Japan vs United States Economy
The U.S. is taking the same Keynesian approach of government deficit spending, QE, bailouts, yield curve pegs and the purchase of ETF’s Japan took in 1990 when their stock market crashed.
The U.S. is far different from Japan in several areas, but should we expect the same results? A stagnant, low growth economy for decades?
In this article, I explain three main points to this topic: What exactly happened in Japan when their stock crashed, how has the Yen not collapsed, and what are the differences between the U.S and Japan.
Taking a Closer Look at Japan's situation
Japan's assets prices went down dramatically and their GDP growth was only 1% back in 1990, but they didn't have consumer price deflation.
Their prices stayed relatively the same, asset price were the ones that crashed, yet, the important thing here is their GDP has been relatively stagnant.
Look at this chart that dates back to 1981.
This graph shows consumer debt or the private sector debt, to GDP, this isn’t government debt.
On the left, the numbers go from 140% to 220%, and it starts in 1981 when debt went up until 1985, which was a very important year.
In 1985 consumer debt went parabolic until 1990, when it crashed, but started to go up again a couple of years after that.
Then, they had a huge deleveraging going all the way down to 2007.
However, it went back up and down again in 2015, around 150%.
I would assume we are the same today, around 150% of GDP.
Now, if we look at a chart of real estate prices, it evidently followed a very similar path along with equity prices of their stock market, as shown in the images above.
Equity prices shoot up in 1990 but have gone down since then, they've never gone back up.
To tackle this type of problem there are two different approaches: Keynesian and Austrian.
For the Keynesian economic approach, we resort to Paul Krugman, who thinks the private sector debt crashing would cause a lot of unnecessary pain. So he thinks the government has to fill the gap with deficit spending.
I drew a blue line across Japan’s private sector debt chart so you can understand what I’m saying.
The blue line is the trend of GDP growth, where it was headed.
Krugman would say the blue line, at some point in the future, in 10 to 15 years, is going to come up to a level where it can service the debt with all the income from the GDP growth.
In his perspective, this approach won’t hurt the corporate sector nor the consumers. All they have to do is print up money, fill the gap, and that’s it.
This approach doesn’t work as expected on a practical scale
The GDP represented by the blue line doesn’t just go up to where it meets the level of the debtor where it could service the debt, the GDP is more like the black line shown in the image.
Once the government starts spending, it gets more involved in the economy and establishes more regulations that lead the economy to freeze.
The GDP growth doesn’t go up at the same trendline, it gets stagnant and then flatlines, and although the sectors aren’t feeling any pain, it gradually gets worse because that level of GDP would never catch up with the amount of credit that was in the system in 1990.
In this type of scenario, the government spends a lot to fill the gap but while they do that, they’re not getting rid of the malinvestment, which is why the economy was sick in the first place, what took them to those high assets bubbles.
There’s also a lot of government control because now they’re spending money, so there are a lot more regulations.
The money supply in the real economy goes through the roof, which represents a higher potential for future inflation that would cause even more pain than allowing the bubble to deflate.
It also produces a lot of social unrest, inequality, and some sort of socialism, not where the government owns the means of production, but where they get very involved in the system.
The government gets involved in the corporate level, the private sector, and all the way down to the local subway on the corner of the gas station.
All of this happened in Japan, the government got more involved in the economy, and therefore it became less dynamic.
This is why, when we have the Keynesian approach when everything crashes, the GDP or the economy doesn’t continue to go up on-trend, it only freezes and stays there indefinitely.
For the Austrian economic approach, we resort to Peter Schiff, who thinks the Japanese approach was not good because they kept on going with artificially low-interest rates, government spending, and fiscal stimulus, which was the reason why they had the bubble in the first place.
So for him, the only solution is to take the medicine, they can’t try to solve the problem with what created it in the first place.
And yes! This approach means bankruptcies, people losing their money, and a lot of pain, but, there’s no other choice. They have to let the system clear the excessive debt, and malinvestment.
