Are We Turning Japanese?

After the Great Crisis and Recession of 2008 there were a lot of economic and market commentators arguing that the US was headed in the direction of Japan. Japan’s economy, stock and real estate markets peaked in the late 80s and they’ve been trying to find the formula for sustainable growth ever since. Since the US had suffered a real estate and stock market crash similar to Japan, the thinking was that the outcome would be similar. I resisted that view because there were and are big differences between post crash Japan and the US. Japan faced a demographic issue that made national economic growth very difficult. If national economic growth is a function of population growth and productivity growth, the Japanese had a permanent headwind in the form of a shrinking population. They could grow but it would have to come from very rapid productivity growth.

The US, I thought, was different. As a country open to immigration, we didn’t face the prospect of a shrinking population and therefore the US could grow out of its post crash problems. I am now beginning to wonder if we don’t have the same problem in a slightly different form. Our population is still growing, at least officially, but it has certainly slowed. Official population growth last year, at about 0.6%, was the slowest since the Great Depression but it was still a positive number. Or was it? What about the unofficial population? There are a number of reasons to believe that the unofficial population (illegal, undocumented, whatever your preferred moniker) probably declined in recent years. Construction jobs in the US are not plentiful and it isn’t exactly a secret that many of the folks swinging a hammer during the boom were here illegally. And my construction industry contacts tell me they have gone home and at least so far, have no intention of coming back. A better Mexican economy, among others in Latin America, and the housing bust reversed at least some of the flow of illegal immigrants to the US. So, maybe we do have a population headwind, just like Japan.

Of equal concern is the shrinkage of our labor force and falling workforce participation rates. What really matters for national economic growth is not population per se but the labor force and people’s willingness to work. The US participation rate has been falling since the turn of the century for a variety of reasons. Part of it is that the Baby Boom generation is retiring but that can’t explain all of it. The drop in the participation rate accelerated after 2008 and shows little sign of improvement (although it did tick up slightly last month). The explanation for that acceleration is complicated to say the least but there are some obvious candidates to explain the drop. The CBO last week released a report that predicted a reduction of roughly 2,500,000 jobs in the next few years due to the effects of Obamacare.  The CBO’s report concentrates on the disincentives to work in the law due to the phase out of subsidies. As income rises, ACA subsidies decline so it reduces the incentive to work and earn more because that has to be balanced against the loss of the subsidy. Of course, that can’t explain the drop that has already occurred but it does give us a clue about the causes.

These types of disincentives exist in all of our poverty programs, from food stamps to extended unemployment benefits and we’ve seen a plethora of them in the years since the last recession. These policies may be compassionate but as I’ve said many times, TANSTAAFL (there ain’t no such thing as a free lunch). Obamacare supporters last week pooh poohed the CBO report because they view it as a positive that people will be able to retain their health insurance even if they work less. By breaking the link between employment and health insurance, Obamacare will allow more leisure and I certainly wouldn’t argue that is a bad thing from a societal or moral standpoint but again, it isn’t free. More leisure is fine as long as one can afford it but surely not when it comes at someone else’s expense. We should also consider the possibility that this break could encourage more entrepreneurship as well since people won’t fret about losing their insurance to start a business. We can’t quantify that as easily as the CBO did the disincentives built into the law but it seems highly unlikely that the positives will offset the negatives.

Paul Krugman estimated the job and work hours loss would reduce GDP by 0.5% a year and dismissed that as “not all that much” and I’m sure he believes it is a price worth paying for universal (or near universal) coverage. Unfortunately, growth has lately been averaging just 2% so “not all that much” works out to a 25% reduction in annual growth. That doesn’t sound insignificant to me and it will have an impact. Again, TANSTAAFL. Health care reform was – and is – necessary but contrary to the way it was sold, it isn’t free and the structure of Obamacare made it more expensive than it needed to be. Personally, I think it would have been more prudent to move slowly and carefully with almost 20% of the American economy but I didn’t get a vote and now Obamacare supporters are reduced to arguing that fewer people working fewer hours isn’t such a bad thing. I don’t envy them trying to sell that to voters in the fall. By the way, I and a lot of others pointed this out before the thing was passed so it isn’t like it was hard to predict.

So, back to the Japanification of America. The reduction in our workforce is not the only way we are starting to look like Japan. Another feature of the Japanese economy during its malaise has been its “zombie” companies and banks. Japanese companies and individuals have spent the last nearly 3 decades working down the debt they accumulated during the boom years. Companies accumulated cash on their balance sheets rather than invest. Banks saddled with bad debts refused to lend, buying up government debt instead. And as that was going on in the private sector the government was adding debt, enacting various “stimulus” plans that raised government spending sporadically with little lasting effect. Debt to GDP at the time of the economic and market peak in the late 80s was less than 70%. Now, after decades of trying to spend their way out of the problem, debt to GDP is over 200%. Last but not least, the BOJ reduced interest rates to zero and then embarked on what we now call Quantitative Easing in 2001. And they are still at it today. Does any of this sound familiar yet?

For investors, the implications are significant. The Japanese stock market has yet to achieve anything close to the peak it achieved in 1989. There have been periods of fabulous gains, always followed by spectacular losses and lower lows. A 60%+ rally in ’95-’96 followed by a 40%+ loss that wiped all the previous gains. Another 60%+ gain in ’99 followed by a 60%+ loss from ’00-’03. A great 140% gain from ’03-’07 followed by another 60% loss to the lows in ’09. Another 60% gain into 2010 followed by a relatively mild 28% loss (and finally a higher low). And now a doubling to the recent highs. I happen to think that Japan is finally exiting its long economic and market nightmare but it may be just as the US is entering its own special deflationary hell. And as we enter – continue? – this period of stagnation, the rest of the world, that has become accustomed to relying on the US as consumer of last resort, will have to adjust their economic models. The emerging world that has grown by exporting to the US will have to find another path to growth. It seems pollyannaish to believe that will happen easily or painlessly.

