With the U.S. economy on course to a slow, part-nationalized recovery, debate over whether the economy will begin to look like Japan's is beginning to reemerge. Saturday, James Surowiecki writes in the New Yorker that some are openly questioning American banks' ability to earn their way out trouble. New York Times op-ed columnist Paul Krugman is one such skeptic:
It's not at all clear that credit from the Fed, Fannie and Freddie can fully substitute for a healthy banking system. If it can't, the muddle-through strategy will turn out to be a recipe for a prolonged, Japanese-style era of high unemployment and weak growth. Actually, a multiyear period of economic weakness looks likely in any case. The economy may no longer be plunging, but it's very hard to see where a real recovery will come from. And if the economy does stay depressed for a long time, banks will be in much bigger trouble than the stress tests - which looked only two years ahead - are able to capture.The debate of whether the U.S. will one day begin to look like Japan has been around since the beginning of last year, and actually began when it was posited in a trading note heralding from Hong Kong rather than the United States. I confess to playing a somewhat pivotal role in the evolution of the argument, when I broke the story of that note at the TheStreet.com last March under the title Fed Playbook Looks Familiar To Japan. Within weeks, every major newspaper and newswire was running some version of the same story.
It's helpful to look at what was being said back then, and how the argument has shifted to today's context:
"There are two basic options in front of the Fed," goes the argument. The first is "a quick cleansing of the system," such as dramatic interest rate cuts and subsidies to bail out the financial markets. The downside, Parry [the note's author] argues, would have dramatic social consequences however, such as high unemployment and consumer price inflation."Alternatively the Fed can copy the Japanese strategy and put everything on life support and spread the pain over a longer period," writes Parry.What's interesting is that we've experienced both dramatic interest rate cuts and enormous subsidies to bail out the financial markets -- and yet the argument persists. This time, however, it takes the form of financial institutions not being able to earn their way out of debt, leading to a sluggish pace of growth that fails to realize any meaningful capital gains for years to come.
This argument -- the one that Krugman makes -- is much less compelling than the original one, which went that unless some kind of sledgehammer was brought to the economy, the U.S. would remain in a long-term quagmire. Unlike their 1990's Japanese cousins, U.S. banks' earnings are massively responsive to confidence in the equity market, which incentivizes participants to trade, make loans, do deals and indeed, invest in the banks themselves. That's exactly why bank capitalization has been such a major issue in recent weeks.
What is often forgotten too is that for all the synergies, there are enormous differences between the U.S. and Japan. Like most countries in the region, Japan depends upon exports in order to thrive. While growth in exports will become increasingly important in helping the economy recover over the next few years, the U.S. is much more self-sufficient than Japan.
Plus, it's light years ahead in energy and healthcare, two industries which look increasingly likely to feature prominently over the coming years. Recent activity in the investment banking arena shows U.S. and Japanese firms getting very cosy together too, a trend that's likely to persist. That was not the case right after the collapse of Japan's stock market bubble, when U.S. banks stayed well away of the land of the rising sun.
In fact, it's more likely that Japan will end up looking much more similar to the U.S. than the other way round.