“Turning Japanese” was a classic one-hit wonder by The Vapors in 1980 and three decades later it is certainly not music to the ears of US policymakers and debt-strapped households as the world’s largest economy struggles for traction.
The bursting of Japan’s debt bubble in the early 1990s heralded years of deflation and subdued growth, in spite of endless fiscal and monetary stimulus efforts.
That has seen equities languish, with the Nikkei 225 Average some 80 per cent below its peak, and kept the 10-year Japanese bond yield below 2 per cent since early 1999.
Three years and counting since the bursting of the US credit and mortgage bubble, the yield on benchmark 10-year Treasury notes sits below 2 per cent, a level that suggests the US is in danger of emulating Japan’s experience of two lost decades.
One significant concern is that, unlike Japan in the 1990s, the US is struggling at a time when growth expectations across much of the world are slowing. China is tightening policy and no one really knows the extent of contagion that may erupt from the denouement of the eurozone debt crisis. Safe haven buying is pulling Treasury yields lower.
While there are similarities between Japan and the US, there are crucial differences and 10-year yields below 2 per cent should be placed in context. For starters, the US does not face deflation at this juncture and also has a central bank that has been very proactive given its dual mandate of seeking stable prices and maximum employment. The US policy response since 2008 has been far faster than that which occurred in Japan during the 1990s. Therein resides the hope for investors that the process of repairing financial and consumer household balance sheets will conclude well before the end of the decade.
Another key difference between the two countries is that, outside financials, many US corporate balance sheets are healthy. This helps explain why Wall Street, with the exception of financials, has been spared from the type of rout that engulfed Japan’s equity market. But, substitute Japanese corporate balance sheets with those of the US consumer, then align that with banks exposed to such debts, and the parallels between the two countries are uncomfortable.
The vaunted flexibility of the US labour force is being stymied in part by the weakened housing market. Workers cannot move so easily when their main asset is worth less than its outstanding mortgage. Moreover, the robust health of many US company balance sheets reflects, in part, its reluctance to hire workers, particularly those aged over 55. A far more worrying sign for the US is how the recent squabble in Washington over raising the debt ceiling and using fiscal policy to stimulate the economy echoes the political intransigence that has defined Japan’s approach to dealing with its problems.
Aggressive short-term stimulus in conjunction with genuine long-term budget reforms would be a good step. As would a plan to accelerate the writedown of excessive household debt. Such efforts appear a hostage to the febrile political climate and a new stimulus plan announced by President Barack Obama to boost the economy this week faces a tough ride through Congress.
All of which leaves the Fed with the task of boosting the economy, as fiscal measures face the ranks of austerity hawks in Washington.
True to form, bond traders have ignited Treasury prices and sent yields sharply lower over the past month as they bet the Fed would undertake further easing, most likely involving purchases of long-term debt.
The drop in the 10-year yield below 2 per cent reflects eurozone fears and positioning by investors who hope to sell their paper back to the Fed, rather than a signal that the US is moving into a Japanese-style deflationary spiral.
With the Fed determined to stop the US from sliding into deflation, an eventual recovery slowly beckons as households rebuild their savings and home prices stabilise.
And “Turning Japanese” will simply remain a 1980s pop music artefact.
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