I believe it will occur during the Obama Administration's second term. Obama and his advisers' initial response to rising prices after the election will be to "temporarily" impose some form of price and wage controls to put a lid on prices before the Fed starts to tighten money and credit. While Obama's advisers understand the fallacies of price and wage controls, political pressure from the Democrats will lead to the expediency of controls. As politics is substituted for market based pricing, there will be massive distortions in production, which, if left in place too long, will seriously prevent future growth.

It will be a mess.

Please also see Economic Megatrends That Will Drive Our Future.

Comments

[Anonymous]

Some major differences being missed are:
- the size of the bubbles in the RE and stock market in Japan were much larger than the US
- Japan had and continued to have a large trade surplus (most people got this)
- Japan had negative or zero population growth, demographics between the two countries are very different
- the US dollar is the reserve currency
- both countries were affected by international recessions but the timing and the type of recessions are different
- the debt levels in other countries are much higher this time
- the US is not in the worse boat, look at Japan, the UK and some other countries in Europe
This is different, perhaps more like the 1970s, how it will turn out is anyone's guess. Also, the timeline will not be apparent until long after the events. Are we at the bottom of a trough, or on the way down?

[Anonymous]

As a side note, Japan produces some valuable exports. America's top export is derivatives.

[Anonymous]

Hilarious. You hit the nail on the head.

[Econophile]

Very clever!

[SWRichmond]

You've only reviewed some of the economic factors, and none of the political ones. 

1. Reserve currency difference
2. Global empire difference
3. Ability to earn foreign exchange by exporting to the largest consumer economy on the planet and in the midst of a credit bubble difference
4. Unemployment rate difference

There is no valid comparison between Japan's experience and what the U.S. has in store for it.

[mannfm11]

Do you know if we paid the Chinese back for our bonds, they would probably take the money and buy bonds with it?

[Econophile]

Since the yuan is tied to the dollar, they don't have much of a choice other than to invest in our debt. Sword rattling won't change that.

[mannfm11]

I wrote an email to someone today that has a popular site.  I don't know if he will read it, but I will probably put it on my blog, as I spent some time writing it, plus it had some ideas I want to develop.  Deflation is an interesting creation because it isn't entirely what people think it is and the solution to it isn't the Irving Fisher solution of avoiding swelling dollars.  It is clearly the existence of too much debt.  But, I have a theory that the existence of too much debt and how much debt is too much is far from what we end up with and quite often so is the time frame.

In short, I believe deflation started in the late 1980's and the US was bailed out by moving its interest rates, which had been too high for a decade down to more normal levels and triggering a refinance/consumer spending boom and a housing recovery boom.  These generated money for a stock bubble.  They also forced the hand of Japanese who had their stock bubble burst when the US caught a deflationary cold in 1990.  To preserve their export market, Japan lowered their interest rates and created their own housing boom which made a bubble that burst and cut off free credit for expansion.  The US was able to reflate a lot, but the amount of debt and the size of the Japanese economy was too large for the US to pump them up too.  At best we kept the economy going. 

Then in 2000 the stock bubble burst here.  Greenspan did what he did before and this time the speculation went from stocks to housing.  Japan created a 100 year mortgage, the US did 2 better, creating interest only and subprime where you could sign with a paw print.  This pushed Japan back one more step. 

Here is the problem with zero interest rates.  There isn't enough interest for older people to retire and I am sure that created an immediate back lash in consumer spending in Japan.  To have no interest earnings on a pile of money means you have to save an amount of money for each year you think you are going to live.  It also allows for huge piles of debt to lay around everywhere.  You can't pay back 4 years of earnings.

Another problem in Japan is the savings rate.  They say it is a problem here, but debt and savings are mirrors of each other.  If the US consumer is in debt, his savings will pay down his debt. Savings in Japan only creates more of it.  It is almost like they need to take every dime they have and spend it and we need to take it all and save it. 

I got the idea that deflation started in the 1990's after reading the reports attached to Pintos on the FHA last week.  I knew that default rates on real estate in the late 1990's was near a record, but I thought it was merely because the economy was bad.  It was high I think now because deflation had already started its influence and the debt was just beyond payment.  We have been and had been hocking home equity in some fashion for several years to fight off the effects of excessive debt.  It has caught and passed us now. 

