Japanizing the World Economy
This guest post is from PEF members Marc Lavoie and Mario Seccareccia, both of whom are full professors of economics at the University of Ottawa.
The â€œJapanizationâ€ of the World Economy
Over the last twenty years, the Japanese economy underwent a long period of economic stagnation that some economists have characterized as a protracted â€œbalance-sheet recessionâ€. The period has been dubbed by some as the era of the two â€œlost decadesâ€ in Japan. However, there are now ominous signs that seem to presage a widening of this contagion to the world economy, or at least to the industrialized Western countries. This long recession in Japan was preceded by the breaking of the bubbles in both the stock and the real estate markets, whose sharp decline in prices pressured Japanese households to de-leverage, which, in turn, led to terrible negative consequences on overall spending. For over a decade, the central bank of Japan pursued a monetary policy of zero interest rates in an effort to kick-start private spending, but this was to no avail. The Japanese fiscal authorities pursued generally a mildly expansionary fiscal policy, but only to back track on too many occasions, in a futile attempt to implement fiscal austerity and reducing budget deficits and debt.
The United States is facing a similar situation with the all too familiar behavioural reaction on the part of the policy authorities. We are now probably witnessing the bursting of a third bubble in ten years in the stock market. The real estate market which began to collapse in 2006 still remains in a state of disarray. Both US banking institutions and American households remain overly indebted, while non-financial business enterprises prefer to keep their profits highly liquid rather than risk investing in new machines and equipment. Much like in Japan, the only avenue left to sustain growth in the economy is through greater public spending. However, as we have seen with the political wrangling over the debt ceiling, the Obama administration has largely been held hostage by fanatics of the Tea Party movement and other advocates of balanced budgets Ã outrance, including some within the Democratic Party itself. Tragically, these political leaders do not understand the full macroeconomic and financial implications of their strong opposition to budget deficits in this â€œbalance-sheet recessionâ€, in which every sector is seeking to de-leverage itself on the backs of some other sector in a dangerous financial game of musical chairs. The dramatic volatility and sharp decline in stock market prices recently is not caused by some irrational fears that the US government will default on its debt payments which everyone knows it will not and cannot. Rather, behind all the smoke screen about the public debt, private investors now understand that the American and European economies, which have historically been the motors of growth in the world economy, are now headed straight towards another serious recession, with their governments being politically or institutionally incapacitated to implement pro-growth policies in the short to medium term.
The downgrading by Standard and Poorâ€™s of US government debt on August 6, 2011, from AAA to AA+, will have absolutely no impact on longâ€“term yields, such as yields on 10 year US governments bonds which had actually fallen to 2.20% at the beginning of this week. In the case of Japan, which Standard and Poorâ€™s had downgraded to AA- on January 27, 2011, the yield on 10 year Japanese bonds was 1.05% on August 9, despite the fact that Japanâ€™s public debt to GDP ratio was over 200%, about double the US ratio! At the same time, notwithstanding the lower debt ratios in some of the European countries, these yields on 10 year bonds in Greece, Portugal and Ireland, varied between 10 and 15%, and they were between 3.1 and 5.2% for Italy, Spain, Belgium and France. In the case of Canada, these same yields were at 2.41%. What difference is there between Canada, the United States and Japan on the one hand, and the European countries within the Eurozone on the other?
The difference is that Canada, the United States and Japan are sovereign states and issuers of their own currency, while the countries of the Eurozone are not, because of the existence of a single supranational currency. Hence, those three countries (with their own sovereign currencies) cannot possibly default on their payments, regardless of the opinion of the analysts of Standard and Poorâ€™s, unless their governments recklessly choose not to want to meet their obligations because of some opportunistic political motives. These three countries issue their own currencies, their foreign exchange rates are not fixed, and they face no institutional constraint with regards to the central bank purchases of government securities. In other words, if you hold a government security that you would like to cash, the respective governments of these three countries would be able draw a cheque on their accounts at their respective central banks, and could then reissue and sell new bonds, directly or indirectly, via their central banks without any other consequence.
The situation of the countries of the Eurozone is quite different. The European Central Bank (ECB) cannot accommodate any national government within the Eurozone. The ECB can only refinance banking institutions. It cannot make any cash advances to their national governments, nor can it directly purchase any newly-issued bonds. Indeed, the ECB would historically not even engage in purchases of national government securities in their secondary markets â€” a self-imposed constraint which it abandoned on May 10, 2010 when it was confronted with the startling fact that Greek and Irish debt had become unsustainable. When the Portuguese, Spanish and Italian bonds began to succumb to speculative attacks this year, the ECB abandoned once again its long-standing principle of not intervening in the secondary bond market. With the excuse of better achieving its objective of Euro-wide price stability, on August 7, 2011, the ECB began once again to purchase government securities in the secondary markets, and was able to prevent a sharp rise of long-term interest rates in Spain and Italy with a certain degree of success. However, the stabilisation measures of the ECB are conditional: its governor, Jean-Claude Trichet, requires of the Italian and Spanish governments to implement drastic austerity measures that will plunge these already precarious economies into recession. If the Greek scenario of a vicious cycle is also played out in these two countries, the European Financial Stability Facility (EFSF) initially set up to help bail out smaller countries such as Greece, Ireland and Portugal, will have to be replenished and it will inevitably increase the speculative attacks against France, which, together with Germany, will be forced to finance the largest share of the new funding. And if France also collapses as a result of these speculative attacks, then even Germany that most analysts see as the stalwart or unfailing pillar of the Eurozone would itself be at risk of default. However, even before reaching such a situation, European banks, which are the principal holders of European â€œsovereignâ€ debt, would themselves have become insolvent. It is perhaps this fear that would explain why the prices of bank stocks have been declining over the last several months, much as during the 2008 debacle.