If this approach is taken, GDP will take a hit for a year or two but will make the economy healthy so it can go back to the historic trend growth.
Over the long run, in the next 10 to 15 years, there are much better results.
The country would have a higher GDP growth and a much better balance sheet.
Unfortunately, Japan didn’t take Peter Schiff’s advice, but the Keynesian approach: A lot of government spending, big deficits, QE that took interest rates down to zero and even negative.
The bank of Japan printed money to buy stocks and bonds, and now they own 50% of government debt.
This is mindblowing, but I’m sure Keynesians would argue the problem wasn’t their approach, but that they didn’t do it enough!
You’ll need to decide which approach is right or wrong, but think how did the Japanese asset bubbles grow so large in the first place? What was the catalyst and what created this problem?
Well… the Plaza Accord in 1985 was the trigger.
Let’s look at a report from the IMF and you’ll see why in 1985, the United States convinced Japan and Germany to artificially devalue the dollar against the Yen and the Deutsche Mark.
As a result, the Japanese economy kind of stalled out in 1986, and to solve this problem they took the Keynesian approach with a sizeable macroeconomic stimulus, interest rates were reduced by three percentage points and sustained until 1989.
“A large fiscal package was also introduced in 1987, even though a vigorous recovery had already started in the second half of 1986.
By 1987 Japan’s output was booming but so were credit growth and asset prices with stock and urban prices tripling from 1985 to 1989.
Then, in January 1990 the stock bubble burst.”
This sounds very consistent with what we’ve done in the United States over the last 10 years.
How the US is different than Japan
We fix a slow-growth economy through massive deficit spending and keeping interest rates artificially low while at the same time the real estate and stock market booms.
The exact same movie played over and over again. History doesn’t repeat exactly, but it sure does rhyme.
Why hasn't the Japanese economy collapsed?
Why hasn't the Japanese economy not collapsed, and why haven’t they seen hyperinflation?
From our viewpoint, the whole thing should have erupted a decade ago, if not earlier.
But they started with a different quantitative easing, a light one where instead of printing up money and buying assets off the balance sheets of the banks, the only thing they did was use that money to fill up their reserve accounts so they wouldn’t collapse.
The net result was the banks still had toxic assets on their balance sheet and couldn’t do anything with them, so this didn’t free up the banks to make more loans in the real economy or grow the money supply.
Japan is an export nation
Japan is also a big-time export nation, which means they export a lot more goods and services than they import.
If a country exports more goods than it imports, more demand of their currency is created, strengthening, therefore, the local currency.
So if the bank of Japan prints money, that would normally create inflation.
However, there’s kind of an artificial bid outside of Japan for all those Yen because of the goods, cars, refrigerators, and electronics they export to other countries like the United States.
Remember it this way. The more a country exports and the bigger their trade surplus is, the more demand there is for the local currency.
So as the bank of Japan created more supply, the exports created more demand, that’s one of the main reasons the Yen hasn’t gone into hyperinflation mode.
Japan is a nation of savers
Japan is also a nation of savers, not spenders. There was a report showing that the Japanese save anywhere between 20% and 30% of their total income.
So the bank of Japan prints a lot of money and injects it into the system through government spending.
However, the Japanese take the Yens and deposit them into the bank, hence very little money gets outside of the banking system to buy goods and services.
If there’s not a lot of money, there’s not more money chasing the same goods and services, so consumer price inflation doesn't go up.
One of the things Krugman said that I actually agree with is inflation is not caused by money printing, spending money does.
Japanese don’t spend much money
Japanese don’t spend much money and that’s why they don’t see a lot of price inflation.
They’re also a huge creditor nation, which means they export all of the products they’re manufacturing and send them to the United States, and in exchange for it, we send them dollars.
They take some of those dollars and exchange them for Yen, of course, and put them right into the banking system because they save, they don’t spend it.
But they also take some of the dollars and send them back to the United States to buy assets.
They don’t just buy stuff, they buy assets like United States real estate, stocks, and bonds.
