To What Extent, If Any, Is the U.S. Economy at Risk of Becoming "Japanized"?

After the bursting of the Japanese real estate bubble in the 1990s, the ratio of Japanese sovereign debt to GDP soared as Japan initiated massive fiscal stimulus, including unprecedented spending for public investment in infrastructure. Surprisingly, government bond yields plummeted. In addition, both public and private institutions in Japan bought extraordinary amounts of JGBs (ten-year government bonds). As one analyst noted at the time, "For banks, insurance companies, and many other institutions including the Bank of Japan and working families themselves, their attics, basements, closets, and cabinets were stuffed with JGBs. The situation reached the point that an abrupt and sustained rise in interest rates from robust growth would have theoretically bankrupted Japan, Inc." The result led to what some analysts call Japan's "lost decades."

Of course, the U.S. and Japanese economies are not the same. There are differences in demographics. Plus, the U.S. economy enjoys a powerful innovative sector and a culture that tolerates and anticipates start-up failure. But does the Japan analogy to the United States today have any relevance?

TAKESHI FUJIMAKI

Former Member, House of Councillors, Japan, and former Tokyo Branch Manager, Morgan Guaranty Trust Company of New York

The future of the U.S. economy depends on whether the U.S. Federal Reserve is willing to learn from the Bank of Japan's mistakes during the Japanese asset bubble period (1985-1989).

The Japanese economy during the bubble period was a frenzied economy. Trucks ran around all over Tokyo with building materials, restaurants were open until midnight, and there were long lines to enter restaurants. There were also long taxi queues everywhere in Tokyo at midnight. People had to wait for months in order to get Nissan's most expensive model because production could not keep up with demand.

The Japanese bubble was caused by severe asset inflation. The Nikkei stock index soared 3.37 times in five years ([yen]11,542 at the end of 1984 to [yen]38,915 at the end of 1989). There is no official data that tracks the movement of real estate prices, but prices in commercial areas soared at least six times in five years. I personally saw transactions where prices rose by ten times in the same period. It was estimated that the total price of land in Tokyo was greater than that of the whole United States.

People who owned stocks and real estate felt as though they had become rich, and spent money. Nissan's most expensive cars sold very well. People bought Nissan's stocks hearing that news. A virtuous cycle started. This was a typical asset effect.

In spite of a frenzied economy, the consumer price index at that time was very low (overall CPI in the Tokyo area was 0.7 percent for years 1986 and 1987, and 0.9 percent for 1988). The reason for the low CPI was the yen's strong appreciation. The yen appreciated from [yen]251.58 to the dollar at the end of 1984 to [yen]122.00 to the dollar by the end of 1987. The very strong inflationary pressure caused by a frenzied economy was cancelled out by a very strong deflationary pressure caused by the appreciation of the yen.

The Federal Reserve keeps on saying that the current inflation is temporary. If the current inflation is caused mainly by the lack of supply, I may accept that argument. But judging from my experience of the Japanese bubble, the inflation in the United States this time will last longer and will be much stronger than what the Fed is probably thinking.

U.S. stock prices are recording historical highs these days, just like the Japanese bubble period. Historical highs mean, generally speaking, that anybody who owns stocks is enjoying a profit. Given that there are more Americans who are invested in the stock market than Japanese during the bubble period, the asset effect is likely to be extremely strong in the United States. It means that the inflationary pressures caused by asset inflation are very strong. Furthermore, there is no deflationary pressure because the dollar is relatively stable.

During the bubble period, I cautioned the Bank of Japan that if real estate prices doubled from the current level, businessmen would not be able to buy homes near their offices, so their commuting time would become much longer and their quality of life would deteriorate.

At that time, as I mentioned earlier, Japan's CPI was very low. On the other hand, the overnight call rate was around 4 percent (4.375 percent at the end of 1988), and the long-term rate was around 5 percent (the ten-year JGB rate was 4.811 percent at the end of 1988). So real interest rates were very high, and could not explain the frenzied economy.

So the Bank of Japan should have paid attention not only to the CPI, but also to asset prices to determine its monetary policy.

