The recession that Japan experienced in the 1990s, and that still pervades Japan today, started out in a very similar way to the way the subprime mortgage/credit crunch started in the US. The real estate market was in a bubble, and when that burst, the banks’ problems made it worse. The NYT looked at the similarities and found that a better response by the US will prevent us from following Japan’s downward trend.

The people whom the NYT interviewed are probably smarter than I, but I am not so sure we can beat the downturn without following the Japanese example, although I don’t think we should be doomed to stay in the doldrums for a decade as the Japanese have been. The NYT sees the big difference as fiscal policy. The Japanese used only monetary policy — keeping interest rates at almost zero for almost a decade — but apparently not so much fiscal policy.

First, the fact that the Japanese have kept interest rates at almost zero demonstrates the limits of monetary policy as practiced by the Fed. Secondly, the Republican tax cuts mean that we have been running our fiscal policy as if we have been in a recession for the last seven years. Now that we are in one, inplementing a strong anti-recession fiscal policy is likely to ignite inflation, because we are not starting with a balanced budget. We are starting with a budget already badly in the red. Printing money is a recipe for inflation.

I don’t think the Republicans care much about inflation, because it allows them to decrease the value of the debt they have run up the last seven years. It allows them to pay if off in cheaper dollars. Of course, for everyone else, it means that they are stuck with cheaper dollars when they get paid, when they buy things and for everything else.

The lesson of inflation, and low interest rates in general, is don’t save. Spend what you’ve got and borrow at low interest because you can pay it back in cheaper dollars. But look at Latin America: the chickens come home to roost. People won’t invest in your country, because their investments lose money as the inflated currency depreciates. We are already seeing foreigners (Chinese, Saudis) talk about diversifying out of the dollar into the Euro or a basket of more stable currencies. At some point, inflation and the depreciating dollar will force interest rates to rise, back to the high rates of old days (the 1970s) of 15-20 percent, or more if things get really bad. Such high rates are very bad for domestic business. Maybe globalization will make the coming scenario different from the 1970s scenario, but it will be a first test; so, who knows.

I would like to know what Paul Volker thinks, who got us out of the 1970s stagflation painfully, but successfully.

Leave a Reply

Your email address will not be published. Required fields are marked *