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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