Anyhow, I think deflation was the cause of this problem.  The reports were clueless as to why with a good economy and stable or rising home prices were defaults and foreclosures so unusually high.  More debt than we can pay.  Debt has to be paid off in some fashion and housing is one place it doesn't wait, but comes due every month.

[Econophile]

Deflation is always a monetary phenomenon. Deflation occurs where there is a demand for cash because of economic or political uncertainty, or where the demand for money exceeds the existing money supply at any given moment. The effect of deflation is generally declining prices. Because bad investments were made during the prior inflation, these economically failed businesses cannot pay off their debt. If we let them keep the debt by propping them up in various ways, then that doesn't mean they will be profitable, it just means they are continuing their failed business plan. Until the debt is wiped out by bankruptcy or forgiveness, capital will not be redirected to profitable businesses. It has always worked that way in every recession/depression.

[Anonymous]

unless the guys from Goldman and JPm get together and buy up the many, many houses here in SoCal that overhang this RE mkt, we'll have nothing but deflation in the ONLY mkt that counts. good luck Benbie, et. al in stopping this Niagra sized waterfall. smooches!

[Anonymous]

didn't read the article because i already know the answer....which is that we will have a multi decade depressionary future just like or worse than japan's.....

the dollar carry trade has begun in force and will in turn force interest rates low to perpetuate it and keep a lid of sorts on debt service of the federal debt....

however, artificially low interest rates destroy capital....the yen carry trade financed our boom during the 1990s/00s....the american economy is radioactive....

speaking with a recruiter today she that jobs have been scarce all year and that those which materialize vanish just as quickly before they are filled....she said so many companies are holding back....anecdotal evidence of wilted green shoots...

[Anonymous]

+10

[Spitzer]

God almighty. I quit reading after he said that 

"The perception of a recovering economy will carry the Democrats and President Obama to victory in the 2012 election."

Obama is done fool

[smokeybear]

The big difference between Japan and the US is that Japan still HAD an income. They exported more than they imported.

As the we increased our dependency on imports thereby reducing our income margin, the only way to make up the difference was through exponentially increasing public and private debt.

If your family keeps spending more than it brings in eventually you must either increase your debt load or go bankrupt. The problem with increasing your debt load with static or falling income is that sooner or later you arrive at what Hyman Minsky called "ponzi finance" -- that is, you begin to repay debt with more debt.

In time the karma that this irregular economic exercise creates is that of debt saturation and its ever-present companion, insolvency. Natural forces take over human idiocy.

Therefore even though Japan has been in a constant struggle with deflation for decades, they were yet able to maintain an income by selling more than they bought...... to us.

So, my fine zeroed-in friends.....

Until we can manage to produce sufficient income to not only pay for imports, but also pay down debt approaching infinity, we will eventually forget this never-ending mental game of comparing and wishfully aligning ourselves with Japanese deflation.

In the end an over-patched, cracked, bald tire must simply be discarded.

0.

[Econophile]

Smokey, this is a common economic misconception. Current accounts don't matter. As I pointed out above, we've had growth since the 1980s running current account deficits. If you live in Iowa and buy more goods from Kentucky that you sell to Kentucky, does that matter? No. What you are talking about is what was called Mercantilism, where state operated enterprises toted up their 17thC winnings by how much gold they had coming in. Adam Smith and others showed the fallacies of that argument. Trade is good for all parties.

[Daedal]

If I provide a farmer with accounting services, and he gives me food in exchange, then we are both better off. He is able to manage his assets, and I get to eat as a result. So trade doesn't necessarily need to be an exhange of goods.

Having said that, if I'm a farmer and a Calulator manufacturer, and I let you borrow my calculator, which you then use to trade me for some food that I farmed, then the net result is that I gave you food, period. IE, I'm net worse off, and you are net better off (at my expense). This latter example is more closely the relationship between USA & China, rather than the former, which I believe you think exists.

[Econophile]

The "USA" doesn't buy Chinese goods, consumers do. The rest is accounting tricks so to speak. Dollars lent to the federal government don't have anything to do with my purchase of Chinese goods. If the US government wishes to print more dollars and devalue it so that my prices of imported goods rise, that's the impact. Foreign trade isn't smoke and mirrors or you wouldn't be wearing that T-shirt that was made in China.

[Unscarred]

I'll take Fed policy during the 1930's for $200, Alex.

http://online.wsj.com/article/SB1000142405297020344010457440282220294423...

