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Friday 8 January 2010
A warm welcome to the lost decade
As we enter the second decade of the 21st century, the world of international business and finance is feeling better about itself than at any time for the past 2-1/2 years.
As we enter the second decade of the 21st century, the world of international business and finance is feeling better about itself than at any time for the past 2-1/2 years.
You wouldn’t exactly say there is a mood of self-congratulation about. But there is a definite sense of relief in the air. Confidence is mounting that the global economy has avoided its worst-case scenario following the financial crisis of 2008.
Thanks to drastic emergency policy action by the US Federal Reserve, which promptly slashed interest rates and began printing money, and the Chinese government, which launched an unprecedented programme of economic stimulus, hopes are high that we have managed to avert the threat of a 1930s-style United States Depression or a 1990s-style Japanese lost decade.
Not everyone shares the optimism, however. Dozens of commentators have pointed out that last year’s recovery in world stock markets, which saw America’s benchmark S&P 500 Index bounce back by two-thirds from its March low, mirrors similar rebounds in earlier crises; rebounds that subsequently turned out to be temporary bear market rallies as markets ran out of steam and rolled over, plunging afresh to new lows.
And in terms of the underlying economics, there are also some disturbing similarities between the 2008 crisis and the bursting of Japan’s bubble economy in the late 1980s.
According to Julian Jessop, the chief international economist at London-based research house Capital Economics, those similarities imply that the developed world may not be able to escape sinking into its own Japanese-style lost decade after all.
Japan’s years in the economic wilderness followed the bursting at the beginning of the 1990s of the country’s twin stock and property bubbles (see the first chart). Like the US equity and real estate booms almost 20 years later, those bubbles were inflated by policymakers who kept interest rates low in response to subdued inflation, which in turn had been held down by external causes.
In the case of Japan, it was the appreciation of the yen following the Plaza Accord. In the US, it was the deflationary emergence of China as an international trading power.
In both cases, the bubbles were fuelled by financial deregulation leading to ballooning leverage levels, which left the banking systems dangerously exposed to real estate prices.
In Japan, the excess leverage was concentrated mostly in the corporate sector, and the result was a long period of sub-par growth as corporations shrank their balance sheets.
In the US, it is mainly households that are carrying too much debt. If anything, that means the impact of deleveraging on demand will be even more painful, given the importance of household expenditure to the overall economy.
That suggests deflationary pressure could turn out to be an even bigger problem for the US economy than it was for Japan.
The standard riposte to this argument is to counter that the US policy response has been far more rapid and wholehearted than in Japan, where the central bank did not embark on its policy of quantitative easing - printing money - until 2001.
But although quantitative easing in the US has provided plenty of liquidity for the stricken banking system, its wider effectiveness in a demand-deficient economy is debatable. In Japan, most of the extra liquidity simply ended up on deposit at the central bank in the form of excess reserves.
What growth spurts there were during Japan’s lost decade were driven by the government’s massive fiscal expansion. But each time the stimulus was removed, the economy slumped back again.
The fear now is that other developed economies could find themselves in a similar hole, reliant on continued government stimulus and rising national debt levels to maintain anaemic growth rates.
Except that Jessop at Capital Economics warns the situation could be even worse. The US and other struggling major economies today lack two important crutches that supported Japan in the 1990s.
First, as the second chart illustrates, Japanese households entered the lost decade with high savings rates as a proportion of disposable income, and were able to run down their savings in order to maintain consumption.
The US is in the opposite position. Households entered the decade with a savings rate close to zero, which, as of November, had increased to 4.7 per cent of disposable income, eating into their spending potential.
Second, the Japanese economy was supported by robust external demand for its exports. Today, with global demand subdued, the US is unlikely to be so lucky.
As a result, there is a real danger that the widespread confidence business people and investors feel going into 2010 could turn out to be misplaced, and that far from emerging from their crisis, many developed world economies could now be at the threshold of a painful lost decade of their own.