So basically what’s happening is the Japanese are producing all the stuff we consume, and we as Americans, are trading the consumption for our assets.
Japan is the largest creditor nation, and the United States, the largest debtor nation
Nonetheless, this has gone to an extreme, as we can see in the images, Japan is the largest creditor nation, and the United States, the largest debtor nation.
This is measured using something called Net International Investment Position (NIIP).
Lyn Alden explains it this way:
“Creditor nations are measured by the NIIP which is how much assets the people in the country or the government itself have, the total assets that the country has in other countries.”
For example, Japan owns a lot of assets in the United States and other countries, and also other countries own some pieces of Japanese assets like stocks, bonds, real estate.
The NIIP is the difference between how much they own from other countries versus how much countries own of their assets.
So a creditor nation owns more assets than foreigners own of their assets, and a debtor nation is vice-versa.
Some of the largest creditor nations are Japan, Germany, Singapore, Switzerland, Norway, Saudi Arabia, and Taiwan. Meanwhile, the United States is the largest absolute debtor nation.
In addition, the United States is one of the worst in terms of GDP percentage, but some countries are even worse such as Spain, which lies at the bottom of the debtor hole.”
In conclusion, Japan hasn’t collapsed or seen hyperinflation because they did a different type of quantitative easing, their exports are massive which creates a demand for Yen, and also they save a lot more money than they spend.
If the money they save remains in the banking system, and the money they do spend is for buying assets outside of Japan, the local domestic economy doesn’t have much more money chasing the same amount of goods and services.
Therefore, consumer price inflation doesn’t really go up at all.
What Sets Japan Apart from the Unites States?
We already discussed the quantitative easing Japan did was different because it created lower deposits in the economy, their velocity is also very slow because they save so much, and they’re a creditor nation.
So in a time of distress like right now, they can sell off assets for the cash flow they need to get by at a corporate level and a household level.
Due to the fact that their exports are very high since they have a trade surplus, more demand for the local currency is created.
But, the major difference between the U.S. and Japan is the money supply (m2).
Look at this chart, from 1980 to 2020.
On the left, the value goes from zero trillion dollars to $18 trillion. The United States in 1990 had about $3 trillion of m2, and it started to go up until today when we have $17 trillion, a 6X increase.
If we look at Japan, just comparing apples to apples, if they were using dollars and assuming in 1990 they also had a money supply of $3 trillion, right now it would be $6 trillion, it went up 2X.
Compare a 6X increase to a 2X increase, this is huge!
We have many differences with Japan, but there are also some similarities.
Look at Japan’s real growth since 1990:
This chart shows GDP adjusted for inflation.
Please notice the growth for Japan is around 1% average, and if we look at the same chart for the United States, the average growth is 2.5%
The average growth is not that much different. I know over 20 years its compounded, so there’s a big difference at the end of the 20 years, but on an annual basis, it’s very similar.
It’s not like the United States is growing at 10% and Japan’s at a negative five…
Also, if the United States accurately measured inflation, our GDP would be very similar to Japan.
I don’t think the U.S. is going to be the next Japan, I think they already are from a standpoint of real GDP, we’ve used the exact same playbook: quantitative easing, ZIRP, and are now buying equities or corporate bonds.
It’s the exact same thing all over again, we’ve seen this movie and how it plays out.
But, because of the difference in the money supply, the velocity and your debt, I think we’ll have an inflationary lost decade, which means GDP remains very low while having persistently high inflation.
When I talk about inflation, I'm referring to consumer prices and most likely higher than average unemployment.
However, nothing is certain, this is just my base case.
What concerns me most about the United States, and the dollar being the world's reserve currency is the fact that we as Americans don’t have control over the strength of the dollar.
Its because we don’t have exports and savings that we’re not like Japan.
Japan can tweak it, they can save and export more.
But in the U.S. we’re totally reliant on the entire world wanting our dollars, and if it ever comes to a point where the world doesn’t want them anymore, the inflationary decade will turn into a hyperinflationary lost decade.