Are We Following Japan Off a Cliff?

The Federal Reserve continues whipping the reluctant economy to push forward with its announcement of keeping rates below 1% -- probably until late 2014. These near-zero interest rates have been tried in the past, with not-so-spectacular results, as illustrated by Japan's "lost decades."

Is our economy following the trail that Japan blazed, and are we headed for a few lost decades of our own?

Japan's "growth"
Following the burst of Japan's property bubble of the 1980s, Japan's Nikkei (INDEX: ^N225) index retreated from its onetime high of 38,957 yen in 1989 to its current value around 8,900 yen. One dollar, or yen, invested at the peak of the market would be worth $0.23. The Dow Jones (INDEX: ^DJI  ) has already shrunk about 10% from its 2007 high of 14,164 to its current 12,670.

Japan's GDP also limped ahead in the '90s, with an average growth rate of about 1.5% compared to the U.S. rate of 3.2%. Since 2000, Japan's growth rate at about 1% remained half of the U.S. rate of about 2%. Any way you slice Japan's GDP growth, it's been anemic and has lagged other developed nations.

Could this slowdown happen to the U.S.? Is it already happening? Let's look at a few similarities.

Central bank rates
Just like Japan's central bank, the Fed has cut interest rates leading to our current zero interest rate policy, or ZIRP for short: 

The Fed predicts increasing its rate in a few years, but Japan has held its rate at or below 1% since 1995 and failed to spur any meaningful growth. Now, the U.S. flirted with near-zero rates before, but our own housing bubble floated the economy and allowed the Fed to increase rates in 2005, before again cutting them to near zero.

After this failed, both central banks in Japan and the U.S. moved to the next option to pump the economy -- quantitative easing, also known as QE. The Bank of Japan purchased government bonds from the secondary market starting in 2001, while the Fed began purchasing other assets in 2008, which began programs nicknamed QE1 and QE2. Through flooding more money into the market, the central banks hoped to drive lending. Japan's results were mixed, with no clear positive outcome from its quantitative easing. On the effectiveness of the Fed's actions, last September former Fed Chairman Alan Greenspan said, "I find it very difficult to find any significant impact as yet from QE1 and QE2." Many analysts believe current Fed Chairman Ben Bernanke's latest statements point to more actions, or a QE3.

Debt-to-GDP
While the central banks push their economic horses to water, the governments drown in debt to get them to drink. Through beefy stimulus packages, governments spend on infrastructure projects, cut taxes, or do anything else possible to improve the economy and remain in power. The U.S. and Japan ran up quite a tab:


Japan's figures begin in 1991 while the U.S. figures begin in 2006. The dotted line is projected.

Japan's debt continues to climb -- its gross debt-to-GDP now sits at a staggering 234%! Arguments about whether that high of a debt level means anything abound, but the takeaway here is that the U.S. debt growth matches Japan's and could signal potentially similar conditions for low future growth.

Real estate values
From the peak of Japan's housing bubble in 1991, the Urban Land Price Index, which measures Japan's land value trends, has declined every single year. Since the peak of the U.S. housing bubble in 2006, the Case-Shiller Index, which measures price changes in 20 major U.S. metro areas, has trended in a similar direction:

Of course, demographics affect demand for real estate and values, and whereas the U.S. population is growing at a rate of 0.963%, Japan's population is actually shrinking -- its growth rate is -0.278%. But for the economy, consumers spend less when they watch what is usually their largest asset -- namely, a home -- shrink in worth.

The Foolish takeaway
These similarities don't mean the U.S. is destined for slow growth. The two countries still have vast differences, like our growing population and political resistance to ever higher debt ceilings. But if these economic markers continue to follow in Japan's footsteps, I'd put my money on a different horse for higher growth.

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Fool contributor Dan Newman would love to see some different trends. He also holds no shares of any companies mentioned above. Follow him @TMFHelloNewman. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (11)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 31, 2012, at 9:39 PM, JohnMaxfield37 wrote:

    Dan -

    Really enjoyed the article!

    Here are two things that I'd ask.

    First, is the US in a liquidity trap as Japan has been? I think there are strong arguments that it is, though the Fed denies it as it's bound to do for fear of a self-fulfilling prophecy.

    Second, what will China's financial ascent do to ours and Japan's respective abilities to market bonds? I believe it'll drive up yields. You can probably do the math from there in terms of the impact on Japan.

    What'd you think?

    - John

  • Report this Comment On January 31, 2012, at 10:15 PM, TMFHelloNewman wrote:

    Thanks, John!

    I think we're in our own style of liquidity trap. I think the Fed is very aware of Japan's lessons, and I think Americans are just too different than the Japanese. Sure, people are saving more (4% of disposable income from the latest numbers), but nowhere near what the Japanese were saving in the 90s (quick search comes up with +10%).

    I also think it'd be awhile before China creates too many waves. If they skipped out on our market, I would think that the Fed would happily eat up any lost demand to drive rates wherever it saw fit. And foreigners hold so little of Japanese debt, the largest impact from China over the next five years will just be the clouds of pollution floating over the sea. After five years though, who knows... as Morgon Housel wrote, things change fast.

  • Report this Comment On February 01, 2012, at 3:26 AM, Dude119 wrote:

    So much has been written about Japans so called collapse, but this article in the NY times paints a far different picture of Japan's so called collapse:

    http://www.nytimes.com/2012/01/08/opinion/sunday/the-true-st...

    Though Japans debt problem must be solved, its not anywhere near "falling off a cliff".

    Japan has over $17 TRILLION in private savings and many Japanese companies have been using the strength of the yen to go on a buying spree not seen since the 1980's. But they have learned there lessons from the mistakes they made (Rockefeller Center and Pebble Beach, etc..) and are buying much more strategically. Much of the press has gone to what China has been buying overseas, but Japans M&A activity dwarves that of China.

    Far from being the economic basket case Newman and so many others like him like to call Japan, its changing again before our eyes.

    Now that the recovery from the triple whammy of the earthquake , tsunami and radioactive fallout is in full swing, Japan is again showing signs of much improved growth. It will never reach the double digit rates of growth it had in the 60's and 70's, but then what country can maintain that rate of growth?

  • Report this Comment On February 01, 2012, at 9:53 AM, TMFHelloNewman wrote:

    Thanks for the comment Dude119. Fingleton raises good points, but make sure to read Krugman's comments:

    http://krugman.blogs.nytimes.com/2012/01/09/japan-reconsider...

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