Is the U.S. turning Japanese? Before rendering judgment, consider that although "Japanification" may not be the desired outcome for the U.S., it is far from the worst outcome. Despite having lost its economic vibrancy decades ago, Japan has managed to maintain positive real growth, though lower than other countries (Chart 1).
Despite being positive, real growth was not enough to prevent deflation and the so-called Lost Decade in Japan. Indeed, moderating trend growth and deflation feel very bad even if real growth is on average positive. Importantly, the last 20 years in Japan have seen continuously deflating real estate and equity prices. The fall in asset prices has been punctuated with a few reversals, but prices are down more than 70% from peak levels (Chart 2). Deflation has reigned through most of the period and the general price level in Japan today is the same as in the early 1990s.
To be sure, the opposite could occur in the U.S. "“ inflation sparked by accommodative monetary policy or rising demand for goods that companies have scaled back their ability to produce, and PIMCO is also incorporating this possibility in the set of long-term scenarios.
Still, we must appreciate Japan's Lost Decade, which resulted in an economic malaise and embedded a deflationary trend that is now in its second decade (Chart 3). And if a Japan-like deflationary scenario becomes the baseline for the U.S., it would have profound implications for asset prices. The U.S. may yet escape such an outcome, but a comparison between the two countries reveals an uncomfortable similarity with respect to the roots of the crisis, the progression of economic turmoil and the policy response.
Yet, there are important differences between the U.S. and Japan. Chronologically, the U.S. looks to be following a high-speed version of the Japanese scenario. The immediate economic crisis unfolded more quickly and was deeper in the U.S. than Japan. The U.S. experienced much larger loss of employment and developed a larger output gap than Japan did (Chart 4). On the optimistic side, the policy response in the U.S. (both fiscal and monetary) has occurred much more quickly and with greater force than it did in Japan.
Another important difference, and one that should not be dismissed, is the difference in national savings rate. Japan is a savings surplus country. It entered its crisis as creditor nation; it still runs a current account surplus; and so far it has continued to build national savings on yearly basis, despite the economic crisis. In contrast, the U.S. is a debtor country on a national basis (Chart 5).
The U.S. spends more than it earns every year and borrows the difference. Some might dismiss this, since the U.S. benefits from having the world's reserve currency and maintains special borrowing privileges. This is probably true over the short term; but the U.S. current account deficit is another manifestation of economic imbalances that have been allowed to build as if by virtue. As this situation is ultimately unsustainable, it presents an added vulnerability and an important difference to the Japanese experience.
On the monetary policy side, conventional policy has been exhausted with rates at zero percent. Quantitative easing aggressively expanded the central banks' balance sheet but credit growth and broader money creation are failing. Any new monetary policy action will increasingly belong to the realm of experimentation, which is inherently unstable and prone to error.
In the second half of the 1990s, it was the rapid withdrawal of fiscal stimulus that led to a double-dip recession in Japan. Similarly, fiscal stimulus in the U.S. is scheduled to be rapidly withdrawn over the coming quarters, and there is reason to doubt that the handoff from government spending to private sector growth will happen quickly enough to avert an economic slowdown.
Although the debate rages on in policy circles, Japan seems to have shown there are limits to the effectiveness of fiscal spending. This follows logically; having too much debt relative to income results in the need to delever at the national level. And while the government can temporarily offset the economic contraction that comes from loss of private sector demand, it becomes increasingly powerless over longer periods of time. Keynes' notion of "animal spirits" and private sector confidence are necessary to promote investment and job creation. Uncertainty regarding unsustainable debt dynamics are damaging unless the debt stock can be lowered or national income raised.
In Japan, debt-financed government spending has prevented delevering on a national level (Chart 6). Deflation caused the problem to become more ensconced. So far, the U.S. is heading down a similar path with private sector delevering being more than offset by government borrowing so that national debt is continuing to rise (Chart 7).
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