November 7, 2001 Is the Faltering U.S. Economy in Danger Of Emulating Japan's Long, Slow Swoon? By JACOB M. SCHLESINGER and PETER LANDERS Staff Reporters of THE WALL STREET JOURNAL With each passing week, the similarities increase. In the 1980s, Japan was considered the model capitalist economy; in the 1990s, the U.S. held that distinction. In both cases, the good times ended with the bursting of a stock-market bubble, pricked, at least in part, by a nervous central bank. In both cases, predictions of a quick turnaround proved to be wrong. The excessive American investment in fiber-optic high-speed phone lines echoes Japan's decade-earlier investment binge in memory-chip factories. The plight of one well-respected American company, Enron Corp. -- which has lost two-thirds of its market value in just three weeks -- is reminiscent of the previously invisible weakness Japan's slump exposed at many of that country's banks. Even the recent squabbling in the U.S. Congress that threatens to derail a package of economic-stimulus measures sounds eerily similar to the bureaucratic and political wrangling that stymied bold fixes in Japan. And now, U.S. monetary policy, considered to be the most powerful tool for countering the nation's downturns, is looking increasingly like Japan's, as interest rates fall toward zero. Most analysts continue to answer with a resounding no. They point out that Japan burst not just a stock-market bubble, but also a real-estate bubble, which in turn laid low its banking system. The U.S. bubble appears to have been limited to stocks, and the American banking system remains strong. (clip) In part, it is U.S. policy makers' willingness to inflict short-term pain that allows for that flexibility. American officials argue that Japan would have come out of its crisis more quickly if it had handled its banking crisis the way the U.S. handled the American savings and loan crisis in the 1980s. Back then, U.S. government-ordered thrift shutdowns and foreclosures caused shareholders to lose their investments and borrowers to lose their properties. In Japan, failed banks were propped up, and their problems allowed to fester. Still, American-style free markets are hardly immune from excesses, and more and more become apparent the longer the economy idles. Telecom companies spent tens of billions of dollars to lay tens of millions of miles of fiber-optic cables, an estimated 2.6% of which is now being used. Blue-chip American Express Co. ended up writing off more than $1 billion in junk-bond investments that were considered relatively low risks until the economy went sour. "Subprime" lender Providian Financial Corp. sent its earnings and stock price soaring in the late 1990s by tapping the once largely ignored pool of consumers with checkered borrowing records. Providian insisted that it used sophisticated models to limit its risks. Nonetheless, it ended up announcing a surprising 71% drop in third-quarter earnings last month, and its stock fell by more than half. More surprises are almost certainly in store. Many analysts argue that the U.S. stock market -- even at more than 25% below its peak -- remains a bubble waiting to deflate further. The Standard & Poor's 500-stock index still is trading at a price-to-earnings ratio of between 21 and 28 times earnings, depending on the measurement, and would need to fall at least 30% to reach its historic average P/E ratio of 15, according to the Leuthold Group, a Minneapolis-based investment research firm. Fragile Safety Net Even workers supposedly protected by union contracts have a fragile safety net. In the wake of the terrorist attacks, major airlines, such as AMR Corp's American Airlines and Delta Air Lines invoked force majeure clauses in their labor contracts, allowing them to skirt many negotiated protections and dump workers without advance notice. Partly as a result, the Conference Board's index of consumer confidence plunged to 85.5 in October from 114 in August, one of the swiftest declines on record. While Japan's unique circumstances may account for some of its problems, they also may demonstrate a broader and more disturbing point: that policy may at times be relatively powerless to contain the destructive forces of a bursting bubble. As companies are saddled with excess capacity, they have little incentive to borrow to expand, no matter how low interest rates fall. Even after the sharp drop in capital spending over the past year, the percentage of industrial capacity in use in the U.S. in September was just 75.5% -- the lowest level since 1983 and hardly an inducement for companies to build new factories. Layoff-spooked consumers also may be unwilling to spend tax rebates enacted to encourage shopping. A recent University of Michigan survey concluded that just over one in five households have spent the rebate checks mailed out this summer, with the rest tucking the money into savings or using it to pay debt. At the extreme, the supply overhang from a collapsing bubble can touch off a dangerous cycle of deflation, or falling prices. In a deflationary environment, consumers curb spending, waiting for goods to become still cheaper in the future. Borrowers get crushed by debt burdens as their loans become more expensive in relative terms. Companies, forced to keep cutting prices, cut back on workers and purchases of supplies, spreading pain throughout the economy. In Japan, deflation got under way in earnest in 1998 after the collapse of a major bank and securities company. In both 1998 and 1999 wholesale prices fell 1.5%, and after a flat year in 2000, they are falling again in 2001. The U.S. isn't there yet. But commodity prices have fallen sharply since 1998, while U.S. consumer prices, by some measures, appear to be slipping. The Commerce Department reported last week that its favored measure of inflation -- the price index for gross domestic purchases, or prices paid by U.S. residents -- fell by 0.3% in the third quarter, a sharp reversal from the 1.3% increase in the second quarter and the first quarterly decline in nearly 40 years. (Analysts say the number was artificially depressed by one-time factors relating to Sept. 11 -- insurance benefit payouts that, for measurement purposes, lower insurance prices.) In a deflationary world, the central bank's powers to respond are diminished because monetary policy works most effectively if interest rates can fall below the rate of inflation. But rates can't do that if inflation falls below zero.
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