Japan's 'Lost Decade' Argues Against Obama's Policies
During last Monday’s White House press conference, President Obama argued for his stimulus bill, saying, “"If you delay acting … you potentially create a negative spiral that becomes much more difficult for us to get out of. We saw this happen in Japan in the 1990s… and as a consequence, they suffered what was called 'The Lost Decade' where, essentially… they did not see any significant economic growth.”
As an argument for the President’s stimulus plan, this example fails profoundly. In fact, the Japanese case argues against Obama’s stimulus.
Japan’s problem in the 1990s was a deflationary recession – the worst such in modern history – caused by a hyper-strong currency and tax increases.
The trouble began in the mid 1980s when the yen began a sustained rise, climbing against the dollar from ¥240/dollar to ¥120/dollar by the late 1980s and rising to ¥60,000/oz. of gold, according to Nathan Lewis’s book, “Gold: The Once and Future Money.”
Asset prices, especially land, rose during the late 1980s due to tax cuts, falling interest rates, and a demographic shift that drove up urban real estate prices. Faced with rising asset prices, in the early 1990s the Bank of Japan (BOJ) – oblivious to the deflationary gold signal – made a disastrous misdiagnosis, assuming there was an asset bubble that needed popping.
The BOJ decided to strengthen the yen further via tight money, a policy applauded by the U.S. Treasury which believed a stronger yen would improve the U.S. trade deficit. The BOJ pushed the yen higher – reaching an eye-popping ¥80/dollar, or ¥32,000/oz. of gold in 1995, essentially doubling the yen’s value in five years.
This monetary deflation was compounded by a series of tax hikes meant to reduce asset values. This policy mix, a reversal of the classical sound money/low tax policies that made Japan an economic miracle, hammered the economy into deep recession.
During this period, the Japanese government engaged in numerous, mammoth infrastructure spending projects, meant to increase “aggregate demand.” The result was a nation of bridges to nowhere and empty superhighways, as The New York Times reported recently. A telling quote: “Economists tend to divide into two camps on the question of Japan’s infrastructure spending: those, many of them Americans like [Treasury Secretary Tim] Geithner, who think it did not go far enough; and those, many of them Japanese, who think it was a colossal waste.” That is, citizens who actually lived through it think the spending was ineffective, but outside theorists like Geithner know better. Meanwhile, the ‘90s stimuli quadrupled Japan’s national debt, driving it to more than 180 percent of GDP.
Stateside, the current $820 billion spending package – on top of the $1 trillion existing national debt, plus the billions combined from what has been spent from the TARP, last year’s stimulus, and Geithner’s just-unveiled financial plan – will push U.S. debt in a similar direction.
As for Japan, it remained in deflation until the BOJ abandoned its interest rate target – then set at zero – and went to “quantitative easing,” meaning directly increasing the monetary base. The deflation ended in 2001 and, aided by tax cuts, Japan’s economy revived.
The United States’ situation today is quite different. The greenback has steadily weakened for 8 years, plunging from around $250/oz. of gold in 2001 to about $900/oz. today. (The average gold price across the 1980s and ‘90s was $350/oz.) Today’s gold price indicates substantial dollar inflation is baked into the cake, though traditional indicators can take six years to register it.
Some analysts, including Steve Forbes, see the dollar’s fall as the impetus for capital sloshing into hard assets in recent years, causing massive over-investment in real estate, and price shocks in commodities such as oil and agriculture, which slowed economic growth. Combined with a substantial decline in international trade caused by see-sawing currencies, recession has taken hold and financial markets have ground to a halt.
Though today the U.S. faces a weak rather than a strong currency, the right policy mix should be similar to Japan’s eventual solution: a renewed commitment to sound currency followed by reduced tax rates, especially on capital. Massive spending will do little to stimulate, and may actually impede recovery.