[Apocalypse Now]

We had inflation bordering on hyper-inflation already.  People seem to lack the proper perspective, only looking forward to inflation but we already had it as evidenced by many commodities, housing prices, and equities and that bubble of inflation popped and we are now in deflation off those highs. 

Do you know how to spot a real estate bubble? It's when housing prices increase faster than average wage increases - notice the base here relies on wages, that's an important understanding going forward as we tie prices back to reality.  It would be interesting to see average wage changes relative to a number of asset classes for a view toward over and under valued assets.

The system is trying to reinflate the bubble and stabilize real estate since this is the banks primary investment, but money velocity, unemployment and business growth incentives are not supportive.  It is very clear we are in a deflationary spiral.

With wages going down inflation would be brutal - if we do have it, millions will starve to death since they won't have access to funds to pay for food and shelter.  This could only be averted if jobs pick up and wages increase, or Bernanke literally starts dropping money from helicopters. 

A currency crisis could bring about hyper-inflation, and the recent rumors of moving off the US dollar petro currency will devalue it further.  This is a grand strategy if we think that exports will pull us out of the depression since with all our debt the devaluation would benefit exports, foreign capital investment, and reduce the impact of the debt - but of course hurt the savers (American, Arab and Chinese).  The US could devalue the dollar without causing inflation for US supplied products, and the same goes for imported goods from countries that are also printing money with us.

I believe Japan and the GD are still very relevant comparisons, and it looks like the 30 year and Bill Gross believe the same.

[Anonymous]

If we get a second term of Obama and he continues this spending, then we are DONE. Our decline will be unavoidable at that point and probly sooner.

[Souverainiste]

The only way money supply is shrinking is if you're standing on your head while you look at the chart.

[Econophile]

Money base is growing, M1 and other measures are shrinking. Go to FRED and check it out.

[Econophile]

To Anon #96801:

I'm not sure what the relative current accounts and savings rates add to the conversation. Our current account deficit has declined as we reduce imports and slightly increase exports because of the declining dollar. Japan's positive current account surplus has decreased a bit (about 10% because of falling exports). But so what? We've run deficits for 20 years.

Our savings rate has gone up, but is currently flattening (about 3%). Japan's has been declining from a high of 12% in the early '90s to about 2.2%. Japan's is declining because of an aging population. U.S. has been increasing because of the factors I mentioned: economic uncertainty and retirement deficits.

Current accounts don't mean a lot; its only value is to calculate the dollars abroad that will impact dollar levels and maybe Treasury debt financing.

What matters in this conversation is the resolution of debt.

Can you expound a bit on your question?

[Anonymous]

Yes, the resolution of debt is the key question. Here, i believe US and Japan will end the same. But what also matters is how fast we'll get to the final point. Looking back at Japan at the beginning of the lost decades, it's structure of economy, savings rate and current account surplus that help Japan to endure the decline for so long. We do not have these luxuries, so our road to the bitter end would be much shorter. Your prediction about Obama's second term might be wishful thinking.

I do believe also, that all our "bank failures" so far are not nearly enough to make clear difference from Japan case, and our establishment really dreams about copying this scenario, which is impossible given the sheer size and composition of impaired assets.

Hope for small business - led revival may also be futile. Some people mentioned taxes, but i think the main obstacle is the structure of our economy with bloated service segment.

Well, it seems in the end we come to the same conclusions, only i am gloomier.

[Econophile]

I think my point is that in the next 3 years, the bulk of CRE debt, which is the coming problem, will cause more bank failures and the ultimate resolution of this debt. Consumer debt is already declining significantly. Toxic (RMBS) debt is being written down as more homes go into foreclosure--and as you know, loan renegotiations haven't worked out too well.

So contra to most deflationists, I think this debt will work its way through the system sooner than later. I don't get the argument that Japan's current account supported their economy. We have had solid growth since the 1980s (nominal) while running current account deficits. It doesn't matter.

Small business will recover: as I pointed out, it's still a very business friendly place relative to the rest of the world. The service sector is what we do. You are confusing concepts of "we have to make something" with reality. We can't compete labor-wise in a world of free trade. Get over it. Common economic misconception.

If we get there shorter, which is my argument, then we'll see inflation sooner. I just don't see 19 years of deflation.

