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Recent articles on the subprime crisis and the US in 2007 vs Japan in 1989

February 13, 2008
By Ken Worsley


A few days ago, a piece entitled “Japan’s lost decade a lesson as American economy falters” by Steve Lohr appeared in the New York Times and its syndicated publications. In the article, Mr Lohr argues that there are “broad parallels” between the bursting of Japan’s bubble in the early 1990s and the current crisis in the US. As he puts it:

After a long boom, the Japanese economy in the 1990s, as in the US today, was jolted by a plunge in the real estate market.

In Tokyo, the government and bankers were slow to recognize the size of the problem. Bad loans piled up. The financial troubles rippled through the economy as consumer spending and job growth fell…

…A lengthy slowdown, [economists] say, could alter the economic psychology of the US, echoing the Japanese pattern, as the nation enters a period of diminished confidence that restrains spending and investment.

Mr Lohr goes on to point out that failings in Japan’s economic policy in the years following the bursting of the bubble caused even greater pain, a point that few would argue with. Japan’s fate is described as a warning to the United States, as 18 years after the bursting of the bubble, Japan’s main stock index (the Nikkei 225) is still only worth about 33% of what it was at its peak.

The Dow Jones Industrial Index closed at a record high of 14,164.53 on October 9, 2007. A long-term drop such as Japan’s would leave the DJIA at 4674.3 sometime in 2025. That seems difficult to imagine, and probably tells more about the overvalue of Japan’s Nikkei 225 in 1989 than the Dow Jones’ current value.

Lohr’s article quotes Edward Lincoln, director of the Japan-US Centre for Business and Economic Studies at New York University, as saying, “In America, we force the bad news out faster than the Japanese did, and we deal with it faster. That should limit the damage from the economic shock.”

It’s hard to argue with Lincoln, unless you happen to particularly hate the Federal Reserve (and that’s fine). Nonetheless, we still have one parallel to the trouble Japan faced during its lost decade. Namely, no one seems to believe that the full extent of losses from subprime investments have been reported.

Lohr’s article puts it this way: “Nouriel Roubini, an economics professor at New York University, warned that the $US100 billion in bad loans reported by banks could increase nearly tenfold.”

That’s a lot of missing money. In another article, entitled “Is Japan Hiding Billions In Subprime Losses?“, Greg Peel points out that an estimated $400 billion in wealth has been wiped out by the subprime crisis. With US and European banks accounting for $130 billion of that figure thus far, and reported losses at Japanese banks at $4.7 billion, there’s still a lot of missing losses.

At any rate, we found it hard to take seriously the idea that Japan’s “lost decade” could provide much of a warning for the US economy. After all, we heard doom predicted after the 1997 Asian crisis and the popping of the dotcom bubble in the early 2000s. Those severe downturns never materialized; the Dow reached higher and higher highs, which indicates an uptrend that has not yet stopped - or even showed signs of slowing.

We’re not the only ones to think this way. In an excellent piece published by this week’s Asian Wall Street Journal and entitled “Crisis Comparisons“, Richard Katz, the editor of the semi-weekly Oriental Economist Alert, takes on the claims made in Mr Lohr’s article, and argues:

Japan’s prestigious Nikkei newspaper recently ran an opinion piece by one of its staff writers arguing that the U.S. travails “may be a recurrence” of Japan’s lost decade.

Such pessimism is just as inaccurate today as when the same comparisons were made during the dotcom bust at the onset of this decade. Certainly, the likelihood of a U.S. recession is growing — although even that assumption is not certain. But for a financial shock to severely damage a modern economy, that economy has to be vulnerable due to deepseated structural flaws. Late-1980s Japan was the poster child for this malady. Three factors define the difference between today’s American subprime crisis and Japan’s lost decade: the source of the crisis, the magnitude of the strain and the response of policymakers.

Japan’s crisis was woven into the fabric of its political economy. The 1980s “bubble” was as much a symptom of Japan’s flaws as a cause of the ensuing bust.

