Friday, January 1, 2010

Lost Decade

And I don't mean the one that just ended, bad as it was in some ways. My concern is for the next decade, as the current bubble is wound down, or not. The Economist reports on the economic history of the last twenty years in Japan, subtitled: Twenty years on Japan is still paying its bubble-era bills.

Graphic shows how Japanese investors have fled stocks to bonds as deflationary expectations and lack of business vitality put the economy into a long decline.

The most pernicious effects of the bust, economists say, have been transmitted via banks and businesses. Banks found themselves loaded down with non-performing loans. Belatedly they faced up to many of their losses, restructured and consolidated. But according to Takuji Aida, an economist at UBS in Japan, long-term yields remained very low because of deflationary expectations, thereby flattening the yield curve (the difference between short- and long-term interest rates). That prevented banks from earning their way out of crisis, so lending remains weak.

Companies, meanwhile, have been focused on paying down debt, as well as coping with deflation in the domestic economy and competition from cut-price imports. Large exporters were forced to restructure and enjoyed a long boom from 2002 to 2007. But firms in more protected areas of the domestic economy have fared badly: profitability, wages and investment have declined in the past decade.

As Reason magazine pointed out last year, Obama is following the same failed policies that Japan followed in the 1990s in their efforts to revitalize their economy.

But that stimulus did not save the Japanese economy in the 1990s; far from it. The ensuing period came to be known as the Lost Decade, characterized by multiple recessions, an annual average growth rate of less than 1 percent, and a two-decade decline in stock prices and corporate profits.

The Japanese government’s easing of credit rates, instead of spurring real demand, created artificial demand. Federal loans and stimulus spending were not economically productive, and they vastly increased the nation’s debt and prolonged the economic malaise. Worse, businesses spent critical time on the sidelines, waiting for government bailouts and other centralized actions, instead of speedily consolidating their losses, clearing their balance sheets of bad investments, and reorganizing.

I am optimistic about America, and always have been, but it is a long term optimism based on the character of our people and the genius of our constitution. In the short term, we are not immune to losing a decade either, the 1930s come immediately to mind, for example, and government actions, such as higher tariffs, intended to help the economy actually delayed recovery then as well.

I also blame Republicans, as much as Democrats for this. Bush and Paulson initiated the first bail out, with Republicans in Congress along for the ride. John McCain could have won the last election; the turning point came near the second debate, which he had proposed to postpone to deal with the mounting banking and AIG crisis. His failure to break with Bush and the Democrats and oppose the first bail out package signaled the end of his maverick image. In hindsight, had he been able to stop the bail out we would have all been better off, and McCain might be President.

This is why the Tea Party movement is so valuable, because we recognize that the key problems facing America have to do with the size of the debt and expansion of the federal government into the private sector. This expansion is guaranteed to slow the unwinding of failed investments needed for a healthy recovery. We have already seen various examples of this skulduggery, Congress intervening to prevent Government Motors from closing dealerships, and shading dealings by the Fed to get Bank of America to buy Merrill Lynch, to name two.

McCain was right to try to rebrand the GOP as the party of reform, but reform and reduced government go hand in hand. Time to step up our demands to end porkulus and bail outs.