U.S. Seen Avoiding Japan’s Mistakes
This has been a season of shock for the United States, and the extent of the latest shock--the economic one--is only beginning to seep in.
A nation that thought it was secure against attack was struck at its heart. An economy that seemed ready to grow forever appears to have slipped into recession. Leaders who once promised peace and prosperity now admit they can deliver neither quickly.
Policymakers are forced to confront questions that would have seemed laughable only months ago: Could the good times really be at an indefinite end? Could the U.S. follow the country closest to it in economic size, Japan, into a decade of downturn and depression? Could Americans, like the Japanese, discover that the central bank interest rate cuts on which they have relied for so long to spur growth are ineffective?
The answer, according to a variety of analysts, is “no,” but the conclusion is a much closer call than generally appreciated.
“The same forces of a bursting asset bubble, overcapacity and deflation that pushed Japan into the soup are the ones that are driving the United States into recession,” said Robert J. Barbera, chief economist with Hoenig & Co., a Rye, N.Y., brokerage firm, “and they’re pushing much harder than even most economists realize.
“The chances are good we’ll avoid Japan’s fate because we’re acting more aggressively to turn things around,” he said. But success is far from certain.
Japan is caught in the velvet prison of deflation, or an economy-wide decline of prices. And now there are signs that a mild deflation may be getting underway here.
On Friday, the Labor Department said prices paid to American factories, farms and other goods producers in October plunged a record 1.6%.
Ten days earlier, another report indicated the price declines are not limited to goods but include services. The government said the so-called personal consumption expenditure deflator showed overall prices paid by consumers in the July-through-September quarter slipped at a 0.4% annual rate. It was the first quarterly decline in nearly half a century.
Deflation Fears in U.S.
Of all the problems that deflation has caused Japan, none attracts greater attention among U.S. analysts at the moment than the central bank’s inability to use interest rate cuts to manage the economy.
And no wonder. Americans have come to rely almost exclusively on the Federal Reserve and its chairman, Alan Greenspan, to steer the U.S. economy toward growth.
But after a decade of wild success, the Fed seems to have lost its magic. With the U.S. central bank’s benchmark rate now at 2%--its lowest level in four decades--and the economy still sinking, many are wondering whether a deflationary downward spiral has taken hold here and is undermining the Fed.
Most economists still say “no,” and their arguments generally fall into one of three categories:
* No, because the U.S. economy did not suffer a blow as bad as Japan’s and therefore is not experiencing the same sort of deflation. Although both countries experienced spectacular asset bubbles then busts, Japan’s during the 1980s was across the board, and America’s during the 1990s was largely confined to high tech. As a result, there is not as much economic damage to repair.
* No, because Japanese economic managers made a series of terrible policy mistakes that paved the way for deflation--mistakes that their U.S. counterparts already have demonstrated they will not repeat. Most important, after raising interest rates in the early 1990s to pop Japan’s bubble, the Bank of Japan only grudgingly reduced them again, leaving the economy to founder. By contrast, the Fed, which did something similar by raising rates in 1999 and early 2000, has executed one of the sharpest policy about-faces in its history this year.
“They were massively behind the curve,” Adam Posen, a senior fellow at the Institute for International Economics, said of Japanese central bankers. “They were massively afraid of inflation long after it disappeared.”
* No, because of political differences between the two countries. Observers note that Japanese voters have left the same political party in office that was there when the nation first stumbled. By contrast, American voters threw the current president’s father out of office for failing to do enough to end what turned out to be one of the mildest recessions since World War II.
But even the most optimistic U.S. economist will acknowledge at least a mild case of nerves about why the Fed’s rapid-fire rate cuts this year have had so little broad-based effect on the economy. And even the most sanguine will admit to concerns that a case of deflation, if it is underway here, could take the starch out of further Fed cuts.
To a generation of Americans who grew up with inflation, or generally rising prices, deflation--especially of the sort that has occurred in Japan--seems like heaven, a progression of better sales, rebates and bargain days.
Topsy-Turvy Economy
Unfortunately, deflation has two nasty side effects.
First, it turns normal economic incentives on their heads so consumers, instead of rushing out to buy low-priced items today, hold off in the expectation of still lower prices tomorrow.
Second, it neutralizes interest rate cuts as a means of reviving growth. The reason: With prices deflating and the purchasing power of money rising, any loan would have to be repaid with money worth more than those borrowed. Hence, there’s little incentive to borrow no matter how low the interest rate.
“When deflation is rampant, cash is king,” said Robert Z. Lawrence, a Harvard economist and former member of the Council of Economic Advisors under President Clinton. “People would rather keep money in their pocket than spend or invest it.”
If the U.S. is slipping into deflation, the result will be a new experience for Americans, a passage into a looking-glass world in which virtually all economic incentives are turned on their heads. “We’re on the verge of realizing that we suffer from an economic illness we haven’t had before,” said James W. Paulsen, chief investment officer with Wells Capital Management in Minneapolis.
Japan’s Falling Values
But it is an illness that the Japanese are intimately acquainted with and one they have learned to cope with, in large measure, by curbing their personal spending even as prices have fallen. For example, the price of a fleece jacket that once cost $25 has skidded to $8, and the cost of a serving of gyudon, a popular beef and rice dish, has plunged by 30%.
As the purchasing power of Japanese families has climbed, so has fear caused by a stagnating society.
“Even though things are cheap right now, I don’t feel like spending money on anything,” said Kyoko Masuyama, a 78-year-old Tokyo housewife.
Deflation has left homeowners like the Maeda family stuck with loans that far exceed the shriveled value of their houses.
The Maedas bought their house in suburban Tokyo in 1989 for $430,000 after taking out a $300,000 loan. But with land prices declining for the last 10 years, the property is worth only about $250,000.
Like so many other Japanese families, the Maedas feel trapped. To help cope, 45-year-old housewife Miyako Maeda has taken a part-time job as a data-entry clerk at a cosmetics company. “I never dreamed things would go down the way they have,” Maeda said. “The value just keeps falling year after year.”
That’s a scenario Americans would rather not experience. “There’s a chance we could end up like Japan,” said Allen Sinai, chief global economist with Decision Economics Inc. in Boston. “Maybe it’s a 10% to 15% chance, but that’s not trivial,” he said.
“It’s worth worrying about and doing everything we possibly can to make sure it doesn’t happen.”
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Gosselin reported from Washington and Magnier from Tokyo.
