Friday, February 01, 2008

Japan Redux?

Jim Jubak worries that the US will fall into the liquidity trap that bedeviled Japan for 15 years after their stock and property bubbles popped back in the early 90s. It's something I've worried about too, but in the end I don't think we will get the same result as Japan. Here's the lead from Jubak:

Ben Bernanke's Federal Reserve increasingly looks like it's headed toward a repeat of the errors that took Japan into a decade-long banking crisis and economic slump, beginning in the early 1990s.

Welcome to the United States of Japan, where growth slows to a crawl, the stock market goes nowhere and savings earn nothing. Just in time for the retirement of the baby-boom generation, too.

There are a lot of similarities between the current situation in the US and the Japan of the early 90s. There are also some significant differences. In Japan the banks took much longer to write off bad loans due to a cultural aversion to shame. In the US we tend to take our lumps and move along. I don't remember any bank CEOs getting canned in Japan over their problems. The bubbles in Japan, particularly in real estate, were also much bigger than ours.

The major difference though is the role of the dollar. Japan's bubble popping experience resulted in deflation. I suspect that when our economy finally succumbs to the massive amount of debt we've built up, the result will be inflation as all those dollars we've spread around the world come home to roost.

Jubak makes some good points though. The Fed may cause the credit crunch to last longer by giving the banks hope that policy will bail them out:

By giving banks the hope they can dodge rather than bite the bullet, the Federal Reserve has created the possibility that what would have been a very painful but short lesson for the banks could turn into a long-term drag on the financial markets and the economy.

If banks lend less because they're spending so much time watching their past mistakes that they shudder at the idea of adding loans to their balance sheets, if nobody trusts the prices for distressed assets, so big parts of the financial markets remain frozen in place, if consumers and corporations with decent credit can't get new loans to fix bad ones or to expand production or consumption, then the economy will run slower than its potential. And if the Japanese experience is any indication, it will run slower for a very long time.

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