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Economics: Japan Redux?
New York: November 24, 2008
By John R. Stephenson

For decades, Japan had it great. Americans fretted as Japanese companies bought up national treasures such as Pebble Beach golf course and Rockefeller Center in New York . Through much of the 1960s, economic growth was an impressive 10 percent a year and even in the 1970s, it clocked in at a solid 5 percent a year. A reputation for manufacturing excellence, a strong work ethic and vibrant export markets made Sony, Toyota and Mitsubishi household names. In cars, cameras and televisions, Japan 's economy was on the move — quickly becoming the second largest in the world.

But the good times weren't going to last. A perfect storm of easy money and deregulated financial markets was turning a miracle into a nightmare and in a hurry. With lots of cheap money easily available, businesses bought up all the property and stocks they could get their hands on. The result was predictable — a massive bubble in real estate and stocks was forming on Japan 's shores. And then the bubble burst, sending the Nikkei stock exchange tumbling to less than one fifth of its 1989 peak. Japanese house prices are off big — down some 40 percent from their bubble-era highs.

As real estate prices fell and stocks crashed, businesses and investors struggled to repay their bank loans. By 1997, the crisis that started in real estate and stocks had spread to the banking sector as the banks were forced to write-off many of their outstanding loans. When real estate prices started to tumble, Japan moved quickly to slash interest rates and stimulate the economy. But, that wasn't enough. Faced with no alternative, the government had to rush in and bail out the banks and inject funds into the financial system in a desperate attempt to grease the wheels of commerce.

The bail out of the Japanese financial sector has kept their banks intact, but for many observers, this was a mistake. Hobbled with debt and kept alive by government bailouts, many of these financial institutions were known as zombie banks. With falling asset prices and little growth, Japan 's economy has been caught in the deflation trap. With little or no prospect of earning a decent return on their investments, the average Japanese investor has been forced to invest outside of Japan . For almost two decades, Japan has been caught in a low growth, low interest rate trap, which has kept economic growth to a virtual standstill and the consumer on the sidelines.

It's different this time. Or so the analysts would have you believe. The same group that failed to warn you about the impending doom in the U.S. financial market is now trying to tell you that everything will be okay. Perhaps they are right, but the parallels with Japan 's experience couldn't be more obvious. In the United States , low interest rates encouraged speculation in stocks and real estate. This was coupled with a deregulated financial system that offered excessive compensation for short-term gains. The result was a massive credit bubble that was formed and soon enveloped most of the western world before it popped.

But America is the most open, flexible and free market economy there is and the American people are used to upheaval and change. The U.S. government is in overdrive working hard to address this situation and take the painful next steps to slow the decline of the American economy into a Japanese style deflationary economy. Or so we're told. Yet, the actual record of the Japanese experience during these trying times would suggest that quite possibly the American experience will be much worse.

For starters, Japan acted quickly to chop interest rates when real estate prices first started to crash in 1991. The Japanese bubble wasn't nearly as big as the American bubble which grew for two decades whereas in Japan , the bubble grew for only five years. At the height of Japan 's credit bubble, three yen of credit were required to make one yen of national income. For America , it was $8 dollars of credit for every dollar of income — making the American credit bubble the largest in history.

Japan is a land of savers and America is a land of spenders. Japan 's savings rate was a healthy 16 to 17 percent when their crisis erupted. America 's savings rate is about zero. The national checkbook in Japan is in a surplus with $1.3 billion more coming into the nation's coffers each and every day than is going out. In the U.S. , the situation is the exact opposite with $2 billion a day leaving the country to finance the massive American consumption. Yikes!

Include credit cards and mortgage debts and the average American has more than 160 percent of their annual income outstanding in the form of debt. The American banks are still far too leveraged, meaning more painful deleveraging of both the consumer and businesses will need to occur before this is all over.

Then there's Detroit . With the auto industry in a tailspin, it is not a matter of if, but rather when, Detroit will stumble, sending millions more on to the unemployment line. With 1.2 million Americans already out of work, a complete shutdown of the big three automakers could hurl another 3 million Americans out of work — making a bad situation much, much worse. While the car companies globally are all experiencing a slowdown, Detroit is saddled with too many unionized workers and too many legacy costs. That has made laying off employees and trimming production much more difficult to do than for the foreign automakers who have set up shop in the U.S. According to a research report by Deutsche Bank, the average hourly wage for General Motors worker is $71 an hour, versus $47 at Toyota .

Could America be heading over the cliff just like Japan ? Most economists think that America is reacting fast enough, to avoid a deflationary spiral, but I'm not so sure. For starters, many of these very same analysts never saw this disaster coming in the first place. Most of the major Western economies are already in recession, making this problem a truly global problem. Investors are scared. They are already hoarding cash and deferring spending. Will it end quickly? Perhaps, but a lot depends on restoring badly damaged consumer confidence.

With the election of Barack Obama as President of the United States , the American people had a feel good election. The new president surely has his work cut out for him. U.S. economic growth will be anemic or negative and Obama may need to create a massive infrastructure stimulus package to get the economy moving again. With tons of aging infrastructure, America is badly in need of a facelift. Just like Franklin Delano Roosevelt, Barack Obama will need to propose a new deal for America — one that focuses on infrastructure rather than banking bailouts.

When global economic growth does recover, it will be the great commodity companies and the infrastructure companies that will be best positioned to prosper. For now, cash is king — at least until this current storm blows over.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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