Chancellor: Turning Japanese? Hardly

Good Ed Chancellor piece in the FT on why so many investors are betting the U.S. is turning Japanese — big debt, slow growth, deflation, etc. — and are likely wrong.

Many people believe we are turning Japanese. Or rather, that the US economy is doomed to a combination of lacklustre growth and a declining price level in the years ahead. This is the only rational explanation for the extremely low yields on Treasuries. The trouble is there is little historical evidence outside Japan to support the notion that deleveraging leads to prolonged deflation or even retards growth. Besides, there are numerous differences between the US situation today and that of Japan over recent decades.

An essay in the latest Bank for International Settlements Quarterly Review (Debt Reduction after Crises by Garry Tang and Christian Upper) examines 20 previous credit booms that ended in banking crises. The authors find that deleveraging normally occurs after the bust (Korea’s consumer debt binge after 1997 being a notable exception). Yet Japan is the only country in this sample to have experienced a lengthy deflation. Inflation, on the other hand, has played a large role in reducing the debt burden after most credit booms.

Nor do falling debt levels necessarily slow economic growth. Although banking crises usually involve a large initial drop in output, recovery generally takes place despite ongoing debt reduction. Economies respond to changes in the flow of credit rather than the stock. This point is widely misunderstood. As Deutsche Bank’s Michael Biggs has argued, when the pace of credit growth slows the economy suffers even though the stock of debt continues rising. Likewise, if deleveraging tails off after a downturn, then a positive credit impulse will stimulate demand.

Japan is the exception rather than the rule amongst the credit crippled nations. But it wasn’t deleveraging that led Japan into the deflationary mire. Rather, in the first half of the 1990s, credit was constrained because banks hid bad loans and had insufficient capital.

More here. [-]