The US and Europe Will Go the Way of Japan

The Current Situation in the U.S. and Europe Closely Resembles the Stagnation in Japan in the Early ’90s

Lately, many experts have been searching for an analogy in which to frame the current economic crisis. The most common to be referenced is the Great Depression of the 20th century. The Financial Times has compared it to the Thirty Years War of the 17th century. But perhaps the best analogy would be Japan in the 1990s.

The Japanese economy experienced rapid growth for several years, which triggered fears of Japanese buyouts of American companies. The economic boom on the islands between 1985 and 1989 was fueled by cheap credit and low interest rates. These led to a huge housing bubble. The central bank finally responded by raising interest rates and, since 1990, Japan has experienced relative stagnation. The Japanese have spent billions, if not trillions, in an effort to jump-start their economy but to no avail. The central bank cut interest rates to even lower levels than before the bubble burst, but that did not help. Despite these efforts, they have no results to show for it, except a ballooning debt now exceeding 200 percent of GDP.

The similarity between the situation in Japan and the present day United States is striking. Both countries kept interest rates low and developed housing bubbles, which burst when the central banks raised interest rates. The Americans are spending much more than the Japanese to revive their economy, but with equally negligible effects.

Some economists believe that the American economy will bounce back and grow. The questions remain: how much and how fast?

The level of debt in the United States is nearing 100 percent of GDP. Though at present, debt instrument yields are very low, so the cost of servicing the debt does not take up much of the federal budget. However, the looming threat of refinancing will spell trouble and bring along higher rates. The budget will be the first to suffer and, not long after that, the American taxpayers, since taxes will need to be raised to reduce spending.

There is one more similarity between Japan and the United States. During the two decades of crisis, the Japanese economy experienced short periods of growth followed by repeated stagnation. The United States experienced an uptick in growth after the first phase of the financial crisis, but is showing signs of once again slowing down. Many are blaming the problem on Europe, but the fact remains that the American economy is flat-lining.

The comparisons are not are not only between the United States and Japan. The bankruptcy of Lehman Brothers affected European banks as well, which triggered government-funded bailouts. At the same time, they tried to pump money into the stalling economies. As a result, the debt levels of many European nations jumped up very rapidly, which triggered the crisis in the eurozone. This comes back around to the banks, since sovereign debt is a large part of their portfolio. As a result of the downturn, banks are also struggling with private borrowers, which coupled with bond losses are leaving the banks deep in the red. The same happened in 1990s Japan. The Japanese banks were helped by the central bank, just as the European Central Bank is pumping billions of euro into European financial institutions now. In Japan, these efforts did not bring about positive results. In Europe, ECB money rapidly returned to it in the form of deposits held in banks.

The difference between Japan and Europe is that while Japan was able to spend money to stimulate the economy, Europe cannot afford the luxury. The nations of the eurozone need to stop increasing the size of their debts immediately.

There is a risk in the next couple of years of having no public support for the economy or an increase in lending. There is also [a risk of] deterioration in living standards in some countries. All of this might lead to a few years of miserable economic growth or the lack of it, very similar to the situation in ‘90s-era Japan.

Of course, Japan was a nation, as opposed to the EU, which is a collection of countries. Some experts contend that Europe will do better than Japan because of Germany. However, Germany’s current economic success is largely due to the crisis, which weakened the euro. An eventual recovery of the euro will decrease the competitiveness of German factories and exports, especially if and when a good portion of consumers, like those in Greece or Spain, begin to switch from spending money to actively saving it. If Germany slows down, then all of Europe will stagnate.

The prolonged stagnation of the Japanese economy caused the country, which was close to being the leading nation in the world, to be outpaced by more dynamic countries. Currently, China is the second largest economy in the world. Behind China are other pretenders to the throne, such as Brazil and India. Meanwhile, Japan reported negative economic growth from the recession in 2009 through the third quarter of 2011.