Thursday, February 5, 2009

Roubini on the U.S. and Japan: we're really not out of the woods yet

This is a great article that highlights (from a bird's-eye view) the differences and similarities between the Japanese economy in the 1990s (through the early 2000s) and the current U.S. crisis. Nouriel Roubini from Forbes:
Let me explain why the U.S. and the global economy face the risk of an L-shaped near-depression if appropriate policy actions are not undertaken.

First, note that Japan made many policy mistakes that the U.S. should and could avoid. Japan cut policy rates two years after the bust of its asset bubble, while the U.S. eased monetary policy aggressively after August 2007. Japan went into quantitative easing and reversed its zero interest rate policy too slowly; it waited two years after the bursting of its bubbles to do a fiscal stimulus (and reversed it too early with a consumption tax). The U.S. did one--albeit a failed one--last year, and is doing another large one now. Japan created a convoy system of zombie banks and corporations that were restructured too late, while the U.S. may become more aggressive in cleaning up the financial system. Japan had structural rigidities, like lifetime employment, that slowed down the adjustment, while the U.S. has flexible labor markets, with workers who have lost jobs moving fast to new sectors and regions where jobs are abundant.

But by many measures, the U.S. started its financial and economic crisis in much worse shape than Japan. Indeed, Japan was in much better macro and financial shape than the U.S. before and during its stagnation. Japan had the benefit of high household and national savings rates and low leverage of the household sector, a large current account deficit and a net foreign asset position that allowed it to finance its large fiscal deficit during the stagnation. The U.S., by contrast, has had near-zero household savings and massive leverage for years. The U.S. carries large current account deficits and is the largest net foreign debtor in the world, relying on the kindness of strangers, or--more accurately--on the kindness of its strategic rivals (China, Russia) or unstable petro states to finance its twin fiscal and current account deficits.

The U.S. may make some of the same mistakes as Japan and suffer similar macro policy constraints that could limit its ability to more rapidly resolve the financial crisis. First, monetary policy, however aggressive, is like pushing on a string when you have a glut of capacity, credit and insolvency, rather than just illiquidity problems.

Second, fiscal policy has its limits for a nation that is already the biggest net debtor and net borrower, one which needs to borrow $2 trillion net ($2.5 trillion gross) to finance its fiscal deficit. Every other country (including the U.S.' traditional lenders and creditors) is now running large fiscal deficits with the risk of a sharp back-up in long-term interest rates once the tidal wave of new U.S. Treasuries hits the market.

Third, the U.S. is taking an approach to bank recapitalization and cleanup that looks more like Japan--a convoy system and a delayed true cleanup, as the necessary pain to shareholders and unsecured creditors of banks is avoided or delayed--than like the successful outright takeover and nationalization process Sweden has chosen.

Fourth, the market-friendly, case-by-case approach to the necessary debt reduction of insolvent private non-financial agents--corporate for Japan, households for the U.S.--will be too slow. A systemic debt overhang requires across- the-board debt reduction that is not politically feasible, at this point, in the U.S.

Thus, even if the U.S. were to do everything quickly and correctly (in terms of monetary, fiscal, bank cleanup and household debt reduction) we would still have a severe two-year U-shaped recession, lasting until early 2010. The weak recovery of growth, 1% or so, continues to feels like a recession even after you're technically out of it, until 2010-2011. But if the U.S. does it wrong, this severe U-shaped U.S. and global recession may turn into a nasty, multi-year, L-shaped near-depression like that experienced by Japan.

We don't have to go back to the Great Depression (when output fell over 20% and unemployment peaked over 25%); even a stag-deflation and near-depression like that in Japan would be most severe for the U.S. and the global economy. And while six months ago I was putting the odds of this L-shaped near-depression at 10% or so, they have now risen to one-third.

Time is of the essence, and the clock is working against U.S. and global policymakers. The time to stop dithering has long passed; the time to implement a program of forceful, coherent, credible, globally coordinated monetary, fiscal, financial clean-up and debt-resolution policies is now.

The U.S. and global economy are truly risking a near-depression if the policy reaction is not bold, aggressive, sustainable and credible.
RW: I highlighted the essential problem right now: how to attack the perhaps imminent systemic banking crisis. Hopefully policymakers will get their acts together and bring something to the table that will work.

Rebecca Wilder

2 comments:

  1. It's not a "systemic banking crisis".

    It's a debt crisis of epic proportion.

    Americans went on a twenty year exponential-rate debt binge fostered by Bush-Clinton-Bush and Greenspan.

    Like yeast that multiply until they die in their own excrement, thus creating alcohol, this unsustainable debt binge has poisoned the economy.

    Americans lack sufficient buying power to pay for living expenses (food, fuel, electricity), debt (mortgages, credit cards, car loans, home equity loans) and taxes.

    This lack of buying power comes from not making and selling things the world wants.

    This lack of buying power comes from violating Say's Law -- output pays for workers to prosper (i.e., supply makes its own demand).

    This is the consequence of an irredeemable paper currency, unchecked fractional reserve banking and a charter monopoly holding the manufacture and distribution of money (the Federal Reserve).

    As I have posted several times, here's the only legitimate fix:

    1) let all insolvent banks go bankrupt (e.g., Citi)

    2) pay MZM money depositors (checking accounts, savings accounts, money market accounts) their full account amount and not only to the FDIC guarantee limit

    3) randomly assign the accounts in #2 to solvent, regional banks

    4) auction off all building and equipment of the failed banks

    5) fire all of the senior level executives -- men and women who have proven to the world that they are the most inept, most incapable bankers in history.

    6) have all bond holders, stock holders, note holders take 100% losses on the failed banks.

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