Friday, November 16, 2012

Tough lessons to be learned from Japan's 20+ year economic struggle

The number one lesson to be taken away from Japan's 20+ year economic slump is not to repeat its policies when it comes to handling a bank solvency led financial crisis.  Particularly when there is an alternative, the Swedish Model, that has been proven to work.

However, if policy makers and financial regulators insist on following these failed policies, the number two lesson is to recognize that the economy will be in a permanent slump interrupted by brief periods of fiscal and monetary policy driven growth.

The reason that the economy is in a permanent slump is the capital needed by the real economy for growth and reinvestment is instead being shoved into the black hole of debt service on the excess debt in the financial system.

The Irish Independent ran an article looking at some other lessons one can learn from Japan's experience.
JAPAN is shrinking again and its government thinks the answer lies in more of the same policy the Bank of Japan(BOJ) has been unsuccessfully implementing for 17 years.
Sound familiar in the EU, UK and US?
Japan's economy contracted by 0.9pc in the third quarter, data showed on Monday, reversing earlier quarters of growth and taking the country into a nosedive equating to a 3.5pc annual decline. 
Inevitably, this has economists and policy-makers fretting over whether Japan is sinking into a recession, technically defined as two successive quarters of economic contraction. 
"I cannot deny the possibility that Japan has fallen into a recession phase," Japan's economy minister Seiji Maehara said.... 
Japan's issue isn't whether it is sinking into its fifth recession in 15 years – as if recessions were somehow discrete phenomena like colds – but why it is now 20 years into an economic malaise....
Regular readers know that the reason it is 20+ years into an economic malaise is that it has never adopted the Swedish Model and required its banks to absorb the losses on the excess public and private debt in the financial system.
In nominal terms, Japan's economy is now the smallest it has been since 1993, hardly a ringing endorsement of campaign after campaign of quantitative easing and other extraordinary measures. 
Please re-read the highlighted text again as the black hole of excess debt has effectively swallowed Japan's economic growth for 20 years.
"The most important lesson of the last 20 years in Japan and of the last four years in western economies is that monetary policy is ineffective when there is no private demand for funds," Nomura economist Richard Koo wrote in a note to clients before the data was released.
"In Japan, there has been little or no private loan demand since 1995, when the BOJ brought interest rates down to near-zero levels. And neither the economy nor asset prices have recovered, even though, as BOJ governor Masaaki Shirakawa has noted, the BOJ embarked on quantitative easing fully eight years before its counterparts in Europe and the US."
True.  This is exactly what we are experiencing in the EU, UK and US.
Mr Koo coined the phrase 'balance-sheet recession' to describe a contraction driven and reinforced by the paying back of debt. 
That idea has taken hold, and an appreciation of the limits of monetary policy has spread.
Your humble blogger highlighted it in an earlier post on fixing 'balance sheet recessions'.
Mr Koo's prescription, for large and decisive amounts of government stimulus and for investment and tax incentives, is less widely accepted....
I rejected Mr. Koo's prescription because simply adopting the Swedish Model fixes the problems caused by excess debt in the financial system.
There seem to be two easy lessons from Japan, both of which sadly it may be too late for the West to follow. 
The first is don't allow massive amounts of debt to build up, and the second is don't confuse a period of growth while debt is shrinking with a recovery.
The easy lesson from Japan is if you allow massive amount of debt to build up, use your banking system to absorb the losses and protect the real economy.

Protecting your banks from losses and preserving banker bonuses only results in a long-term economic slump.

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