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3 US can fast exit from bad
times By Edward J
Lincoln
soften the downturn in our economy.
So it is unlikely that we are facing a decade of
stagnation, like Japan.
The next
difference is prices, related to the previous
point. The Japanese made so many mistakes in
monetary and fiscal policy in the 1990s that they
ended up having their economy slip into deflation.
Deflation means the overall price level, like the
Consumer Price Index or the GDP price deflator, is
going down.
If any of you have been to
Japan - some of you I know have been to Japan, or
come from Japan - you say: "So what's the problem?
In the mid-1990s, prices in Japan seemed bizarrely
high. So if
prices
are coming down in Japan, how could that be a bad
thing?"
Well, first of all, prices in
Japan seemed high for two reasons: One, the
exchange rate. The Japanese yen was overvalued. So
if you look at Japanese prices as a foreigner
going to Japan and think about the dollar
equivalent of that, a fair amount of it was simply
that the exchange rates were out of alignment.
The second thing is that we tend when we
go to a country and see prices are high, we're
thinking in microeconomic terms, we're thinking of
particular products, right? Everybody knows that
musk melons in Japan are ridiculously priced -
$50-$100 to buy a perfect melon in the
supermarket. Well, that doesn't mean that overall
prices in Japan are high. It just means that in
particular markets there is bizarre pricing. So
changing relative prices, getting down prices of
things that seem strangely high, is a very
different thing than saying all prices in the
economy are coming down.
Economists don't
like deflation. They don't like it because all
modern economies live on debt. If you own a house,
you realize that debt is much easier to repay if
you have modest inflation. Modest inflation means
that over time all prices are going up, including
your income. But the one thing that is not going
up in value is your mortgage. It's a fixed amount
of money. You borrow $300,000 from the bank and,
even if you've got inflation, that's not going up.
It's still $300,000, or what's left after you've
paid some of it back. And so it's easier and
easier and easier for you to repay, to meet your
monthly mortgage payments, as time goes by.
So that if you get to be old enough like
me, you reach the point where you can chuckle and
laugh at all the young people. Your mortgage - in
fact, my mortgage got paid off two months ago. By
the time you pay it off, it looks ridiculously
cheap. So that encourages the whole process of
debt formation in the economy.
In reverse,
if you have deflation, that means year by year it
gets harder to pay back the money, because your
income is going down - or, if it's a corporation,
the price of your output is going down - and it
gets harder and harder to meet the payments to the
bank. So, in general, we don't like deflation. We
don't like high inflation either, but moderate
inflation of, say, 1 or 2% a year, economists love
that.
Japan allowed its economy to slip
into deflation. Once you are in that situation, it
turns out it can be difficult to get out. How
difficult it is to get out, I think we have
learned a lot from the Japanese experience. It has
been hard for them. They may be getting out of it
this year, after roughly a dozen-to-fifteen years
of modest deflation.
It's hard to get out
partly because monetary policy doesn't work well
anymore. Normally we think about raising and
lowering interest rates. So let's say you've
lowered interest rates to zero, but you've got
deflation, and deflation is getting worse, so
you've got like 2% deflation. That means that real
interest rates in your economy are 2%. And there's
nothing you can do about it. You can't get real
interest rates down any lower because you hit the
zero bound on nominal interest rates. So we don't
like it. And they got stuck with it.
I
don't think that is likely to happen in the United
States, again perhaps because the Fed has learned
from observing what happened in Japan and
recognizes that it is real important to squash
downturns quickly before you get close to
deflation. That's what the Fed did in 2001-2002,
when we had a recession. They got interest rates
down real quick, because we had prices drifting
down towards zero inflation in this country. The
Fed, I think, was a little concerned about that.
At the present time, again, we have cut
interest rates very quickly. It should bolster the
economy. And frankly, this time around we've got
enough upward price pressure that I don't think
deflation is really an issue for this economy. In
fact, if anything, there is a potential issue of
stagflation, which we had back in the 1970s, where
you've got the economy slowing down but you've
still got inflation higher than you want, in both
cases driven by commodity prices, the price of oil
going up.
The next difference is the scale
of the problem. In Japan, I told you the stock
market had tripled in value in five years and then
lost all of those gains so it went back down
again. We're talking about a drop in the stock
market of 70% from its peak at the end of 1989.
