Download The US and UK resembled Japan during its lost

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The US and UK resembled Japan during its lost decade. Real estate prices were in a debt
driven bubble. When the bubble burst, asset values collapsed, sending shockwaves throughout
the marketplace. Aggressive and unorthodox central bank action prevented a complete financial
meltdown. Although monetary policy offers some support to an economy, it is not enough to
stimulate an economic recovery after a nationwide asset bubble collapses.1 In this situation, a
government must increase deficits to fiscally stimulate the economy while the private sector
deleverages.
Over 30 years ago Japan experienced almost exactly what the western world is going
through today. The country had a nationwide real estate bubble. From 1977 to 1990 prices more
than doubled.2 When the bubble burst prices fell 76% from the peak.3 As banks realized losses
on loans a credit crunch ensued, threatening financial stability.
To prevent a financial crisis the Bank of Japan became the lender of last resort.
Government bonds were swapped for illiquid assets with private banks. Liquidity was injected
directly to the interbank market, eliminating rollover risk. And non-bank financial institutions
like Yamaichi Securities received emergency loans. In an attempt to prompt credit growth
interest rates were cut to zero and the monetary base increased 110% (Table 1).4 The central
bank’s unprecedented responses restored market confidence and stability but did not stimulate
growth.5
A 190% increase in Japanese non-financial private sector debt fueled the housing
bubble.6 When the bubble burst asset values collapsed, while liabilities remained the same,
rendering large segments of the private sector balance sheet insolvent. Individuals will not
borrow money when they have negative equity, regardless how cheap credit is. This is why the
money supply remained relatively flat and bank loans decreased, despite ample liquidity and zero
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interest rates (Table 1).7 To regain financial health, the private sector paid down debt for 14 years
however that deleveraging threatened to deflate the economy provoking the government to
intervene.8
The Japanese successfully stimulated the economy by cutting taxes and increasing
spending. From 1990 to 2005 fiscal stimulus bought 2000 trillion yen in GDP while adding 460
trillion yen to the deficit.9 As a result, GDP stayed above the pre-bubble peak and unemployment
stayed below 5.5%, which is remarkable given the private sector lost 1500 trillion yen of wealth
after the bubble burst.10 Expansionary fiscal policy did not crowd out the private sector, nor did it
cause excessive inflation because the private sector was deleveraging. However the Japanese
committed a policy error when they tried to cut the government’s deficit.
Twice the Japanese attempted to reduce government debt before the private sector had
finished deleveraging: first in 1997 and again in 2001. Each time the economy deflated, GDP
decreased, tax revenues decreased, and deficits increased. Premature fiscal reforms increased the
deficit by 142 trillion yen, due to decreased tax revenues, and resulting in nine extra quarters of
economic contraction.11 Were it not for premature fiscal reforms, Japan would have come out of
its recession cheaper and quicker. Japan’s failures and successes should serve as policy models
for the western world.
The US, like Japan, had a debt fueled real estate bubble. Home prices increased over
200% from 1992 to 2007.12 When the bubble burst home prices fell 33%.13 The collapse in asset
prices sparked a credit crunch. To prevent a complete financial collapse the Federal Reserve
stepped in to prevent a financial crisis much like the Bank of Japan.
The Federal Reserve purchased commercial debt directly from the market through its
Commercial Paper Funding Facility eliminating rollover risk. Primary dealers swapped illiquid
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assets for Treasury Bills with the central bank. Currency swaps were coordinated with 14 foreign
central banks easing conditions at which banks operating abroad access dollars while money
market mutual funds received direct support from the Fed.14 Attempts to stimulate growth were
the same as Japan’s, the interest rate was cut to zero and the monetary base increased 220%, and
they failed for the same reasons (Table 2).15
Private sector debt fueled the housing bubble in the U.S. as it did in Japan. From 1992 to
2008, US consumer debt increased 216% to finance the housing bubble.16 When the bubble
burst, individuals had more liabilities than assets making them balance sheet insolvent. To regain
solvency, households increased net savings 147% to pay down debt.17 Households do not want
more debt, which is why bank loans decreased 19% and the money supply increased marginally
despite zero interest rates and ample liquidity (Table 2).18 Real estate bubbles and the destruction
they wreak on an economy are not unique to Japan and the U.S.
The UK had a debt fueled bubble similar to the US and Japan. Real estate prices
increased 250% from 1992 to 2007.19 When bubble popped home prices declined 19%.20 A
credit crunch ensued as lenders feared counterparty risk. The Bank of England intervened to
prevent a financial crisis using similar monetary policies as the US and Japan.
