And Now, the Good News

Does America now face 10 long years of economic stagnation? Could the next decade for the U.S. be as barren as the last one was for Japan? Might the awful confluence of two rare events--a sharp bursting of a tech-driven bubble and a surprise terrorist attack--generate a liquidity trap that ends America's long-term prosperity? Listen closely to the worried words of a number of economists, Wall Street money managers, and Washington policymakers, and the questions appear to be growing in resonance. We, too, take the argument very seriously, not because it is right--it isn't--but because it highlights the dangers ahead for the U.S. as it battles both recession and terrorism. Washington and Corporate America must choose the right policies if the country is to return to growth and prosperity in the near future.

It is all too easy to dismiss Japan's long stagnation with an arrogant "they blew it, we won't." There are significant parallels between Japan's and America's economic experience. Japan has long suffered from overcapacity and lack of confidence--too much stuff and too little consumer demand for it. This is America's predicament today. Japan has long tried to solve these economic problems with sharply lower interest rates and dramatically higher government spending. This is exactly what the U.S. is doing. Japan had a soaring stock market that made capital cheap and overbuilding easy. Its collapse dealt a huge blow to personal wealth and confidence. All sound familiar? Don't forget that Japan was the high-tech leader in the 1980s. There is enough credibility in the parallels to legitimately make people nervous.


But the differences between America and Japan are equally striking and important. The flexibility and transparency of a deregulated, market-driven, entrepreneurial, competitive economy give the U.S. its real strength. Just witness how fast U.S. markets respond to new events. In the '90s, on the upside of the boom, markets channeled capital to new technologies and startup companies. In this steep economic downturn, markets are flushing out overcapacity, winnowing the weak from the strong. They are repricing assets and, in effect, writing down bad debts at an astonishing pace. Vulture funds are moving into distressed companies, and venture capitalists are already looking for the next big thing. Corporations are cutting back, sloughing off units, or going bankrupt. Many are using lower interest rates to restructure their finances, as are many individuals. Consolidation is taking place at warp speed. Creative destruction is alive and well in America (pages 37, 40).

Not so in Japan, where consolidation has proceeded in slow motion for an entire decade of woe. Equity cross-holdings by companies and banks have long hidden real earnings and masked serious corporate losses. Banks have refused to mark loans to market, obscuring the true values of depressed assets. They have little incentive to make new loans regardless of how low the Japanese central bank cuts interest rates. Government bailouts have kept corporations and banks from going out of business. Political corruption has wasted trillions of taxpayer dollars, running up a gargantuan public debt. All this has kept Japan frozen in place.


Still, there are troubling signs that the U.S. may be showing some of Japan's symptoms. Corporations increasingly obscure their real earnings with pro forma and other accounting gimmicks. CEOs are blaming far too many financial problems on the terrorist attacks rather than the economic slowdown and their own blunders. Competitiveness in some sectors is suffering as well. Take telecom, where big, monopolistic Baby Bells have been quick to raise prices on broadband connections to private homes as their upstart competitors have fallen victim to consolidation. Government bailouts are growing, too. Given what we now know, it may have made more sense to let the airlines operate in bankruptcy rather than just hand them, Japanese-style, $15 billion in cash and loan guarantees, no strings attached. Other industries are now rushing to line up for federal largesse.

These should be resisted. Handouts can weaken consolidation and slow the pace of recovery. Washington should take care to keep the markets free and competitive. Corporations, for their part, should resist the temptation to use the terrorist attacks as cover to massage their numbers. Instead, they should clean up their books and give investors more truthful financial information.

There is a decent chance that the U.S. will be growing again, perhaps strongly, by the second half of 2002 after passing through a severe and painful recession over the next six to nine months. Policy is working, and worries about a liquidity trap are overblown. The Federal Reserve is cutting rates quickly, deeply, and continually. The Bush Administration mailed rebate checks out early in the downturn, and its fiscal policy is shaping up to be expansive, but not wildly so. There is proper concern to moderate the next stimulation package so that it doesn't raise long-term rates. With the markets correcting themselves and corporate consolidation well under way, growth should return.

The key is confidence. It marks the last difference between Japan and the U.S. Japanese consumers long ago lost confidence in their leaders to take the steps necessary to right their economy. Consumers retrenched, cutting back on spending and saving huge sums to protect themselves. This crippled growth for 10 years. Consumer confidence is also weak in the U.S., crushed by the twin jolts of recession and terrorism. But confidence in the institutions of government--the Presidency, the Federal Reserve, and the military--to secure the nation and return the economy to prosperity remains extremely high. If Washington can manage the perilous days ahead without damaging the agility of the nation's economy, confidence and growth may well rebound with a strength that surprises.

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