"We Are Not Japan, But..."

Sydney M. Williams

Thought of the Day

“We Are Not Japan, But…”

October 19, 2010

An article on the front page of Sunday’s New York Times, “Japan Goes From Dynamic to Disheartened–Retrenchment Offers the West a Grim Vision of the Future” was sobering – “chilling”, as described by my partner, Andy Monness.

By the summer of 1945, Japan was devastated. Of a population of about 73 million in 1940, approximately 2.7 million had been killed. As a percent of their population, Japan’s losses were more than ten times those in the United States. The only atomic bombs ever used in hostile action devastated Hiroshima and Nagasaki, in August 1945. However, like the mythical Phoenix Japan rose from the ashes of war to become the world’s second largest economy. (It has recently been surpassed by China, and is now stagnating.) In the early years, as Japan took to the task of rebuilding, she was not alone. In the immediate aftermath of the War, the American government, under the auspices of the Supreme Commander of the Allied Powers, played a crucial role, for example paying the Japanese government large sums for “special procurements” during the Korean War. Nevertheless, most of the credit for their economic “miracle” must go to the Japanese people. For the thirty-five years between 1955 and 1990, their economy compounded at 12%; per capita income increased ten fold – a growth rate that exceeds that of China today.

Since 1990, Japan’s economy has essentially stood still. GDP has stagnated, per capita income has declined and “the nation,” as Martin Fackler writes in the Times piece, “has been trapped in a corrosive downward spiral of prices…” Mr. Fackler goes on: “Now, as the United States and other Western nations struggle to recover from a debt and property bubble of their own, a growing number of economists are pointing to Japan as a dark vision of the future.” While there is little question, in my mind, that there is no easy quick exit from our troubles – we have dieted on a menu of debt-induced growth and are now undergoing treatment, accompanied by DTs.

But before, emptying the bank account, selling the homestead, purchasing a shotgun and heading for the hills, it is important to re-look at the size of twin Japanese bubbles in 1989. The Nikkei Index peaked on December 29, 1989 at 38,915.87. Stocks commonly sold at 150-250X earnings. The Index compounded annually for 44 years at 17% – a feat, I believe, unmatched in human history. Even with the Nikkei at 9498.49 – less than one quarter of its high 21 years ago – the sixty-five year compounded annual return has been 8.8%, about 250 basis points better than long term returns from U.S. stocks.

Real estate prices were even more dramatic, both in their rise and in their fall. According to Wikipedia, peak prices in Tokyo’s Ginza district (roughly equivalent to New York’s Madison Avenue) fetched $93,000 per square foot in 1989. In contrast, in the summer of 2007 when prices in New York were close to their highest levels, 660 Madison Avenue (home to Barneys New York) sold for $1,453 per square foot. By 2004 prices for office space in Tokyo’s financial district had lost 99% of their value and Tokyo’s residential homes were selling for one tenth of their peak prices, but were still listed as among the most expensive in the world.

An economy undergoing detoxification from consumer over-borrowing, as ours is now doing, cannot be enticed to grow through increasing leverage. That, in my opinion, is the mistake the Fed and all those in Washington and elsewhere who are urging more quantitative easing are making. Lower mortgage rates will not attract home buyers, nor will cheap borrowing costs encourage hiring or greenfield investment by businesses. What is needed is confidence in the future. That should be the sole focus of Washington. Lower rates are a boon to speculators, which is why many on Wall Street favor them. They have produced enormous profits for bond funds like PIMCO. But low rates are a bane to savers and especially hurt the elderly – food and fuel prices are being driven higher by speculators with access to cheap credit, while bond and saving account yields are low. Low interest rates abet the rise in commodities, a move which at some point will be reflected in higher consumer prices. And, of course, low interest rates mask the negative impact of expanding federal deficits.

It is, of course, this recent experience of ours that causes one to compare our situation to that of the Japanese. But the differences are more significant than the similarities. In contrast to Japan, our stock bubble – pale in comparison to that of Japan – was limited to tech, media and internet stocks. It occurred ten years ago, five to seven years before our real estate bubble. Japan’s two bubbles occurred simultaneously.

But even more important, the U.S. is a nation of immigrants, of peoples from all over the world. That diversity is our strength. Japan’s population is homogenous. The population of the United States, according to the CIA World Factbook, is growing at a rate just under 0.98%, while Japan’s is declining at 0.19%. The total fertility rate (the expected number of children born per woman in her child-bearing years) for the years 2005-2010, according to the United Nations, is 2.05 in the U.S. and 1.27 in Japan. (Anything over 2.00 indicates positive growth.) As well, we are blessed with an abundance of raw materials and a climate conducive to a variety of crops.

Despite my assertion that we are not Japan, I am mindful of the risks we face. It is demand that is missing from our economy. Quantitative easing is an attempt to goose demand by supplying cheap dollars – a perversion of supply side economics. Taken too far, it risks cheapening the dollar. In The Economic Consequences of the Peace, John Maynard Keynes wrote: “Lenin is said to have declared that the best way to destroy the Capitalistic System is to debauch the currency…The process engages the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million can diagnose.”

But we are not Japan. The differences are too big, but that does not mean we do not face risks. Japan’s fate should be a constant reminder to policy officials in Washington. More than anything – more than flooding the system with currency, more than paternalistic promises from Washington – we need a restoration of confidence that provides the individual and business the incentives and the conviction to invest, be it in a home or in a factory. Low interest rates and a depreciating dollar will not do the job.