This is in continuation of the article published (in this blog) couple of weeks ago titled "Will 2012 be similar to 1932? Japan in 1990s?" We discussed about the parallels between 1929 Crash and 2009 Crash and discussed some of the common reasons behind both downturns i.e. - the structural weaknesses, reckless lending, high leverage, speculation, asset bubbles, massive bank failures, stock market crash, etc were some of them.
We had also discussed about the parallels of 2009 Crash to the Collapse of Japanese economy after their fantastic economic growth in the 1970s and 1980s, where Japan witnessed fast rise in real estate, stock market and all asset classes fuelled by cheap credit policy. But mainly due to mismanagement of the interest policy regime, the stock market crashed, debt crisis followed, banks collapsed, triggering bailouts by Japanese Govt, which sound so similar to the US story of 2008 end/early 2009.
What did Japan do during the 1990s after the gigantic economic shock? Among the steps by Japan, zero interest rate regime was the most famous to create demand. But deflation set in Japan creating lot more problems. Stock market index (Nikkei) that touched 38,957 in Dec 1989 is still hovering around 9000 levels today. The real estate prices are now going at the fraction of bubble times. Why did the deflation set in the Japan? Many reasons are highlighted by various authorities.
a) Sharp drop in post bubble asset prices. It is partly emotional. After burning the fingers in the crash, many investors (including retail investors) won't touch the same asset class and may even warn their children.
b) Risk averse banks: Post bubble, many banks were literally destroyed by the large percentage "non-performing" credit assets(i.e.loans that had to be written off). This reduced the credit risk appetite of banks.
c) Businessmen, who recently experienced the trauma of economic collapse and witnessed drying up of demand and non-payment by debtors did not take risky decisions. They were reluctant to borrow and expand questioning whether the hard pressed consumers will buy more.
d) Japanese people became fearful of banks' collapse. They bought gold or invested in United States/Japanese Treasury securities instead of bank deposits, reducing the funds available with banks.
A university professor at Tokyo University in a recent research of young adults stated that "the lost decade made young people timid and afraid of what to do; it is made them even more risk averse". It is not good news for Japanese, who are famous for their hard work and astonishing growth from the shambles of Second World War.
Against this background, it is understandable why Ben Bernanke is pumping money into the US Economy through Quantitative Easing. Deflation should never be allowed to lift its ugly head. Deflation was the major problem in post 1929 crash also. As we mentioned earlier in this blog, the Governor of the Fed had studied the 1929 US depression (and got PhD). Those days the dollar was pegged to gold. Because of this peg, the Fed in 1920s couldn’t just print dollars to counter deflation. Thank God, there are no more gold standards out there.
Let us hope USA won’t witness a lost decade. USA has a more dynamic economy than Japan with greater employment mobility and entrepreneurial energy. The working age of Americans is not shrinking unlike Japan. Moreover, USA has sprung back from its previous recessions since the Second World War smartly because its free economy allowed the economic agents greater flexibility to cut costs or lay off or recruit resources. Let us hope this dynamism will ensure that there is no lost decade for the USA, which will benefit the world, since US is still the biggest economic player in the world. Let us also hope China will not play a spoil sport in this great recovery game.
What this mean to you and me? Well Be on Guard. Your hard earned money is always at risk of a possible economic upheaval. Remember the best two principles of Warren Buffet (a) Never lose money in investments/savings (b) Always remember the first rule. As you know, it is not an easy job; but very little alternatives.
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