- The Washington Times - Wednesday, May 21, 2003

Compared to Europe and Japan, America’s annual economic growth rate during the first quarter — an anemic 1.6 percent in absolute terms — turned out to be a relatively roaring performance. Our economy can claim the dubious honor of being the tallest dwarf.

Recent data reveal that the German economy, by far the largest in the eurozone, has satisfied one popular definition of recession, having declined for the second quarter in a row. While economic activity in the 12-country eurozone as a whole stagnated during the first quarter, the German economy, where the unemployment rate is rapidly approaching 11 percent, declined by an annual rate of 0.9 percent. Its year-over-year growth rate came in at 0.2 percent, less than one-tenth of America’s paltry 2.1 percent through the first quarter. Italy’s economy, the third-largest in the eurozone, registered a contraction of 0.4 percent during the first quarter.

The situation in Japan, where the stock market has plunged nearly 80 percent since its 1990 peak, is worse — much worse. With a growth rate of almost zero in the first quarter, Japan is now on the brink of yet another recession. By some estimates, it would be Japan’s fifth recession since its stock- and property-market bubbles burst. Following its steep recession in 2001, the worst in two decades, the Japanese economy began to expand slowly, only to lapse into three consecutive quarters of decelerating growth. Now, even Japan’s minuscule growth evaporated in the first quarter, during which it matched its highest unemployment rate over the past five decades.

Compounding Japan’s growth dilemma is the fact that its nearly 4-year-old bout with deflation appears to be intensifying. After registering annual declines of 1 percent to 2 percent in recent years, Japanese prices during the first quarter were 3.5 percent below year-earlier levels, the largest 12-month descent ever recorded there. Frightfully, Japan may have entered a deflationary spiral. Worse still, the yen has been significantly appreciating against the dollar, having recently reached its highest level since February 2001. Not only does that reduce demand for Japanese exports, which have represented Japan’s traditional growth sector, but an appreciating currency also accelerates the deflationary process. Meanwhile, the Japanese government bailed out Japan’s fifth-largest bank over the weekend by injecting $17 billion of capital into it, effectively nationalizing the financial institution.

Also over the weekend, the International Monetary Fund issued a report warning that Germany faced a high risk of experiencing its own deflationary problems. Consumer price inflation in Germany has fallen to 1 percent. At the same time, its deflation-inducing output gap, which measures the difference between its economy’s actual output and potential output (when factors of production are fully utilized), continues to grow larger and more ominous. Making matters worse, the euro is appreciating against the dollar even more rapidly than the yen, a fact that intensifies deflationary pressures across the eurozone and particularly in Germany.

Economists of nearly all persuasions agree that policy errors significantly worsened the recession that followed the collapse of the stock market bubble in 1929. Those policy errors included a much-too-tight monetary policy, a misplaced preference for balanced budgets in time of economic weakness and trade protectionism. Their result was the Great Depression of the 1930s. Regrettably, the European Central Bank, which inexplicably refuses to reduce short-term interest rates, and Democratic presidential candidates, who are tripping over themselves promising to rescind tax relief enacted in 2001 and to restrict foreign exporters’ access to America’s market, appear to have learned nothing from the history of the Great Depression.

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