December 2002
By ROBERT PEGG
With the U.S. economy in the midst of a weak recoveryÑand the Federal Reserve Board unlikely to cut interest rates further anytime soonÑominous comparisons between the economies of the U.S. and Japan are once again gaining attention.
Japanese executives now say that their country's fragile economy is losing what little momentum it had, according to a recent survey published by the Bank of Japan. The survey suggests that without new impetus from exports to the U.S. and Asia, the Japanese economy could slip back into a recession soon. The growing possibility would only worsen the problems that already harm that economy, such as deflation, high and increasing unemployment rates, a growing number of bankruptcies and the banking system's huge number of non-performing loans.
Japan's stock market and real estate bubbles collapsed in 1990, almost a decade before stocks in the U.S. peaked. Japan has thus far failed to correct its problems and begin a strong economic recovery. The Japanese stock market is hovering near an 18-year low, consumer prices are declining and the Japanese central bank already has cut interest rates to almost zero, limiting its use of monetary policy to stimulate the economy.
Despite the superficial similarity, nonetheless, few U.S. policy makers believe that America will fall into the same trap. They believe that the U.S. equity bubble never reached the same proportion as the Japanese version, and that the American financial and political systems are more flexible.
In a Federal Reserve study of lessons to be learned from Japan, economists said that governments should take bold steps to support pricesÑsuch as sharp rate cuts or new spending initiativesÑwhen declining price levels become a serious risk. Deflation is difficult to anticipate and even more difficult to end once it has started. Few economists believe that the U.S. economy is in a deflationary mode.
Although both countries have huge capitalistic economies (they are number one and two in the world) Japan and the U.S. differ in many important respects. In the U.S., equity markets, which tend to remove money quickly from failing companies, dominate corporate finance. In Japan, banks dominate corporate finance and they often make concessions to avoid foreclosures. The U.S. competitive two-party political system, unlike Japan, was able to inject, through increased spending and tax cuts, money into the economy at the start of the economic slump. Moreover, the Federal Reserve cut interest rates far more quickly than did the Central Bank of Japan. The Federal Reserve Board can cut further if it had to, although further cuts may have minimal effects.
The biggest similarity was that investors in both countries almost began to see their economy as recession proof at the height of their economic booms and this misplaced feeling sent stocks to unsustainable highs. Although troubling economic signs recently have grown in the U.S., consumers have continued to increase their spending throughout the economic downturn. American optimism and willingness to take on debt make them less likely to curtail shopping at the mall to the degree that the Japanese consumer has. However, with stocks and incomes down, and parts of the world in turmoil, Americans may begin to hold on to more of their money in anticipation of a rainy day.
The government also has helped economic growth over the past year, with federal agencies creating new security projects in the aftermath of 9/11. Now, however, many state and local governments face budget deficits and may have to cut spending or increase taxes to avoid state constitutional restrictions.
The biggest risk to the U.S. economy going forward is the possibility of outside shocks. With a glut of goods reflecting weak demand in many industries, few companies have pricing power or sufficient market share to withstand economic shock, such as what took place on Sept. 11, 2001. One possible shock could be a new wave of corporate scandals that will further frighten investors and hurt businesses and consumer confidence. Another possible shock might be a sharp increase in mortgage defaults caused by a spike in oil prices that could lead to cutbacks in lending and cause home prices to fall.
The most likely outcome, according to most economists, is for an economy that expands more quickly than Japan's, but more slowly than the American economy of the mid to late 1990s. Time will tell.
About the author: Mr. Pegg is president of Kirkbride Asset Management, Inc., the New York City-based investment advisory firm that serves businesses, institutions and private individuals.