Commercial paper was purchased directly by the Bank of England to eliminate a role
over risk. Primary dealers swapped illiquid assets for Treasury Gilts with the Bank of England.
Insolvent and overleveraged institutions were nationalized by the bank or acquired by
competitors in government facilitated deals. Stocks of distressed banks like RBS, HBOS and
Lloyds TSB were purchased to stabilize share prices. The bank’s attempt to spur credit growth,
.5% interest rates and a 165% increase in the monetary base, was the same as its American and
Japanese counterparts and it failed for the same reasons (Table 3).21
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From 1992 to 2008 a 244% growth in UK consumer debt financed the housing bubble,
much like Japan and the US.22 When real estate prices collapsed, households became balance
sheet insolvent as liabilities exceeded assets. To regain solvency, household savings increased
209% from 2007 to 2010 to pay off debt.23 Bank lending is down 18% and the money supply is
up only slightly despite cheap credit because consumers want to minimize debt (Table 3).24 Even
though the two economies of the US and UK suffer the same problems the two countries differ
on fiscal policy.
In 2009 the US passed the $827 billion American Recovery and Reinvestment Act to
stimulate economic activity. According to CBO estimates it increased real GDP by 3.5% to
9.2%, employed 3.1 to 8 million people, and prevented unemployment from being 1.7% to 4.3%
higher from 2009 to 2012.25 In contrast, the UK, after relatively small stimulus measures, cut
spending and raised taxes to lower government debt. Not surprisingly, the US’ economy is
stronger than the UK’s: unemployment rates are falling in the US while rising in the UK and
GDP is growing faster in the US than in the UK (Tables 4 and 5).26,27,28,29 Given the political
discourse in the US and austerity measures in Europe it appears the world has not learned from
the Japanese.
The fundamental problem was always private sector debt. It was the private sector that
took on too much debt, fueling the housing bubble and artificially inflating growth. But now it
must pay back debt accumulated during the binge years, which means it must increase savings.
The only way the private sector can increase savings is if the government deficit spends because
a government deficit is by definition the private sectors savings. Without fiscal stimulus global
economic growth will remain anemic for the western world’s deleveraging process has just
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begun (Table 6).30,31,32 High government deficits must become the new norm or else the western
world will lose a decade of economic growth.
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Table 1: Monetary Policy Failed to Stimulate Lending
Table 2: Failed Monetary Policy US:
Source: Board of Governors of the Federal Reserve.
Notes: 1. 2008 = 100.
Table 3: Failed Monetary Policy U.K
Source: Bank of England.
Notes: 1. 2008 = 100. 2. Reserves are seasonally unadjusted data.
Table 4: Percent Change in GDP Quarter to Quarter
Sources: Office for National Statistics, Bureau of Economic Analysis
Table 5: Unemployment Rate
Sources: Office for National Statistics, U.S. Bureau of Labor Statistics.
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Table 6: Private Sector Deleveraging Process
400
350
300
250
UK
200
US
150
Japan
100
50
0
1
3
5
7
9
11 13 15 17 19 21 23 25 27 29
Notes: 1. For Japan 0 = 1980. 2. For UK 0 = 1992. 3. For US 0 = 1992. Sources: Office for
National Statistics, Board of Governors of the Federal Reserve, Cabinet Office of Japan.
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Notes
1. Janet Yellen. “Unconventional Monetary Policy and Central Bank Communications,”
Board of Governors of the Federal Reserve System. Presentation at the U.S. Monetary Policy
Forum, New York, NY, February 25, 2011.
http://www.federalreserve.gov/newsevents/speech/yellen20110225a.pdf.
2. Japan Real Estate Institute Inc. “Six Large City Areas,” Statistics Bureau of Japan.
www.stat.go.jp/data/nenkan/zuhyou/y1712000.xls.
3. Ibid.
4. Bank of Japan. BOJ's Main Time-series Statistics (Monthly). Tokyo, Japan: 2012
http://www.stat-search.boj.or.jp/ssi/mtshtml/m_en.html.
5. Hiroshi Nakaso. “The Financial Crisis in Japan During the 1990s: how the Bank of
Japan Responded and the Lessons Learnt,” Bank for International Settlements 6, no. 1 (2001): 182.
6. Cabinet Office of Japan. Aggregate National Accounts Stock 1980-2012. Tokyo,
Japan: 2012. http://www.esri.cao.go.jp/en/sna/h19-kaku/21annual-report-e2.html.