The Bank of Japan claimed that the price movement of real estate would be reflected in the CPI through attributable rent, so paying attention only to CPI was sufficient.

But the Bank of Japan finally recognized that real estate prices should not be treated as one of the factors of CPI but that the price movements of assets was very important. They tightened the monetary policy quickly, but it was too late, and we experienced the so-called lost decades after that. Satoshi Sumita, the governor of the Bank of Japan at the time, reflected on his mistakes in his book:

Real estate prices in Tokyo began to rise in doubledigit percentages from around 1987 and stock prices rose very quickly. I regret that the Bank of Japan did not raise interest rates quickly enough. I accept that I did not recognize the importance of asset price movements. It was the first experience for Japan where the CPI was not overheated, but only asset prices went up (later called a bubble). That phenomena was not seen anywhere in the world. ... I am responsible for not being able to understand the impact of severe asset inflation (real estate, stocks, paintings, antiques). (Bubble, Nikkei Business, December 2000, p. 275, translation by author.)

Under a similar risky situation in the United States, the Fed continues to accelerate monetary easing.

Some people think that tapering is the beginning of tightening monetary policy. It is not. It should be judged by the size of the balance sheet of the central bank.

Even if the tapering starts, as long as the amount of bonds purchased by the Fed is larger than the amount of bonds which Fed holds to maturity, the balance sheet of the Fed will expand. It means more and more money is supplied to the asset markets, and may continue to push up asset prices.

I think there is the risk that the United States will experience lost decades like Japan if the Fed does not pay strong attention to asset inflation.

After the bubble period, the Japanese government spent a lot of money and piled up huge amounts of debt to cope with severe economic conditions. I feared that Japan would go bankrupt around 2014. But Haruhiko Kuroda, who became governor of the Bank of Japan in 2013, decided to start debt monetization, which had been considered a prohibited strategy because it risks creating hyperinflation.

Today, the Bank of Japan purchases 60-70 percent of the JGBs issued every year. If a person who was not in the market suddenly appears as a monster buyer, the price of any asset will go up substantially.

Because of the extremely low long-term interest rates artificially created by the Bank of Japan, politicians do not feel any pain for spending money.

The Japanese government may have escaped from bankruptcy, but the Bank of Japan now holds 53 percent of outstanding of JGBs ([yen]530 trillion out of [yen]993 trillion). The average interest rate of these holdings is very low.

If long-term rates go up by a mere 0.2 percent, the Bank of Japan will have negative net worth.

If so, the Bank of Japan's debt, that is, the yen's value, may go down significantly and Japan may face hyperinflation.

There is no difference between bankruptcy and hyperinflation for the people.

I hope the Fed will learn from the Bank of Japan's mistake. The good thing in the United States is that there are people issuing warnings of inflation risk. On the contrary, during the Japanese bubble period, everybody was bullish and no one issued any warnings in Japan.

Another good thing is that the United States uses the mark-to-market accounting method. In Japan at that time, everybody used accrual accounting, which made it difficult to cut losses. As a result, recovery time was prolonged.

TAKATOSHI KATO

Senior Adviser to the President, Japan Center for International Finance, and former Deputy Managing Director, International Monetary Fund

The United States and Japan share some common traits in the area of macroeconomic policy orientation such as ballooning fiscal deficits and massive monetary quantitative easing. And decelerating U.S. population growth (0.35 percent for the year ended July 2020) as well as the aging of the population pyramid, if sustained, could potentially be a source of concern, Japanizing the U.S. social structure.

Yet in my view, the social orientation of the two countries is radically different. The Japanese mind tends to avoid "rock-the-boat"-type risk-taking and still favors excellence in bricks-and-mortar manufacturing. The U.S. mind, on the other hand, is constantly in search of new initiatives and new orientations. Politically, Japan has been effectively under one-party rule for many years, where new initiatives that push the envelope are less likely to be tested. In the United States, regular administration turnover is the norm rather than the exception. Society tends to expect revolving-door shifts in policy orientation, which can be a source of dynamism in the United States.

My teaching experience at U.S. universities indicates that U.S. tertiary education rewards excellence for students who come up with untested innovative ideas. In Japan, however, students who neatly summarize the pros and...