During the 2008 financial crisis, governments had committed themselves to pursue contra-cyclical fiscal stimulus packages to secure growth via deficit spending. However, over a year later, in Toronto the G20 leaders decided to revert back to the well worn policy of fiscal austerity in support of sound finance that our finance minister, Jim Flaherty never ceases to remind us and seems to wear as a badge of honour. The mistakes of Japan over the last two decades and the errors committed during the Great Depression of the 1930s are being repeated once again on a colossal scale. Politicians internationally and bureaucrats of the ECB continue to believe that public sector deficits cause inflation and low private sector spending, even though Japan has shown that, despite large deficits and an enormous growth in the money supply, it has remained in a state of practically zero inflation for two decades. Regardless of their effects on public debt ratios, national governments must return to expansionary fiscal policy, which would be the only source of growth in the world economy today. Without it, we would have achieved what most policy makers least want, which is the â€œJapanisationâ€ of the world economy.
Hi Marc and Mario,
We can only wish we were faced with Japanization! Japan has managed to have the lowest unemployment rate amongst the largest economies despite its economic stagnation, around 4%. (http://www.bls.gov/ilc/intl_unemployment_rates_monthly.htm#Rchart1)
While the immediate situation is generally poor, the good news is that in Canada we are fully able, if we so choose, to keep unemployment low and provide ourselves with all the infrastructure and social programs we need, as is any wealthy country with its own non-convertible free floating currency. Let us hope one day we are able to get past the obsession with debt-to-GDP ratios, ”fiscal sustainability”, and other manifestations of inappropriate household financial logic.
Perhaps one day a Canadian political party will campaign on such a program. Last night I listened to several television commercials from the 1964 U.S. presidential campaign, including one on reducing poverty. Today they would sound wildly radical. It was quite jarring to see just how far backward we have gone.
Thanks for the informative post Marc and Mario. It would be useful if you could comment on Marc’s post today and further clarify the differences between central bank puchases in the secondary market and direct financing of new government bonds. My take is that QE 2 in the US and QE in the UK were mainly about secondary purchases… which is why both had such little impact.
Please contribute more!
Andrew: I have put an answer to your question in the comments to Marc Lee’s blog.
Keith, Your point about the unemployment rate in Japan at, for instance, 4.6% in June is well taken. I also wish that we had such rates here in Canada. However, there is a clear structural difference between the Japanese and Canadian labour markets, with Japanese firms being traditionally less reluctant to lay off workers than their Canadian counterparts. However, when looked at in historical perspective, Japan used to have unemployment rates between 1% and 2% during the previous era, which does represent more than a doubling of the unemployment rate! It is also important to note that with stagnant productivity growth today (when compared to the earlier postwar era) both in Canada and Japan, the same additional dollar of public spending would make a greater dent on the unemployment rate today than it it did in the good old days! Therefore shame on both our Canadian and the Japanese governments for not getting unemployment down to those rates that we used to have, for instance, in the 1960s!
Andrew, As Marc Lavoie said, we both commented separately on Marc Lee’s post.
Great post. It was uploaded by Warren Mosler and is getting some discussion. It is incredible that the gold standard canards have such sway over politics, media and many economists still. I pulled out my – now very old! – economics 101 textbook from U of O not too long ago to see how much I agree with now that I am slightly wiser and its no wonder that there is little understanding of modern fiat currency as the text was completely beholden to gold standard thought. Keep educating! Jason
This is a very good comparison of the Japanese and current situations. Also, excellent discussion on the ECB. We should all be equally concerned about Europe these days. Here you have a central bank that increased rates (a bit earlier this year) the very next day that one of its member states received IMF assistance. This is inflation control taken to an absolutely ridiculous level.
Marc and Mario, keep out the great work. My hat goes out to you both. It’d be great to read more from you here at PEF, a great discussion forum.
Messrs Lavoie and Seccareccia. You are correct that there is a difference between Euro members and Canada, japan and US with respect to the possibility of default. However, I would intend a nuance between Canada and Japan on the one hand and United States on the other hand with respect to default, notwithstanding the inherent capacity of each to print their respective currency.
I would have to disagree with the article. Michael Pettis has, IMO, a better take…. mpettis.com/2011/09/big-in-japan/
I also don’t agree with the notion of public spending being the only, or even perfered , solution. Addressing the the cause of growing unemployment and income differentials, such as trade distortions would be more effective and sustianable.