We agree with this, and thus assume that all eyes must now be on US policymakers. Structurally, the US is certainly more sound now than Japan was in the late 1980s, though the US is now facing lower productivity growth than it did in the 1990s. At the same time, the US does not face a potential demographic disaster such as the one that currently looms over Japan and has begun to drag down domestic spending and GDP; we find it hard to imagine that US consumer spending will be seriously hurt in the next decade. However, there is a dark underside to US consumer spending, which is the vast public (current account) and private debt incurred by shopping on credit.

As Mr Katz put it, “[F]or things to get really bad in the U.S. and the global economy, policymakers would have to mess up far more badly than they have done so far or are likely to do. Alarmism is just as dangerous as complacency.”

And that’s good news for Japan, or any other major exporter to the US.

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Comments

18 Responses to “Recent articles on the subprime crisis and the US in 2007 vs Japan in 1989”

  1. Contrarian on February 14th, 2008 8:57 am

    Incomes in the U.S. have been flat in real terms for the last 8 years and the Dow is lower, now, in real terms. Indeed, if you measure GDP, U.S. equities, income, etc. in currencies not linked the the U.S. dollar (or carry trade currencies), the U.S. looks like it has been struggling for years. In other words, expansion in the United States was largely an illusion of inflation and leverage (which seems poised to unwind over the next several years).

    I think that the United States situation is different that the 1990 Japan one. Japan was a classic boom-bust scenario: over-investment, unsustainable expansion eventually led to over-supply, over-capacity and the ensuing crisis. Compare this to the United States, in which this “expansion” is largely characterized by exported production to the emerging world and debt growth. This unusual boom (and what appears likely to be) bust scenario can only be enjoyed by an entity with unlimited (as far as has been tested so far) borrowing capacity. Stephen Roach was right to suggest that there is nothing healthy about an economy defined overwhelmingly by consumption (72 percent last year).

    I don’t think the Dow is heading to 5000, but I do think that the United States is at a point where, at best, it will be treading water while watching Asia (except Japan) account for growth in global GDP.

  2. DR on February 14th, 2008 11:10 pm

    I saw that article and nearly barfed. I have seen similar articles over the last decade or so. Every time there is a hint of recession in the US, our reliable journalists/pundits will crank out some nonsense like this. As noted, there were (and are) very few similarities between the Japanese and US economies.

  3. Kevin on February 15th, 2008 1:48 am

    “Incomes in the U.S. have been flat in real terms for the last 8 years and the Dow is lower, now, in real terms. ”

    One might be able to find stats to support that assertion if one measures from the very peak of the bubble in 2000 (as so may people are wont to do). But I could equally say:

    “Incomes in the U.S. have risen in real terms for the last 6 1/2 years and the Dow is MUCH higher, now, in real terms.”

    So measure from peak, or measure from trough, to get the desired result, your choice.

    Meanwhile, aside from the basic superficial similarities, I think the U.S. is in a fundamentally different situation than 1990s Japan. It was obvious to clear- headed Westerners in 1989-90 that the Japan stock market and real estate were stunningly overvalued. I recall reading Peter Lynch’s observation circa 1987 that he didn’t mess with Japanese stocks because they were so irrationally overvalued and he didn’t understand it. We’ve got some residential properties that are overvalued but on a much lesser scale. The stock market’s probably about right and nothing short of an exogenous calamity would bring it to Dow 5000 — the below-8000 dip immediately following 9-11 is probably as bad as anything can get, and even back then I bitterly regretted that I didn’t have the cash to back up the truck, or I would have.

    Meanwhile the population is younger, more optimistic and creative, GROWING, and has a higher propensity to consume; and in every way the economic fundamentals are more rational.

  4. Contrarian on February 15th, 2008 8:08 am

    Kevin:

    You’re just making things up now. 6.5 years ago was…midway through 2001.

    Incomes hadn’t fallen much from the 2000 peak. If you look at incomes, as reported by the IRS, you’ll find that incomes were still flat over your time period in real terms (2007 returns haven’t been filed, so I don’t have last year’s data, but I will hazard a guess that it won’t help your case much).

