[OPE-L:6166] WSJ: America/Japan analogy

From: Rakesh Bhandari (rakeshb@stanford.edu)
Date: Wed Nov 07 2001 - 16:02:17 EST

November 7, 2001 
Is the Faltering U.S. Economy in Danger 
Of Emulating Japan's Long, Slow Swoon?


With each passing week, the similarities increase. In the 1980s, Japan was
considered the model capitalist economy; in the 1990s, the U.S. held that
distinction. In both cases, the good times ended with the bursting of a
stock-market bubble, pricked, at least in part, by a nervous central bank.
In both cases, predictions of a quick turnaround proved to be wrong.

The excessive American investment in fiber-optic high-speed phone lines
echoes Japan's decade-earlier investment binge in memory-chip factories.
The plight of one well-respected American company, Enron Corp. -- which has
lost two-thirds of its market value in just three weeks -- is reminiscent
of the previously invisible weakness Japan's slump exposed at many of that
country's banks. Even the recent squabbling in the U.S. Congress that
threatens to derail a package of economic-stimulus measures sounds eerily
similar to the bureaucratic and political wrangling that stymied bold fixes
in Japan.

And now, U.S. monetary policy, considered to be the most powerful tool for
countering the nation's downturns, is looking increasingly like Japan's, as
interest rates fall toward zero.

Most analysts continue to answer with a resounding no. They point out that
Japan burst not just a stock-market bubble, but also a real-estate bubble,
which in turn laid low its banking system. The U.S. bubble appears to have
been limited to stocks, and the American banking system remains strong.


In part, it is U.S. policy makers' willingness to inflict short-term pain
that allows for that flexibility. American officials argue that Japan would
have come out of its crisis more quickly if it had handled its banking
crisis the way the U.S. handled the American savings and loan crisis in the
1980s. Back then, U.S. government-ordered thrift shutdowns and foreclosures
caused shareholders to lose their investments and borrowers to lose their
properties. In Japan, failed banks were propped up, and their problems
allowed to fester.

Still, American-style free markets are hardly immune from excesses, and
more and more become apparent the longer the economy idles. Telecom
companies spent tens of billions of dollars to lay tens of millions of
miles of fiber-optic cables, an estimated 2.6% of which is now being used.

Blue-chip American Express Co. ended up writing off more than $1 billion in
junk-bond investments that were considered relatively low risks until the
economy went sour. "Subprime" lender Providian Financial Corp. sent its
earnings and stock price soaring in the late 1990s by tapping the once
largely ignored pool of consumers with checkered borrowing records.
Providian insisted that it used sophisticated models to limit its risks.
Nonetheless, it ended up announcing a surprising 71% drop in third-quarter
earnings last month, and its stock fell by more than half.

More surprises are almost certainly in store. Many analysts argue that the
U.S. stock market -- even at more than 25% below its peak -- remains a
bubble waiting to deflate further. The Standard & Poor's 500-stock index
still is trading at a price-to-earnings ratio of between 21 and 28 times
earnings, depending on the measurement, and would need to fall at least 30%
to reach its historic average P/E ratio of 15, according to the Leuthold
Group, a Minneapolis-based investment research firm.

Fragile Safety Net

Even workers supposedly protected by union contracts have a fragile safety
net. In the wake of the terrorist attacks, major airlines, such as AMR
Corp's American Airlines and Delta Air Lines invoked force majeure clauses
in their labor contracts, allowing them to skirt many negotiated
protections and dump workers without advance notice. Partly as a result,
the Conference Board's index of consumer confidence plunged to 85.5 in
October from 114 in August, one of the swiftest declines on record.

While Japan's unique circumstances may account for some of its problems,
they also may demonstrate a broader and more disturbing point: that policy
may at times be relatively powerless to contain the destructive forces of a
bursting bubble.

As companies are saddled with excess capacity, they have little incentive
to borrow to expand, no matter how low interest rates fall. Even after the
sharp drop in capital spending over the past year, the percentage of
industrial capacity in use in the U.S. in September was just 75.5% -- the
lowest level since 1983 and hardly an inducement for companies to build new

Layoff-spooked consumers also may be unwilling to spend tax rebates enacted
to encourage shopping. A recent University of Michigan survey concluded
that just over one in five households have spent the rebate checks mailed
out this summer, with the rest tucking the money into savings or using it
to pay debt.

At the extreme, the supply overhang from a collapsing bubble can touch off
a dangerous cycle of deflation, or falling prices. In a deflationary
environment, consumers curb spending, waiting for goods to become still
cheaper in the future. Borrowers get crushed by debt burdens as their loans
become more expensive in relative terms. Companies, forced to keep cutting
prices, cut back on workers and purchases of supplies, spreading pain
throughout the economy.

In Japan, deflation got under way in earnest in 1998 after the collapse of
a major bank and securities company. In both 1998 and 1999 wholesale prices
fell 1.5%, and after a flat year in 2000, they are falling again in 2001.
The U.S. isn't there yet. But commodity prices have fallen sharply since
1998, while U.S. consumer prices, by some measures, appear to be slipping.
The Commerce Department reported last week that its favored measure of
inflation -- the price index for gross domestic purchases, or prices paid
by U.S. residents -- fell by 0.3% in the third quarter, a sharp reversal
from the 1.3% increase in the second quarter and the first quarterly
decline in nearly 40 years. (Analysts say the number was artificially
depressed by one-time factors relating to Sept. 11 -- insurance benefit
payouts that, for measurement purposes, lower insurance prices.)

In a deflationary world, the central bank's powers to respond are
diminished because monetary policy works most effectively if interest rates
can fall below the rate of inflation. But rates can't do that if inflation
falls below zero.


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