7. Bank of Japan. Bank Loans, Monetary Base, M3 1998 – 2012. Tokyo, Japan: 2012.
http://www.stat-search.boj.or.jp/ssi/cgi-bin/famecgi2?cgi=$graphwnd_en.
8. Bank of Japan. Flow of Funds Household and private non-Financial Sector
Corporation Liabilities 1996-2012. Tokyo, Japan: 2012. http://www.stat-search.boj.or.jp/ssi/cgibin/famecgi2?cgi=$graphwnd_en.
9. Richard Koo. “How to Avoid a Third Depression,” The House Committee on Financial
Services. Testimony before the House Committee on Financial Services July 22, 2010.
financialservices.house.gov/Media/file/hearings/111/Koo%207_22_10.pdf.
10. Ibid.
11. Ministry of Finance Japan. Current Japanese Fiscal Conditions and Issues to be
Considered. Tokyo, Japan (2006), 6.
12. Standard and Poor’s Rating Service. “S&P/Case-Shiller Home Price Indices,”
http://www.standardandpoors.com/indices/sp-case-shiller-home-priceindices/en/us/?indexId=spusa-cashpidff--p-us----.
13. Ibid.
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14. Ben S. Bernanke. The Crisis and Policy Response. The Board of Governors of the
Federal Reserve. Washington DC: 2009.
http://www.federalreserve.gov/newsevents/speech/bernanke20090113a.htm.
15. Board of Governors of the Federal Reserve. Loans and Leases in Bank Credit,
Monetary Base and M2 Seasonally Adjusted 2008-2012. Washington DC: 2012.
http://www.federalreserve.gov/datadownload/.
16. Board of Governors of the Federal Reserve. Total Consumer Credit Owned and
Securitized Seasonally Adjusted 1992-2012. Washington DC: 2012.
http://www.federalreserve.gov/datadownload/Chart.aspx?rel=G19&series=3e4b643fa48b7bff996
2454e556c8761&lastObs=&from=&to=&filetype=csv&label=include&layout=seriescolumn&ty
pe=package&pp=Download.
17. U.S. Department of Commerce Bureau of Economic Analysis. Household Net
Savings 2007 Q3 to 2011 Q3. Washington, DC:
http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1.
18. Board of Governors of the Federal Reserve.
19. Nationwide Building Society. Historic House Prices.
http://www.nationwide.co.uk/hpi/historical.htm.
20. Ibid.
21. Michael Joyce, Matthew Tong and Robert Woods “The United Kingdom’s
Quantitative Easing Policy: Design, Operation and Impact,” Bank of England Quarterly Bulliten
51, no. 3. (2011): 200-212.
22. Office for National Statistics. United Kingdom Office for National Accounts the Blue
Book. (Newport, U.K.: 2011), 221. http://www.ons.gov.uk/ons/rel/naa1-rd/united-kingdomnational-accounts/2011-edition/index.html.
23. Ibid.
24. Bank of England. Bank Lending to Private Sector non-Financial Institutions, M4,
Reserve Balances Plus Notes and Coins 2008-2012. London, England: 2012.
http://www.bankofengland.co.uk/mfsd/iadb/CategoryIndex.asp?Travel=NIxAZx&CategId=allcat
s&CategName=Combined A to Z.
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25. Congressional Budget Office. Estimated Impact of the American Recovery and
Reinvestment Act on Employment and Economic Output From April 2011 Through June 2011.
Washington D.C. 2011. http://www.cbo.gov/ftpdocs/123xx/doc12385/08-24-ARRA.pdf.
26. U.S. Bureau of Labor and Statistics. Seasonally Adjusted Unemployment Rate.
Washington DC: 2012. http://data.bls.gov/timeseries/LNS14000000.
27. U.S. Department of Commerce Bureau of Economic Analysis. Percent Change from
Previous Period in Real Gross Domestic Product 2009 Q1 to 2011 Q4. Washington, DC: 2012.
http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1.
28. Office for National Statistics. Seasonally Adjusted Quarter on Quarter Growth.
Newport, UK: 2012. http://www.ons.gov.uk/ons/rel/gva/gross-domestic-product--preliminaryestimate/q4-2011/tsd-gdp-preliminary-estimate-q4-2011.html.
29. Office for National Statistics. Unemployment for all Economically Active Persons 16
and Over Seasonally Adjusted. Newport, UK: 2012. http://www.ons.gov.uk/ons/publications/rereference-tables.html?edition=tcm%3A77-222467.
30. Board of Governors of the Federal Reserve.
31. Cabinet Office of Japan.
32. Office for National Statistics.