This Is So Not Like Japan
April 13, 2008
Some people have been comparing the present situation, in the US particularly, with the situation in Japan in the 1990s. Here’s a typical remark:
At the surface, many economic events seem sort of similar. There was a boom, some good times. They came to an end, maybe with a collapse of rather aggressively priced markets. There is a long stagnant period, which is often blamed on the bust. This general template fits both the Great Depression and Japan.
It is often imagined that there is a sort of “liquidity trap,” or that things need to be “liquidated” before the economy can right itself. Usually, such things don’t really exist. There is a sort of argument dating from the Great Depression, that once “demand” suffers a setback, it is hard to start it going again. The problem, according to these views, is not enough shopping. If there were more shopping, then companies would have more revenue, and the economy would “jump start” itself.
It has become popular in Japan, for example, to demand “reforms.” What are these “reforms”? Typically a grab-bag of mostly irrelevant nonsense. Often the government actually follows through and implements some of these “reforms.” The result, not very surprisingly, is that these efforts bear few results, because they don’t address the real economic problems. This produces the call for more “reforms,” with the reformers typically oblivious to the fact that the previous “reforms” didn’t work. As long as the economy is underperforming, there are these calls for “reforms.” It is exceedingly stupid, and has been going on for over a decade now.
One of the “reforms” I remember was that the cost of internet access should be reduced. Japan had a legacy pay-by-the-minute phone system, as opposed to the US unlimited-local system. Thus, when dialup was common, and people started to spend several hours per day on the phone for internet access, they began to run up big bills. This lasted for a few years, until cable/DSL became widely available. At that point, people switched promptly, because they could get DSL access for $40 a month as opposed to dialup for $200. Driven by such price incentives, the adoption of broadband was actually faster in Japan than in the US. Now 100mbps fiber access has become fairly common. All of it was largely irrelevant to the broader economy, of course.
Then there was the “Japan’s population is shrinking” argument, which was common as early as 1998 or so, even though Japan’s population continued to grow (slowly) until 2005. The fact that the population was growing (although it was predicted to begin shrinking later) never made much impression on those who blamed the economic difficulties of 1999-2002 or so on the shrinking population. It was another fable. Japan is a rather crowded place, with 120 million people in an area 91% the size of California, and about 85% of that mountainous. Already, there are about 3x as many people as can be supported by local agriculture, as there simply isn’t enough arable land. Australia doesn’t have an economic problem, despite being over 6x the size of Japan with 1/6th the number of people — in fact, there are fewer people in all of Australia (20m) than there are in Tokyo alone (36m). In the end, income is related to productivity, so as long as Japanese people are productive they will enjoy a high income, whether there are a lot of them or fewer. Same for Australia.
I could go on, but the point is that there is a sort of fable that develops, in which people who do no research tell other people their rather uninformed opinion of what’s going on, and in time a consensus develops which is not really based on anything at all. It seems like there’s a huge body of evidence, because there are so many people who are saying the same thing. But actually, there’s not much there at all. For example, there’s the fable that the problem with Japan’s banks was that they didn’t “liquidate” their bad debt holdings. I’ve argued previously that it shouldn’t matter whether such things are managed by the bank or some other holder. Usually these “liquidation” arguments are really just con jobs to get the government to force the banks to sell them some assets at a super-low price. But, in this case, Japan’s banks actually did liquidate quite a bit of stuff. Beginning around 2000, they were required to “get rid of their bad debt” within about a two year time period. They had to report semiannually on what happened to the bad debts they had on their books at 2000. By 2003, I remember that about 90% of it was gone.
This is from Sumitomo Mitsui Financial Group’s FY2002 (ended March 2003) annual report. The top table shows that of all the problem loans at the bank at 1H2000 (September 2000), of 3,247 billion yen, only 400 billion (12%) remained as of March 2003. However, the bank ended March 2003 with 2,654 billion of problem loans, with the remainder accumulating after September 2000. Note that in 2H2000 alone (October 2000-March 2001), a mere six months, the bank accumulated an additional 711 billion yen of problem loans.
The problem was, between 1998 and 2001, there was a recession that created many more new bad debts, so the total number of bad debts didn’t change much, and actually went up I think. Now, the conclusion of this exercise might have been that a) the banks liquidated the debt, and b) it didn’t work, as it didn’t solve the underlying economic problems, which caused the old bad debt to be promptly replaced by new bad debt. But did people come to that conclusion? No, they concluded that the bank’s didn’t liquidate the debt, even though they did, and that this non-liquidation was the cause of the continuing economic difficulties. It was totally wrong, although everyone thinks they were right because they received so much confirmation from other people who believed the same thing, which was easy to do since none of them ever did any research.
OK, that’s way too much intro for the real subject of this message. The point is, if you want to figure out what’s going on with an economy, I’d suggest following the process outlined in my piece on crisis management. That is:
Answer these questions:
1) Was there a significant tax change, such as high or rising taxes?
2) Was there a significant monetary change, such as a change in the currency’s value (against gold), foreign exchange rates, or interest rates?
