Gloomy Days: What if Japan and the US Stagnate?

Listener 1 December, 2001.

Keywords: Macroeconomics & Money

As the chief economist of the OECD recently explained ‘even without further adverse developments, [I expect] an immediate slump and then global stagnation probably until late next year’. He went on to say he ‘is probably optimistic’. The pessimism arises from the splutterings of the three great motors of the postwar economy.

Japan has been stagnant for a decade, as a result of its past growth based on irrational exuberance financed by excessive credit creation. By 1990 the banks had widespread non-performing loans (that is were not servicing there debt and meeting other contractual obligations). Rather than deal with them precipitously, they tried to let the businesses trade their way out of the financial mess, but they (and therefore their banks) have been unable to do so. One estimate is that over a sixth of the outstanding advances of big Japanese banks are problem loans. (The total bad loans for East Asia has been estimated as about 5000 years of New Zealand’s current output/GDP.) Monetary stimuluses, tax cuts and increased government spending have failed to get Japan on a growth path again, because the monetary system which is underpinned by the banks is malfunctioning.

America is now in a recession (you will be told in January), which may be the worst since the 1930s. There are parallels to Japan. The US’s growth in the 1990s involved irrational exuberance too, so that much debt exists which is not backed by productive assets, and may already be non-performing. The acutest problem sectors are the new technology ones, with spillovers into the finance and real estate sectors (and worries about consumer debt). The airline industry is also in trouble. It was even before September 11, but the drop in travel since has made it worse. Of course people are spending their money on other things (like tourism closer to home), but the airlines are demanding government subsidies, an example of a central precept of capitalism: profits are privatised, losses socialised.

There is a view that the US may end up like Japan, although it is too soon to tell. On the upside, the Bush government has been giving enormous tax cuts (mainly to friends). While this may help the non-performing debts in the mining industry for instance, the new technology industries did not strongly support the republican election campaign, and were not greatly rewarded. Additionally, there is the surge in government spending for the ‘war on terrorism’, so that the military and security industries are recruiting, even if the new technology and financial ones are laying-off workers. Since monetary and fiscal stimulus did not resolve Japan’s economic difficulties, prolonged stagnation (but this time coupled with inflation) in the US cannot be ruled out.

Any US recession will affect Europe, as it exports less there, and gets less American investment. But if the US economy stagnates, can the European economic motor drive the rest of the world out of a long recession? Because the European economy is as big as the US economy and financially sounder, there are grounds for some optimism, but there are at least two cautions.

First, the European Union is a federation, lacking the central authority to make quick quality economic decisions. A further complication is that no country may run a government (fiscal) deficit greater than 3 percent of GDP. In the long run the rule will be so often breached (directly and by astute accounting devices) to become meaningless, but in the interim it reduces the flexibility of response to a deteriorating economic situation.

Second, while the financial affairs of EU businesses seem better placed than their US counterparts, there is a major exception. Earlier this year their telecommunication companies spent two years of New Zealand GDP to acquire the rights to use the part of the radio frequency spectrum called 3G(eneration), which wirelessly transfers data twelve times as fast as mobile phones. The European telecoms often paid up to eight times more per unit than elsewhere in the world. It seems likely they suffer from the ‘winner’s curse’ of paying too much in an auction. (The New Zealand payments were exceptionally modest.) The purchases were funded largely by bank debt, and the companies face huge debt servicing bills (say $NZ20-40b a year in total.) It seems unlikely that the use of 3G will generate those funds in the near future (some think they never will). So the European banks have just taken on a huge chunk of non-performing loans too.

I shall not be surprised if the European telecoms (and their banks) ask the governments from which they bought the 3G spectrum for some (a lot) of their money back (perhaps not as crudely, but that will be the effect). The best policy response is not obvious, but it almost certainly will contribute to the breaching of the fiscal constraint rule.

The prospects for 2002 are not great, even if we ignore the terrorism which is largely outside this column’s compass. Given that we can expect little comfort from the Japanese and US economies, all eyes are on Europe. Their difficulty is not the Taleban but their telecoms.