In the United States, we've had the Dow
Jones Industrial Average double in 10 years.
Substantial, but it's not like tripling in five
years. And on the down-side - of course, none of
us know exactly what the future brings, but my
guess is we're talking about maybe a correction of
20%, not 70%.
In the real estate market in
Japan, we also had a tripling of urban real estate
prices in the space of six years and a drop of 70%
over the next decade. In the United States, in
contrast, according to one price index for urban
real estate, we've had a price increase of 80% in
five years. That's less than a doubling. And on
the down-side, I'd be surprised if we've had an
overall correction of more than 20-25%.
And I don't think it is going to last very
long. We've had occasional downturns - maybe not
nationwide, but certainly in particular markets
like New York. It tends to shake out in a couple
of years and then turns back up.
On the
real estate side, part of the difference may be
simply in both economic growth and in population
growth. In terms of economic growth, we're growing
at 3.0-3.5% a year, on average, over long periods
of time. Japan is now down to probably 1.0-2.0% a
year. As you grow, you have more demand for office
buildings and things like that. That demand growth
is stronger in the United States, and should be
stronger over the next decade in the United
States, than in Japan.
And similarly with
population. We still have a growing population.
Japan does not. Japan now has a shrinking
population. It is shrinking particularly rapidly
at the younger end of the demographic chain, and
that means that we are going to see fewer and
fewer and fewer new households looking for a place
to live. So the longer-term prospects are, I
think, for a fairly quick recovery in real estate
prices - or at least a turn back up, if not a
total recovery - in the United States.
There is also a big disparity in terms of
the scale of the problem on the financial losses.
In Japan, the face value of non-performing loans
at Japanese banks was in excess of a trillion
dollars. That is in an economy of $5 trillion. So
we are talking about bad loans of roughly 20% of
GDP.
Now, we say a "bad" loan. We're
talking about, say, a mortgage where the borrower
is not repaying the loan, and this is the face
value. How much was the mortgage? The real cost in
the economy, of course, is what can be recovered
from that. Obviously, the value of the mortgage
has not gone to zero. The property is still worth
something. You don't know that until you have
forced the borrower into foreclosure, seized the
property, and resold it.
The real cost in
Japan was probably on the order of $500 billion.
That's still 10% of GDP in Japan. Again, that's a
pretty big asset loss for the economy to absorb.
And this is just real estate; we're not talking
about the stock market here.
In the United
States, my colleague at the Stern School, Nouriel
Roubini, who is a perennial pessimist on economic
issues, has suggested that the losses in the
United States in the current subprime/financial
sector problems could be a trillion dollars. But
that's in a $13 trillion economy, so we're talking
8% loss. And again, this is the face value, not
the final real cost, which is probably about half
of that. So we're talking maybe, in a worst-case
scenario, losses equivalent to 4-5% of GDP. That's
half of the real value of the losses relative to
the size of the economy in Japan. So there is
really no comparison in the scale of the problem
here.
Yes, the US economy is going to be
hurt by this. Sure, we're probably going to have a
recession this year. My guess is that it's going
to be a pretty mild recession. We'll be out of it
relatively quickly. We'll be getting to work
cleaning up the aftermath of the mess in the
subprime market over the duration of this year.
Personally, I think the US situation is
shameful, messy. It does reflect hubris, greed,
arrogance - all those bad things that some people
associate with Wall Street, that everybody thought
were really great until the market turned bad. And
there are some similarities with Japan. But the
bottom line is I think we will be out of this
problem far, far faster than Japan was and that
the cost of the losses in the economy will be much
smaller than they have been in Japan.
American capitalism certainly has lots of
problems, lots of things you can criticize if you
want, but on the plus side there is a lot of
flexibility and an ability to correct mistakes
pretty quickly. We are no better than the Japanese
or anybody else at getting ourselves into trouble
because either of hubris, greed, or simply
misunderstanding things, or making even honest
mistakes. But it seems to me that one of the
positive features of the American system is that
when bad things do happen you can correct them
relatively quickly.
Edward J
Lincoln is the director of the Center for
Japan-US Business and Economic Studies and
Professor of Economics at New York University
Stern School of Business. His research interests
include contemporary structure and change in the
Japanese economy and US economic policy toward
Japan and East Asia.
(Published with
permission of the Global Policy Innovations
program at the Carnegie Council for Ethics in
International Affairs.
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