2010/9/2
What Is Truly Frightening Is a Japanese-Style Economic Crisis
From the lead article by Peter Tasker (co-founder of Arcus Investment) in this week’s Japanese edition of Newsweek

Greece is to blame for all this… Yet, curiously, there is no sign of tension at all in the bond markets.…
The role of bond-market investors is to keep watch over politicians’ spending. And yet… What this means is this: throughout the developed world, consumers troubled by the trauma of the economic crisis are spending less and saving more. Cautious companies are holding back on investment—in other words, no one is borrowing. As a result, vast amounts of private money are surging like a tsunami into government bonds, where safety comes first. By former standards, the state of national finances is appalling, but after a global economic crisis, those old standards no longer mean anything.

Perspective: What the world should fear is not a Greek-style collapse but a Japanese-style morass of deflation from which there is no escape for years.

The High Price Japan Paid

Where will this situation eventually lead? Let us look at Japan’s example.
The yield on Japanese government bonds fell below 3 percent in 1996.
Many people thought there was a government-bond bubble, but Japan fell into deflation two years later.
Nominal yields looked low at first glance, but once prices were taken into account, the returns were attractive enough.
Today, with government debt approaching 200 percent of GDP, the yield on Japanese government bonds is below 1 percent.
Even so, investors are satisfied simply to get their principal back…

But everywhere outside Greece, a current of deflation like the one that struck Japan’s economy is gathering force.…
Becoming like Japan is far more dangerous than becoming like Greece.

You may wonder why becoming like Japan’s economy is so dangerous.
After all, did Japan not manage reasonably well through the lost twenty years following the collapse of its bubble? It may look that way on the surface, but Japan paid a high price.
Japan’s GDP growth over the twenty years after 1989 fell short of America’s growth over the twenty years after the Great Depression of 1929.

The “Psychological Deflation” of Lost Confidence

Inevitably, Japan’s geopolitical standing has declined, and it no longer has the strength to confront China’s challenge.
“Japan as Number One”—with its relentless industrial strategy, extraordinarily aggressive business leaders, and consumers who spared no expense—has faded from memory.
A “psychological deflation,” in which confidence and certainty about the future have been lost, has brought about a situation in which it would be no surprise for government-bond yields to fall to zero.

Inequality is widening as well.
Since the beginning of the twenty-first century, the number of households in Japan with annual incomes of 3 million yen or less has increased by 50 percent.
There was a recent report of families collecting the pensions of elderly people who had long since died. It is a bizarre piece of news that lays bare just how severe Japan’s economic condition has become.

Deflation is like quicksand.
It is easy to fall in and extremely difficult to get out.
The best response is to stay away from it.
We must not let Greece distract us.
We must use every fiscal, monetary, and regulatory means available to avoid falling into a Japanese-style economic crisis that heedlessly strips us of our own strengths.