    The Dow is not “MUCH higher.” If you go back to summer 2001 (as you suggested), the Dow was around 11,000. The October 2007 peak came on the heels of geometric average returns of less than 5% over your time period.

    Suppose that you meant 5.5 years, when incomes hit a local minimum (and so did the Dow). Incomes outpaced inflation by about 1 percent since then (again, I don’t have the 2007 IRS data). Yeah, the Dow did awesome over that time. Big deal; most markets did better. And, I measured peak to peak. You measured from bottom to top. I’m not sure what your point is.

  5. Ken Worsley on February 15th, 2008 12:48 pm

    Contrarian,

    Was that comment directed at the commenter above you (Kevin)? Or the guy who wrote the piece (Ken)?

    I see you quote “much higher,” but a full text search of this page only turns up that exact match in the comments section, not the main piece.

    Anyway, let us know.

  6. paz on February 15th, 2008 4:57 pm

    The idea that the US would go through anything resembling what Japan has is absurd. The US holds open congressional hearings on these sorts of messes so that an attempt can at least be made to get to the bottom of it and do something in terms of policy to correct it.

    They don’t always make all the right moves, but at least the problem is dealt with. Firms will have a much harder time hiding bad debt over decades. The level of scrutiny is much higher.

    That doesn’t stop them from messing up again, but what really hurt Japan was the extent to which everything could be hidden. It just stays in the dark. How long will it be before we know how much subprime loss is hidden at Japanese banking institutions?

  7. Willie on February 16th, 2008 6:13 am

    “What do you call someone who thinks the US is in a recession?”

    An optimist.

    Everyone here seems to be quite optimistic about the US. I’d say that the American empire is winding down, and the dollar’s days as the world’s standard may be coming to an end. This doesn’t mean the collapse of the US, but it doesn’t sound like happy days ahead.

    Unless I’m mistaken, hourly wages in the US maxed in 1973, at least for men. And that’s believing the government’s lying statistics.

  8. Contrarian on February 16th, 2008 6:50 am

    Sorry. I meant kevin. I read so much stuff by you that your name is on the top of my mind whenever I respond at this site. I was thinking kevin, but my fingers were not responding to my brain.

  9. W. Anthony Malcolm on February 16th, 2008 2:48 pm

    Good article Ken. Long time no blog for me. As I’ve been following the news from the U.S., it seems that the economy is slowing, but the Fed Reserve (like em or hate em) is trying to manage the situation as carefully as possible.

    Congress and the President approved a stimulus package that is suppose to inject the average consumer with some needed cash, but, I believe, that is just a lip stick covering that will wash off soon. The last few tax back deals the government ran didn’t do much, as people used them to pay down debt. That said, those same consumers ended up incurring more debt.

    I think Ken makes a good point in saying, “However, there is a dark underside to US consumer spending, which is the vast public (current account) and private debt incurred by shopping on credit.” This is what will really damage the U.S. economy. Spending money you don’t have. I have no problem with using credit cards, but the average American household has like 7 to 9 credit cards, and these days they are probably maxxed out. Use your card, but pay it off. People end up going delinquent and that saps the strength of banks and other financial institutions to continue to loan money. It’s a loan, not a grant.

    Lastly, the Fed and other government institutions need to control how the debt is being managed by these private financial institutions. I read the other day that the largest bank in Switzerland is feeling a pinch because it has accrued debt from the U.S. housing market and is now losing out on what they thought was an investment. And they can’t really call in the debt because that would topple market systems everywhere else, so they are stuck with it. Why is a bank in Switzerland holding U.S. mortgage debt? Imagine if Japanese, Chinese, Singaporean, and other national banks called in debts owed to them from U.S. lenders (which is what is happening)? The World system would crash. The U.S. government needs to be less hands off, and more hands on with how money and lending is managed within its borders. Lenders should not be allowed to shop around debt, or we will forever be talking in crisis terms.