3) Was there some other sort of issue?
Here are some answers for Japan, as far as I remember:
1) Yes, there were enormous increases in taxes, mostly on assets, particularly property. Property holding taxes exploded higher during the 1990s, in a purposeful act by the government to suppress property values. Also, the capital gains tax rate on property hit 90% for short term holdings in 1991, with 60% for long-term holdings, and this was not reduced until 1998. These were specifically to depress property values. Plus, there were some other significant taxes, such as a new withholding tax on interest income (it was effectively tax-free in most situations before), a consumption tax applied in 1989 and raised in 1996, a capital gains tax on equities, and some other taxes. This was offset somewhat by lower income taxes. Recently, there have been major increases in payroll taxes, which are particularly burdensome in Japan because they apply to all income, with no upper limit. Also, there may have been some significant capital gains tax increases, which I will have to research further.
2) Monetary conditions in Japan were wildly deflationary (rising yen) for many years. Between 1985 and 2000, the value of the yen tripled against gold. Super-ouch!!!! The yen’s value also rose against other currencies, introducing competitive issues — it went from 250/dollar in 1985 to more like 120/dollar in the 1990s, and about 100/dollar today. The BOJ raised interest rates rather aggressively in the early 1990s, specifically to suppress property values, but interest rates fell to extraordinary lows later, reflecting the monetary deflation.
This is what monetary deflation looks like.
3) There was rather aggressive pricing of property and equities in the late 1980s, although I think it was not as “bubble-like” as many people assume. If not for the problems described in 1) and 2) above, I think the economy would have done reasonably well during the 1990s, after an initial adjustment, overall similar to the US recession of 1990-1992. Indeed, if the income tax cuts of the 1990s (and late 1980s) were not matched with tax hikes elsewhere, the 1990s could probably have been pretty good for Japan overall, after the early difficulties. Around 1960, Japanese property and equity valuations also reached a peak, compared to earnings and cashflow from property operations. Both markets then stagnated for years, as valuations fell to a lower level. However, the economy did just fine during this period.
Here are some answers for the US presently, in my opinion:
1) No, there haven’t been any major tax hikes, and indeed there was a positive move toward lower capital-related taxes in 2003. However, it is likely that this tax cut will be reversed, adding to existing problems.
2) Monetary conditions in the US have been increasingly inflationary. The USD’s decline against other currencies has been experienced mostly as a positive thus far, due to “competitive advantage.” Interest rates have been extraordinarily low, given the inflationary conditions.
3) There was a bubble in residential housing, and a super-duper bubble in credit and derivatives. This unwind has been the main reason for economic weakness thus far. Plus, there is another, longer term factor, which is that the US consumer is maxed out on credit on something like a generational basis, and this is “reverting to the mean” at a brisk pace presently. Then, there are things like the explosion of derivative products, which is an Alice-in-Wonderland factor that doesn’t really have much historical precedent.
Here are some answers for the Great Depression:
1) Yes, there were enormous increases in taxes worldwide, first on trade (tariffs) and then on incomes and capital. These tended to get progressively worse through the decade, although that was not the case in Germany and Japan, where taxes began to fall somewhat in the later 1930s.
2) Monetary conditions were quite stable initially, as currencies remained pegged to gold. Forex rates were stable and interest rates were not particularly high. However, the rounds of “beggar thy neighbor” currency devaluations that began with Germany and Austria in August 1931, followed by Britain in September 1931 and Japan in December 1931, introduced a whole new factor to the worsening situation.
3) Asset valuations were not particularly high in 1929, in my opinion, as the stock market traded for about 20x trailing earnings — not much different than where it is today. However, there was an enormous surge in earnings at the time, somewhat similar to the 20%+ annual increases in earnings seen in India recently. Thus, expectations were geared for super-growth, and had to change rather drastically to reflect the emerging reality of tariff warfare and global recession. Excepting some oddities like the Florida land bubble, most lending seemed reasonably responsible, given existing expectations of high growth. The “laissez faire” approach to the financial system — there was as yet no deposit insurance and banks failed regularly, or the fact that equities could be bought on 10% margin — left the system somewhat more vulnerable to “systemic” issues. Also, today’s safety-net policies such as unemployment insurance or Social Security had yet to be implemented.
So, in this analysis, we see that there aren’t many similarities between the Japanese case and the US case at all. Japan had tax hikes, and the US had tax cuts. Japan had really terrible monetary deflation, and the US has had monetary inflation. Japan had some, but in my opinion not a ridiculous amount of, silly credit and asset valuation, while these factors made mankind’s first trip to Mars in the US case. (The worst overvaluations in the US were in the credit sphere, not so much valuing a $1 asset at $6 but valuing a $0.15 asset at $1.) Both the Japan case and the present US case also differ from the Great Depression case in several important particulars.
The fact that many people could consider these two (or three) examples as being similar, when they are different on virtually every important factor, shows how little research is actually being done. It’s not really all that hard to figure things out when you actually look, according to the 1-2-3 model presented here.