There are ways we could avoid Japan’s fate but they would require a political consensus that just does not presently exist. Monetary policy cannot, as Japan has shown, repair what ails the US economy. Getting back to our historical growth rates will require major fiscal and regulatory changes that, for now, are all but impossible. If Japan is our fate expect a wild ride over the next decade or so or at least until our politicians wake up and smell the sake.

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5 Responses to Are We Turning Japanese?
  1. I disagree; Japan is trapped in a deflationary depression as is the US. The problem is that debt is too high, no one wants to borrow any more as they are having problems paying off the debt they already have, and the economy sucks because no one is borrowing money to take advantage of profit opportunities. This means the printing being done by the Fed isn’t expanding the money supply because our fractionated banking system isn’t lending that money out to expand the money supply.
    It’s called Capitalism for a reason; the capital has to be put to work for the system to work. To solve the problem the debt must go down, the best way to do this is with inflation, which will force wages up and make debt less onerous. The best way to create inflation is to pay off all foreign holders of US Treasuries ($5+ Trillion), this would liquefy world trade, devalue the dollar, give US exporters a price advantage, kick those countries that have been manipulating their currency to gain a price advantage (China, Japan, etc…) in the teeth (they overpaid for those dollars), and reduce the US Government debt burden.
    The Fed should then set an inflation target of 4%-5%, and use bank reserve requirements to maintain that target, while letting interest rates float freely to let the market tell them if inflation will rise or fall in the near future.

    • Interesting. Unfortunately, the “new monetary consensus” has a very strong hold on central bankers. Despite the extraordinary measures taken since late 2008, the overwhelming majoring of CB economists believe the the overnight rate should be the key tool for setting monetary policy. Setting gross monetary aggregates is an approach taken my Milton Friedman. We may well be moving to a reserve requirement system, especially with the FED able to pay interest on reserves. In practice, it is usually totally safe to keep under one percent of assets in liquid cash for customer withdrawals.

      The private sector debt burden is a huge drag. One way to fix this would be for the Federal government to run relatively large budget deficits for the next five years. (~6 percent of GDP) Remember (S-I)=(G-T) +(X-M) by identity. This could be achieved by simply repealing the payroll tax which is regressive.

      Households would then be able to repair their balance sheets. Of course, some may take the opportunity to gorge on more debt and buy cheap stuff from China…. The (X-M) term from above. The Fed would probably need to raise interest rates fairly quickly to prevent an explosion of private debt as after tax incomes rose…..

      In general, the past five years has proven that you can’t have good monetary policy without good fiscal policy. Interest rate is just one variable in investment decisions, and consumers really can’t spend again without paying off more debt first. Finally, as you acknowledge, getting inflation up again while in a liquidity trap is difficult. What we essentially need to do is to transfer some of the debt to the public sector by running deficits so that the private sector can save.

      Unfortunately, fiscal policy makers are clueless on how public finance actually works. The US faces no solvency problems, and is a zero default risk. It sells debt in its own currency. It exchanges government IOUs (T-bills, notes) for other government IOUs (Federal Reserve notes). It also has the power to impose liabilities on the public denominated in government IOUs (Federal Reserve Notes again). Finally, via the central bank it can create more IOUs to expire other IOUs at will. Conclusion: THERE IS ZERO RISK OF THE US BEING FORCED TO DEFAULT ON ANY OBLIGATION. Of course, idiot political leaders could choose default because they do not understand how the system works. But hopefully, the Tea Party is on the wane.

      Now, just because the government in theory faces no real budget constraint other than sense imposed ones, doesn’t mean that the government should spend without limit. In general, the government tends to use inputs (labor, machines, raw materials, ect.) much less efficiently than the private sector. Also, when the government spends too much and removes too much output from the private sector for “public purposes,” the private sector faces shortages, leading to inflation. This aside, in a depressed economy with high unemployment, there is virtually zero risk of the government taking up too much of the national output. Machines are idle, and workers are jobless…. Therefore its tragic that President Obama sees a reduction in the budget deficit as good news, especially when the country faces no solvency issues. Millions of people remain unemployed and lives are destroyed.

      In 2016, some candidate needs the gumption to actually educate the public on how the government spends, explain why budget deficits do not threaten national solvency (again, the public sector’s deficit is the private sector’s surplus!) and then pledge to run deficits of at least 6 percent of GDP for his/her first term. Again, I would achieve this via a combination of cutting/eliminating the payroll tax and making high return infrastructure investments.

    • If the Fed sets an inflation target at 4-5% and let interest rates float freely, won’t interest rates shoot straight up? What investor would lend money at the current interest rates then? I would think this type of rapid rise in interest rates would be extremely harmful to such a feeble economy as the US has. Also, think about the people relying on fixed income investments (elderly, retirees, etc.) – they would be devestated by such rapid inflation that your inflation target would bring on. The price of oil alone, as its dollar denominated, would gouge people’s budgets in such an impactful way. And, how do put a stop the inflation once it gets going? That is a fine art that I don’t believe anybody can properly anticipate.

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