  10. Kraig on February 17th, 2008 12:33 pm

    Everyone here seems to be quite optimistic about the US.

    Unfortunately. There’s not too much to be optimistic about, especially knowing who’s been elected over the past eight years. Doesn’t speak well for the population in general.

  11. Ken Worsley on February 18th, 2008 10:04 am

    Willie, I don’t think being optimistic over how the US will fare in the current short-term economic cycle necessarily makes one optimistic over the long-term future of the country. They’re pretty distinct issues.

  12. Paz on February 18th, 2008 10:46 pm

    “What do you call someone who thinks the US is in a recession?”

    An optimist.

    Really? Given what the US has pulled through before, I don’t see that as overwhelmingly optimistic. Of course, there needs to be an end put to wasting money on stupid wars.

  13. Alex Sinclair on February 19th, 2008 10:47 am

    Japan is competitive and their consurmer is not heavily burdened by debt. It is true that wages are lower than they were some 5 or 10 years ago but that is also part of their competitive advantage. They also have seen their currency weak against most of the world’s currencies. Exports to the US are likely to decline but exports to Asia, Europe and the rest of the world are increasing. Japan is very competitive against the paper Tigers and China as their currencies have been rising. Japan remains a capable exporter and as the US economy deleverages; Japan will do better than most in Asia. The yen/$ rate is not really that important to Japan in this environment. Japanese investors are likely to move away from $ denominated investments as the US consumer deals with too much debt and the credit crunch works its way through the system over the next couple of years. If the US goes into recession 90 yen to the $ is in the cards.

  14. Ken Worsley on February 19th, 2008 11:13 am

    Yen at 90 means the Nikkei will have to be way down, well under 10,000 - talk of ‘decoupling’ has disappeared quite quickly as analysts realized it was a pipe dream. “Decoupling” has basically come to mean that the Nikkei reacts to US news in the AM, Asia news after lunch.

    Consumers may not be as heavily burdened by debt in comparison to the American consumer (though there is plenty of consumer debt, and comparing anything to the US is bound to be skewed since the US is so far off on this), but they will be burdened by higher prices and stagnant wages. With 55% of GDP being generated by domestic demand, I don’t see how decade-long stagnant wages are part of a competitive advantage…especially seeing how that influenced the last election results.

  15. oldies on February 20th, 2008 4:02 pm

    See this one:

    http://www.guardian.co.uk/world/2008/feb/20/japan.globaleconomy

    A nice countertake to some of the BS that’s been slung around comparing subprime to the bursting of Japan’s bubble.

  16. seth on February 26th, 2008 9:32 pm

    Ken, while I agree on the lack of any meaningful ‘decoupling’, your thoughts on the yen/Nikkei tie reflect what we’ve seen recently, but by no means need to continue to exist in the future. A host of factors could throw that correlation off, and the weakening of the dollar may be chief among them.

    I say we will see the Nikkei rally a bit this year. Will this result in a weaker yen? It’s definitely possible, but one has to wonder whether traders (big or small) are willing to re-assume the risk that comes along with betting up to 120 in the current environment.

  17. Kraig on March 2nd, 2008 12:47 pm

    seth:

    I say we will see the Nikkei rally a bit this year. Will this result in a weaker yen? It’s definitely possible, but one has to wonder whether traders (big or small) are willing to re-assume the risk that comes along with betting up to 120 in the current environment.

    Either way is assuming risk. I don’t see how the Nikkei would rally (which involves assuming risk), without the yen weakenin (which also shows a lack of aversion to risk).

  18. Hillary Clinton’s Wall Street Journal Interview: Does she Really Fear a “Japan-Style Malaise” in the US? Japan Economy News & Blog - Business, Economy, Marketing and Economic Reports on March 29th, 2008 10:16 pm

    […] Japan fifteen years ago and the US today. A few weeks ago we laid out our position as to why attempts in the media to link the two events were simply untenable, constituting lazy journalism at best, and scaremongering at […]

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