Here’s a question with an easy answer. When you’re in a desperate situation, and you know someone else who has been in a similar situation and made some bad choices as to how to get out of it, do you (a) do exactly what he did or (b) cast about for some other solution?
First, some clarity. The situations in question, as you may have guessed, are the Japanese “lost decade” of the 1990s and the current American “credit crunch.” The similarities between the two are striking. On December 29, 1989, the Japanese stock market hit an all-time high of 38,957.44. Not only has it never even come close to duplicating that performance, it’s currently valued at 7,162.90 – about what it was worth in 1982. Throughout 1990, the Nikkei posted near-constant losses. There was a reprieve in 1991-1992, but it dropped some more in the following years and bounced around but generally declined until 2003. This was the consequence of the infamous “bubble economy.” Like with the Great Depression, the initial collapse was probably unavoidable, given the financial and regulatory environment of the time. It was very much a case of irrational exuberance, caused by almost exactly the same thing that is casuing the current problems in America (irresponsible lending based on overvalued mortgage assets), and there wasn’t much anyone could’ve done in 1990 but let the Nikkei fall. What WAS, in all probability, avoidable was the so-called “lost decade.” That was a problem created entirely by the unwillingness of Japan’s political class to accept some pain in exchange for later gain. The banks continued making bad loans because the central bank kept cutting interest rates until they were literally zero (1998), and the government kept stepping in to hand out cash every time this scheme failed to work. The downward spiral was eventually broken under the stewardship of reformist prime minister Junichiro Koizumi – probably the only postwar Japanese leader to understand “no pain no gain.”
Let’s start with Dr. Krugman, since his intellectual dishonesty is well known. An October 25 post on Krugman’s blog suggests that the problem with the bailout is that it isn’t expensive enough.
Japan’s bank bailout in 1998 was more than $500 billion, in an economy whose dollar GDP was only about 1/4 that of the United States today. Do the math. And the just-announced IMF loan to Iceland is $2.1 billion — that’s for a country with only 300,000 people. Both of these numbers seem to suggest that an eventual outlay of $2 trillion is in the realm of possibility.
Yes, that’s all very convincing until you bother to remember that Japan didn’t start recovering until 2003. There is NO EVIDENCE WHATEVER that the $500billion that the Japanese government spent on that bailout did any good at all. In other words, at best Japan just put $500billion in an empty oil drum and lit it on fire. At worst, it used this money to prop up bad loans and crowd out the kind of prudent investment necessary to restart its economy. On either interpretation, why the HELL does Krugman think it’s a good idea to throw MORE money at a bailout that we have historical reasons to believe WON’T WORK??? Thanks, but I’ll pass. The data point about Iceland is, of course, completely irrelevant. Iceland may well be asking for proportionally much more money than we are, but (a) Iceland’s entire economy is a banking economy (aside from some fish here and there, it doesn’t have any industry or exports) and (b) we don’t know whether the Iceland bailout is going to be successful, i.e. the most generous thing we can say about this citation of it as evidence that financial prudence is more expensive is that the jury’s still out (the trial hasn’t even happened). Notice also that Krugman’s hallmark dishonesty is on full display here. When we’re talking about Japan, it’s the sensible “size-of-economy” that’s the standard of comparison. When we’re talking about Iceland, we’ve inexplicably switched to “size-of-population,” which of course has nothing to do with anything. But what’s especially galling about the whole thing, as if it needed pointing out, is that Krugman is citing a case of known failure as a recipe for success. The Nobel Committee was really engaging in self-parody when it gave this man a bus pass, let alone an award.
Now here’s Bernanke. He wants to cut interst rates to 1%. Again, does no one remember that Japan did exactly this in the 1990s to no effect? It’s as though, instead of a simple inability to learn from history, there’s a stubborn refusal to do so. I understand the logic here, and it’s not wrong so much as uninformed. Bernanke is operating under the assumption that the problem is that banks are holding on to their loan capital. So, to stimulate new lending, you want to make loan capital “cheap” by lowering the prime interest rates. That seems to make sense. But – just as with Japan in the 90s – the problem has been misdiagnosed. The problem isn’t that banks aren’t lending. In fact, the dollar amount of loans is still growing by as much as 10%. They only call it a “slowdown” because the rate of growth in lending is down. But note that in absolute terms, more loans were made this year than last. The problem is more likely that there’s too much lending going on. (After all, many of those loans that accounted for lending last year were mortgage investments – neither prudent nor economically productive. It is NOT a bad thing if we write fewer of those this year!) Now, a slowdown in lending WILL mean more unemployment and it WILL mean recession and it WILL therefore mean pain. But this is all unavoidable. If the whole problem is that loans are coming in bad (rather than that loans aren’t happening), then obviously you want loan money to be harder to get in the hope that the dwindling supply of loan money gets better-allocated. It is never – that’s NEVER – a good idea to throw value at investments that don’t return value. It was when Japan finally got around to learning that the hard way that winds started to blow in their favor again. When your problem is a mass of bad loans, the solution is not to lend more than ever! The solution is to lend less and more prudently, and to let the unprofitable businesses fail. This is a simple allocation problem: we want money going to those parts of the economy that are most productive. By cutting interest rates even further when there is no evidence that lending has seized up (failed to grow as quickly as last year is NOT the same thing as seized up! Repeat after me: “there is no credit crunch.”), he’s inviting more bad loans, more misallocation of resources, and inflation. Brilliant.
Look – this isn’t that hard. Japan at least had the excuse that its situation was new. We don’t. We saw what happened to Japan – so I suggest we learn from it rather than aping solutions we know aren’t helpful.
I suppose the upshot is that it means there won’t be a second term for President Obama. The downshot is that we may be in for a “lost decade” of our own. And the down-down-shot is that it was all completely avoidable. Ben Bernanke has done all he can do. He needs to take his finger off the trigger and let events play out. It isn’t his job to prevent recessions – just to soften them. He’s done that, and it’s enough. Please, please, let’s now leave the interest rate alone! (I wouldn’t actually mind if he raised it.) And for the sake of God in Heaven NO MORE BAILOUT MONEY! As for Paul Krugman, the only thing that seems likely help him at this point is an arsenic pill in his coffee.