- The Washington Times - Sunday, October 13, 2002

Economic forecasters often try comparing today's economy with other times and other places. Those with a dismal bent are particularly fond of pointing to Japan's stagnant "post-Bubble" economy, suggesting this proves the crash in U.S. stock prices may likewise leave our economy stagnant for a decade or more. The Economist says, "America's economy look awfully like Japan's in the early 1990s." No it doesn't.
Japan's stock market was strong from 1988 to 1990 because the economy was then growing by 5.7 percent yearly. And Japan's stock market has been awful since 1992 because the economy barely grew by 1 percent a year and profits were even worse. To conclude that the Japanese economy stopped growing because the stock market fell is to get cause and effect all jumbled up.
Japan's problems began with the 1988 Basle Accord that created tough new rules for the world's banks. By the early 1990s, those heavy-handed capital standards began to force banks to slash loans to business and boost their holdings of government IOUs. Japan's banks were compelled by the Bank of Japan to severely ration credit.
As the Bank of Japan was working hard to "burst the bubble" in stock and land prices, the Japanese Treasury decided to do the same with new taxes on retail sales, capital gains and land. The capital-gains tax made it far less attractive to hold stock, shoving stocks down further. The land tax had the same depressing effect on land prices, and nasty ripple effects on stocks and banks. Land had been a key asset behind corporate stock and important collateral for bank loans. Stocks, in turn, were a significant portion of bank capital. When stocks the banks owned dropped in value, the Basle rules required an even tighter squeeze on business and consumer loans.
Brutal monetary and tax policies sank the value of Japanese land and stocks, and wiped out bank capital and loan collateral. The mandated cutbacks in bank lending to businesses slaughtered many companies. Good loans became "bad loans" because of a bad economy. Meanwhile, the government wasted huge sums on costly public works schemes that saddle future taxpayers with a gigantic public debt. As the Economist put it, "Japan's policymakers appear to have followed the Keynesian textbook."
Because Japan's banks have long been on the verge of collapse, with $423 billion of bad debt, fearful Japanese take money out of the banks and hoard currency. This bank run in slow motion forces banks to keep extra cash in reserve, in case too many depositors cash at once.
The currency the Japanese are stuffing under mattresses plus the extra bank reserves add up to the "monetary base." The Bank of Japan could increase the monetary base by buying Japanese or U.S. securities and paying for them by adding to banks' reserves. Once the banks had enough reserves to feel comfortable, they could increase profits by using extra reserves to create new checking accounts by buying bonds or making loans.
Unfortunately, the Bank of Japan just doesn't get it. So the demand for cash keeps outpacing supply. The result shows up in rapid growth of currency, which is hoarded, but very slow growth of broad measures of the money supply. Over the past year, the broadly defined money supply grew by 8.3 percent in the United States but only 3 percent in Japan.
To get the cash they crave, the Japanese have no choice but to liquidate goods and assets at distress-sale prices. The result is falling prices deflation. The real burden of old debts rises because producers have to sell more widgets to raise the same amount of yen. Consumers and businesses are slow to buy, because everything is expected to be cheaper if you wait.
What, you may well ask, does all this have to do with the United States today? Absolutely nothing. Unlike Japan, our government is not trying to slap new taxes on stockholders, companies or land. On the contrary, there have been glimmers of hope that our government might do the opposite, perhaps by cutting the tax on dividends to 20 percent. Unlike the Bank of Japan, our Federal Reserve has not gone out of its way to depress the stock market since 2001, and the broad money supply has grown quite quickly. Unlike Japan, American banks are in decent shape and U.S. depositors are confident their money is safe.
Superficial comparisons between the so-called "bubbles" in Japan and the United States ignore all the facts that matter. There are lessons to be learned from Japan's prolonged fiasco, but they are mainly lessons about how bad policies do indeed produce bad results.

Alan Reynolds is a senior fellow with the Cato Institute and a nationally syndicated columnist.


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