2 comments:
A warm welcome to the lost decade
Tom Holland
04 January 2010
As we enter the second decade of the 21st century, the world of international business and finance is feeling better about itself than at any time for the past 2-1/2 years.
You wouldn’t exactly say there is a mood of self-congratulation about. But there is a definite sense of relief in the air. Confidence is mounting that the global economy has avoided its worst-case scenario following the financial crisis of 2008.
Thanks to drastic emergency policy action by the US Federal Reserve, which promptly slashed interest rates and began printing money, and the Chinese government, which launched an unprecedented programme of economic stimulus, hopes are high that we have managed to avert the threat of a 1930s-style United States Depression or a 1990s-style Japanese lost decade.
Not everyone shares the optimism, however. Dozens of commentators have pointed out that last year’s recovery in world stock markets, which saw America’s benchmark S&P 500 Index bounce back by two-thirds from its March low, mirrors similar rebounds in earlier crises; rebounds that subsequently turned out to be temporary bear market rallies as markets ran out of steam and rolled over, plunging afresh to new lows.
And in terms of the underlying economics, there are also some disturbing similarities between the 2008 crisis and the bursting of Japan’s bubble economy in the late 1980s.
According to Julian Jessop, the chief international economist at London-based research house Capital Economics, those similarities imply that the developed world may not be able to escape sinking into its own Japanese-style lost decade after all.
Japan’s years in the economic wilderness followed the bursting at the beginning of the 1990s of the country’s twin stock and property bubbles (see the first chart). Like the US equity and real estate booms almost 20 years later, those bubbles were inflated by policymakers who kept interest rates low in response to subdued inflation, which in turn had been held down by external causes.
In the case of Japan, it was the appreciation of the yen following the Plaza Accord. In the US, it was the deflationary emergence of China as an international trading power.
In both cases, the bubbles were fuelled by financial deregulation leading to ballooning leverage levels, which left the banking systems dangerously exposed to real estate prices.
In Japan, the excess leverage was concentrated mostly in the corporate sector, and the result was a long period of sub-par growth as corporations shrank their balance sheets.
In the US, it is mainly households that are carrying too much debt. If anything, that means the impact of deleveraging on demand will be even more painful, given the importance of household expenditure to the overall economy.
That suggests deflationary pressure could turn out to be an even bigger problem for the US economy than it was for Japan.
The standard riposte to this argument is to counter that the US policy response has been far more rapid and wholehearted than in Japan, where the central bank did not embark on its policy of quantitative easing - printing money - until 2001.
But although quantitative easing in the US has provided plenty of liquidity for the stricken banking system, its wider effectiveness in a demand-deficient economy is debatable. In Japan, most of the extra liquidity simply ended up on deposit at the central bank in the form of excess reserves.
What growth spurts there were during Japan’s lost decade were driven by the government’s massive fiscal expansion. But each time the stimulus was removed, the economy slumped back again.
The fear now is that other developed economies could find themselves in a similar hole, reliant on continued government stimulus and rising national debt levels to maintain anaemic growth rates.
Except that Jessop at Capital Economics warns the situation could be even worse. The US and other struggling major economies today lack two important crutches that supported Japan in the 1990s.
First, as the second chart illustrates, Japanese households entered the lost decade with high savings rates as a proportion of disposable income, and were able to run down their savings in order to maintain consumption.
The US is in the opposite position. Households entered the decade with a savings rate close to zero, which, as of November, had increased to 4.7 per cent of disposable income, eating into their spending potential.
Second, the Japanese economy was supported by robust external demand for its exports. Today, with global demand subdued, the US is unlikely to be so lucky.
As a result, there is a real danger that the widespread confidence business people and investors feel going into 2010 could turn out to be misplaced, and that far from emerging from their crisis, many developed world economies could now be at the threshold of a painful lost decade of their own.
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