Japan’s Lost Decade….If We’re Lucky

Easy come, easy go.  This week, S&P gave back almost all of its gains from the prior week by dropping 4.8%.   The S&P has fallen in five of the first six weeks in 2009.  

The economic news was sparse but still gloomy: unemployment claims stayed well above 600 thousand, business inventories fell, and the Michigan sentiment index dropped much lower than expected. 

On the earnings front, most of the Q408 results are in, and this week’s actuals and outlooks were generally poor–again.  Interestingly, the as reported results for the S&P for Q408 will be negative for the first time in history; at the year end closing price of 903, the TTM P/E ratio is well over 30, implying that the market expects a massive rebound in earnings later this year.

How realistic is this?  Japan’s experience in the 1990’s suggests that it is not very likely.  At under 8,000 the Nikkei 225 is trading at approximately 80% below its peak of 39,000 attained in 1989–almost 20 years ago!

How comparable is Japan?  More than we realize. 

For starters, the nature of their crisis is very similar to ours:  the bursting of a real estate bubble and credit bubble. 

But in many ways, our problems and our proposed solutions are worse.  Our residential real estate prices doubled in the five years before peaking.  Japan’s real estate prices climbed only 50%.  Our credit bubble pushed total private (excluding government) debt to 300% of GDP; Japan’s peak level never soared so high.  Our net debtor status makes us dependent on the investment and savings of the rest of the world; Japan’s high domestic savings rate allowed it to borrow from it’s own people.  Also, most of the developed world is entering a severe recession today; Japan had the ability to export to stronger global markets to pull itself out of the abyss.  Finally, our credit bubble collapse is far more severe in the non-bank securitization markets, making it much harder to fix; Japan’s credit bubble collapse focused on the banking sector, a much more manageable problem than collapsed securitization.

 And our proposed solutions are no better than Japan’s.  In fact, we’re pursuing the same monetary and fiscal fixes that did not work in Japan.  The monetary stimulus is ineffectual (pushing on a string); the fiscal stimulus is both too small (liberal economists argue that we’re trying to fill a $3 trillion demand gap with $800 billion) and inappropriate (conservative economists argue that long-term spending projects won’t work as well as short-term tax incentives).  And most importantly, the credit fix matches almost exactly Japan’s initial failed efforts:  taxpayer capital injections into struggling banks (think Citi) holding worthless loans made to struggling households (think non-performing mortages ). 

Japan’s annual GDP growth averaged only 1% for all of the 1990’s.  Given our problems and solutions (so far), we would be lucky to average 1% for the next ten years.

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