[Anonymous]

i agree that current accounts / trade deficits can
be a confusing issue because at some superficial
level they do not matter....yet large chronic
deficits do indicate a flight of capital....and
that is a problem....

it is a problem because it represents lost jobs and
lost income...each job loss represents a loss of
dependent jobs and skills....it weakens the nation
rather than strengthens it....

i agree that we don't have to make anything and get
utterly sick of the argument which says that our
problems are due to that shortcoming....i could
either produce shit or shovel shit and in the small
it doesn't matter as long as either are profitable
....and if shoveling shit is more profitable then
i would rather shovel it than make it...

yet, the inability to shit is probably symptomatic
of other problems such as capital flight and shitting
supports a great deal of secondary and tertiary jobs...

the inability to support manufacturing is
indicative of tax, regulatory, and monetary policy
inimical to capital formation.....

we could compete in a "labor-wise" world if we could
capitalize labor and non-labor to produce...however,
america is in complete capital meltdown....thus
jobs go overseas....

one other point on current accounts....if our
trade deficit is due to importation of capital that
would be one thing....if it is simply a drain for
expenseable goods/services then again we see symptoms
of a dysfunctional economy....

above all, i abhor the retarded notion that we have
to trade....no we don't have to trade....fine if
we do and fine if we don't....having a self
sufficient economy is a desirable goal...surplus
can be exported....talk of trade is an obsessive
compulsive disorder which has no intrinsic or
economic merits...

[Econophile]

I guess we are at an impasse here. Trade is good for the US. What you see is lost jobs due to foreign competition. What I see is increasing employment over the years we've had trade deficits. You can't dispute this fact. Except for the present business-credit cycle. We aren't suffering from a loss of capital in the US. That just isn't true. See my comments elsewhere on Mercantilism.

But thanks for your comments.

[Anonymous]

What's the probability of snagging one of those zombie positions where you collect a paycheck for staring out a window all day.

And, if I can't have a window seat, how about an internet connection so that I can day trade and ogle porn all day, a la RoboT.

Ass long as there are no drug testing requirements, I'm in.

[MountainHawk]

Obama again in 2012.... say it ain't so... 

[Anonymous]

Interesting arguments. It would be more helpfull, though, if you incorporate in your analysis the difference in saving rate and current account balance for both countries.

[uno]

As far as wages yes there will be deflation.  Taxes (state, local, fed, VAT, trader, health care) will all go up for who ever is left in the middle (plebian) class.  As far as necessities, (gas, heating oil, food) there will be hyper-inflation.  Lucky the fed (Satan's little helpers) will come up with more hedonics to prove we are better off.

[Daedal]

Toward your "Small business is the source of growth" point: Higher Taxes, Higher health care costs, and lack of available credit, as well as a lack of economic activity (business) will change the paradigm you speak of. ie, If you're betting on small business to drive economic growth, you're not going to see what you saw in the past.

Also, I wouldn't be so certain about a weak dollar carry trade for Obama's re-election. They can print all the money they want, but that doesn't cure any of the ills, like unemployment. And it simply further delays restructuring and proper reinvestment of assets, which would drive employment.

In short, government policy that you've outlined will ensure a higher unemployment and a lower standard of living for those employed. Take the stock market out of the equation, and all you're left with is a lot of misery. Wait until we start getting another round of layoffs in the next few months.

Your comparison is good, but you give too much weight on optimism, I think. What about the debt levels of individuals in USA vs Japan; as I recall Japan has always had a positive savings rate and they primarily financed their own deficits. The income taxes USA collects go to pay Interest on USA's debt. It's absurd.

[Econophile]

Not sure we are talking about my article here. I am not advocating any government policies here. My view is that the government caused this crisis.

You may be correct that Obama will tax the crap out of business, but I don't think so. You may wish to read my article on the coming national sales tax. Carry trade? Where did that come from? That's dead with equally competing zero "fed funds" rates.

Obama may not win a second term, but I think he will (history is on my side). Since most of the Republicans support Keynesian fiscal stimulus, where do they go? Maybe the only issue for them will be Afghanistan. See my other comments on the savings rate. One of the important points in the article was that they were able to finance internally their deficits because of the postal savings system.

[Anonymous]

shades of mish shedlock. another japan/united states analogy. gads.....:)

[Econophile]

Nope, Mish sees years of deflation just like Japan.

[Gordon_Gekko]

NO.