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Why This Recession Could Last 20 Years

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Ponder these two data points for a second:

  • On Dec. 29, 1989, the Nikkei 225, Japan's benchmark stock index, hit an intraday trading high of 38,957.
  • Earlier today, it closed at 9,977.67, some 74% off those 20-year-old highs.

It seems crazy if you don't know the history. After all, Japan's not some faded boomtown; it's the second-largest economy on Earth, a perennial hotbed of innovation, with huge companies like Sony (NYSE: SNE  ) , Toyota (NYSE: TM  ) , and Canon (NYSE: CAJ  ) that are market leaders and household names all over the world.

So what happened? Long story short, a huge real estate bubble popped and a protracted banking crisis followed.

Ponder that for a second. Sound familiar?

So here's the obvious question: Is that what we have to look forward to here in the U.S.?

It's exactly the same, only different
Back in 2000, the International Monetary Fund released a paper that reviewed the Japanese banking crisis and tried to draw  lessons from its experience. The paper pointed to four causes of the crisis, which it said were "typical of banking crises" generally:

  • Excessive asset expansion during an economic boom period.
  • Liberalization (meaning deregulation) without appropriate adjustment to remaining regulations.
  • Weak corporate governance.
  • Regulatory forbearance when the system came under stress.

So let's review. Excessive asset expansion? Yeah, I'd say our real estate boom qualifies. Liberalization? Yup -- we had the repeal of Glass-Steagall and other regulatory constraints on banking. Weak corporate governance? I don't remember the directors of any of the major banks calling for reductions in subprime exposure before it was too late. And regulatory forbearance? I think the phrase "too big to fail" says everything we need to know there.

Yep, we definitely had -- and arguably still have -- a banking crisis. We didn't need the IMF to tell us that. But that in and of itself doesn't mean that we'll be sitting around 20 years from now wondering if the S&P 500 will ever get back over 450. The Japanese government's response to the crisis was very different from that of the United States. In a nutshell, it was several years before its government did much of anything, and what it finally did do was arguably too little, too late.

But at the same time, it's hard to argue with this: In the past decade, the S&P 500 index is down more than 20%. It's a disturbing parallel to ponder, especially for those of us worried about our retirement portfolios.

Experts agree, it's different. Sort of.
The Fool's retirement guru, Robert Brokamp, recently asked a bunch of his favorite experts whether they thought the U.S. stock market could end up going the way of Japan's. And the consensus answer was … well, there wasn't one, really. As with any economic question, there are a lot of different ways to look at it.

The answers Robert received are presented in an article in the new issue of the Fool's Rule Your Retirement newsletter, available online at 4 p.m. EST today. I'll point you there for the full story -- it's worth reading carefully -- but meanwhile, here are some key points to ponder:

  • The U.S. government -- believe it or not -- has been harder on its banks: Several of Japan's banks were essentially bankrupt, but were allowed to zombie-shamble along for years without recognizing their losses, and even survivors like Nomura (NYSE: NMR  ) struggled under an enormous burden. U.S. banks like Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , and Wells Fargo (NYSE: WFC  ) may still have a long way to go, but they've already written off a significant portion of their losses -- as much as 60%, according to a recent IMF estimate -- which bodes well for an eventual recovery.
  • Japan's bubble was bigger: The Japanese market's P/E ratio in 1989 was close to 100, whereas the U.S.'s topped out around 40 at the height of the dot-com boom, according to one expert cited in Robert's article. Japan's real estate crash was also significantly worse, with some prime properties in Tokyo losing 99% of their boom-peak value.
  • The Fed has the advantage of learning from history. Many of the actions we've seen -- including the big bank bailouts and promises of continued low interest rates -- were informed by the Japanese experience. That doesn't mean we'll have a smooth ride, but it does mean that the drivers are at least aware of the biggest potholes.

Still, it's an ambiguous, worrisome parallel, worth taking some time to ponder, and I encourage you to check out Robert's article for the full scoop. If you're not a Rule Your Retirement member, just grab a free trial and full access is yours for 30 days, with no obligation.

Fool contributor John Rosevear has no position in the companies mentioned. You can try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (24)

Comments from our Foolish Readers

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 December 03, 2009, at 7:22 PM, xetn wrote:

    The post war period in Japan has been based on a type of mercantilism and centrally planned by the government. (

    This is not much different than China's model during the last 30 years.

    The collapse of their property bubble is no different from the 2008 bubble in the US; to liberal Fed expansion of the money supply, sub-market interest rates and then an attempt to spend their way out of the problem using the same tactics that got them into the mess. The difference is: Japanese saved a very high percentage of their income, forestalling price inflation (the same as China). In the US it is the banking system that is "saving" (excess reserves at the Fed).

    Every thing the Japanese central planners did was at the expense of their citizens. Sound familiar?

  • Report this Comment On December 04, 2009, at 3:27 AM, gigiobc wrote:

    absolutely read

    Richard Koo

    "the holy grail of macroeconomics"

    there is a much better analisys and explanation and recipe for present depression.

    IMF analisys and the results of its interventions are mixed at best.

  • Report this Comment On December 04, 2009, at 12:31 PM, BMFPitt wrote:

    "Many of the actions we've seen -- including the big bank bailouts and promises of continued low interest rates -- were informed by the Japanese experience. That doesn't mean we'll have a smooth ride, but it does mean that the drivers are at least aware of the biggest potholes."

    The fact that they knew the pothole was there and floored it anyway is not a comforting thought.

  • Report this Comment On December 11, 2009, at 6:39 PM, GoNuke wrote:

    Here are some issues that will affect US economic growth in the next decade.

    Demand drives economies.

    US consumer demand is down due to:

    - a reduction in aggregate household incomes due to increased unemployment levels;

    - an increase in savings amongst the employed who fear losing their jobs and health care coverage; and

    - an increase in savings rates

    1) paying down debt is a form of saving

    2) tighter credit makes it harder to increase personal debt

    3) to compensate for loss of wealth associated with house prices and financial portfolios

    Rising employment levels will have a huge impact on consumer demand but US consumer demand tends to benefit China more than the US.

    For the last 100 years the US has been a self-sufficient economy. Domestic demand has driven the US economy. Exports have not been a significant contributor to US GNP. Germany and Japan are high wage countries but they also major exporters of manufactured goods -cars in particular. Both Germany and Japan have a highly skilled workforce. The US does not. The US has abandoned training of skilled workers. Instead Americans seek University degrees. Those that do not go to University tend not to acquire skills that are conducive to manufacturing productivity.

    UAW rules made it all but impossible for the US car makers to introduce the kind of skills acquisition programs that created the highly skilled Japanese auto workers that contributed enormously to Japanese productivity.

    Economic growth in the US will depend on increases in productivity which are generally achieved through capital spending. Capital spending includes new plant and equipment AND investment in human capital which includes education and health.

    The US can increase productivity by targeting investment in public education and health care.

    To date the US has shown massive resistance to broad investment in human capital. This bodes ill for the US economy.

    2010 marks the 65th anniversary of the end of WWII. The next decade will witness the retirement of the baby boomers. Retirement affects savings and consumption rates. Retired people are net spenders which increases demand but they also experience reduced incomes which reduces demand.

    If nothing changes then the US companies that are likely to flourish in the next decade will be ones that export high margin technology intensive products that compete on performance, not price.

    This can include US companies that manufacture in China. If the main content of a product is intellectual property then, even if the physical product is assembled in China, most of the labor costs are incurred in the US by the creators of the intellectual property.

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