June 12, 2002
From the desk of Jane Galt:Meanwhile, Japan heads rapidly down
Meanwhile, Japan heads rapidly down the drain.
Japan is vindication of Keynes to this extent: it turns out that Keynes was right about at least one thing.
The basic idea is this: for various reasons, people decide to put off spending into the future. The technical term for this in economics is "saving".
[This is all vastly simplified because I'm writing a website, not a Macro textbook. 'Kay?]
Because you (and 120 million other consumers) aren't buying things, factories produce less. This throws people out of work. This produces even less current demand for goods, which means factories produce less . . .
Keynes theorized that an economy could essentially stall out; for it to pick up, people would need to start buying things, but they would refuse to do so, because of deflationary expectations, uncertainty about the future, and other sundries. With this vicious circle in operation, production would get permanently stuck at an artificially low level, like the car you had to sell because it wouldn't shift to second gear.
It also turns out that Keynes was wrong to this extent: his solution doesn't work. The Keynsian solution to this is government spending. Japan has a deficit of 7% of GDP and debt approaching 150% of national income, and a very large number of roads going nowhere, government buildings where nothing happens, and bridges connecting two places that were already quite well served by the bridges they had. Yet the stagnation drags on.
The monetarist solution is lowering interest rates. Also didn't work; the Japanese government is practically begging people to take these yen off their hands -- take as much as you like! Are you sure you don't want thirds? -- and the economy's still moribund.
There are some people arguing that they should just start printing money, but it's not clear that that would work either; Japan's credit is already on the rocks, and people seem to suck up any excess liquidity in the system by sticking it under their mattress with the rest of their cash.
So what the hell's going on?
Japan seems to have four overlapping problems.
The first, and probably the most important, is the demographic crisis. Japan averages 1.3 children per mother, far below replacement rate. Women in their 20's and 30's are refusing to get married, because the familial structure of Japanese marriages seems to be somewhat onerous. Whatever the reason, the population is aging fast. People alive today know that there are not enough people in the workforce to support a public pension; they're trying to sock it away for their retirement. Unfortunately, all this saving, much of which goes into government bonds for boondoggle construction projects with a negative net return, is killing their economy now, which doesn't improve the future outlook. And since the outlook is so grim, they figure they'd better put some money away. . .
This both feeds into, and off of, deflationary pressures. Deflation is the opposite of inflation; it means a dollar tomorrow will buy more than a dollar today. Since we're all raised on a 70's fear of inflation, this sounds like a good thing. But deflation has problems. For starter's, it was a major cause of the Great Depression. Deflation crushes borrowers, who have to pay each loan installment with ever-more-expensive money. While it makes people eager lenders, it makes reluctant borrowers. While theoretically, interest rates should move to equialize demand for savings and demand for investment, interest rates cannot go below zero. Therefore, when deflation gets too bad, the monetary policy of the central bank can't use the usual means to stop it. Think of it this way: if I offer to just give you five bucks on the condition that you pay it back in a week, and in a week you know that you'll be able to buy 20% more stuff with the five bucks, this is not, for you, a good deal; it's an effective interest rate of 20%. And you can't lower it any more unless I offer to pay you to take my money.
Japan has a lot of people willing to lend (save) but no one who wants to take them up on it; it's just too expensive.
Which leads us to the third major problem: the banks.
The banking system is a disaster. Large parts of it appear to be insolvent; only the willingness of the central bank to prop them up through a combination of bad loans and bad accounting is keeping them afloat. But no one really knows, because Japan Inc. didn't, apparently, thrive on transparency.
Banks are the primary vehicle of money creation in a modern economy. The central bank pumps in liquidity; the banks make loans; the loans expand the money supply. Only any money that goes into the banking system goes to prop up the disastrous balance sheets. And no one wants to borrow any money, anyway, because the future doesn't look so bright, which is not a good time to start a new business, and the deflation means the interest rates are too high, and besides, the potential borrowers all busy saving for retirement.
Meanwhile, the deflation and the crappy economy, which are caused by. . . the deflation and the crappy economy, are eating away at the bank's balance sheets because each bout of deflation/crappiness produces more borrowers who can't meet their loan payments, and the deflation means that whatever was securing the loan is probably now worth less than the loan so there's no point in foreclosing; the banks string them along hoping they'll be able to pay at some unspecified point in the future. Meanwhile, the banks can't afford to make new loans because they're insolvent, and even the banks that are solvent have difficulty finding loans to make because people don't want the money, but also because the uncertain economic outlook makes such loans risky. Which causes. . . deflation and a crappy economy.
On top of all this, the only people in Japan who are spending any money are the aforementioned young single women who are rapidly driving the nation to its demographic doom. Everyone else has developed a mania for making do with less. If there's anything a nation in a deflationary crisis needs less than a "Back to Basics" movement, it's hard to imagine what it could be, but that's exactly what Japan has developed; it's a thriving fad to find out exactly how little you can spend.
So what to do? People are fresh out of ideas. Something has to be done to force consumers to digorge their cash in favor of consumer goods. But what can they do? Create inflation, somehow. But other than operating the printing presses on a Weimar Republic scale (which is what Paul Krugman, among others, has advocated and who knows, maybe it's the answer), how do they do it? The ex-boy's father was an economist specializing in Japan, and his particular prescription was announcing a sales tax to be phased in over a number of years; it's as good a thought as any, I suppose, though the political fallout is apparently unacceptable. But now, with the debt downgraded and the risk of default looming, perhaps they'll try such a scheme. They've got to try something.
And why should you care? Because we're going to have ANOTHER GREAT DEPRESSION RIGHT NOW! No, that's not why, although I did recently read a hysterical article claiming it was so. Rather, because Japan is the canary in the gold mine.
No large industrial society in history has attempted to cope with the kind of massive demographic shift that's occuring in all Western countries, with the old living longer past their productive years, and fewer and fewer young people to support them. Japan is the first nation to hit that shift, because its diet makes people longer lived, and its birthrate is extraordinarily low. Even absent the banking crisis, this kind of deflationary pressure may result when our own crisis hits, as people desperately try to save for future consumption, and thereby tank the economic growth that could provide that consumption. Japan's crisis may be unique in the conflation of a banking disaster, but that doesn't mean we shouldn't be taking a long, hard look in the mirror.
Hang in there, folks; we're in for a bumpy ride.
Posted by Jane Galt at June 12, 2002 02:44 PM | TrackBack | Technorati inbound links