MTV, big shoulder pads, and even bigger hair. The Fall of the Berlin Wall. The Japanese economic super engine. What do all of these have in common? The 1980s—a decade known for questionable fads and significant events in both American and world history.
But times have changed. Most trends have faded, along with Japan’s economic supremacy. The country has devolved from the epitome of economic growth to stagnation in just three decades. Now, some investors are drawing parallels between the US and Japan. Is the US headed on a similar trajectory?
Japan’s Economic Fall
Envy of Japan’s economic prowess and fear that it would overtake the US economy has morphed into widespread acceptance of its “new normal” of mediocre growth. So, what went wrong?
A confluence of five factors helped shape Japan’s modern economy:
- Property and stock bubbles fueled by rapid debt growth peaked in 1989 and never recovered to prior heights.
- Massive deleveraging of corporate balance sheets, and to a lesser extent, household balance sheets, limited growth.
- Deleveraging and balance sheet reductions led to near or below zero inflation over the last 30 years.
- Real interest rates eased as inflation collapsed. Although they started to creep up in the mid-2000s, rates fell again during the 2008 global financial crisis (GFC) and have languished near the bottom range.
- Growing government debt combined with low rates and inflation.
Another important area was population growth. A rising percentage of senior adults, different attitudes toward immigration, and family size combined with declining birthrates have been a headwind to demographic and economic growth, especially compared to the U.S. That said, Japan’s population growth only turned negative around a decade ago, making demographics lower on the list of contributing factors to its economic challenges. But together, these paint a picture of an economy that struggles to grow despite monetary and fiscal stimulus. Should Americans brace for a similar fate?
It’s easy to argue that US policy responses to economic crises like the GFC and COVID-19 resemble Japan’s. Yet, the policies’ diminished effectiveness seems even more analogous. Despite massive stimulus over the last ten years, US GDP has averaged only 2.3% annual growth. At the same time, corporate and government debt has swelled. But unlike in Japan, interest rates—while low—have gotten off the ground. Where did Japan go wrong? The slow, purposeful descent of Japan’s rate in the early 1990s was initially designed to burst its asset bubbles (housing and stock). But policymakers subsequently failed to raise rates beyond the lower bound for 25 years.
Similarly, US rates moved sharply lower during the financial crisis and remained there for five years—but there’s a key difference. Beginning in 2015, US rates were systematically raised, creating space above the lower bound for future policy responses. So, despite falling to zero today, the oscillation throughout the years marks a sharp contrast between the paths of US and Japanese rates (Display).
When Low Prices Hurt
What accounts for the difference between the path of rates in the US and Japan? Inflation, mainly. Inflation impacts businesses and consumers in separate ways. Low prices discourage business investment and hiring and may even foster lower wages. Meanwhile, consumers respond to disinflation by putting off large ticket purchases as they wait for prices to fall. Collectively, such behaviors reduce tax revenues and slow growth.
Japanese inflation collapsed in the early 1990s and has languished at or near zero since. Juxtapose that to the US, where inflation has hovered around the 2% target since the GFC (Display). Even though it fell at or below zero twice—in 2010 and 2015, it recovered relatively quickly towards the target range.
How Does Economic Growth Compare?
While US economic growth has disappointed, it’s clocked in well above zero. In fact, we’ve just experienced the longest expansion in US history—at nearly 11 years. In contrast, trend growth near zero renders a prolonged expansion nearly impossible. That’s why Japan has swung in and out of recessions, with large drawdowns in equity prices, since the 1990s. That should bode well for the US. Absent extreme anomalous events, like today’s economic shutdown, a trend well above zero makes sustaining financial strength easier.
On closer inspection, labor and business investment—critical components of growth—appear to explain the divergence. In the US, investment remains strong enough to add to GDP, unlike in Japan, where it has detracted. Similarly, labor has subtracted from growth since Japan’s bubble burst. What about in the US? Before the COVID-19 crisis, employment represented the most significant driver of the US economy. While we’d expect the shutdown to keep unemployment unusually high for some time, we believe labor will again contribute to future growth.
Similarities, But Not Where It Counts
Japan’s experience serves as a useful case study of the interconnectedness between policy and the economy. But while likenesses abound, the differences between the two economies far outweigh the similarities. Along with divergence in inflation, capital, and labor, we see another (less concrete) reason why the US can avoid the growth trap that has plagued Japan. Americans have historically responded to economic crises with resiliency—and have typically found a way to press forward. That intangible is what drives innovation, and we believe it will continue to propel future growth.
- Greg Young, CFA
- Senior Investment Strategist—Investment Strategies